United States
                       Securities and Exchange Commission
                             Washington, D.C. 20549

                                   Form 10-KSB

     Annual Report Under Section 13 or 15(d) of The  Securities  Exchange Act of
1934

     For the fiscal year ended December 31, 1998

     [ ] Transition Report Under Section 13 or 15(d) of The Securities  Exchange
Act of 1934 for the Transition Period from _____________ to _______________

                           Commission File No. 1-14005

                            FRISBY TECHNOLOGIES, INC.
                 (Name of small business issuer in its charter)

        Delaware                                         62-1411534
(State or other jurisdiction of            (I.R.S. Employer Identification No.)
 incorporation or organization)

                 77 East Main Street, Bay Shore, New York 11706
               (Address of principal executive offices) (Zip Code)

                    Issuer's telephone number: (516) 969-8570

     Securities registered under Section 12(b) of the Exchange Act:

                         Common Stock, $0.001 par value
                                (Title of Class)

     Securities registered under Section 12(g) of the Exchange Act:

                                      None
                                (Title of Class)

     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 No

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

     Check whether the issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the  distribution  of
securities under a plan confirmed by a court. Yes No

     State issuer's revenues for its most recent fiscal year. $2,869,139

     State the number of shares  outstanding of each of the issuer's  classes of
common equity, as of March 8, 1999. 5,120,613

     As of the close of business on March 8, 1999, the aggregate market value of
the registrant's  common stock held by  non-affiliates  computed by reference to
the price at which the stock was sold was approximately  $7,400,000.  The shares
are currently  traded on the NASDAQ SmallCap Market under the symbols "FRIZ" for
the Common Stock.  The  information  required by Part III of this Form 10-KSB is
incorporated by reference to the  Registrant's  definitive proxy statement to be
filed with the Commission within 120 days.


<PAGE>

Part I

Item 1. Description of Business.

General

     Frisby Technologies, Inc. (the "Company") is engaged in the development and
commercialization of innovative branded thermal management products for use in a
broad range of consumer and industrial products such as gloves,  boots, athletic
footwear,  apparel,  protective and  temperature  retardant  equipment,  medical
equipment,   electronics  cooling  systems,  packaging  materials,  and  coating
substances.  The Company's  Thermasorb(R)  and  ComforTemp(R)  products  utilize
licensed patents and the Company's  proprietary  microencapsulated  phase change
material  ("MicroPCM")  technology  to enhance  thermal  characteristics  (i.e.,
insulation,  cooling or  temperature  control  properties).  For  example,  when
Thermasorb(R)  additives  and  ComforTemp(R)  foams  are  incorporated  into ski
gloves,  the skier's hands would remain within a constant,  pre-set  temperature
range without the typical accumulation of moisture.  Also, if a firefighter were
to  wear  flame  retardant  clothing   incorporating   ComforTemp(R)  foam,  the
firefighter  would  remain  cooler  and be able to fight  fires  longer and more
safely than a firefighter wearing flame retardant clothing without ComforTemp(R)
foam.

     Thermal  management  is the  process  by which the  temperature  of various
materials can be controlled or  manipulated.  The thermal  management  materials
industry consists primarily of a wide variety of non-phase change materials such
as  Thinsulate(R)  brand  insulation  for use in  apparel,  flexible  and  rigid
polyurethane  foams  for  use  in  footwear,   sporting  goods,  automotive  and
transportation industries, specialized chemical additives for use in temperature
resistant  paints  and  coatings,  and  liquid  coolants  for use in  aerospace,
automotive  and  computer/electronics  cooling  systems.  Phase  change  thermal
management  materials are comprised of materials that have the ability to absorb
and  reject  large  amounts of heat by  changing  from solid to liquid and back,
thereby greatly enhancing the ability to heat or cool a particular object.

     The  Company's  products  offer  impressive  and   cost-effective   thermal
management  solutions for a broad range of  industries.  The  Company's  current
MicroPCM based products  consist of a series of thermal  additives,  a series of
foams  in  which  the  thermal  additives  are  embedded,  and  fabric  packages
containing these foams.  The Company  currently  markets its thermal  additives,
foams and fabric packages under the trademarks  Thermasorb(R) and ComforTemp(R),
respectively.

     The  Company's  marketing  strategy is based on  penetrating  large  select
markets  for  its  thermal  management  technology  through  relationships  with
strategic partners. The Company works closely with its strategic partners within
each market to develop  commercially viable product  applications.  To date, the
Company  has  entered  into such  strategic  partnerships  with,  among  others,
Titleist and Foot-joy  Worldwide,  Schoeller Textil AG, Wells Lamont Division of
Marmon Holdings, Inc., LaCrosse Footwear, Inc., and Bell Sports Corp.

<PAGE>

     Sale of Common Stock in Public Offering

     On April 1, 1998, the Company  consummated an Initial Public  Offering (the
"IPO") of 1,600,000 shares of Common Stock at a price of $7.00 per share. On May
15, 1998,  Barington Capital Group, L.P., the underwriter in connection with the
IPO (the  "Underwriter"),  exercised  its  over-allotment  option to purchase an
additional 240,000 shares of the Common Stock at a price of $7.00 per share. The
total net proceeds to the Company  amounted to approximately  $10,384,000  after
the  underwriters'  discount  and related  expenses.  The net  proceeds of these
transactions  were used for the  operation  of the Company and the balance  have
been invested in cash deposit accounts and cash equivalents,  institutional U.S.
Government Money Market Funds and commercial paper of selected U.S. companies.

     Products

     The Company's  product  portfolio  currently  consists of its Thermasorb(R)
additives  and  ComforTemp(R)  foams.  These  products  offer  advanced  thermal
management  solutions  for a broad  range  of  industries.  In  addition,  these
products address the expanding need for improved thermal management capabilities
in a wide variety of commercial products. In response to the requirements of its
strategic  partners,  the  Company  will  work to  develop  applications  of its
products  in  other  base  materials  such as epoxy  resins,  gels,  paints  and
composite materials.

     Thermasorb(R)  additives  are a  series  of  thermal  management  additives
developed   using  the  latest   advances  in   microencapsulation   technology.
Thermasorb(R)  MicroPCMs  are  micron-sized  particles  in  the  form  of a  dry
free-flowing powder,  consisting of a heat absorbing core material  encapsulated
within a proprietary,  durable shell wall.  Thermasorb(R)  additives can improve
the thermal storage capacity of a variety of host materials,  including  liquid,
foam,  epoxy and  composite  materials.  Thermasorb(R)  additives  are currently
commercially  available in a variety of transition  temperature settings ranging
from  43(degree)F  to  190(degree)F.  The variety of the Company's  Thermsorb(R)
additives  allows  for  an  engineered  solution  for  a  multitude  of  thermal
requirements.

     ComforTemp(R)  foams  are a series  of foam  products  containing  embedded
Thermasorb(R) additives. ComforTemp(R) foams can be fabricated in different ways
to have the  ability  to retain or  exclude  heat,  thereby  maintaining  a more
constant  temperature.  Thermsorb(R) and ComforTemp(R)  products have impressive
and cost-effective  thermal management  properties.  For example,  Thermasorb(R)
additives  incorporated into solid materials enable those materials to absorb up
to ten times more heat than traditional insulating materials. Moreover, in tests
performed for the United States Air Force by Triangle  Research and  Development
Corporation ("TRDC"),  liquid coolants containing  Thermasorb(R)  additives have
been  shown to  dissipate  up to 40 times more heat than  traditional  coolants.
ComfoTemp(R) foams are currently available in a light,  breathable  polyurethane
which has the added  capability  of  wicking  away  moisture  while  maintaining
comfort in extreme hot or cold climates.  For cold weather apparel products, the
greatest asset of  ComforTemp(R)  foam is its ability to retain body heat during
periods  of  activity  and to  release  the heat back to the  individual  during
periods of  inactivity,  when the body is most in need of warmth.  ComforTemp(R)
foams  can  be  "recharged"  repeatedly,  as  they  recharge  depending  on  the
individual  level of physical  activity or other  external  conditions.  For hot
weather products,  ComforTemp(R)  foams can be used as a thin thermal barrier or
heat shield to provide  protection against extreme heat as well as to facilitate
the  regulation of body heat  generated  during  activity,  thereby  providing a
cooling  effect.  ComforTemp(R)  foams  can  also be used  as a  therapeutic  or
"climate  controlled"  wrap for comfort or medical  purposes.  The lamination or
attachment  by other means of  ComforTemp(R)  foams to a wide variety of fabrics
yield ComforTemp(R) fabric packages.

<PAGE>

     Purchasing

     The Company  currently  outsources all of its production  needs for the raw
phase change materials, Thermasorb(R) and ComforTemp(R), and anticipates that it
will continue to do so for the  foreseeable  future.  The Company  currently has
both  formal  and  informal  agreements  and is  negotiating  definitive  supply
agreements  with all  companies  involved  in each  stage  of the  manufacturing
process.  In the event that any of those  companies  were  unable to continue to
supply the Company  with  materials or services,  the Company  believes  that it
would be able to arrange for other  sources  available  on similar  terms and at
competitive prices.

     Currently,  all of the Company's  requirements for Thermasorb(R)  additives
are manufactured by the Minnesota Mining and Manufacturing  Company ("3M").  The
Company and 3M are parties to a Reciprocal  Secrecy Agreement  pursuant to which
each agrees to maintain the  confidence of the others'  proprietary  information
and to not use or divulge that  information  except with the written  consent of
the other.  In September  1998,  the Company and 3M entered into a memorandum of
understanding  that provides  firm fixed  pricing for the Company's  anticipated
requirements  for  Thermasorb(R)  additives for the five year period through and
including the year 2003. The parties are currently  negotiating the final supply
contract.   Prior  to  October  23,  1997,  the  Company  obtained  all  of  its
requirements  for  ComforTemp(R)   foams  under  purchase  orders  with  Lendell
Manufacturing,  Inc.  ("LMI").  On October 23, 1997, the Company  entered into a
memorandum  of  understanding  with LMI  granting LMI the  exclusive  license to
manufacture  a  specific  hydrophilic  polyurethane  version  of  the  Company's
ComforTemp(R)  foams.  Since October 23, 1997,  the Company has purchased  foams
from LMI under the  Memorandum  of  Understanding.  Foamex  International,  Inc.
("Foamex")  is an  additional  supplier  for  the  production  of  ComforTemp(R)
polyurethane   foams.   The  Company  has  agreed  to  permit   Foamex  to  sell
ComforTemp(R)  polyurethane foams for applications  specifically consented to by
the Company. Foamex is a major manufacturer of foam products, having significant
manufacturing capacity both within and outside of the United States. The Company
has  relationships  with  other  suppliers  for each of the  other  steps of the
production process for Thermasorb(R) and ComforTemp(R).

     The  Company  monitors  and  tests  its  products  during  each step of the
manufacturing process for quality assurance purposes.  Raw phase change material
("PCM"),  identified  by lot number,  is delivered to the Company to ensure that
the quantity of heat the PCM can hold at different temperature levels adheres to
the  Company's  product  specifications.  After  encapsulation  of raw PCM,  the
Company tests and verifies the quality of the shell wall and validates  that the
product satisfies its thermal  requirements.  The Company verifies and tests the
foam  products  prior to  shipment  to its  strategic  partners.  All testing is
performed by the Company's  quality  assurance  employees at the Company's North
Carolina facility or by third-party quality representatives at the manufacturing
site.

<PAGE>

     The Company  historically has not had material losses of inventory and does
not experience material losses due to cost and market fluctuations, overstocking
or technology.  The Company's inventory turnover for the year ended December 31,
1998, was approximately three (3) times.

