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


                                   FORM 10-K
 
(Mark One)
 
[X]     ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
        ACT OF 1934 
        For the fiscal year ended January 3, 1998 .
        or
 
[ ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934
        For the transition period from ______________ to ____________.
 
                        Commission File Number 0-22561

                                 JETFAX, INC.

            (Exact name of Registrant as specified in its charter)


              Delaware                                       77-0182451
    (State or other jurisdiction of                       (I.R.S. Employer
     incorporation or Organization)                      Identification No.)


                1378 Willow Road, Menlo Park, California 94025
             (Address of principal executive offices)  (Zip Code)


      Registrant's telephone number, including area code: (650) 324-0600

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  Common Stock, $.01
                                                                par value


   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes [X]   No [ ]

   Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [ ]

   As of March 23, 1998, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was approximately $38,491,905 based upon the
closing sales price of the Common Stock as reported on the Nasdaq National
Market on such date.  Shares of Common Stock held by officers, directors and
holders of more than ten percent of the outstanding Common Stock have been
excluded from this calculation because such persons may be deemed to be
affiliates.  The determination of affiliate status is not necessarily a
conclusive determination for other purposes.

As of March 23, 1998, the Registrant had outstanding 11,742,238 shares of Common
Stock.
                           ________________________

                     DOCUMENTS INCORPORATED BY REFERENCE:

   Portions of the following documents are incorporated by reference in this
report: Registrant's Proxy Statement for its 1998 Annual Meeting of Stockholders
which will be filed with the Securities and Exchange Commission no later than
120 days after January 3, 1998. (Part III).


   This Report on Form 10-K includes 59pages with the Index to Exhibits located
on pages 33 to 35.
<PAGE>
 
                                 JETFAX, INC.
                                   INDEX TO
                          ANNUAL REPORT ON FORM 10-K
                        FOR YEAR ENDED JANUARY 3, 1998



<TABLE>
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                                                                        Page
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<S>        <C>                                                          <C>
                                    PART I

 Item 1    Business....................................................   1
 Item 2    Properties..................................................   9
 Item 3    Legal Proceedings...........................................   9
 Item 4    Submission of Matters to a Vote of Security Holders.........   9

                                    PART II

 Item 5    Market for the Registrant's Common Equity and
           Related Stockholder Matters.................................  10
 Item 6    Selected Financial Data.....................................  12
 Item 7    Management's Discussion and Analysis of Financial
           Condition and Results of Operations.........................  13
 Item 8    Financial Statements and Supplementary Data.................  29
 Item 9    Changes in and Disagreements with Accountants on
           Accounting and Financial Disclosure.........................  29

                                    PART III

 Item 10   Directors and Executive Officers of the Registrant..........  30
 Item 11   Executive Compensation......................................  31
 Item 12   Security Ownership of Certain Beneficial Owners
           and Management..............................................  31
 Item 13   Certain Relationships and Related Transactions..............  31

                                    PART IV

 Item 14   Exhibits, Financial Statement Schedules, and Reports
           on Form 8-K.................................................  32
 Signatures............................................................  55

</TABLE>
 
<PAGE>
 
                                    PART I

ITEM 1.  BUSINESS

OVERVIEW

  JetFax, Inc. is a leading developer and provider of integrated embedded system
technology, branded products and desktop software solutions for the
multifunction product ("MFP") market, which consists of electronic office
devices that combine print, fax, copy and scan capabilities in a single unit.
The Company focuses on two distinct segments of the MFP market, the small
office/home office ("SOHO") segment and the corporate segment.

  The Company's embedded system technology is made up of proprietary ASICs,
software and firmware that reside on a modular controller circuit board (an
"embedded system"). This technology provides the intelligence of a MFP and
coordinates, controls and optimizes a MFP's printing, faxing, copying and
scanning operations. JetFax licenses and manufactures its embedded system and
desktop software for a range of MFP solutions sold under the JetFax brand name
and the brand names of its OEM customers. The Company believes its embedded
system technology and desktop software enable OEMs to offer more competitive
products with improved price/performance, shortened development cycles and
reduced development and product costs. The Company currently licenses its
embedded system technology or software to 25 licensees worldwide, including
Hewlett-Packard, Oki Data, and Samsung.

  Since its inception in 1988, the majority of the Company's revenues have been
generated from sales of JetFax branded products and consumables, including the
Series M900, the Company's current line of branded products introduced in
September 1997. The Company believes that it offers the most advanced and
innovative MFP solutions currently available in its product class. For example,
the JetFax M5, the Company's branded product preceding the Series M900, was the
first MFP to support two telephone lines for simultaneous receiving and sending
of faxes, and the Company was one of the first to market a MFP with a high speed
33.6 Kbps modem.

  The Company believes its JetSuite software will define a new category of all-
in-one software for MFPs that will replace the piecemeal software components
historically bundled by MFP vendors. As a result, corporate and SOHO workers can
increase productivity and realize substantial time and cost savings relative to
traditional office protocols and equipment usage. The Company's JetSuite desktop
software can be sold on a stand-alone basis or bundled with the JetFax embedded
system to provide a complete, integrated hardware and software solution.
JetSuite is currently bundled with products from Hewlett-Packard and Oki Data.
With the merger of DocuMagix, Inc. in December 1997, the Company also offers
PaperMaster electronic file cabinet software through bundling with OEM hardware
products, as well as in the retail software market. The Company additionally
offers JetPCL software, which provides high quality conversion of documents
encoded in Hewlett-Packard's Printer Control Language (''PCL''), the industry
standard.

PRODUCTS

  JetFax offers the following products and solutions to its OEMs and other
customers:

  JetFax Branded Products and Related Consumables.   JetFax develops,
manufactures and markets a high quality MFP under the JetFax brand name. For
this branded solution, JetFax procures an integrated printing and scanning
engine and integrates its embedded system technology with the engine at its
facility.

  The Company's current branded MFP is the Series M900, which the Company began
shipping commercially in September 1997. The Series M900 offers the
functionality of a high-volume, full-featured plain paper fax machine in
addition to its multifunction print, copy and scan capabilities. The Series M900
is based on a LED printer engine, which uses the same drum and toner print
technology as a laser printer ("laser/LED"). The Series M900 is comprised of
four models (M900, M910, M920 and M930) which include features such as a two-
line capability, which allows simultaneous receiving and sending of faxes, 

                                       1
<PAGE>
 
and a high-speed 33.6 Kbps modem for single-line models, which reduces the
transmission time of a typical fax. The models M920 and M930 are field
upgradeable from the base M910 unit. List prices of the Series M900 range from
approximately $2,000 to more than $3,500 depending on the options included.

  The Company also sells consumables for its products, including toner
cartridges, imaging drums and inkjet cartridges. These consumables, which need
to be purchased periodically by customers over the life of the product, are
typically procured by the Company from the manufacturer of the printing engine
and are labeled with the JetFax brand name. Certain consumables not procured
from the Company or its suppliers are not easily used with JetFax products or do
not provide optimal functionality. Revenues from sales of consumables
represented 17%, 14% and 14% of the Company's total revenues in the year ended
December 31, 1997, the nine months ended December 31, 1996 and the year ended
March 31, 1996, respectively. The Company believes that such revenues will
increase as the installed base of JetFax branded MFPs grows.

  Embedded System Technology.   JetFax develops and licenses its embedded system
technology for manufacture and integration by its OEM customers into their MFPs.
This technology includes a complete embedded system design, modified to meet the
OEMs' specifications and requirements. Such hardware and software modifications
are performed by JetFax and typically include changes to the printer and scanner
interfaces and to the control panel and user interface. The Company generally
receives development fees in return for such modifications, in addition to
prepaid and per unit royalties for the license. The Company's embedded system
technology has been customized and licensed for use in the dex 855 currently
manufactured by Samsung and the Hewlett-Packard LaserJet 3100 introduced in
March 1998, as well as the previously sold Minoltafax 1000, the Xerox 3006, and
Xerox WorkCenter 250.

  The Company offers completely assembled embedded system circuit boards to its
OEMs as well as systems integration services. An OEM can choose to procure the
embedded system boards directly from JetFax for integration at the OEM's
facility or the OEM can ship its printing/scanning engine to JetFax for final
assembly and testing. The Company believes its ability to offer a variety of
manufacturing and systems integration capabilities provides OEMs with a means to
reduce development costs and time-to-market.

  JetSuite Software.   The Company believes its JetSuite software will define a
new category of all-in-one software for MFPs that will replace the piecemeal
software components historically bundled by MFP vendors. JetSuite software is
designed to provide a comprehensive software solution for users of MFPs in a
Microsoft Windows (3.1, 95, NT) environment. JetSuite is installed on a user's
PC and combines low-level device drivers for printing, faxing, copying and
scanning with a visual "desktop" application that allows a user to organize,
convert and manage documents created or received using a MFP. Using JetSuite, a
user can create a self-viewing, portable version of any document, whether
"printed" electronically, captured from an Internet Web page, scanned or
faxed. Such a portable document can then be e-mailed and viewed without
requiring the recipient to have a specific software application or viewer
installed on their system. All of the document's original formatting, layout,
colors and look are maintained in a portable JetSuite document. JetSuite fully
supports both fax-based and e-mail-based document transmission and provides
links to popular third party software applications, such as word processors and
graphics programs, allowing users to move documents in and out of the JetSuite
desktop easily. The Company offers JetSuite to OEMs for use with the OEMs'
embedded system or bundled with JetFax's embedded system technology, as well as
an option with JetFax branded MFPs.

  PaperMaster Software.   PaperMaster began shipping in 1994 as one of the
leading retail packages of personal document management software.  Since that
time, the product also shipped through OEM bundles with a number of scanner
products from several of the leading scanner manufacturers including Logitech,
Storm, and Microtek.  PaperMaster uses a file cabinet metaphor as its user
interface, allowing one to unlock and open various file drawers and folders and
insert a variety of document types.  The software indexes documents, allowing
users to search and retrieve documents based on text strings.  Also included are
web links to allow users to easily save and retrieve web-based HTML documents.
Subsequent to the 1997 fiscal year end, Hewlett-Packard announced that it is
bundling PaperMaster with its new CD-Writer Plus storage system.  The CD-Writer
allows a PaperMaster user to "publish" a file cabinet containing documents of
all types to a CD. This capability extends the market for PaperMaster to the
storage arena, opening a new market segment for PaperMaster and broadening the
product's scope beyond that for traditional desktop scanners.

                                       2
<PAGE>
 
  JetPCL Software.   Hewlett-Packard's Printer Control Language (''PCL'') is the
industry standard method of delivering commands from a PC software package to a
printer. The Company's JetPCL software is a PCL-emulator that provides high-
quality conversion of documents encoded in PCL into various image formats,
including fax. JetPCL is currently a leading PCL conversion package for
suppliers of standalone fax and network fax server products and the Company has
licensed JetPCL to more than 25 OEM customers. JetPCL also supports host-based
conversion of PCL for print devices, allowing lower cost printers to support
legacy DOS applications that generate PCL output. JetPCL is included in the
Company's JetSuite software, providing PCL capability for DOS-based printing on
MFPs. JetPCL supports PCL versions 4, 5 and 5E and is available on the following
platforms: DOS, DOS Extender, OS/2, NetWare NLM, Microsoft Windows 3.1,
Microsoft Windows 95, Microsoft Windows NT and major UNIX platforms.

TECHNOLOGY

  Embedded System Technology.    JetFax's third generation embedded system
technology is based on the Company's application specific integrated circuit
(''ASIC'') semiconductor designs integrated with a Motorola 680X0
microprocessor. The specialized ASICs perform most of the heavy computational
tasks, allowing the single 680X0 microprocessor to drive the embedded system and
service all of the functions -- printing, faxing, copying and scanning --
required by a MFP. The ASICs perform a variety of imaging functions and provide
high-speed data paths for large image data files that are quickly moving through
the various processes in the system. The ASIC imaging functions include error
diffusion scanning, edge enhancement, background compensation, scaling and print
smoothing. A high-speed image bus and numerous direct memory access ("DMA")
channels are also provided by the ASICs to optimize system performance and
provide easy access to a specialized compression/decompression imaging
processor. The Company believes it has developed an economical hardware design
with enough modularity built in to support a range of products and speeds,
including such features as high speed 33.6 Kbps modems, quick scanning of under
three seconds per page and extensive battery-protected memory.

  The firmware in JetFax's embedded system is centered on the Company's task-
swapping, real-time operating system. The operating system rotates among the
various functions such as printing, faxing, copying or scanning, allocating
enough processing time for each task to prevent any significant performance
deterioration when swapping among other tasks. The majority of firmware in the
Company's embedded system, including the operating system, is written in
assembly code, which the Company believes provides greater efficiency and
maximum use of available processing power. The Company constantly evaluates the
level of assembly coding used in its systems and incorporates higher-level
languages in those areas where the use of such languages may result in greater
efficiencies.

  Software Technology.   The foundation of JetSuite, is its portable document
technology which replicates documents for storage, transmission and viewing.
JetSuite portable documents use a highly compressed print-imaging format
containing a combination of text, fonts, color, graphic elements (such as lines
and circles) and bitmaps. This portable document technology allows a single
document data base to handle both hard copy images from scanned or faxed
documents and electronically created documents. JetSuite portable documents
(.JSD files) can easily be shared with others by using a freely distributable
compact version of the JetSuite viewer that combines with a .JSD file to create
a self-viewing document. Self-viewing documents can be transmitted to other PC
users through standard e-mail without requiring the recipient to have a
particular viewer or software application. JetSuite also provides a range of
imaging functionality for fast viewing, zooming and panning, as well as document
markup and cleanup functionality. The JetSuite scan function includes support of
the industry standard TWAIN interface, allowing users to scan documents directly
to other scanning applications. In its fax application, JetSuite includes full
functionality for both sending and receiving faxes, a phone book for managing
names, addresses, phone numbers and fax groups, and an inbox and outbox for
managing faxes. JetSuite also includes integrated third party OCR technology,
which allows users to convert scanned text documents to editable text files in a
variety of different word processor and spreadsheet formats.

  PaperMaster Software.   Due to its lengthy product history, PaperMaster
contains a number of key 

                                       3
<PAGE>
 
technologies that distinguish it from its competition. As new documents are
added to its file cabinets, documents are automatically indexed to a very
efficient and fast search and retrieval system. Furthermore, documents can be
automatically placed in the proper file cabinet and folder based on certain
criteria that are selected for certain files and folders. PaperMaster also
includes plug-ins and browser links that make it very easy to store, print and
file documents from the Internet. With its "publish" feature, PaperMaster now
allows users to write an entire file cabinet to external storage devices while
embedding a viewer and search engine for locating the documents within the file
cabinet. All of this is achieved through an intuitive file cabinet user
interface that closely resembles the operations that a user would perform with
standard hard copy documents.


CUSTOMERS

  The Company's customers include office equipment dealers and distributors who
resell the Company's branded MFPs, options and consumables, as well as OEMs that
license the Company's embedded system technology and software in conjunction
with the manufacture and distribution of MFPs.

  JetFax Branded Products.   In the United States and Canada, the Company
distributes JetFax branded products, options and consumables through office
equipment dealers, primarily through IKON and dealers associated with BTA. In
the year ended December 31, 1997,  the nine months ended December 31, 1996 and
fiscal year ended March 31, 1996 revenues recorded by the Company from dealers
associated with IKON represented 19%, 18% and 11%, respectively, of the
Company's total revenues. The Company also distributes its products through
regional distributors. As of December 31, 1997, the Company had approximately
200 dealer sales locations in the United States and Canada. The Company sells
its branded products internationally through office equipment dealers. Sales to
Messerli, one of the Company's office equipment dealers located in Switzerland,
accounted for 3%, 3% and 10% of the Company's total revenues in the year ended
December 31, 1997, the nine months ended December 31, 1996 and the fiscal year
ended March 31, 1996, respectively.

  OEM Relationships and JetSuite and PaperMaster Software.   The Company
receives license fees and development fees for the Company's embedded system
technology and desktop software from a number of manufacturers of MFPs. JetFax
currently licenses embedded system technology or desktop software to 25
companies and has OEM relationships with Hewlett-Packard, Oki Data, and Samsung.

  Hewlett-Packard Company.   Effective in January 1997, the Company entered into
a development and license agreement with Hewlett-Packard for the inclusion of
the JetFax embedded system technology and JetSuite software in a Hewlett-Packard
product. The development was completed in early 1998 and the HP LaserJet 3100
was launched in March 1998.

  Oki Data Corporation.   In September 1996, the Company entered into a license
agreement with Oki Data for the inclusion of JetSuite software with a number of
Oki Data MFPs which are currently in the market.