     Sales and Marketing

     Currently,  the  Company's  sales  strategy  consists  of (i)  establishing
relationships  with companies  with  recognized  "brand-name"  products and (ii)
working with its strategic  partners to increase the number of end-use  products
incorporating  Thermasorb(R)  and  ComforTemp(R)  offered for sale.  The Company
seeks to leverage off the resources of its strategic partners and their existing
sales,  marketing and distribution  systems to maximize exposure of its products
to retailers  around the world.  This strategy  permits the Company to support a
large volume of end-use sales through a small in-house  sales staff  servicing a
small number of strategic  partners.  The combined sales forces of the Company's
strategic  partners  comprise an  extensive  network of  salespersons  and sales
representatives.

     A  significant  portion  of the  Company's  marketing  and brand  promotion
efforts are coordinated through its strategic partners. The Company's agreements
with its strategic  partners typically obligate the strategic partner to display
and   promote   the   Company's   trademarks,   including,   Thermasorb(R)   and
ComforTemp(R),  in all promotional materials, point of sale displays, and direct
product  advertising for end-use products  incorporating the Company's products.
The  Company  coordinates  the  promotion  of its  Thermasorb(R)  additives  and
ComforTemp(R)  products with the promotional  efforts of its strategic  partners
and implements  public relations  campaigns in order to accelerate the inclusion
of feature  stories and references to  ComforTemp(R)  products and its strategic
partners in targeted  industry and consumer  periodicals.  The Company  believes
that  this  co-branding  strategy  will  help to  enhance  its  advertising  and
marketing efforts, thereby allowing the Company to allocate a greater portion of
its financial  resources to the identification of new strategic partners and the
development of new product applications in conjunction with its new and existing
strategic partners, and the identification of appropriate acquisitions.

     The Company earns revenues from the sale of its Thermasorb(R) additives and
ComforTemp(R)  foams to its strategic  partners for inclusion in their products,
earns royalties and license fees for exclusive  agreements and development  fees
for development  services.  In order to maintain  exclusive  rights within their
respective  fields of use,  several  of the  Company's  strategic  partners  are
required to make minimum purchases of the Company's products.

     The Company does a significant  amount of business with a limited number of
strategic  partners.  Total  revenues  from  two  strategic  partners  comprised
approximately  53% (35% and 18%) of the  Company's  total  revenues for the year
ended December 31, 1998. The United States government and two strategic partners
comprised  approximately  84% (39%, 34% and 11%) of the Company's total revenues
for the year ended December 31, 1997.

<PAGE>

     Advertising

     In addition to the coordinated efforts with strategic partners, the Company
uses advertising  placements in various national trade and consumer publications
in order to build brand name recognition of its  Thermasorb(R) and ComforTemp(R)
products and  trademarks.  Total expenses  related to  advertising  creation and
placements in 1998 were $992,000.  The Company also maintains  Internet sites on
the World Wide Web at www.frisby.com and  www.comfortemp.com.  The sites promote
the  Company's  products  and  brands as well as its  licensees'  products.  The
Company also attends and exhibits its products at numerous tradeshows during the
year.

     Research and Development

     From its  inception in 1989 until  mid-1997,  the  Company's  revenues were
largely  derived from a variety of government  related  research and development
contracts  which funded the Company's  research and  development  efforts during
that period. Terms and conditions under these government contracts varied from a
cost  plus  basis to a fixed  price  basis.  Upon  completion  of  research  and
development  under these  contracts,  the government may retain some rights to a
royalty-free license to use the newly development  technology for certain of its
own  uses,  and  the  Company  retains  all  other  rights  to use  and  further
commercialize the newly developed technology.

     Beginning in 1997,  the product  development  focus has shifted more toward
commercialization  of  its  product  and  related  applications  and  away  from
government funded projects.

     For the years ended December 31, 1998 and 1997, the Company was involved in
government research and development  projects related to technology that is used
to improve the thermal management properties of military aircraft and protective
outerwear.

     From time to time,  the Company  becomes aware of and considers  conducting
funded research projects that do not relate to thermal  management.  The Company
expects to evaluate future funded research and development projects on a case by
case  basis and will  engage in those  projects  management  considers  to offer
complementary  opportunities  for the  Company.  To date,  the  Company  has not
developed any  non-thermal  technologies  or products that it considers ready to
commercialize.

     At December 31, 1998, the Company had ongoing research  projects  providing
engineering  services directly or indirectly for the United States government in
the amount of less than $50,000 and proposals  outstanding for research projects
having  an  aggregate  potential  value  of  less  than  $250,000.  The  Company
anticipates  that it will continue to conduct  funded  research  projects in the
future.

<PAGE>

     Patents/Intellectual Property

     In 1991, the Company  secured  exclusive  rights under a Joint  Development
Agreement and  subsequently  entered into the TRDC License with TRDC whereby the
Company was granted a perpetual  exclusive  worldwide rights with respect to all
applications  of  bulk  PCMs  and  MicroPCMs   covered  by  TRDC's  patents  and
proprietary  intellectual  property other than MicroPCMs  relating to fibers and
fabrics with reversible  enhanced thermal storage  properties  ("MicroPCM Fibers
and Fabrics") which previously had been licensed to Outlast  Technologies,  Inc.
("Outlast") in a separate agreement (the "TRDC/Outlast Agreement").  Pursuant to
the  terms  of the  TRDC  License,  the  Company  has  the  exclusive  right  to
manufacture  bulk PCMs and  MicroPCMs  (except  MicroPCM  Fibers  and  Fabrics),
end-use products and improvements and the right to market,  sell, use, lease and
distribute  all  applications,  and to  sublicense  such rights.  The Company is
required  to pay TRDC a royalty  based on gross  product  sales  revenues  and a
percentage of any royalties the Company receives from its strategic partners and
sublicensees. The TRDC License establishes minimum annual royalties payable over
the term of the TRDC License which are offset to the extent of any actual earned
royalties  paid  to  TRDC  and a  percentage  of any  research  and  development
contracts  accepted by TRDC from the Company.  Pursuant to the terms of the TRDC
License,  the Company is required to pay all of the patent expenses with respect
to inventions that  exclusively  benefit the Company and a portion of the patent
expenses  with respect to  inventions  in which the Company  shares the benefits
with others.  Effective January 3, 1997, TRDC assigned its rights under the TRDC
License to an  affiliated  entity.  TRDC is obligated  under the TRDC License to
notify  the  Company  and  to  give  the  Company  the  benefit  of  any  future
developments for bulk PCM and MicroPCM  technologies  other than MicroPCM Fibers
and Fabrics.

     The TRDC  License  granted to the  Company  broad  exclusive  rights in the
MicroPCM Technology. Even so, the Company wanted to secure exclusive rights to a
significant  portion of the fabric  related  rights  granted  earlier by TRDC to
Outlast,  especially in light of the Company's  initial successes with strategic
partners  in the  fields of  apparel  and  footwear  where  there  exists a high
likelihood of some combination of the Company's  Thermasorb(R) and ComforTemp(R)
products with some type of fiber or fabric.  In order to expand the scope of the
Company's  rights in the  MicroPCM  Technology,  in January  1998,  the  Company
entered into an agreement  with Outlast (the "Outlast  Agreement").  The Outlast
Agreement,  among other  things,  secures  additional  exclusive  rights for the
Company and limits  Outlast's rights with respect to the combination of MicroPCM
foams with  fibers and  fabrics.  Under the Outlast  Agreement,  the Company has
exclusive rights,  for most applications,  to manufacture,  sub-license and sell
ComforTemp(R)  foams that are  attached  to fibers and fabrics or intended to be
attached  to  fibers  or  fabrics  so long as the  foam is  greater  than 2mm in
thickness.  The Company also may sell  Thermasorb(R)  additives for use in foams
attached  to fibers and  fabrics and agreed to pay Outlast a royalty if they are
used in such combinations  with fibers and fabrics,  with minimum annual payment
requirements  in effect for as long as the Company  desires the  agreement to be
exclusive (including  exclusive of Outlast).  Pursuant to the Outlast Agreement,
Outlast  will not sell  ComforTemp(R)-type  foams  greater than 2mm in thickness
attached  to fibers and  fabrics  for ten years,  unless the  Company  elects to
permit its agreement to become non-exclusive.

     In September  1998, the Company entered into an agreement with TRDC whereby
the Company (i) reduced the future  royalty  rates  payable to TRDC based on the
Company's  product sales revenues and royalty income received from its strategic
parties  and (ii) was  assigned  TRDC's  rights  in the  TRDC/Outlast  Agreement
including the rights to royalty payments from Outlast.  These items have the net
effect of reducing the Company's future royalty expense.  As consideration,  the
Company  has  given  TRDC  a  combination  of  cash,  stock  options,  and a put
agreement.

<PAGE>
     Currently,  TRDC's intellectual property relating to MicroPCMs includes ten
issued United States patents,  and two European patent which expire from 2006 to
2013.  TRDC or its  licensees  are in the process of applying for  international
patent  protection for the TRDC patented  technology.  The Company believes that
its MicroPCM technology is adequately  protected by its existing licenses of the
TRDC  patents and by its  proprietary  know-how,  although  the  validity of the
patents  underlying  the licenses and the limits of the licenses have never been
contested in any legal proceeding.

     In September 1998, the Company obtained the exclusive  license for a patent
from the University of Miami for the  application of  encapsulated  phase change
materials within liquids.  This patent has  applications  within the electronics
and computer  industries.  The Company  continues to look for  opportunities  to
license additional complementary technologies.

     The following table sets forth information  regarding the patents currently
licensed to the Company.
<TABLE>
<CAPTION>


                                                                                                 Patent Expiration
Date of Patent     Patent Number      Description                       Industry                      (Year)
<S>               <C>                 <C>                               <C>                        <C> 

2/28/89            4,807,696          Thermal Energy Storage            Automotive,                    2006
                                      Apparatus Using Encapsulated      Aerospace, Electronics
                                      PCMs.
3/27/90            4,911,232          Heat Transfer Using MicroPCM      Automotive,                    2007
                                      Slurries                          Computers, Electronics
4/16/91            5,007,478          MicroPCM Slurry Heat Sink         Computers, Electronics         2008
8/25/92            5,141,079          Cutting/ Cooling Fluid            All Industries                 2009
7/6/93             5,224,356          Thermal Energy Absorbing and      Electronics                    2010
                                      Conducting Potting Materials
3/1/94             5,290,904          Thermally Enhanced Heat Shields   Protective Apparel             2011
11/22/94           5,366,801          Coated Fabric With Reversible     Protective Apparel             2011
                                      Enhanced Properties
5/16/95            5,415,222          Microclimate Cooling Garments     Protective Apparel             2012
3/19/96            5,499,460          Moldable Foam Insole with         Footwear                       2013
                                      Reversible Enhanced Thermal
                                      Storage
6/10/97            5,637,389          Thermally Enhanced Foam           All Industries                 2012
                                      Insulation
9/8/98             5,804,297          Thermal Insulating Coating        All Industries                 2011
                                      using MicroPCMs
1/14/98            0611330*           Coated Fabric With Reversible     All Industries                 2013
                                      Enhanced Properties

</TABLE>

     *European  Patent  granted with respect to the invention  covered by United
States Patent No. 5,366,801

<PAGE>

     The Company has registered the trademarks  Thermasorb(R)  and ComforTemp(R)
with the United States  Patent and Trademark  Office (the "PTO") and has applied
for registration of the trademark  Comfort in the Extreme(TM)  which application
has been allowed by the PTO.  Effective  March 9, 1998,  the Company  received a
registered  Canadian  trademark for ComforTemp(R).  A trademark  application has
also been submitted for ComforTemp(R) in the European  Community,  as well as in
most industrialized  nations of the world including among others,  Japan, China,
Russia and Korea.