  Samsung Electronics Corporation.   In June 1995, the Company entered into a
development agreement with Samsung for the use of the Company's third generation
embedded system technology in a new laser multifunction product. This product is
marketed by Danka Corporation in the United States as the dex 855.


SALES AND MARKETING

  The Company markets and sells its products worldwide to OEMs, dealers and
distributors. The Company maintains separate sales forces for its branded
products and OEM/licensing businesses, and its marketing department supports all
aspects of the Company's worldwide business. As of December 31, 1997, the sales
and marketing department (including order entry, technology support and customer
service personnel) consisted of 33 employees and contractors.

  OEM Relationships.   The Company licenses its embedded system technology,
JetSuite software, PaperMaster software and JetPCL software to OEMs. The Company
continues to enhance its relationships

                                       4
<PAGE>
 
with existing OEMs and seeks to obtain new OEM customers through dedicated
account management and marketing programs. The Company works closely with OEM
accounts to define product requirements, create development plans and manage
development programs. The marketing group promotes JetFax as a leading provider
to OEMs of MFP solutions through a combination of public relations and press
coverage, exhibits and presentations at trade shows, product brochures and other
marketing promotions.

  JetFax Branded Products.   The Company's branded products are primarily sold
in the United States through office equipment dealers. The Company's sales force
provides dealer training programs, sales incentive programs which include cash
incentives, group trips, volume discounts and market development funds.
Marketing activities to promote JetFax branded products include direct mail,
print advertising and an ongoing public relations program.

  Software.   The Company's software marketing strategy is to license both
JetSuite and PaperMaster software for bundling with multiple OEM products. In
addition, the Company intends to promote software upgrades and add-on software
products in a number of ways, including in-box flyers, software installation and
reminder screens, mailings to registered users, website advertisements and co-
promotions with OEMs.

  The Company's international sales efforts are focused on Western Europe,
Australia and New Zealand. The Company's branded products are sold
internationally through office equipment distributors in Australia, Canada, the
Netherlands, New Zealand, Scandinavia, Switzerland and the United Kingdom. The
Company also sells directly to office equipment dealers in the United Kingdom
and through a subsidiary, JetFax GmbH, in Germany. The Company has sales,
service or support personnel located in Germany, the Netherlands, Ireland and
the United Kingdom. International marketing efforts are focused on providing
country specific marketing materials, sales incentive programs for dealers and
participation in trade shows.


RESEARCH AND DEVELOPMENT

  JetFax's principal research and development activities are located at the
Company's headquarters in Menlo Park, California and at its software
applications division located in Santa Barbara, California. As of December 31,
1997, the Company's research and development department consisted of 45
employees. The primary activities of these employees are new product
development, enhancement of existing products, product testing and technical
documentation.

  The Company's research and development efforts focus on ongoing development of
both the Company's MFP embedded system technology and desktop software. The
Company is in the process of developing future MFPs with both improved feature
sets and reduced manufacturing costs. These improvements are expected to include
increased printing speed, additional base memory, higher speed scanning, simpler
PC connectivity and advanced compression algorithms that will decrease fax
transmission cost while increasing memory storage. The Company believes that its
branded product development efforts provide the Company with a competitive
advantage for its embedded system technology and software by defining the needs
for new products, guiding future enhancements and testing new implementations.
By introducing advanced new features in the corporate market, the Company
believes that it is able to maintain its technology lead while further refining
such features before introducing them to its OEMs.


INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

  The Company's success is heavily dependent upon its proprietary technology. To
protect its proprietary rights, the Company relies on a combination of
copyright, trade secret and trademark laws and nondisclosure and other
contractual restrictions. The Company has no patents or patent applications
pending. As part of its confidentiality procedures, the Company generally enters
into nondisclosure agreements with its employees, consultants, OEMs and
strategic partners and limits access to and distribution of its designs,
software and other proprietary information. Despite these efforts, the Company
may be unable to effectively protect its proprietary rights and, in any event,
enforcement of the Company's proprietary rights may be expensive. The Company's
source code also is protected as a trade secret. 

                                       5
<PAGE>
 
However, the Company from time to time licenses portions of its source code and
designs to OEMs and also places such source code and designs in escrow to be
released to OEMs in certain circumstances, which subjects the Company to the
risk of unauthorized use or misappropriation despite the contractual terms
restricting disclosure. In addition, it may be possible for unauthorized third
parties to copy the Company's products or to reverse engineer or obtain and use
the Company's proprietary information. Further, the laws of some foreign
countries do not protect the Company's proprietary rights to the same extent as
do the laws of the United States. There can be no assurance that the Company's
means of protecting its proprietary rights will be adequate or that the
Company's competitors will not independently develop similar technology.

  As the number of patents, copyrights, trademarks and other intellectual
property rights in the Company's industry increases, products based on the
Company's technology increasingly may become the subject of infringement claims.
The Company has in the past received communications from third parties asserting
that the Company's trademarks or products infringe the proprietary rights of
third parties or seeking indemnification against such infringement. The Company
is generally required to agree to indemnify its OEMs from third party claims
asserting such infringement. There can be no assurance that third parties will
not assert infringement claims against the Company or its OEMs in the future.
Any such claims, regardless of merit, could be time consuming, result in costly
litigation, cause product shipment delays or require the Company to enter into
royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company, or at all,
which could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, the Company may initiate
claims or litigation against third parties for infringement of the Company's
proprietary rights or to establish the validity of the Company's proprietary
rights. Litigation to determine the validity of any claims, whether or not such
litigation is determined in favor of the Company, could result in significant
expense to the Company and divert the efforts of the Company's technical and
management personnel from daily operations. In addition, the Company may lack
sufficient resources to initiate a meritorious claim. In the event of an adverse
ruling in any litigation regarding intellectual property, the Company may be
required to pay substantial damages, discontinue the use and sale of infringing
products, expend significant resources to develop non-infringing technology or
obtain licenses to infringing or substituted technology. The failure of the
Company to develop, or license on acceptable terms, a substitute technology
could have a material adverse affect on the Company's business, financial
condition and results of operations.


MANUFACTURING AND OPERATIONS

  The Company manufactures its JetFax branded products for distribution to the
corporate segment of the MFP market. The Company generally outsources materials
from suppliers and performs final assembly and testing at its main facility in
Menlo Park, California. As of December 31, 1997, the Company's manufacturing and
operations department consisted of 24 employees.

  The Series M900 is the Company's current product line of branded MFPs. The
major components of the Series M900 products are the print engine, the scanner,
the user interface and the multifunction embedded system technology and modem
electronics, all of which are outsourced. The JetFax embedded system and modem
assemblies are built to specification by an external printer circuit board
assembler. Final product assembly at the Company's headquarters consists of
integrating the components on a progressive assembly line. Each Series M900
product is tested at the Company by an internal self test for a period of not
less than 24 hours, followed by a series of functional and margin tests to help
ensure reliable performance at the customer's site. The Company's final assembly
and test facilities have recently been improved to allow for better material
flow, process definition and production efficiency.

  The Company relies on various suppliers of components for its products. Many
of these components are standard and generally available from multiple sources.
However, there can be no assurance that alternative sources of such components
will be available at acceptable prices or in a timely manner. Any shortage or
interruption in the supply of any of the components used in the Company's
products, or the inability of the Company to procure these components from
alternate sources on acceptable terms, would have a material adverse effect on
the Company's business and financial condition and results of operations. The
Company

                                       6
<PAGE>
 
generally buys components under purchase orders and does not have long-term
agreements with its suppliers. Although alternate suppliers may be readily
available for some of these components, for other components it could take an
undetermined amount of time to qualify a replacement supplier and order and
receive replacement components. The Company does not always maintain sufficient
inventory to allow it to fill customer orders without interruption during the
time that would be required to obtain an adequate supply of single sourced
components. Although the Company believes it could develop other sources for
single source components, no alternative source currently exists and the process
could take several months or longer. Therefore, any interruption in the supply
of such components could have a material adverse effect on the Company's
business, financial condition and results of operations.

  Many of the components used in the Company's products are purchased from
suppliers located outside the United States. Foreign manufacturing facilities
are subject to risk of changes in governmental policies, imposition of tariffs
and import restrictions and other factors beyond the Company's control. There
can be no assurance that United States or foreign trading policies will not
restrict the availability of components or increase their cost. Any significant
increase in component prices or decrease in component availability could have a
material adverse effect on the Company's business, financial condition and
results of operations.

  Certain components used in the Company's products are available only from one
source. The Company is dependent on Oki America, as the supplier of major
components, including the printer engine, of the Series M900. Oki America is
also a competitor of the Company. The Company is also dependent on AMI to
provide unique ASICs incorporating the Company's imaging and logic circuitry,
Motorola to provide microprocessors, Pixel, to provide a specialized imaging
processor and Rockwell to provide modem chips. If Oki America, AMI, Motorola,
Pixel or Rockwell were to limit or reduce the sale of such components to the
Company, or if such suppliers were to experience financial difficulties or other
problems which prevented them from supplying the Company with the necessary
components, it would have a material adverse effect on the Company's business,
financial condition and results of operations. These sole source providers are
subject to quality and performance issues, materials shortages, excess demand,
reduction in capacity and/or other factors that may disrupt the flow of goods to
the Company or the Company's customers and thereby adversely affect the
Company's business and customer relationships. Any disruption in the Company's
sources of supply could limit or delay production or shipment of products
incorporating the Company's technology, which could have a material adverse
effect on the Company's business, financial condition and results of operations.


COMPETITION

  The market for MFPs and related technology and software is highly competitive
and characterized by continuous pressure to enhance performance, to introduce
new features and to accelerate the release of new products. The Company's
branded products compete primarily with the dominant vendors in the fax market,
all of whom have substantially greater resources than the Company and include,
among others, Canon Inc., Panasonic, a division of Matsushita Electrical
Industrial Co., Ltd., Pitney Bowes Inc., Ricoh Co. Ltd., Sharp Electronics
Corporation and Xerox. The Company also competes on the basis of vendor name and
recognition, technology and software expertise, product functionality,
development time and price.

  The Company's technology, development services and software primarily compete
with solutions developed internally by OEMs. Virtually all of the Company's OEMs
have significant investments in their existing solutions and have the
substantial resources necessary to enhance existing products and to develop
future products. These OEMs have or may develop competing multifunction
technologies and software which may be implemented into their products, thereby
replacing the Company's proposed or current technologies, eliminating a need for
the Company's services and products to these OEMs. The Company also competes
with technologies, software and development services provided in the MFP market
by other systems and software suppliers to OEMs. With respect to MFP embedded
system technologies, the Company competes with, among others, Peerless Systems
Corporation, Personal Computer Products, Inc. and Xionics Document Technologies,
Inc. With respect to desktop software, the Company competes with, among others,
Caere Corporation, Simplify Development Corporation, Smith Micro Software, Inc.,
Visioneer Inc., Wordcraft International and Xerox.

                                       7
<PAGE>
 
  As the MFP market continues to develop, the Company expects that competition
and pricing pressures will increase from OEMs, existing competitors and other
companies that may enter the Company's existing or future markets with similar
or substitute products or technologies. Software solutions may also be
introduced by competitors that are less costly or provide better performance or
functionality. The Company anticipates increasing competition for its MFPs,
technologies and software under development. Most of the Company's existing
competitors, many of its potential competitors and all of the Company's OEMs
have substantially greater financial, technical, marketing and sales resources
than the Company. In the event that price competition increases, competitive
pressures could cause the Company to reduce the price of its branded products,
to reduce the amount of royalties received on new licenses and to reduce the
fees for its development services in order to maintain existing business and
generate additional product sales and license and development revenue, which
could reduce profit margins and result in losses and a decrease in market share.
No assurances can be given as to the ability of the Company to compete favorably
with the internal development capabilities of its current and prospective OEM
customers or with other third-party vendors, and the inability to do so would
have a material adverse effect on the Company's business, financial condition
and results of operations.


BACKLOG

  The Company had essentially no backlog at either December 31, 1997 or December
31, 1996, which is in line with the normal practice in the markets in which it
operates.  The office equipment dealer channel for MFPs typically requires
shipment at time of order placement, and the Company has managed operations to
fully satisfy customer demand within each fiscal quarter.  The software business
conventionally does not have backlog, and revenues from the Company's
development programs are recognized on a percentage of completion basis.


EMPLOYEES

  As of December 31, 1997, the Company had 118 employees and 3 full-time
equivalent contractors. There is no labor union representation for any of the
Company's employees. The Company has never experienced a work stoppage, and
relations with employees are considered good. The Company hires contract
employees on an as-needed basis to meet temporary or specific needs.

                                       8
<PAGE>
 
ITEM 2.  PROPERTIES

  The Company's headquarters and principal operations are in leased facilities
totaling approximately 38,000 square feet in Menlo Park, California, and the
lease for this facility has been amended to expire in January 2003. In September
and December 1997, the Company entered into a lease for additional office and
administrative facilities in an adjacent building totaling approximately 17,000
square feet. The lease for this additional facility is coterminous with the
expiration date of the initial lease agreement and expires in January 2003.  The
Company has a month-to-month lease for approximately 2,400 square feet in Santa
Barbara, California for its software application organization. The Company
believes that suitable additional or alternative space at commercially
reasonable terms will be available in the future as required.


ITEM 3.  LEGAL PROCEEDINGS

  To the Company's knowledge, there are no pending legal proceedings which are
material to the Company or its business to which it is a party or to which any
of its properties is subject.

  In the event of an adverse ruling in any intellectual property litigation that
might arise in the future, the Company might be required to discontinue the use
of certain processes, cease the manufacture, use and sale of infringing
products, expend significant resources to develop non-infringing technology or
obtain licenses to the infringing technology. There can be no assurance,
however, that under such circumstances, a license would be available under
reasonable terms or at all. In the event of a successful claim against the
Company and the Company's failure to develop or license a substitute technology
on commercially reasonable terms, the Company's financial position and results
of operations could be adversely affected.


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

  During the fourth quarter of 1997, no matters were submitted to a vote of
security holders.

                                       9
<PAGE>
 
                                    PART II



ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

(a)  Market Information and Recent sales of Unregistered Securities

    The Company's Common Stock is traded on the Nasdaq National Market tier of
The Nasdaq Stock Market under the trading Symbol "JTFX".

    The Company completed an initial public offering of 3.5 million shares of
Common Stock (2.75 million shares offered by the Company and 0.75 million shares
offered by selling stockholders) in June 1997. The Company's Common Stock began
trading on June 11, 1997. Prior to the initial public offering, the Company's
Common Stock was not publicly traded.

    The range of daily closing prices per share for the Company's common stock
from June 11, 1997 to January 3, 1998 was:

<TABLE>
<CAPTION>

YEAR ENDED DECEMBER 31, 1997:                                   HIGH              LOW
<S>                                                       <C>               <C>
    Fourth quarter..........................................   $ 9.375            $5.188
    Third quarter...........................................   $11.000            $8.000
    Second quarter (from June 11, 1997).....................   $ 8.125            $6.875
</TABLE>

    The reported last sale price of the Company's Common Stock on the Nasdaq
National Market on March 23, 1998 was $4.75. The approximate number of holders
of record of the shares of the Company's Common Stock was 213 as of March 23,
1998.  This number does not include stockholders whose shares are held in trust
by other entities. The actual number of stockholders is greater than this number
of holders of record.  The approximate number of beneficial stockholders of the
shares of the Company's Common Stock as of March 23, 1998 was 3,202.

    The Company has authorized Common Stock of $0.01 par value and Preferred
Stock. In connection with the initial public offering, all of the convertible
preferred stock, except the Series P Redeemable Preferred Stock, and related
accrued dividends outstanding at the time of the initial public offering
automatically converted into 6,456,681 shares of Common Stock. Approximately
$2.8 million of the net proceeds were used for the mandatory redemption of the
Series P Redeemable Preferred Stock following the closing of the Company's
initial public offering in June 1997. Subsequent to the Company's initial public
offering, the Company has not issued any Preferred Stock.

    The Company has not paid any cash dividends on its capital stock. The
Company currently intends to retain its earnings to fund the development and
growth of its business and, therefore, does not anticipate paying any cash
dividends in the foreseeable future. In addition, the Company's existing credit
facilities prohibit the payment of cash or stock dividends on the Company's
capital stock without the bank's prior written consent. See Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" and Note 6 of Notes to
Consolidated Financial Statements contained in Item 14.