     The Company and its' partners have several patents pending and also intends
to file for additional patents related to its technologies and products.

     In addition  to its  licenses  and  trademarks,  the Company is  developing
considerable  proprietary  technology  and trade  secrets  with  respect  to the
selection of the raw  material(s)  to be used for the capsules'  core  material,
shell wall  materials  and the  composition  of the  capsule  which the  Company
believes accords it a considerable  competitive advantage.  The Company believes
that  significant  barriers  have been  created  for  potential  competitors  by
securing  licenses  under  patents  which grant and protect its rights to a wide
variety of  applications,  spanning a broad  spectrum of industries  and end-use
products.  In order  to  further  protect  its  proprietary  trade  secrets  and
know-how,  the  Company  generally  requires  any person  having  access to such
confidential  information to execute an agreement  whereby such person agrees to
keep such information confidential.

     Competition

     The Company's  Thermasorb(R) additives and ComforTemp(R) foams compete with
a wide variety of natural and synthetic  insulating  products,  including  other
applications of MicroPCMs and bulk PCMs,  open and closed cell foams,  synthetic
insulators (e.g.,  Thinsulate(R)),  fleece,  wool and down. The Company believes
that its  ComforTemp(R)  foams  offer  significant  benefits  over  natural  and
synthetic insulation materials and foams not containing MicroPCMs because of (i)
the ability of the ComforTemp(R) foam to absorb heat and release it when cooling
occurs; (ii) its lightweight,  low bulk  characteristics;  (iii) its durability;
(iv) its  rechargeability;  (v) its  ability to be  customized  to a  particular
temperature   within  a  wide  range  of  temperatures  in  a  wide  variety  of
applications;  (vi) its minimal maintenance requirements;  and (vii) its ability
to be combined with other  available heat  management  materials.  The Company's
products  also  have the  capacity  to  function  reversibly.  Depending  on the
placement of the ComforTemp(R)  foam, it may be engineered to absorb,  reject or
regulate heat.

<PAGE>

     The Company  competes  directly with Outlast in certain  applications.  The
license  granted to Outlast by TRDC permits it to market  applications of fibers
and fabrics with  reversible  enhanced  thermal  storage  properties  ("MicroPCM
Fibers  and  Fabrics").   The  Company  believes  that  the  principal  area  of
competition with Outlast involves  applications where MicroPCM Fibers or Fabrics
less than 2mm thick may be used instead of combinations  including the Company's
ComforTemp(R)  foam.  The  Company  believes  that  products  incorporating  its
ComforTemp(R)   foam  will  offer   significant   advantages  over  such  fabric
applications  because  fabrics  will not have  sufficient  mass of  MicroPCMs to
provide a significant thermal management solution.

     The Company competes with other companies, including R.G. Barry Company and
Phase Change  Laboratories,  Inc.,  that utilize  bulk PCMs  primarily  for heat
retention   products.   The  Company   believes   Thermasorb(R)   additives  and
ComforTemp(R) foams offer superior performance  characteristics  compared to its
competitors'   products  because   microencapsulation   obviates  the  need  for
containment of the PCM in a sealed bag or other packaging which may tear or leak
resulting in contamination of the end product.

     The  Company's  products  also  compete  with active  mechanical  and solid
cooling alternatives (e.g., fans,  conductive heat sinks) currently utilized for
selected  electronics  and computer  cooling  applications  and certain  medical
products. For these applications, Thermasorb(R) will compete within a fragmented
product  market   comprised  of  specialty   firms,   including   Aavid  Thermal
Technologies,  Inc. and various smaller  companies,  including Advanced Ceramics
Corporation, Thermacore, Inc., Chipcoolers, Inc. and Marlow Industries, Inc. The
Company believes that  Thermasorb(R)  would be an effective means to enhance the
performance  of  thermal  solutions  being  provided  by these and other  firms,
resulting in a fertile area for  strategic  partnerships  within this segment of
the industry.

     The Company's products will also compete on a technical level with actively
cooled liquid solutions (e.g.,  automobile radiator circulating water to cool an
engine)  which the Company  believes is inferior  in  technical  performance  to
Thermasorb(R)-based  cooling solutions.  The Company recognizes,  however,  that
there is a significant price differential  between existing  water-based systems
and cooling solutions incorporating the Company's Thermasorb(R)  additives.  The
Company  believes that based upon its current  technology  the  additional  cost
involved in utilizing a  Thermasorb(R)  solution will not be justified in such a
price sensitive market;  therefore, the Company will not target this area in the
near term.

     Employees

     As of December 31, 1998, the Company  employed  approximately  30 full-time
employees  of which 6 were  management  personnel,  10 were  sales  and  product
support personnel,  7 were product development  personnel, 4 were administrative
personnel, and 3 were inventory purchasing and quality assurance personnel.

<PAGE>

     Item 2. Description of Properties

     The  Company  currently  has three  facilities.  The Company  occupies  its
current headquarters located in approximately 2,000 square feet of space located
at 77 East Main Street,  Bay Shore, New York. This space will be occupied by the
Company  pending  completion  of its  permanent  space also to be located in Bay
Shore.  The landlord for both the temporary and the permanent space in Bay Shore
is the Town of Islip. The temporary space in Bay Shore is currently  occupied on
a rent free basis and the Company  believes it will continue to be occupied on a
rent free basis until the Company takes  occupancy of the permanent space in Bay
Shore.

     In 1998, the Company entered into a lease with an unrelated third party for
the lease of a new facility in North  Carolina.  The Company planned to move its
North  Carolina  and  South  Carolina  facilities  into the new  North  Carolina
facility by June 1998.  However,  on August 27, 1998,  the facility to which the
Company was  relocating  its North  Carolina  operations  was destroyed by fire.
There was no  significant  impact on the  operations  of the Company as the fire
occurred prior to moving into the building it intended to occupy.

     The Company  now leases  premises  at 8 West Third  Street,  Winston-Salem,
North  Carolina,  a 3,000 square foot facility,  which the Company uses as sales
and marketing offices. This lease is on a month-to-month basis and is rent-free.

     The Company  leases  premises at 3380 Old  Lexington  Road,  Winston-Salem,
North  Carolina,  a 10,000  square foot  facility,  which the Company  uses as a
technology  development  center and warehouse.  This lease expires September 30,
1999, and has an annual rent of approximately $90,000.

     In September 1999, the North Carolina  operations will be consolidated into
the Frisby Technologies Center, a 20,000 square foot facility located on 8 acres
in Winston-Salem, North Carolina. This facility will be used as executive, sales
and marketing  offices,  a technology  development  center and a warehouse.  The
lease  includes a 12-year lease term and includes  annual rent payments  ranging
from $147,000 to $202,000. The Frisby Technologies Center can be expanded in the
future if necessary.

     The Company does not consider any of the  facilities it currently  occupies
suitable for its future needs and is  negotiating  a new lease for minimum space
in New York and has  executed a lease for a new  facility  in North  Carolina as
described  above. The Company believes that the new space in North Carolina will
be sufficient for the Company's  product  development and marketing  efforts for
the foreseeable future.

     Item 3. Legal Proceedings.

     The  Company is not  currently  involved in any legal  proceedings.  In the
ordinary course of its business,  the Company, from time to time, may be subject
to litigation.

<PAGE>

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

     None.

     Part II

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

     The Company's securities are traded on the NASDAQ SmallCap Market under the
symbols "FRIZ" for the Common Stock.

     The outstanding  shares of Common Stock are currently held by approximately
1,200 shareholders of record, and the Convertible  Preferred Stock by one holder
of record.  The transfer  agent and  registrar  for the Common Stock is American
Stock Transfer & Trust Company.

     The following  table  indicates the quarterly high and low stock prices for
fiscal 1998 since its IPO:

Quarter Ended                                    High              Low
-----------------------------              ----------------- ----------------

June 30, 1998                                  $9.75             $6.50
September 30, 1998                             $7.375            $2.50
December 31, 1998                              $5.937            $2.00

     The  Company  has paid no  dividends  on its common  stock for the last two
years and does not expect to pay dividends in the future.

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

     The  following  management's  discussion  and analysis and this Form 10-KSB
contain forward-looking  statements which involve risks and uncertainties.  When
used herein,  the words  "anticipate,"  "believe,"  "estimate," and "expect" and
similar expressions as they relate to the Company or its management are intended
to identify such  forward-looking  statements  within the meaning of the Private
Securities  Litigation  Reform  Act  of  1995.  The  Company's  actual  results,
performance or achievements  could differ  materially from the results expressed
in or implied by these forward-looking statements.

     General

     The following  discussion  should be read in conjunction with the Company's
audited  financial  statements  for the years ended  December 31, 1997 and 1998,
appearing elsewhere in this Form 10-KSB. The financial  information for the year
ended December 31, 1996 is presented for comparison purposes only.


<PAGE>


     The  following  table  sets forth  certain  operating  data in dollars  and
percentage of total revenues for the years indicated:
<TABLE>
<CAPTION>

                                                              Year Ended December 31
                                                    1996               1997           1998
<S>                                              <C>                  <C>              <C>   

Revenues:
     Product sales .........................    $    14,000        $   474,000      $2,198,000
     Research and development projects......      1,120,000            487,000         196,000
     Licenses and royalties.................         75,000            301,000         475,000
                                                   --------          ---------        --------
                                                       
Total revenues..............................      1,208,000          1,262,000       2,869,000
Cost of sales:
     Product sales..........................         12,000            452,000       2,126,000
     Research and development projects......      1,004,000            258,000         159,000
     Licenses and royalties.................         20,000            265,000         234,000
                                                  ---------          ---------        --------
                                                      
Total costs of sales........................      1,036,000            976,000       2,518,000
                                                  ---------          ---------        --------
                                                      
Gross profit................................        173,000            286,000         350,000
Selling and marketing expense...............         83,000            315,000       2,234,000
General and administrative expense..........        207,000            900,000       2,401,000
                                                  ---------          ---------        --------
                                                       
Loss from operations........................       (118,000)          (929,000)     (4,285,000)
Interest expense (income)...................         19,000             37,000        (367,000)
                                                  ---------          ---------        --------
                                                       
Loss before income taxes....................       (136,000)          (965,000)     (3,919,000)
Income tax (benefit) provision..............        (49,000)            45,000              --
                                                  ---------           ---------       --------
Net loss....................................     $  (88,000)      $ (1,010,000)   $(3,919,000)
                                                  ==========          =========     ==========
Net loss per common share - basic and diluted    $    (0.03)      $       (.36)   $      (.84)
                                                  ==========          =========     ==========
</TABLE>

<TABLE>
<CAPTION>

Balance Sheet Data:

                                                        December 31,        December 31,
                                                           1997                  1998
                                                      ------------------ ------------------
<S>                                                     <C>                   <C>    

Working capital                                        $   416,000         $   8,515,000          
Total assets                                             1,268,000            13,113,000          
Long-term liabilities                                      141,000             1,467,000          
Total liabilities                                          792,000             3,395,000          
Total shareholders' equity                                 475,000             9,718,000          

</TABLE>


     Years ended December 31, 1998 and 1997

     Revenues.  The Company  generates  revenue from three primary sources:  (i)
sales of its Thermasorb(R)  additives and ComforTemp(R) foam products for use in
its strategic  partners'  products;  (ii) revenue from research and  development
contracts  related to the United States  government and from private  companies;
and  (iii)  license  fees  and  royalties  from  the  use of  Thermasorb(R)  and
ComforTemp(R)  trademarks by strategic partners in end-user products, as well as
other fees earned in connection  with its agreements  with  strategic  partners.
Total revenues for the year ended  December 31, 1998 increased by  approximately
$1,607,000 to $2,869,000  compared to $1,262,000 for the year ended December 31,
1997.