    During the year ended December 31, 1997, the Company did not sell any equity
securities that were not registered under the Securities Act of 1933, as
amended, except for the issuance of an aggregate of 900,000 shares of the
Company's Common Stock on December 5, 1997 which were issued to the shareholders
of 

                                       10
<PAGE>
 
DocuMagix, Inc. with and into the Company in connection with the merger of
DocuMagix, Inc. (see Note 2 of Notes to Consolidated Financial Statements). The
sales of the above securities were deemed to be exempt from registration under
the Securities Act in reliance on Rule 506 of Regulation D as transactions by an
issuer not involving a public offering. The recipients of securities in each
such transaction represented their intention to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificate and instruments issued in such transactions. All receipients had
adequate access, through their relationships with the Company, to information
about the Registrant.

(b)     Report of offering securities and use of proceeds therefrom:

In connection with its initial public offering in 1997, the Company filed a
Registration Statement on Form S-1, SEC File No. 333-23763 (the "Registration
Statement"), which was declared effective by the Commission on June 10, 1997.
The Company registered 4,025,000 shares of its Common Stock, $0.001 par value
per share.  The offering commenced on June 11, 1997 and 3,500,000 shares were
sold. The over-allotment option was not exercised and the Company deregistered
525,000 shares on July 11, 1997.  The aggregate offering price of the registered
shares was $28,000,000.  The managing underwriters of the offering were
Prudential Securities Incorporated and Cowen & Company.  The Company incurred
the following expenses in connection with the offering:

<TABLE>
<S>                                                               <C>
Underwriting discounts and commissions:...................................   $1,960,000
Other expenses:...........................................................      800,000
                                                                             ----------
Total Expenses:...........................................................   $2,760,000
                                                                             ==========
</TABLE>

All of such expenses were direct or indirect payments to others.

The net offering proceeds to the Company after deducting the total expenses
above and the proceeds to selling shareholders were approximately $19,662,000.
From June 11, 1997 to December 31, 1997, the Company used such net offering
proceeds, in direct or indirect payments to others, as follows:

<TABLE>
<S>                                                               <C>
Purchase and installment of machinery and equipment:.....................   $   468,154
Acquisition of other businesses..........................................     1,250,000
Working capital:.........................................................     7,690,209
Investment in short-term, interest-bearing obligations:..................     5,429,629
Repayment of indebtedness:...............................................     1,705,342
Redemption of Series P Preferred.........................................     2,794,000
Investment in Minority Interest..........................................       325,000
                                                                            -----------
Total....................................................................   $19,662,334
                                                                            ===========
</TABLE>
                                                                                

Each of such amounts is a reasonable estimate of the application of the net
offering proceeds.  This use of proceeds does not represent a material change in
the use of proceeds described in the prospectus of the Registration Statement.

                                       11
<PAGE>
 
ITEM 6.  SELECTED FINANCIAL DATA

  The consolidated statement of operations data set forth below for the year
ended December 31, 1997, the nine months ended December 31, 1996 and the fiscal
year ended March 31, 1996, and the consolidated balance sheet data at December
31, 1997 and 1996 are derived from the consolidated financial statements of the
Company included elsewhere in this Report on Form 10-K. The selected financial
data for the fiscal years ended March 31, 1996, 1995 and 1994 and the
consolidated balance sheet data at March 31, 1995 and 1994, have been derived
from unaudited financial statements that have been prepared on the same basis as
the audited financial statements and which, in the opinion of management,
include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the Company's results of operations. The
following financial data is qualified in its entirety by, and should be read in
conjunction with, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and notes
thereto included elsewhere in this Report on Form 10-K.

<TABLE>
<CAPTION>



                                                                              NINE MONTHS
                                                                YEAR ENDED       ENDED
                                                                DECEMBER 31,   DECEMBER 31,      FISCAL YEAR ENDED MARCH 31,
                                                                ------------  -------------   ---------------------------------
                                                                   1997          1996(1)        1996         1995        1994
                                                                ------------  -------------   ---------   ---------   ---------
                                                                               (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                               <C>           <C>           <C>           <C>          <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
  Product.......................................................   $16,281       $10,205       $11,143       $6,413       $6,086
  Software and technology license fees..........................     4,493         3,200         3,413          484           --
  Development fees..............................................     2,246         1,468           720        1,200           75
                                                                   -------       -------       -------       ------       ------
    Total revenues..............................................    23,020        14,873        15,276        8,097        6,161
                                                                   -------       -------       -------       ------       ------
Costs and expenses:
  Cost of product revenues......................................    11,886         8,441        11,102        5,249        5,486
  Cost of software and license fees.............................       770           517           587          124           --
  Research and development......................................     5,355         2,554         2,318        1,794        1,776
  Selling and marketing.........................................     6,046         5,212         5,216        1,928        1,476
  General and administrative....................................     3,031         1,726         1,652        1,632          881
  Acquisition and related expenses..............................     2,106            --            --           --           --
                                                                   -------       -------       -------       ------       ------
    Total costs and expenses....................................    29,194        18,450        20,875       10,727        9,619
                                                                   -------       -------       -------       ------       ------
 Loss from operations...........................................    (6,174)       (3,577)       (5,599)      (2,630)      (3,458)
                                                                   -------       -------       -------       ------       ------
 Interest and other income (expense), net.......................       111            --          (259)        (119)          (4)
                                                                   -------       -------       -------       ------       ------
 Loss before extraordinary item and income taxes................    (6,063)       (3,577)       (5,858)      (2,749)      (3,462)
 Provision for income taxes.....................................        96           107            35           --           --
                                                                   -------       -------       -------       ------       ------
 Loss before extraordinary item.................................    (6,159)       (3,684)       (5,893)      (2,749)      (3,462)
 Extraordinary item (2).........................................        --            --            --          349           --
                                                                   -------       -------       -------       ------       ------
 Net loss.......................................................   $(6,159)      $(3,684)      $(5,893)     $(2,400)     $(3,462)
 Series P Redeemable Preferred Stock dividends..................       (68)         (116)      =======      =======      =======
                                                                   -------       -------
 Net loss applicable to common stockholders.....................   $(6,227)      $(3,800)
                                                                   =======       =======

Net loss per share (3):
  Basic.........................................................   $ (0.61)      $ (0.46)
                                                                   =======       =======
  Diluted.......................................................   $ (0.61)      $ (0.46)
                                                                   =======       =======
Shares used in computing per share amounts:
  Basic.........................................................    10,170         8,203
                                                                   =======       =======
  Diluted.......................................................    10,170         8,203
                                                                   =======       =======
</TABLE> 
 

<TABLE>
<CAPTION>
                                                                        DECEMBER 31,                       MARCH 31,
                                                                  ----------------------      ----------------------------------
                                                                    1997         1996(1)        1996          1995        1994
                                                                  ---------     --------      ---------     --------    --------
                                                                                          (IN THOUSANDS)
<S>                                                               <C>           <C>           <C>           <C>          <C>
CONSOLIDATED BALANCE SHEET DATA:
 Working capital.................................................  $12,814       $   542       $ 4,978       $(2,772)     $(4,970)
 Total assets....................................................   18,856         7,092        12,031         3,849        2,700
 Long-term note payable, less current portion....................       --           198            --         2,372            4
 Redeemable preferred stock......................................       --         2,726         2,610            --           --
 Total stockholders' equity (deficit)............................   15,271          (861)        2,708        (4,779)      (4,710)
</TABLE>
____________________                                       
(1)  Effective December 31, 1996, the Company changed its fiscal year end from
     March 31 to a 52-53 week reporting year ending on the first Saturday on or
     after December 31. The 40-week period from April 1, 1996 to January 4, 1997
     is referred to herein as the nine months ended December 31, 1996. For
     presentation purposes, the Company refers to its reporting year ended
     January 3, 1998 as ending on December 31, 1997 and its reporting year ended
     January 4, 1997 as ending on December 31, 1996.

(2)  Represents a gain on exchange of stockholder debt and receivables for notes
     payable.

(3)  For an explanation of the determination of the number of shares used in
     computing net loss per share, see Note 1 of Notes to Consolidated Financial
     Statements. Net loss per share for fiscal March 31, 1996 and earlier
     periods has not been presented because of the significant change in the
     Company's capital structure from the conversion of preferred stock in
     connection with the Company's initial public offering in June 1997. The
     common stock equivalents from the conversion of the preferred stock would
     be antidilutive for such loss years.