<PAGE>

     Product Sales. Product sales for the year ended December 31, 1998 increased
by  approximately  $1,724,000  to  $2,198,000  compared to $474,000 for the year
ended  December 31,  1997.  These  increases  were  primarily  the result of the
Company bringing its ComforTemp(R)  foams and Thermasorb(R)  additives to market
commencing in the second quarter of 1997. Sales to partners that were present in
1997  more  than  doubled  in  1998  as  compared  to  1997  from   $474,000  to
approximately  $1,000,000.  The additional  increase resulted from relationships
with  strategic  partners  that  began in 1998  such as  Titleist  and  Foot-joy
Worldwide, Schoeller Textil AG, and Foamex International.

     Research and Development  Projects.  Revenues from research and development
projects  for the year  ended  December  31,  1998  decreased  by  approximately
$291,000 to $196,000 from $487,000 for the year ended  December 31, 1997.  These
decreases  resulted  primarily  from the shift in the Company's  focus away from
obtaining  and  performing  funded  research  and  development  contracts to the
commercialization of its thermal management products.

     Licenses and  Royalties.  Revenues  from license fees and royalties for the
year ended  December 31, 1998  increased by  approximately  $174,000 to $475,000
from $301,000 for the year ended December 31,  1997.License  fees are recognized
as revenue  ratably  over the life of the license  agreement.  Accordingly,  the
Company has recognized  revenue in 1998 relating to license  agreements  entered
into beginning in the second quarter 1997. Additionally,  royalty fees increased
to $380,000  for the year ended  December  31, 1998 from  $155,000  for the year
ended 1997.

     Cost of Sales.  The  Company's  cost of sales  consists  of: (i) direct and
indirect  costs  incurred in  connection  with  product  sales;  (ii) direct and
indirect costs incurred in connection with revenue from research and development
contracts  relating to the United States government and private  companies;  and
(iii)  royalty  payments  required  to be made to the  inventor  of the  thermal
management  technology  or other  licensors.  Costs of sales for the year  ended
December 31, 1998 increased by approximately  $1,543,000 to $2,519,000  compared
to $976,000 for the year ended December 31, 1997.

     Cost of Sales ---  Products.  The cost of sales related to products for the
year ended December 31, 1998 increased by approximately $1,674,000 to $2,126,000
compared to $452,000  for the year ended  December  31,  1997.  These  increases
reflect the higher volume of product  sales in the year ended  December 31, 1998
as compared to the year ended December 31, 1997.

     Cost of Sales ---  Research  and  Development  Projects.  The cost of sales
related to research and  development  projects  for the year ended  December 31,
1998 decreased by approximately $99,000 to $159,000 compared to $258,000 for the
year ended December 31, 1997.  These  decreases are consistent with the shift in
the Company's  focus away from  obtaining  and  performing  funded  research and
development  contracts and to the  commercialization  of its thermal  management
products.
<PAGE>

     Cost of Sales ---  Licenses  and  Royalties.  The cost of sales  related to
licenses  and  royalties  for the year ended  December  31,  1998  decreased  by
approximately  $31,000 to $234,000 from $265,000 for the year ended December 31,
1997.  This  decrease  primarily  reflect  the  expensing  of the  initial  cost
associated with the Outlast Agreement in 1997.

     Selling and Marketing Expenses.  Selling and marketing expense for the year
ended  December 31, 1998  increased by  approximately  $1,919,000  to $2,234,000
compared to $315,000 for the year ended December 31, 1997.  These increases were
primarily the result of the Company  increasing  its  marketing and  advertising
activity  in order to build  brand name  recognition  of its  Thermasorb(R)  and
ComforTemp(R)  products and trademarks.  These activities  included  advertising
placements  in many  national  trade and  consumer  publications  and  tradeshow
participation.  Additionally,  consulting  expense of  $180,000  was  recorded
related to warrants and options granted to consultants in 1998.

     General and Administrative Expense.  General and administrative expense for
the year ended  December  31, 1998  increased  by  approximately  $1,501,000  to
$2,401,000  compared to $900,000 for the year ended  December  31,  1997.  These
increases  reflect the increase in  personnel  and  personnel-related  expenses,
including  travel,  and recruiting  costs of new  employees. 

     Additionally,  fees and expenses paid to  consultants  have also  increased
over the comparable period for the prior year. These increases are in connection
with the  expansion of the Company's  operations  and  commercialization  of its
thermal management products.

         Net Interest Income/Expense.  The Company earned net interest income of
$367,000  for the year ended  December  31,  1998 as  compared  to net  interest
expense of $37,000 for the year ended  December 31, 1997.  These changes are due
to the investing of the proceeds received from equity transaction during 1988.

     Income Tax  Provision.  The Company  recorded no income tax benefit for the
year ended  December 31, 1998. For the year ended December 31, 1997, the Company
recorded a provision of $45,000 which arose from providing a valuation allowance
against all  deferred  tax assets.  The net  deferred tax assets at December 31,
1998 and 1997 arose  principally  from net operating  loss carry  forwards.  The
valuation  allowances  recorded  are due to  uncertainties  relating to expected
future taxable income that would have to be generated to realize such assets.

     Net Loss.  As a result of the  foregoing,  the net loss for the year  ended
December 31, 1998  increased to $3,919,000  from  $1,010,000  for the year ended
December 31, 1997.

<PAGE>

     Years ended December 31, 1997 and 1996

     Revenues.  The Company  generates  revenue from three primary sources:  (i)
sales of its Thermasorb(R)  and ComforTemp(R)  products for use in its strategic
partners' products; (ii) revenue from research and development contracts related
to the United States  Government;  and (iii) license fees and royalties from the
use of  Thermasorb(R)  and  ComforTemp(R)  trademarks  by strategic  partners in
end-user  products,  as well  as  other  fees  earned  in  connection  with  its
agreements with strategic  partners.  Total revenues for the year ended December
31, 1997 increased by $54,000 to $1,262,000  from  $1,208,000 for the year ended
December 31, 1996.

     Product sales. Product sales for the year ended December 31, 1997 increased
by $460,000 to $474,000 from $14,000 for the year ended  December 31, 1996.  The
increase was  primarily  the result of the Company  bringing  its  ComforTemp(R)
foams to market in 1997.

     Research and development  projects.  Revenues from research and development
projects for the year ended  December 31, 1997 decreased by $633,000 to $487,000
from  $1,120,000  for the year ended December 31, 1996.  This decrease  resulted
primarily from completion of several  long-term  contracts during the year ended
December  31,  1996 and the shift in the  Company's  focus  from  obtaining  and
performing funded research and development contracts to commercialization of its
products.

     Licenses and  royalties.  Revenues  from license fees and royalties for the
year ended  December 31, 1997 increased by $226,000 to $301,000 from $75,000 for
the year ended  December 31, 1996.  This increase  resulted  primarily  from the
Company's entry into three additional  strategic  partnership  agreements during
1997. These arrangements provided for payments to the Company of certain license
fees, at signing, in consideration for exclusive use of the Company's technology
in particular product categories.  In addition, the Company received $155,000 in
royalties based upon sales of end-use products by its strategic partners.

     Cost of sales.  Total cost of sales for the year ended  December  31,  1997
decreased by $60,000 to $976,000 from $1,036,000 for the year ended December 31,
1996.  The Company's  cost of sales  consists of: (i) direct and indirect  costs
incurred in  connection  with  product  sales;  (ii) direct and  indirect  costs
incurred in  connection  with revenue from  research and  development  contracts
relating to the United States  government  programs;  and (iii) royalty payments
required to be made to TRDC in accordance with the TRDC License.

     Cost of sales -- Products.  Cost of sales  related to products for the year
ended  December 31, 1997  increased by $440,000 to $452,000 from $12,000 for the
year ended December 31, 1996. This increase reflected the  commercialization  of
the Company's  products  during the last three months of 1996 and the year ended
December 31, 1997.

     Cost of sales -- Research and development  projects.  Cost of sales related
to  research  and  development  projects  for the year ended  December  31, 1997
decreased by $746,000 to $258,000 from  $1,004,000  for the year ended  December
31, 1996, primarily due to a decrease in projects during the year ended December
31, 1997. This decrease  reflected a shift of personnel to work on the Company's
product  development  effort,  the cost of which is  classified  as general  and
administrative  expenses. This shift reflected the Company's general strategy of
shifting  its focus to  commercialization  of its  products and away from funded
research and development. The related gross profit of such projects increased to
47.0%  for the year  ended  December  31,  1997 from  10.4%  for the year  ended
December 31, 1996.  Approximately  65% of this increase was  attributable to the
Company's  overall  development  contract  mix  consisting  of  more  cost  plus
fixed-fee contracts during 1996 as opposed to more fixed priced contracts during
1997 which fixed price contracts  proved to be more  profitable.  The balance of
this increase was  attributable  to losses incurred during 1996 relating to cost
sharing contracts which the Company performed during 1996.

<PAGE>

     Cost of sales -- Licenses and  royalties.  Cost of sales related to license
fees and royalties for the year ended December 31, 1997 increased by $245,000 to
$265,000 from $20,000 for the year ended December 31, 1996. Approximately 59% of
this increase was the result of the increase in license fees and royalties which
required  increased  licensing  payments to be made by the Company in accordance
with the terms of the TRDC  License.  The balance of the  increase  was due to a
$100,000  charge  related to prior  periods  incurred  upon the execution of the
Outlast Agreement.

     Selling and marketing expense.  Selling and marketing expenses for the year
ended  December 31, 1997  increased by $232,000 to $315,000 from $83,000 for the
year ended  December 31, 1996.  This  increase was  primarily  the result of the
Company increasing its marketing activity with respect to its thermal management
technology  as its products  were ready for market and the pursuit of additional
exclusive and non-exclusive licenses with potential strategic partners.

     General and administrative expense. General and administrative expenses for
the year ended December 31, 1997 increased by $693,000 to $900,000 from $207,000
for the year ended  December 31, 1996.  This  increase was  primarily due to the
shift in personnel and related  costs from funded  research and  development  to
product  development,   which  are  classified  as  general  and  administrative
expenses.  This shift reflected the Company's  general  strategy of shifting its
focus to  commercialization  of its products  and away from funded  research and
development.  The product development  expenses consisted primarily of personnel
and related costs in connection  with the  adaptation of the Company's  existing
thermal  management  technologies  for use by the Company's  strategic  partners
which   personnel   and  related   costs  are   characterized   as  general  and
administrative expenses.

     Interest  expense.  Interest  expense for the year ended  December 31, 1997
increased  by $18,000 to $37,000  from  $19,000 for the year ended  December 31,
1996.  The increase was  primarily  the result of increased  average  borrowings
outstanding under the Company's line of credit.

     Income  tax  provision  (benefit).  The  Company  recorded  an  income  tax
provision for the year ended December 31, 1997 of $45,000  compared to an income
tax benefit of $49,000 for the year ended  December  31,  1996.  The loss before
income  taxes for the year ended  December  31,  1997 was  $965,000  compared to
$136,000 for the year ended  December 31, 1996. The income tax provision for the
year ended December 31, 1997 arose from providing a valuation  allowance against
all deferred tax assets due to uncertainties relating to expected future taxable
income that would have to be generated  to realize  such assets.  The income tax
benefit for the year ended December 31, 1996 resulted primarily from recognition
of a net operating loss carryback and a deferred tax asset.