                                       12
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS


OVERVIEW

  The statements contained in this Report on Form 10-K that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 (the "Securities Act") and Section 21E of the
Securities Exchange Act of 1934 (the "Exchange Act"), including statements
regarding the Company's expectations, hopes, intentions or strategies regarding
the future. When used herein, the words "may," "will," "expect," "anticipate,"
"continue," "estimate," "project," "intend" and similar expressions are intended
to identify forward-looking statements within the meaning of the Securities Act
and the Exchange Act. Forward-looking statements include: statements regarding
events, conditions and financial trends that may affect the Company's future
plans of operations, business strategy, results of operations and financial
position. All forward-looking statements included in this document are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statements. Investors are
cautioned that any forward-looking statements are not guarantees of future
performance and are subject to risks and uncertainties and that actual results
may differ materially from those included within the forward-looking statements
as a result of various factors. Factors that could cause or contribute to such
differences include, but are not limited to, those described below, under the
heading "Factors That May Affect Operating Results" and elsewhere in this Report
on Form 10-K.

  JetFax, Inc. is a leading developer and provider of integrated embedded system
technology, branded products and desktop software solutions for the MFP market,
which consists of electronic office devices that combine print, fax, copy and
scan capabilities in a single unit. The Company was incorporated in August 1988
and since that time has engaged in the development, manufacture and sale of its
branded MFPs, including the 8000-D, the JetFax 4, the JetFax M5, and the current
offering, the Series M900.  The Company has also entered into agreements with a
number of OEMs for the customization and integration of the Company's embedded
system technology and desktop software in OEMs' MFPs.  The desktop software
includes JetSuite, which resulted from the Company's July 1996 purchase of
substantially all of the assets of the Crandell Group, Inc., and PaperMaster,
which was acquired in a December 1997 pooling of interests transaction with
DocuMagix, Inc.

  Effective December 31, 1996, the Company changed its fiscal year end from
March 31 to a 52-53 week reporting year ending on the first Saturday on or
following December 31. For presentation purposes, the Company refers to its
reporting year ended January 3, 1998 as ending on December 31, 1997 and its
reporting year ended January 4, 1997 as ending on December 31, 1996. The most
recent fiscal year discussion and analysis is based on the twelve months ended
December 31, 1997 compared to the twelve months ended December 31, 1996.

  Revenues increased to $23.0 million for the twelve months ended December 31,
1997 from $20.4 million for the twelve months ended December 31, 1996 and $15.3
million for the fiscal year ended March 31, 1996.  In June 1997, the Company
completed an initial public offering of 3.5 million shares (2.75 million shares
offered by the Company and 0.75 million shares offered by selling shareholders)
at $8.00 per share with net proceeds to the Company of $19.7 million.  At
December 31, 1997, the Company had an accumulated deficit of $27.7 million and
total stockholders' equity of $15.3 million.

  The Company's revenues are derived from three sources: (i) product revenues
consisting of sales of JetFax branded MFPs, consumables and upgrades; (ii)
development fees for engineering services; and (iii) software and technology
license fees related to both its embedded system technology for MFPs and its
desktop software.  Historically, product revenues have accounted for the
majority of the Company's total revenues.  For the twelve months ended December
31, 1997, product revenues, development fees, and software and technology
license fees, as a percentage of total revenues, were 71%, 10% and 19%,
respectively.

                                       13
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

  Product revenues result from the sale of the Company's branded MFP products
into the corporate market through business equipment dealers. Revenues from
product sales to resellers, international distributors, OEMs and end users are
recognized upon shipment. OEMs, end users, and international distributors have
no rights of return while resellers have limited return rights. Allowances for
potential returns and exchanges from resellers are provided at the time of sale
based on historical returns and exchange experience. The Company defers revenue
on sales to domestic distributors and recognizes the revenue when the
distributor sells the product to resellers. The Company provides a ninety day
warranty for parts and service on its hardware products as well as ongoing
technical support to the dealer network. The Company provides a limited amount
of telephone technical support to its software customers. Estimated cost of
warranty work and post contract software customer support obligations are
accrued when the revenue is recognized. Development fee revenues are derived
from customizing the Company's embedded system technology and software for
inclusion in specific applications for its OEMs' products. Development fee
revenues are recognized on the percentage of completion method over the
development period. See Note 1 of Notes to Consolidated Financial Statements.
The Company's development contracts with certain OEM customers have enabled
JetFax to accelerate its product development efforts. The Company classifies all
development costs related to such contracts as research and development expenses
because such development fees have only partially funded the Company's product
development activities, and the Company generally retains ownership of the
technology developed under these agreements.

  Software and technology license fees result from licensing the Company's
proprietary embedded system technology and desktop software to OEMs for
integration into their products.  These payments can take the form of one-time
license fees, non-refundable prepaid royalties, or recurring per unit royalties.
One-time license fees and non-refundable prepaid royalties are recognized upon
the later of delivery of the contracted technology or satisfaction of
contractual milestones, if any.  Recurring license revenues from per unit fees
paid by the Company's OEMs are recognized upon the manufacture or shipment of
products incorporating the Company's technology as specified in the related
agreements.  The recurring license revenues reported by the Company are
dependent on the timing and accuracy of product manufacturing or sales reports
received from the Company's OEM customers.  These reports are provided on a
quarterly basis which may not coincide with the Company's quarter end.  However,
the Company attempts to get verbal estimates more frequently.  The quarterly
reports, as well as any verbal estimates, are subject to delay and potential
revision by the OEM.  Therefore, the Company may be unable to estimate such
revenues accurately prior to public announcement of the Company's quarterly
results.  In such an event, the Company may subsequently be required to revise
its previously reported revenues when it publishes its financial statements or
adjust revenues for subsequent periods, which could have a material adverse
effect on the Company's business, financial condition, and results of operations
and on the price of the Company's Common Stock.

  A substantial portion of the Company's branded products sales is to dealers in
the IKON network.  These IKON dealers accounted for 19% of the Company's total
revenues in 1997.  The Company's current OEM customers for engineering
development and technology licenses are Hewlett-Packard, Oki Data, and Samsung;
Hewlett-Packard accounted for 13% of the Company's total revenues in 1997.  The
Company expects that the ongoing obligations under existing OEM contracts will
generate future royalty payments.  The termination of a major dealer
relationship or an OEM agreement would have a material adverse effect on the
Company's business, financial condition and results of operations.  See "Risk
Factors--Dependence on Dealers and Distributors" and "--Dependence on OEMs."

  International revenues accounted for 29% and 27% of total revenues for the
twelve month periods ended December 31, 1997 and December 31, 1996,
respectively.  All of the development fees and software and technology license
revenues, and most of the product revenues, have been denominated and collected
in United States dollars. The Company has not hedged the foreign currency
exposure related to product sales denominated in foreign currencies as the
impact has not been significant.  See "Risk Factors--International
Activities."

  The gross margins for the Company's branded MFP products have been and are
expected to continue to be constrained by the competitive nature of the
marketplace, pricing pressures and the greater name recognition of the larger
companies with which JetFax competes.  The Company believes that sales of its

                                       14
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

branded MFP products provide a substantial revenue base, an opportunity to stay
in close touch with evolving customer and market needs, and a high level of
credibility in demonstrating the Company's advanced technology.  The margins on
consumables, such as toner cartridges and drums, and on upgrades, such as the
two-line upgrade, are typically higher than on the base unit.  In addition, the
Company's consumables generate recurring revenues which tend to increase as the
cumulative number of units sold increases.


RESULTS OF OPERATIONS

  The following table sets forth certain items in the Company's statements of
operations for the periods indicated (in thousands). For comparability purposes,
the Company is presenting unaudited information for the twelve month period
ended December 31, 1996 (due to its change in fiscal year -- see Note 1 of Notes
to Consolidated Financial Statements).

<TABLE>
<CAPTION>
                                                                  
                                          TWELVE MONTHS ENDED       FISCAL 
                                               DECEMBER 31,       YEAR ENDED
                                          ---------------------    MARCH 31,
                                            1997         1996        1996
                                          --------     --------   ----------
                                                     (unaudited)
<S>                                       <C>        <C>          <C>
Revenues:
 Product                                   $16,281      $14,012     $11,143
 Software and technology license fees        4,493        4,623       3,413
 Development fees                            2,246        1,722         720
                                           -------      -------     -------
    Total revenues                          23,020       20,357      15,276
                                           -------      -------     -------
Costs and expenses:
 Cost of product revenues                   11,886       11,750      11,102
 Cost of software and license revenues         770          716         587
 Research and development                    5,355        3,211       2,318
 Selling and marketing                       6,046        7,115       5,216
 General and administrative                  3,031        2,284       1,652
 Acquisition and related expenses            2,106           --          --
                                           -------      -------     -------
    Total costs and expenses                29,194       25,076      20,875
                                           -------      -------     -------
Loss from operations                        (6,174)      (4,719)     (5,599)
Other income (expense), net                    111          (76)       (259)
                                           -------      -------     -------
Loss before income taxes                    (6,063)      (4,795)     (5,858)
Provision for income taxes                      96          107          35
                                           -------      -------     -------
Net loss                                   $(6,159)     $(4,902)    $(5,893)
                                           =======      =======     =======
</TABLE>

  The following table sets forth, as a percentage of total revenues, certain
items in the Company's statements of operations for the periods indicated.

<TABLE>
<CAPTION>
                                             TWELVE MONTHS ENDED     FISCAL 
                                                  DECEMBER 31,     YEAR ENDED
                                             -------------------    MARCH 31,
                                               1997       1996        1996
                                             -------    --------   ----------
<S>                                          <C>        <C>        <C>
Revenues:
 Product                                         71%        69%          73%
 Software and technology license fees            19         23           22
 Development fees                                10          8            5
                                               ----       ----         ----
    Total revenues                              100        100          100
                                               ----       ----         ----
</TABLE> 

                                       15
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

<TABLE>
<S>                                          <C>        <C>        <C>
Costs and expenses:
 Cost of product revenues                        52         58           73
 Cost of software and license revenues            3          3            4
 Research and development                        24         16           15
 Selling and marketing                           27         35           34
 General and administrative                      13         11           11
 Acquisition and related expenses                 9         --           --
                                               ----       ----         ----
    Total costs and expenses                    127        123          137
                                               ----       ----         ----
Loss from operations                            (27)       (23)         (37)
Other income (expense), net                      --         --           (2)
                                               ----       ----         ----
Loss before income taxes                        (27)       (23)         (39)
Provision for income taxes                       --          1           --
                                               ----       ----         ----
Net loss                                       (27)%      (24)%        (39)%
                                               ====       ====         ====
</TABLE>

-------------

The results for all periods presented include the consolidation of DocuMagix,
Inc., which was acquired through a pooling of interests transaction that closed
December 5, 1997. (See Note 2 of Notes to Consolidated Financial Statements.)

Twelve Months Ended December 31, 1997 Compared to Twelve Months Ended December
31, 1996

  Revenues.  Total revenues increased 13% to $23.0 million for the twelve
months ended December 31, 1997 from $20.4 million for the twelve months ended
December 31, 1996.  Revenues from the historical JetFax operations rose 18% to
$20.8 million from $17.6 million and those of DocuMagix decreased 20% to $2.2
million from $2.8 million.

  Product revenue from the sale of the Company's MFPs and related consumables
and accessories were $16.3 million in 1997, a 16% increase from $14.0 million
during the twelve month period ended December 31, 1996.  Consumable revenue
advanced 44% year to year and accounted for two-thirds of the increase in
product revenues, while revenue from accessories fell 3% in 1997.  Revenue from
MFPs rose 9% year to year, which mirrored the 9% increase in MFP units.
Although the MFP revenue and unit increase were symmetrical, this resulted from
an improved product mix in 1997 neutralized by price declines in the Company's
major MFP product lines.  The twelve months ended December 31, 1996 included
revenues from the lower priced inkjet based JetFax 4, which accounted for 16% of
total units in 1996 and less than 1% in 1997, but this improvement in product
mix was offset by a decline of 10% in the average selling price of the Company's
baseline JetFax M5 and Series M900 laser/LED MFPs from 1996 to 1997.  The number
of units sold each quarter was relatively flat during the four quarters of 1997.
The Series M900, the new product line of MFPs, was introduced at the end of the
third quarter, but did not lead to higher unit shipments in the fourth quarter,
due to competitive pricing in the market and delays in the placement of orders
in the business equipment dealer channel.

  Development fees increased 30% to $2.2 million for the twelve month period
ended December 31, 1997 from $1.7 million for the twelve month period ended
December 31, 1996 as major development programs were initiated or continued for
OEMs licensing the Company's embedded systems and PC software. The Company has
previously reported delays on completion of the last milestone of a development
agreement with one of its OEMs. The OEM has been shipping the product for
several months and has agreed that the final milestone payment will be
completely paid. Accordingly, the Company recognized the remaining $247,000 of
revenue during 1997 relating to this final development milestone.

  Software and technology licensing fees decreased 2% to $4.5 million for the
twelve month period ended December 31, 1997 from $4.6 million for the twelve
month period ended December 31, 1996.  The software and technology licensing
fees from historical JetFax operations grew 24% to $2.4 million in 1997 from
$1.9 

                                       16
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

million in 1996. The 1997 year included significant licensing fees from the
Company's software licensing and from the Hewlett-Packard project, which more
than offset the decline due to the end of life of Xerox products for which
JetFax earned royalties.  Software and technology licensing fees for DocuMagix
fell 25% to $2.1 million for 1997 from $2.7 million in 1996, as its separate
Internet software products were withdrawn from the market and emphasis was
focused on the third quarter launch of a new version of PaperMaster which
incorporated Internet capabilities.

  International revenues increased to 29% of total revenues for 1997 compared to
27% for 1996, primarily as a result of higher international product shipments to
Europe. The Company does not sell its product in any Asian countries, though the
product is sold in New Zealand and Australia. In both 1997 and 1996, development
fees were generated from both Japan and Korea. Two customers, IKON Office
Solutions and Hewlett-Packard, accounted for $4.4 million (19%) and $3.1 million
(13%), respectively, of total revenues for the twelve month period ended
December 31, 1997.  One of the customers, IKON Office Solutions, accounted for
approximately 15% of total revenues for the twelve month period ended December
31, 1996.

  Cost of Product Revenues.     Cost of product revenues consists primarily of
purchased materials; direct production labor and supervision for assembly and
test; subcontracted manufacturing, mainly for printed circuit boards; indirect
labor for inventory management, shipping and receiving, purchasing,
manufacturing engineering, document control and operations management; and
related facility and support costs. Cost of product revenues may vary as a
percentage of total revenues in the future as a result of a number of factors
including: relative production volumes; the mix of product shipped and the
varying proportion of MFPs versus consumables and upgrades; changes in
production yields, especially those associated with the introduction of new
products; risk of inventory obsolescence and excess inventory; pricing pressures
in the market; and vendor quality or supply problems.

  Cost of product revenues increased 1% to $11.9 million in 1997 from $11.8
million in 1996.  Given the higher product revenue level in 1997, the product
gross margins advanced to 27.0% from 16.1% in the prior year.  The improvements
in the gross margin for the JetFax branded products and consumables were due to
manufacturing efficiencies, higher volumes, and a shift in mix to the newer
JetFax M5 and Series M900 product lines; the aggregate of these improvements
more than offset a decline in average selling price of MFPs.

  The Company purchases print engines for its new Series M900 product line in
Yen from Oki Data Corporation.  As the Yen weakened since mid-year 1997, the
Company's cost of goods sold related to the print engine was lowered by
$106,000.  In order to reduce the potential volatility related to the ongoing
Yen liability, the Company entered into a Yen hedge in August 1997, which
generated a loss of $94,000 for the twelve months ended December 31, 1997 that
was included in cost of goods sold.  Additionally, the translation of the
Company's intercompany receivables had a small negative impact, which was
partially offset by lower operating expenses of the Company's international
operations.  The Yen hedge may minimize foreign exchange risks that would
otherwise result from changes in foreign currency exchange rates.  There can be
no assurance that these strategies will be effective or that transaction losses
can be minimized or forecasted accurately.  Exchange gains and losses did not
have a significant effect on the Company's results of operations for the twelve
month periods ended December 31, 1997 and 1996, respectively.

  Cost of Software and License Revenues.  Cost of software and license revenues
consists primarily of royalties paid for licensed technology included in the
Company's products, amortization of purchased technology, and the duplication
and packaging expense associated with software sold in the retail market. Cost
of software and license revenues increased 8% to $770,000 in 1997 from $716,000
in 1996.