<PAGE>

     Net loss.  As a result of the  foregoing,  the net loss for the year  ended
December  31,  1997  increased  to  $1,010,000  from  $88,000 for the year ended
December 31, 1996.

     Liquidity and Capital Resources

     From its  inception  through  December 31,  1998,  the Company has incurred
cumulative  losses of  approximately  $4,987,000.  The Company has  financed its
operations to date through research and development contracts relating to United
States  government  programs,  bank  borrowings and issuance of common stock and
convertible preferred stock.

     At December  31,  1998,  the Company  had  working  capital of  $8,515,000,
including   cash   and   marketable    securities   of   $8,072,000,    accounts
receivable-billed  of $1,046,000  and inventory of $672,000,  offset by accounts
payable of $869,000  and  accrued  expenses  and other  current  liabilities  of
$386,000.

     The  Company's  liquidity  during  the year  ended  December  31,  1998 was
significantly  impacted  by the  proceeds  from the IPO,  offset  in part by its
increasing development of its thermal management products and increasing related
sales and  marketing  efforts.  In addition,  the  increases  in  inventory  and
accounts  receivable  arising from product  sales have  increased  the Company's
working capital needs. Net cash used in operating activities for the years ended
December  31,  1998 and 1997 was  $4,554,000  and  $832,000,  respectively.  The
principal factor contributing to the cash used in operating  activities for each
of the years ended  December  31, 1998 and 1997 was the net loss for each of the
respective  periods.  Cash used by investing  activities  was $2,308,000 for the
year ended December 31, 1998. The principal factor contributing to the cash used
in investing activities was the purchase of marketable securities. Cash provided
by financing  activities were  $13,002,000 and $1,154,000,  respectively for the
years ended December 31, 1998 and 1997. The principal financing activity in 1998
was the  receipt of the net  proceeds  of  $2,479,000  from the  exercise of the
Convertible  Preferred  Option and  approximately  $10,523,000 from the IPO. The
principal  financing  activity  in 1997 was the net  proceeds  of  approximately
$1,550,000 from the Private Placement.

     The Company has a $1,000,000 line of credit with a bank. The line of credit
bears  interest  at the lower of the  bank's  prime  rate or a two point  spread
versus the London Interbank Overnight Rate ("LIBOR") and will expire on June 30,
1999. The full amount of the line is currently available.

     The  Company  has  incurred  cumulative  losses  since its  inception  and,
therefore,  has not been subject to significant  federal  income taxes.  Through
December 31, 1998, the Company has generated net operating loss carryforwards of
approximately  $4,692,000  which may be  available  to reduce  future  available
taxable income and future tax liabilities.  These carryforwards  expire in years
through 2018.  The Tax Reform Act of 1986  provides for an annual  limitation on
the  use  of net  operating  loss  carryforwards  (following  certain  ownership
changes) that could  significantly  limit the Company's ability to utilize these
carryforwards.   Upon  the   completion   of  the  IPO,   the  exercise  of  the
Over-Allotment  Option,  or the  subsequent  exercise  of options or warrants in
connection with other future sales of equity,  the Company's  ability to utilize
the  aforementioned  carryforwards  may be  limited.  Additionally,  because the
United  States tax laws limit the time during which these  carryforwards  may be
applied against future taxes, the Company may not be able to take full advantage
of these attributes for federal tax purposes.

<PAGE>

     The Company  expects to use  $1,000,000 in 1999 for the purchase of capital
equipment and furniture for the new facility in North Carolina.

     Based on the Company's  current  operating plan, the Company  believes that
its available cash, cash flow from operations and available line of credit, will
be  sufficient  to satisfy  its  operational  and capital  requirements  through
December 1999. Such belief is based upon certain  assumptions,  and there can be
no assurance that such assumptions are correct.  In the event that the Company's
plans change,  or its available  cash,  cash flow from  operations and available
line of credit are insufficient to fund operations due to unanticipated  delays,
problems,  expenses  or  otherwise,  the  Company  would  be  required  to  seek
additional  financing  sooner  than  anticipated.   Further,  depending  on  the
Company's  progress in marketing  its product  line,  gaining  acceptance of its
thermal  management  technology  and its other  products and services  among the
business community or the  identification of strategic  acquisition or licensing
opportunities,  the  Company  may  determine  that  it  is  advisable  to  raise
additional capital sooner than was anticipated.

     Inflation

     The  impact  of  general  inflation  on the  Company's  business  has  been
insignificant  to date and the  Company  believes  that it will  continue  to be
insignificant for the foreseeable future.

     Year 2000

     The Year 2000 Issue is the result of computer  programs being written using
two digits rather than four to define the applicable  year. Any of the Company's
computer programs that have  date-sensitive  software may recognize a date using
"00" as the year 1900 rather than the year 2000.  This could  result in a system
failure 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.

     Based  on  recent  assessments,  the  Company  determined  that it will not
require  significant  modifications  of its  hardware  or software so that those
systems  will  properly  utilize  dates beyond  December  31, 1999.  The Company
presently believes that with  modifications of its existing  software,  the Year
2000 Issue can be mitigated.

     The  Company's  plan to resolve the Year 2000 Issue  involves the following
four  phases:  assessment,  remediation,  testing,  and  implementation.  As  of
February  28,  1999,  the  Company has fully  completed  its  assessment  of all
internal  systems  that could be  significantly  affected by the Year 2000.  The
completed   assessment   indicated  that  most  of  the  Company's   significant
information technology systems will not be significantly affected,  particularly
the general ledger, billing, and inventory systems. The Company does not believe
that the Year 2000  presents a material  exposure as it relates to the Company's
products.  In addition,  the Company has begun to gather  information  about the
Year 2000  compliance  status of its  external  agents and  continues to monitor
their compliance. To date, the Company is not aware of any external agent with a
Year  2000  issue  that  would  materially   impact  the  Company's  results  of
operations,  liquidity, or capital resources. The Company has requested from its
bank an  assessment  of the extent of the bank's  Year 2000  compliance.  In the
event the bank is not Year 2000  compliant  in a timely  manner,  the Company is
prepared to change  banks.  However,  the Company has no means of ensuring  that
external  agents will be Year 2000 ready.  The  inability of external  agents to
complete their Year 2000 resolution process in a timely fashion could materially
and  adversely  impact the  Company.  The effect of  non-compliance  by external
agents is not determinable.
<PAGE>
     The Company  will utilize its  external  software  and service  provider to
reprogram,  test and  implement the software for the Year 2000  modification  as
needed,  the cost of which is not expected to be  significant.  The Company will
evaluate the status of  completion of Year 2000  modifications  in June 1999 and
will undertake all remaining  necessary  steps to seek to ensure its systems are
Year 2000 compliant. In the event the Company is unable to resolve its Year 2000
modifications in a timely fashion, the business of the Company may be materially
and adversely impacted.

     In the  event the  Company's  computer  systems  are  materially  adversely
affected by the Year 2000 issue, the Company's  business and operations could be
materially adversely affected by disruptions in the operations of other entities
with which the Company  interacts.  However,  the Company believes that the most
likely worst case scenario is that there will be some  localized  disruptions of
systems that will affect individual processes,  facilities or service technology
providers  for a  short  time  rather  than  systematic  or  long-term  problems
affecting  its business  operations as a whole.  In such event,  the Company has
contingency plans for certain critical  applications and is working on plans for
others.   These   contingency  plans  involve,   among  other  actions,   manual
workarounds, increasing inventories, and adjusting staffing strategies.

<PAGE>

     Item 7. Financial Statements.

     The  information  required by this item is incorporated by reference to the
Company's financial statements.

     Item 8. Changes In and  Disagreements  With  Accountants  on Accounting and
Financial Disclosure.

     None

     Part III

     The information required by Part III of this Form 10-KSB is incorporated by
reference to the  Registrant's  definitive  proxy statement to be filed with the
Commission within 120 days.

                                     PART IV

     Item 13. Exhibits and Reports on Form 8-K.

(a) The  following  exhibits  are  hereby  incorporated  by  reference  from the
corresponding  exhibits filed under the Company's  Form SB-2 under  Registration
No. 333-45121:

     3.2 By-Laws

     4.1 Form of Common Stock Certificate

     4.2 Form of Representative's Option

     10.2 Stock Option Plan

     10.3 Amended Employment  Agreement dated as of December 8, 1997 between the
Company and Gregory S. Frisby

     10.4  Employment  Agreement  dated December 6, 1997 between the Company and
Douglas J. McCrosson

     10.5  Shareholder  Agreement  dated  December 10, 1997 between the Company,
Gregory S. Frisby and Jeffry D. Frisby

     10.6 Line of Credit Agreement with European American Bank

     10.7.1 License Agreement dated May 1, 1995 between the Company and Triangle
Research and Development Corp. ("TRDC")

     10.7.2 Assignment of License Agreement  effective January 3, 1997 from TRDC
to Delta Thermal Systems, Inc.

     10.8 License  Agreement  effective  January 1, 1998 between the Company and
Outlast Technologies, Inc.

     10.9  License  Agreement  dated March 31, 1997  between the Company and Fly
Technologies, Inc.

     10.10  License  Agreement  dated  January 23, 1997  between the Company and
Wells Lamont Division, Marmon Holdings, Inc.

     10.11 License Agreement dated February 1, 1997 between the Company and Cove
Shoe Company, Inc.

     10.12.1 License Agreement dated May 22, 1996 between the Company and Thermo
Solutions, Inc. (f/k/a Temptop Container Systems, Inc.) ("Thermo Solutions")

     10.12.3  Memorandum  of  Understanding  dated  January 22, 1998 between the
Company and Thermo Solutions

     10.13  License  Agreement  dated  February 10, 1997 between the Company and
Genfoot, Inc. and Genfoot America, Inc.

     10.14  Contract  No.  00178-96-C-3014  between  the  Company and the United
States of America (Naval Surface Warfare Division)

     10.15  Contract  No.  F08637-97-C-6017  between  the Company and the United
States of America (325th Contracting Squadron/LGCX)

     10.16  Arrangement dated January 21, 1998 between the Company and Minnesota
Mining & Manufacturing, Inc.

     10.17  Memorandum  of  Understanding  dated  October 23,  1997  between the
Company and Lendell Manufacturing, Inc.

     10.18 Memorandum of Understanding  dated April 14, 1997 between the Company
and Bell Sports Corp.

     10.19  Memorandum of  Understanding  dated July 9, 1997 between the Company
and CamelBak/FasTrak Systems, Inc.

     10.20  Memorandum  of  Understanding  dated  December  11, 1997 between the
Company and Foamex International, Inc.

     10.21  Memorandum  of  Understanding  dated  January 15,  1998  between the
Company and LaCrosse Footwear, Inc.

     10.22 Lease dated March 2, 1998 between  Piedmont  Institute for Research &
Technology, II, LLC, as landlord, and the Company, as tenant

     10.23 Lease dated June 1, 1993 between Frisby Aerospace, Inc., as landlord,
and the Company, as tenant

     10.24 Lease dated September 1, 1994 between Charles  Winburn,  as landlord,
and the Company, as tenant

     (b) The following  exhibits are hereby  incorporated  by reference from the
corresponding  exhibits  filed  with the  Company's  Form  10-QSB for the fiscal
quarter ended March 31, 1998.

     3.1 Amended and Restated Certificate of Incorporation

     10.1 Amended MUSI Stockholder Agreement

     (c) The following  exhibits are hereby  incorporated  by reference from the
corresponding  exhibits  filed  with the  Company's  Form  10-QSB for the fiscal
quarter ended June 30, 1998:

     10.6.1 Revised Line of Credit Agreement with European American Bank

     10.25  Consulting  Agreement  dated April 13, 1998  between the Company and
GGC, Inc.

     (d) Exhibits

     10.7.1.1 Amendment to License Agreement between the Company and TRDC

     27.1 Financial data schedule

     (e) Reports on Form 8-K

     The  Company  filed a Report  on Form 8-K dated  October  27,  1998,  which
reported events under Items 5 and 7.



<PAGE>



                                   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.

                                            Frisby Technologies, Inc.

                                        By: /s/Gregory S. Frisby
                                            -------------------------------- 
                                            Gregory S. Frisby
                                            Chief Executive Officer

Dated:  March 31, 1999

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

<TABLE>
<CAPTION>

            Signature                                   Title                                Date
<S>                                                    <C>                          <C>    

/s/Gregory s. Frisby            Chairman of the Board of Directors, Chief          March 31, 1999
---------------------------     Executive Officer; Treasurer
Gregory S. Frisby                 

/s/Stephen P. Villa             Chief Financial Officer                            March 31, 1999
---------------------------
Stephen P. Villa

/s/Jeffry D. Frisby             Director                                          March 31, 1999
---------------------------
Jeffry D. Frisby

/s/Pietro A. Motta              Director                                          March 31, 1999
---------------------------
Pietro A. Motta

/s/Domenico DeSole              Director                                          March 31, 1999
---------------------------
Domenico DeSole

/s/Robert C. Grayson            Director                                          March 31, 1999
---------------------------
Robert C. Grayson


</TABLE>



<PAGE>



                                      

Item 7. Financial Statements.

                            Frisby Technologies, Inc.

                          Index to Financial Statements


<TABLE>
<CAPTION>
<S>                                                                                                    <C>

Report of Independent Auditors.....................................................................    F-2

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

Statements of Operations for the Years Ended December 31,
   1998 and 1997...................................................................................    F-4

Statements of Stockholders' Equity (Deficit) for the Years Ended December 31,
   1998 and 1997...................................................................................    F-5

Statements of Cash Flows for the Years Ended December 31,
   1998 and 1997 ..................................................................................    F-6

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

</TABLE>

                                      F-1
<PAGE>




                         Report of Independent Auditors

The Stockholders
Frisby Technologies, Inc.

     We have audited the accompanying balance sheet of Frisby Technologies, Inc.
as of December 31, 1998 and the related statements of operations,  stockholders'
equity,  and cash flows for each of the two years in the period  ended  December
31, 1998.  These financial  statements are the  responsibility  of the Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audits.

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

     In our opinion,  the financial statements referred to above present fairly,
in all material respects, the financial position of Frisby Technologies, Inc. as
of December 31, 1998,  and the results of its  operations and its cash flows for
each of the two years in the period ended December 31, 1998, in conformity  with
generally accepted accounting principles.


                                  /s/Ernst & Young LLP

Melville, New York
February 3, 1999












                                      F-2
<PAGE>


                            Frisby Technologies, Inc.
                                  Balance Sheet
                                   
<TABLE>
<CAPTION>

                                                                                                  December 31,
                                                                                                       1998
                                                                                                -------------------
<S>                                                                                                  <C>    

Assets
Current assets:
   Cash and cash equivalents                                                                    $       6,516,138
   Marketable securities                                                                                1,555,683
   Accounts receivable - billed, less allowance for doubtful accounts of
     $30,000                                                                                            1,045,975
   Accounts receivable - unbilled                                                                          58,159
   Inventory                                                                                              671,569
   Prepaid expenses and other current assets, including related party
      receivable of $94,320                                                                               595,998
                                                                                                  ---------------
Total current assets                                                                                   10,443,522
Property and equipment, net                                                                               277,494
Intangible assets, less accumulated amortization of $51,300                                             2,000,700
Other assets                                                                                              391,516
                                                                                                  ---------------
Total assets                                                                                    $      13,113,232
                                                                                                 ================

Liabilities and stockholders' equity 
Current liabilities:
   Accounts payable                                                                             $         868,649
   Accrued expenses and other current liabilities                                                         385,533
   Payable to Triangle Research and Development Corporation                                               400,000
   License fees payable                                                                                   189,726
   Deferred license revenues                                                                               85,000
                                                                                                  --------------- 
Total current liabilities                                                                               1,928,908
Accrued license agreement costs                                                                           120,250
Deferred license revenues                                                                                  46,250
Other liability                                                                                         1,300,000
                                                                                                  ---------------
Total liabilities                                                                                       3,395,408

Commitments and contingencies

Stockholders' equity:
   Preferred Stock, 1,000,000 shares authorized; 587,500 shares issued
      and outstanding                                                                                   2,479,000
   Common Stock, $.001 par value; 10,000,000 shares authorized; 5,120,613
      shares issued and outstanding                                                                         5,121
   Additional paid-in capital                                                                          12,199,828
   Accumulated other comprehensive income                                                                  21,000
   Accumulated deficit                                                                                 (4,987,125)
                                                                                                  ---------------
Total stockholders' equity                                                                              9,717,824
                                                                                                  ---------------
Total liabilities and stockholders' equity                                                    $        13,113,232
                                                                                              ===================
</TABLE>

     See accompanying notes.

                                      F-3
<PAGE>



                            Frisby Technologies, Inc.
                            Statements of Operations

<TABLE>
<CAPTION>


                                                                                     Year ended
                                                                                    December 31,
                                                                    -----------------------------------------------
                                                                            1998                      1997
                                                                    ---------------------     ---------------------
<S>                                                                       <C>                   <C>   

Revenues:
   Product sales                                                    $          2,198,275      $            474,179
   Research and development projects                                             196,345                   486,700
   Licenses and royalties                                                        474,519                   300,960
                                                                    ---------------------     ---------------------
Total revenues                                                                 2,869,139                 1,261,839
                                                                    ---------------------     ---------------------

Cost of sales:
   Product sales                                                               2,125,730                   452,377
   Research and development projects                                             158,856                   257,843
   Licenses and  royalties                                                       234,403                   265,350
                                                                    ---------------------     ---------------------
Total cost of sales                                                            2,518,989                   975,570
                                                                    ---------------------     ---------------------
Gross profit                                                                     350,150                   286,269
Selling and marketing expense                                                  2,234,499                   315,169
General and administrative expense                                             2,400,930                   899,620
                                                                    ---------------------     ---------------------
Loss from operations                                                          (4,285,279)                 (928,520)
Interest income (expense), net                                                   366,635                  (36,666)
                                                                    ---------------------     ---------------------
Loss before income taxes                                                      (3,918,644)                 (965,186)
Income tax provision                                                               -                        44,792
                                                                    =====================     =====================
Net loss                                                            $         (3,918,644)        $      (1,009,978)
                                                                    =====================     =====================
                                                              
Net loss per common share - basic and
    diluted                                                         $            (0.84)          $         (0.36)
                                                                    =====================     =====================
                                                               
Shares used in the calculation of  basic
    and diluted net loss per common share                                      4,637,325                  2,842,913
                                                                    =====================     =====================

</TABLE>



     See accompanying notes.

                                      F-4
<PAGE>
                                       
                            Frisby Technologies, Inc.
                  Statements of Stockholders' Equity (Deficit)
<TABLE>
<CAPTION>

                                                                                           Accumulated
                                                                             Additional      Other
                              Preferred Stock           Common Stock         Paid-In      Comprehensive     Accumulated   
                              Shares      Amount       Shares      Amount    Capital         Income         Deficit       Total
                              ------      ------       ------      ------   --------       ------------     ----------    -----
                             

<S>                            <C>        <C>         <C>         <C>          <C>              <C>          <C>           <C>
Balance at
  December 31, 1996             --       $  --        2,839,286    $ 500      $    --           $ --         $ (58,503)   $ (58,003)

Sale of common stock and
  options, net of $956,444 of
  related costs and expenses    --          --          441,327    2,781       1,540,575          --              --      1,543,356

Net loss                        --          --             --        --            --             --        (1,009,978)  (1,009,978)
                             --------     --------     --------   --------       --------      --------       ---------    ---------

Balance at
  December 31, 1997             --          --        3,280,613    3,281       1,540,575          --        (1,068,481)     475,375

Net loss                        --          --             --        --             --            --        (3,918,644)  (3,918,644)

Unrealized gains on
 marketable securities          --          --             --        --             --          21,000           --          21,000
                                                                                                                            --------
Comprehensive (loss)            --          --             --        --             --            --             --      (3,897,644)

Exercise of preferred stock
  option, net of $21,000 of 
  related costs and expenses  587,500    2,479,000          --        --             --            --             --       2,479,000

Initial public offering, net
  of $2,495,907 of related 
  costs and expenses            --          --        1,840,000    1,840      10,382,253          --             --      10,384,093

Issuance of options and 
  warrants to consultants
  and pursuant to acquisition 
  of intangible assets          --          --             --        --          277,000          --             --         277,000
                            --------     --------      --------   --------    -----------      --------       --------     -------- 
Balance at
  December 31, 1998          587,500   $2,479,000     5,120,613  $ 5,121   $  12,199,828     $  21,000    $ (4,987,125) $ 9,717,824
                            ========     ========      ========   ========    ==========       ========     ==========    =========

</TABLE>

     See accompanying notes.
                                       F-5
<PAGE>




                            Frisby Technologies, Inc.
                            Statements of Cash Flows
<TABLE>
<CAPTION>


                                                                                           Year ended
                                                                                          December 31,
                                                                           -------------------------------------------
                                                                                      1998                   1997
                                                                                      ----                   ----
<S>                                                                              <C>                      <C>  

Operating activities
Net loss                                                                         $ (3,918,644)           $ (1,009,978)
Adjustments to reconcile net loss to net cash used
  in operating activities:
   Depreciation and amortization                                                       37,003                  15,121
   Non cash consulting expense                                                        180,000                       -
   Amortization of intangibles                                                         51,300                       -
   Provision for doubtful accounts                                                     30,000                       -
   Deferred income tax provision                                                            -                  44,792
   Changes in operating assets and liabilities:
      Accounts receivable                                                            (723,532)               (226,656)
      Inventory                                                                      (423,883)               (199,712)
      Prepaid expenses and other current assets                                      (491,904)                 (2,269)
      Accounts payable                                                                318,410                 260,190
      Accrued expenses and other current liabilities                                  322,390                  29,965
      Licenses fees payable                                                             5,086                 177,194
      Accrued license agreement costs                                                  19,000                       -
      Deferred license revenues                                                        41,250                  90,000
      Due to related party                                                                  -                (10,550)
                                                                           -------------------    --------------------
Net cash used in operating activities                                              (4,553,524)              (831,903)
                                                                           -------------------    --------------------

Investing activities
Purchases of property and equipment                                                  (447,878)                     -
Purchases of  marketable securities                                                (1,534,683)                     -
Purchase of intangible assets                                                        (325,000)                     -
                                                                           -------------------    --------------------
Net cash used in investing activities                                              (2,307,561)                     -
                                                                           -------------------    --------------------

Financing activities
Net proceeds from private placement                                                 2,479,000              1,543,356
Net proceeds from initial public offering                                          10,523,001                      -
Net repayments of notes payable                                                             -               (250,000)
Borrowings from related party                                                               -                517,000
Repayment to related party                                                                  -               (517,000)
Payment of transaction costs                                                                -               (138,908)
                                                                           -------------------    --------------------
Net cash provided by financing activities                                          13,002,001              1,154,448
                                                                           -------------------    --------------------

Net increase in cash and cash equivalents                                           6,140,916                322,545
Cash and cash equivalents - beginning of year                                         375,222                 52,677             
                                                                           -------------------    --------------------
Cash and cash equivalents- end of year                                     $        6,516,138        $       375,222
                                                                           ===================    ====================
                                                                           
Supplemental information
Interest paid                                                              $            1,189        $        36,666
                                                                           ===================    ====================



</TABLE>


                                      F-6
     See accompanying notes


<PAGE>




                            Frisby Technologies, Inc.
                          Notes to Financial Statements
                                December 31, 1998


1. Organization and Business

     Frisby  Technologies,  Inc.  (the  "Company")  is engaged  in one  business
segment,  the development and  commercialization  of branded thermal  management
products  for use in a broad  range of consumer  and  industrial  products.  The
Company's  Thermasorb(R) and ComforTemp(R) products utilize licensed patents and
the Company's proprietary MicroPCM technology to enhance thermal characteristics
(i.e.,  insulation,  cooling or temperature  control properties) in a variety of
consumer and industrial products.

2.  Summary of Significant Accounting Policies

Revenue Recognition

     Revenues  from sales of products  are  recognized  upon  shipment.  License
revenues are recorded  ratably over the license period,  which generally  ranges
between two and three years.  Royalty  revenues are recorded  when the Company's
strategic  partners  report  sales  of  products  containing  Thermasorb(R)  and
ComforTemp(R) to their customers.

     The Company  accounts  for  significant  long-term  contracts  using on the
percentage-of-completion  method  based  on  the  relationship  of  total  costs
incurred to date to estimated  total costs at  completion.  Adjustments  to cost
estimates  are made  periodically  and related  changes  reflected in operations
cumulative to the date of change.  Revenue on  cost-plus-fixed-fee  contracts is
recognized to the extent of costs  incurred plus a  proportionate  amount of the
fee earned.  Revenue  recognized on  uncompleted  contracts in excess of amounts
billed  is  presented  as  "Accounts  receivable-unbilled"  in the  accompanying
balance sheet. Billings are made in accordance with the respective terms of such
contracts. Provisions for estimated losses, if any, on uncompleted contracts are
made in the period in which such losses are determined.

Cash and Cash Equivalents

     The  Company  considers  all highly  liquid  financial  instruments  with a
maturity of three months or less when purchased to be cash equivalents.

                                      F-7
<PAGE>
                           Frisby Technologies, Inc.
                    Notes to Financial Statements (Continued)

Marketable Securities

     Available-for-sale securities are stated at fair value, with the unrealized
gains and losses  reported in other  comprehensive  income.  Realized  gains and
losses   and   declines   in  value   judged  to  be   other-than-temporary   on
available-for-sale  securities  are  included  in interest  income.  The cost of
securities  sold is based on the specific  identification  method.  Interest and
dividends  on  securities  classified  as  available-for-sale  are  included  in
interest income.

Depreciation and Amortization

     The  Company's  fixed assets are stated at cost.  Depreciation  is provided
over the  estimated  useful  lives  (three to ten years) of the assets under the
straight-line  method.  Leasehold  improvements are amortized on a straight-line
basis over the  shorter of the lease term or the  estimated  useful  life of the
asset.

     Intangible  assets,   consisting  of  the  assignment  of  rights  under  a
third-party  license  agreement and the reduction of future  license and royalty
fees, are being amortized on a straight-line basis over seven years.

Net Loss Per Share

     Basic and diluted net loss per share is calculated in accordance  with FASB
Statement No. 128 "Earnings Per Share."

     The  denominator  used in the computation of basic and diluted net loss per
share  for the  years  ended  December  31,  1998  and 1997  was  4,637,325  and
2,842,913, respectively; the weighted-average shares. The calculation of diluted
net loss per share excludes shares of common stock issuable upon the exercise of
stock  options  and  warrants  (Notes  7, 8 and 11) and  the  conversion  of the
Convertible  Preferred  Stock (Note 7) as the effect of such exercises  would be
antidilutive. There were no dilutive securities as of December 31, 1997.

Fair Value of Financial Instruments

     The reported  amounts of cash,  accounts  receivable,  accounts payable and
accrued liabilities approximate their fair values.

Inventories

     Inventories  consist  substantially of finished goods and are stated at the
lower of cost or market. Cost is determined by the weighted-average method.

                                      F-8

<PAGE>


                            Frisby Technologies, Inc.
                    Notes to Financial Statements (continued)

Advertising Expense

     The cost of advertising,  including creation and placement,  is expensed as
incurred.   The  Company  incurred  approximately  $  992,000  and  $212,000  of
advertising costs for the years ended December 31, 1998 and 1997, respectively.

Use of Estimates

     The  preparation  of financial  statements  in  conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect  amounts  reported  in the  financial  statements  and
accompanying notes. Actual results could differ from those estimates.

Long-Lived Assets

     The  Company  reviews  the  carrying  value  of its  long-lived  assets  in
determining the ultimate recoverability of their unamortized values using future
undiscounted cash flow analyses if there are indicators of impairment.

Stock Based Compensation

     The Company  grants  options for a fixed number of shares to employees with
an exercise  price equal to the market value of the shares at the date of grant.
The Company  accounts for stock option grants in accordance with APB Opinion No.
25,  "Accounting  for Stock  Issued to  Employees"  and related  Interpretations
because the Company  believes the alternate fair value  accounting  provided for
under FASB Statement No. 123, "Accounting for Stock-Based Compensation" requires
the use of option  valuation  models that were not  developed for use in valuing
employee  stock  options.  Under APB 25,  because the exercise  price equals the
market  price of the  underlying  stock on the date of  grant,  no  compensation
expense is recorded.

3.  Significant Concentrations

     The Company  currently  outsources the  manufacture of all of its products,
including Thermasorb(R) and ComforTemp(R), to a limited number of manufacturers.
In September  1998,  the Company and a supplier  entered  into a  Memorandum  of
Understanding (see Note 11 (d)), for its anticipated Thermasorb(R) requirements.
Two licensed  vendors  currently  manufacture the Company's  ComforTemp(R)  foam
products.

                                      F-9
<PAGE>

                            Frisby Technologies, Inc.
                    Notes to Financial Statements (continued)

     The Company does a significant  amount of business with a limited number of
strategic  partners.  Total  revenues  from  two  strategic  partners  comprised
approximately  53% (35% and 18%) of the  Company's  total  revenues for the year
ended December 31, 1998. The United States Government and two strategic partners
comprised  approximately  84% (39%, 34% and 11%) of the Company's total revenues
for the year ended December 31, 1997.

     At  December  31,  1998,  the  three  strategic   partners   accounted  for
approximately 59% (27%, 17% and 15%) of the Company's accounts  receivable.  The
Company  performs  credit  evaluations  of  its  strategic  partners'  financial
condition  and  payment  history  prior to  extending  credit.  Consistent  with
industry standards,  receivables are payable in accordance with the terms of the
underlying contracts and collateral is not required.

4.  Property and Equipment

     Property and equipment consist of the following:

                                                                   December 31,
                                                                       1998
                                                                  --------------
Leasehold  improvements.................................              $51,626
Furniture...............................................               16,247
Equipment...............................................              292,224
                                                                 ---------------
                                                                      360,097
Less accumulated depreciation and                                            
amortization............................................               82,603
                                                                 ---------------
                                                                     $277,494
                                                                 ===============

5.       Marketable Securities

     Marketable securities consist of a publicly traded mutual fund. At December
31, 1998, the aggregate  cost,  fair market value and gross  unrealized  holding
gains were $1,534,683, $1,555,683 and $21,000, respectively.

                                      F-10
<PAGE>
                       Frisby Technologies, Inc. Notes to
                        Financial Statements (continued)

6.       Line of Credit

     During  1998,  the  Company's  available  line of  credit  with a bank (the
"Line"), was increased to $1,000,000. The Line is maintained for working capital
purposes. The Line bears interest at the lower of the bank's prime rate or a two
point spread versus the London Interbank Overnight Rate ("LIBOR") and expires on
June 30, 1999. At December 31, 1998 no amounts were outstanding  under the Line.
Substantially  all of the  Company's  assets  are  pledged as  security  for any
outstanding  borrowing  under  the  Line. 

     On December 30, 1997, the Company repaid all then amounts outstanding under
the Line with a portion of the proceeds from a private placement (see Note. 7).

7.  Stockholders' Equity

     On December 29, 1997,  the Company sold 441,327  shares of Common Stock and
an option to purchase  587,500  shares of the  Company's  Convertible  Preferred
Stock at an exercise price of $4.26 per share expiring on February 27, 1998 in a
private  placement  to a foreign  investor for an  aggregate  purchase  price of
$2,500,000.  The  Company  allocated  $353,000  of  the  purchase  price  as the
estimated  value of the option.  This  transaction  resulted in net  proceeds of
approximately  $1,543,000,  after the payment of related costs and expenses.  On
February 27, 1998,  the foreign  investor  exercised the  Convertible  Preferred
Stock  option.  This  transaction  resulted  in net  proceeds  to the Company of
$2,479,000,  after the  payment of  related  costs and  expenses.  Each share of
Convertible Preferred Stock is convertible into one share of Common Stock at the
election of the investor for a 60-day period commencing on April 6, 1999.

     On April 1, 1998, the Company  consummated an Initial Public  Offering (the
"IPO") of 1,600,000 shares of Common Stock at a price of $7.00 per share. On May
15,  1998,   the   underwriter   in  connection   with  the  IPO  exercised  its
over-allotment option to purchase 240,000 additional shares of Common Stock at a
price of $7.00 per share.  The total net  proceeds  to the  Company  amounted to
approximately $10,400,000 after the underwriters' discount and related expenses.
The  underwriter has an additional  option to purchase  160,000 shares of common
stock at an exercise price of 165% of the IPO price or $11.55 per share expiring
in April 2003.

     In April 1998,  the Company  entered into a two-year  consulting  agreement
with a company  controlled by a member of the Company's  Board of Directors.  In
addition to a monthly  fee,  the  Company  issued  warrants to purchase  110,000
shares of the  Company's  Common  Stock at an exercise  price of $7.25 per share
expiring in April 2003. Additionally,  the Company issued options to consultants
to purchase  4,000 shares of the Company's  Common Stock at an exercise price of
$7.00  per  share  expiring  in April  2003.  The  exercise  prices of the above
mentioned  warrants and options were equal to the market price of the  Company's
Common  Stock at the date of grant.  The  aggregate  fair market  value of these
warrants and options of $250,000 is being charged to expense over the respective
service periods.


8. Stock Based Compensation Plan

     In March 1998,  the  stockholders  adopted a Stock Option plan  pursuant to
which 250,000 shares of Common Stock are reserved for issuance to key employees,
officers, directors and consultants of the Company.

                                      F-11
<PAGE>

                            Frisby Technologies, Inc.
                    Notes to Financial Statements (continued)

     The following table summarizes activity in stock options:

<TABLE>
<CAPTION>


                                                                Shares                        Weighted-
                                                                 Under                         Average
                                                                Option                      Exercise Price
                                                          --------------------     ---------------------------------
<S>                                                        <C>                           <C>  

      Balance at December 31, 1997                        $       --                      $     --
      Grants                                                  190,500                         $6.29
      Forfeitures                                             (14,000)                        $7.00
                                                          ===================
      Balance at December 31, 1998                            176,500                         $6.23
                                                          ===================

      Weighted-average fair value of
      option issued during the year                                                           $4.14

</TABLE>

     The following table summarizes  information about stock options outstanding
as of December 31, 1998:

<TABLE>
<CAPTION>

                                                                                            Weighted-Average                    
                                                                       Options                  Remaining
                  Exercise Price          Options Outstanding         Exercisable           Contractual Life
               ----------------------     ---------------------    -------------------     --------------------
<S>                 <C>                            <C>                  <C>                     <C>   

                       $3.00                        5,000                  -                      4.90
                       $3.19                        2,500                  -                      4.75
                       $3.56                       16,500                  -                      4.90
                       $3.69                       10,000                  5,000                  4.60
                       $4.50                       10,000                  -                      4.60
                       $7.00                       97,500                 97,500                  4.25
                       $7.25                       35,000                 35,000                  4.25
                                          =====================    ===================
                                                  176,500                137,500
                                          =====================    ===================
</TABLE>


     At December 31, 1998, the Company has reserved  1,207,500  shares of common
stock for issuance of all options,  warrants  outstanding  and the conversion of
the Convertible Preferred Stock into Common Stock.

                                      F-12
<PAGE>

     Pro forma information regarding net loss and net loss per share is required
by Statement  123, and has been  determined  as if the Company had accounted for
its stock  options  under the fair value of that  statement.  The fair value for
these options was estimated at the date of grant using the  Black-Sholes  option
pricing model with the following weighted-average assumptions for the year ended
December  31,  1998:  risk-free  Frisby  Technologies,  Inc.  Notes to Financial
Statements  (continued)  interest  rate of 5.0%; no dividend  yield;  volatility
factor of the expected market price of the Company's Common Stock of 1.044 and a
weighted-average expected life of the options of three years.

     For  purposes of pro forma  disclosures,  the  estimated  fair value of the
options is amortized to expense over the options' vesting period.  The Company's
pro forma information follows:

     Pro forma net loss                                    $    (4,538,195)
                                                         ==================
     Pro forma basic and diluted loss per share            $         (0.98)
                                                         ==================


9.  Income Taxes

     Deferred  tax  assets  and   liabilities  are  recognized  for  future  tax
consequences   attributable  to  differences  between  the  financial  statement
carrying  amounts of existing assets and  liabilities  and their  respective tax
bases.  Deferred tax assets and  liabilities  are measured  using  enacted rates
expected  to apply to  taxable  income  in the  years in which  those  temporary
differences expected to be recovered or settled.  Significant  components of the
Company's deferred tax assets are as follows:

                                                              December 31, 
                                                                  1998
                                                              ------------

     Accounts receivable reserve.........................      $  12,000
     License agreement costs.............................         47,000
     Deferred license revenues...........................         52,000 
     Net operating loss carryforward.....................      1,847,000
                                                             -------------
       Total deferred tax assets.........................      1,958,000       
     Valuation allowance for deferred tax assets.........     (1,958,000)   
                                                             -------------
       Net deferred tax assets...........................     $   ----
                                                             =============

     The Company had a valuation  allowance  for deferred tax assets of $406,000
at December 31, 1997. As a result of losses from operations through December 31,
1998,  the Company has available a net operating  loss  carryforward  ("NOL") of
approximately  $4,714,000  for Federal income tax purposes that expires in years
through 2018.

     In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some  portion or all of the deferred tax
assets will not be realized.  The ultimate realization of deferred tax assets is
dependent  upon the  generation  of future  taxable  income during the period in
which the NOL can be utilized and the temporary  differences  become deductible.
Since the  Company has  incurred  losses in  previous  years and it  anticipates
additional losses in 1999, the Company has established a valuation allowance for
deferred tax assets at December 31, 1998. 

                                      F-13
<PAGE>

                       Frisby Technologies, Inc. Notes to
                        Financial Statements (continued)


     Significant  components  of the  income  tax  provision  for the year ended
December 31, 1997 is as follows:


         Deferred:
            Federal..........................$36,000
            State............................  8,792
                                             -------  
         Total...............................$44,792
                                             =======

     The income tax benefit  differs  from the amounts  computed by applying the
statutory United States Federal income tax rate as a result of the following:

<TABLE>
<CAPTION>


                                                                                      Year Ended
                                                                                     December 31,
                                                                             1998                 1997
                                                                          -----------         ----------
<S>                                                                       <C>                 <C>  


Benefit for Federal income taxes at the statutory rate............      $  (1,332,339)         $(328,163)
State income taxes, net of Federal income tax benefit.............           (134,229)           (33,061)
Permanent differences.............................................             (8,759)             ----  
Other.............................................................            (19,326)               214 
Losses not currently deductible...................................          1,494,653            405,802
                                                                         -------------          --------
                                                                        $       --             $  44,792
                                                                        ==============         =========

</TABLE>


10.  Related Party Transactions

     (a)  Frisby   Aerospace,   Inc.   ("Frisby   Aerospace"),   certain  former
stockholders of which were also stockholders of the Company, charged the Company
for space and related services.  These charges, which were non-interest bearing,
were based upon  estimates  of square  footage  used for  facilities  and actual
expenses  incurred  by Frisby  Aerospace  on behalf of the  Company.  Management
believes  that  such  allocations  were  reasonable.  These  charges  aggregated
approximately  $36,000 and $57,000  for the years  ended  December  31, 1998 and
1997,  respectively,  and were  included  in cost of  sales in the  accompanying
statements of operations.  In addition, during the year ended December 31, 1997,
Frisby  Aerospace  provided  the Company with  certain  facilities,  accounting,
clerical and office services without charge. The value of such services were not
deemed  material and,  accordingly,  have not been recorded in the  accompanying
financial statements.

                                      F-14
<PAGE>

                            Frisby Technologies, Inc.
                    Notes to Financial Statements (continued)


     A portion of the proceeds  received from a private  placement  (see Note 7)
was used to repay the amounts  owed to Frisby  Aerospace in full on December 30,
1997.

     (b) The Company has a  receivable  at  December  31, 1998 of  approximately
$94,000 from a  not-for-profit  organization of which the Company's  chairman is
its chairman.  The receivable  represents  management time billed by the Company
under an agreement  between the parties and the reimbursement of direct expenses
incurred  by the  Company  on behalf of this  organization.  These  amounts  are
subject to review and audit by a local  governmental  agency and are believed to
be reasonable and collectible.

11.  License Arrangements and Other Commitments

     (a) The Company signed an Exclusive  License Agreement (the "TRDC License")
in 1995 with a research  and  development  corporation  which  holds  innovative
proprietary technology in microencapsulated and thermal management  technologies
and with which the  Company  had an  existing  agreement  since  1991.  The TRDC
License  gives  the  Company  the  exclusive  worldwide  right  to  develop  and
commercialize  this technology with respect to certain  applications in exchange
for royalties that range from 1% to 5% of product sales revenue and 12.5% to 50%
of license fees and royalty  revenues,  as defined.  Minimum annual payments are
required in accordance with the TRDC License and are payable as follows:

                    1999                                  $78,000
                    2000                                  102,000
                    2001                                  126,000
                    2002 and thereafter                   150,000
                   

     The Company is expensing  such minimum annual  payments on a  straight-line
basis over the period in which such payments fluctuate.  Accordingly, the charge
was  approximately  $73,000  for each of the years ended  December  31, 1998 and
1997.

                                      F-15
<PAGE>
                           Frisby Technologies, Inc.
                   Notes to Financial Statements (continued)

     (b) The  rights to the TRDC  Technology  relating  to  MicroPCM  Fibers and
Fabrics were licensed by TRDC to Outlast Technologies, Inc. ("Outlast") prior to
the Company  obtaining  the TRDC  License.  In order to expand its rights in the
TRDC  Technology,  in January 1998,  the Company  entered into an agreement with
Outlast,  which expands the rights of the Company to include the  combination of
the  Company's  products  with  fibers  and  fabrics.  Under  the  terms  of the
agreement,  the Company paid Outlast  $100,000 as a license  payment  related to
periods prior to the execution of the agreement and such amount has been charged
to cost of sales  for the  year  ended  December  31,  1997.  In  addition,  the
agreement  provides for the Company to meet minimum annual  payments of $250,000
to $600,000 per year from 1999  through  2002,  provided  the Company  elects to
maintain  the  exclusivity  granted by the  license.  The Company  expensed  the
minimum  annual  payment of  $150,000  in 1998.  If  subsequent  to the  initial
licensing  period the Company  elects to extend the  exclusivity  granted by the
license,  the  minimum  annual  payment  for the five years  thereafter  will be
$1,000,000.

     (c) In September  1998,  the Company  entered  into an  agreement  with the
inventor  of  the  technology  used  by  the  Company,   Triangle  Research  and
Development  Corporation ("TRDC"), that reduced the Company's royalty rates from
those described in (a) above. Additionally, the Company has been assigned TRDC's
right to their  original  license  agreement  for  fabrics  with  Outlast.  This
assignment  will result in the Company  receiving  royalty  income from  Outlast
subject to certain payback to TRDC. As consideration, the Company has given TRDC
a combination of cash, stock options and a put agreement.

     (d) The  Company  and  its  Thermasorb(R)  supplier  have  entered  into an
Memorandum of Understanding for a long-term supply agreement that provides firm,
fixed  pricing  for  all  of  the   Company's   anticipated   requirements   for
Thermasorb(R)  additives.  The agreement  includes annual purchase  requirements
over the  five-year  term and  subjects  the  Company  to a maximum  penalty  of
$2,500,000 if no future purchases are made.

     (e) In February 1999, the Company entered into an operating lease agreement
with an unrelated entity for a facility in North Carolina. The lease term is for
12 years and monthly  payments are expected to commence in September  1999. This
lease includes scheduled rent escalations  throughout the lease term, which will
be expensed on a  straight-line  basis over the lease term. The Company has also
entered into several operating leases for computer  equipment.  Rent expense was
approximately  $89,000 and $43,000  for the years  ended  December  31, 1998 and
1997, respectively. Future minimum payments under these leases are as follows:

                1999                    $   119,000
                2000                        204,000
                2001                        180,000
                2002                        175,000
                2003                        182,000
             Thereafter                   1,478,000
                               --------------------
                                        $ 2,338,000
                               ====================

     Upon  execution of the North  Carolina  lease,  the Company will receive an
equity interest in the lessor,  which vests after the twelve-year  lease period.
Notwithstanding  the  equity  interest,  the  Company  believes  that the rental
payments represent an arms-length price for the lease. 

                                      F-16
<PAGE>

                           Frisby Technologies, Inc.
                   Notes to Financial Statements (continued)


12.  Retirement Plan

     All eligible  employees of the Company had been permitted to participate in
a 401(k)/Profit  Sharing Plan (the "Plan") adopted  effective January 1, 1997 by
Frisby  Aerospace  for  employees  of both  companies.  The Plan is funded  from
contributions  by  employees  for their own account and does not provide for any
mandatory or matching contributions by the Company. All employees of the Company
on the effective date of the Plan immediately  became eligible.  An employee who
became  employed  after January 1, 1997 becomes  entitled to  participate in the
Plan after the  completion  of six months of service  and the  attainment  of 21
years of age.  Under the Plan,  participants  are permitted to  contribute  from
their  compensation  any  amount up to the lesser of 20% of their  annual  gross
salary or the maximum deferral allowed under the Internal Revenue Code.

     In April 1998,  the  contributions  to the Plan were  suspended  due to the
pending transfer of the assets attributable to the Frisby Aerospace's  employees
as a result of the sale of Frisby  Aerospace  to an unrelated  third  party.  In
October 1998,  the Plan was amended to only include the Company's  employees and
to also establish a Company matching contribution. The Company currently matches
50% of the  employee's  first 6%  pre-tax  contribution.  The  Company  matching
contribution was approximately $7,300 for the year ended December 31, 1998.

     The Company is entitled to also make optional profit sharing  contributions
at its  discretion.  During the years  ended  December  31,  1998 and 1997,  the
Company did not make any profit sharing contributions to the Plan.

                                      F-17