  Research and Development.  Research and development expenses were comprised
mainly of personnel related costs, engineering prototypes and supplies, payments
to engineering contractors, computer equipment depreciation and facilities
expenses.  Research and development expenses increased 67% to $5.4 million in
1997 from $3.2 million in the prior year.  As a percentage of revenues, research
and development 

                                       17
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

expenses increased to 23.3% for 1997 from 15.8% for 1996. The year to year
research and development increase for the historical JetFax operations was $2.2
million or 106%, while such expenses at DocuMagix (which include $150,000 of
retention bonuses payable to research and development employees) fell $17,000 or
1%. The increases in research and development expense resulted primarily from:
(i) the additional software development personnel added with the acquisition of
the Crandell Group in July 1996, (ii) additional personnel added in 1997 as the
year end research and development headcount for historical JetFax operations
increased from 22 to 41, (iii) external consultant and prototype expenses, and
(iv) DocuMagix retention bonuses. The Company believes that the development and
introduction of new products is critical to its success and expects that
research and development expenses will increase on a dollar basis in the future,
although at a lower rate than that experienced in 1997.

  Selling and Marketing.  Selling and marketing expenses consisted primarily of
personnel related costs and commissions, travel and entertainment expenses of
direct sales and marketing personnel, advertising and promotional expenses,
marketing communications, customer support, and service and facilities expenses.
Selling and marketing expenses decreased 15% to $6.0 million in 1997 from $7.1
million in the prior year. The year to year selling and marketing expenses
increase for the historical JetFax operations was $105,000 or 2.8%, while such
expenses at DocuMagix (which include $77,000 of retention bonuses payable to
selling and marketing employees) fell $1.2 million or 35% in conjunction with
scaling back expenses to match the lower revenues and the change in product
direction away from Internet related products. As a percentage of revenues,
selling and marketing expenses fell to 26.3% in 1997 from 34.9% in 1996 due to
marketing expenses decreasing as revenues increased.

  General and Administrative.  General and administrative expenses included
personnel related costs for administrative, finance, and executive personnel;
outside professional fees; facilities expenses; and retention bonuses for
DocuMagix employees. General and administrative expenses increased 33% to $3.0
million in 1997 from $2.3 million in 1996. The increase in the year to year
general and administrative expenses for the historical JetFax operations was
$649,000 or 60.5%, while such expenses at DocuMagix (which include $169,000 of
retention bonuses payable to general and administrative employees) increased
$99,000 or 1%. The increases were primarily due to higher expenses for
personnel, facilities, business insurance, hiring, and DocuMagix retention
bonuses. As a percentage of revenues, general and administrative expenses rose
to 13.2% in 1997 from 11.2% in 1996.

  Acquisition Charges and Related Expense.  Acquisition charges related to the
purchase of substantially all the assets of the Crandell Group, Inc. in July
1996 and the purchase of DocuMagix, Inc. through a pooling of interests
transaction which closed in December 1997. There were a total of $2.1 million in
acquisition charges in 1997 and none in 1996. The Crandell Group's $1.7 million
portion of the 1997 acquisition charges was comprised of: a $1.0 million final
payment in July 1997 to the Crandell Group in lieu of future royalty payments
(which would have been recorded as compensation as they related to continued
employment); Crandell acquisition charges of $0.6 million for a variable equity
award classified as compensation; and compensation expenses of $56,000
associated with royalties related to the continuing employment of the founders
of the Crandell Group. The $425,000 DocuMagix portion of the 1997 acquisition
charges was primarily comprised of legal and accounting costs related to the
pooling of interests transaction and the estimated lease obligation for the
previous DocuMagix facility.

  Interest and Other Income (Expense).  Interest and other income (expense)
consisted primarily of interest income (expense), foreign exchange gains
(losses), and miscellaneous items of other income (expense). Interest and other
income (expense) increased to $111,000 for the twelve months ended December 31,
1997 from $(76,000) for the comparable period of the prior year. The historical
JetFax operations generated $262,000 of interest income during 1997 while
DocuMagix incurred interest expense of $75,000 for the same time period. Total
interest expense for 1996 was $104,000. Foreign exchange losses were $58,000 for
1997 versus $13,000 for 1996.

  Provision for Income Taxes.  Due to the Company's net losses, there were no
provisions for federal or state income taxes for the twelve months ended
December 31, 1997 or the twelve months ended December 31, 1996.  The income tax
provisions of $96,000 for 1997 and $107,000 for 1996 primarily related to

                                       18
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

foreign withholding taxes on certain development fees.

  At December 31, 1997, net operating loss carryforwards attributable to JetFax,
Inc. of approximately $13.9 million and $4.2 million (not including amounts
related to the Company's DocuMagix subsidiary) were available to offset future
Federal and state taxable income, respectively, and research and development tax
credits of $170,000 and $121,000 were available to offset future Federal and
state income taxes, respectively. Current Federal and California tax law
includes certain provisions limiting the annual use of net operating loss
carryforwards in the event of certain defined changes in stock ownership, as
defined. The Company's ability to utilize its net operating loss and tax credit
carryforwards could be limited according to these provisions. Management
believes such limitation could result in the loss of carryforward benefits which
expire from 2004 through 2012. The use of the above  loss carryforwards is
dependent upon the Company's ability to achieve profitability. The Company's net
operating loss carryforwards attributable to it's DocuMagix subsidiary are
limited according to these provisions to approximately $380,000 per year  or
approximately $5.7 million and $1.9 million in total through the applicable
Federal and California carryforward periods, respectively. See Note 9 of Notes
to Consolidated Financial Statements.

  The Company recognizes deferred tax assets and liabilities based on the
difference between financial reporting and tax bases of assets and liabilities
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. Based on the weight of available evidence,
which includes the Company's historical losses since inception, and the
uncertainties regarding future results of operations, the Company has provided a
full valuation allowance against its net deferred tax assets of $8.5 million at
December 31, 1997, as it is more likely than not that the deferred tax assets
will not be realized. See Note 9 of Notes to Consolidated Financial Statements.

   Net income (loss).  The net loss for 1997 was $6.2 million or $0.61 per share
including acquisition-related charges of $2.1 million related to the acquisition
of the Crandell Group ($1.7 million) and DocuMagix ($425,000). Excluding
acquisition-related charges and a one-time retention bonus ($396,000) associated
with the retention of DocuMagix employees prior to the acquisition, the pro
forma net loss for 1997 was $3.7 million or $0.36 per share compared with a net
loss of $4.9 million for the twelve months ended December 31, 1996. Prior to the
acquisition-related charges and the one-time retention bonus, $905,000 of the
1997 loss resulted from the historical JetFax operations and $2.8 million was
attributable to the operations of DocuMagix.

Twelve months Ended December 31, 1996 Compared to Twelve Months Ended March 31,
1996

   Revenues.  Total revenues increased 33% to $20.4 million for the twelve
months ended December 31, 1996 from $15.3 million for the twelve months ended
March 31, 1996. The increased revenues primarily reflected increased unit
shipments and higher average selling prices of the Company's MFPs as the Company
transitioned from the JetFax 4, an inkjet MFP, to the JetFax M5, a high
performance, laser/LED MFP, which began commercial shipment in June 1995. In
addition, during the twelve months ended December 31, 1996, the Company expanded
the number of large business equipment dealers marketing the Company's products.

  Product revenues increased 25% to $14.0 million for the twelve months ended
December 31, 1996 from $11.1 million for the twelve months ended March 31, 1996.
Development fees increased 139% to $1.7 million for the twelve months ended
December 31, 1996 from $720,000 for the fiscal year ended March 31, 1996, as
major programs were initiated or continued for OEMs. Correspondingly, software
and technology license fees increased 35% to $4.6 million for the twelve months
ended December 31, 1996 from $3.4 million for the twelve months ended March 31,
1996. This increase was primarily due to an increase of $728,000 or 33% in the
DocuMagix software license fees, as well as the Crandell Acquisition in July
1996 which added software license fees of $628,000 for the last two quarters of
the twelve months ended December 31, 1996; these increases were partially offset
by a decline in royalties from Xerox due to the end of life of a related Xerox
product.

                                       19
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

  Cost of Product Revenues.  Cost of product revenues increased 6% to $11.8
million for the twelve months ended December 31, 1996 from $11.1 million for the
twelve months ended March 31, 1996. The product gross margin increased to 16.1%
for the twelve months ended December 31, 1996 from 0.4% for the twelve months
ended March 31, 1996. The product gross margin for the twelve months ended March
31, 1996 was adversely affected by reserves of $760,000 taken in the quarter
ended September 30, 1995 for the write-down of certain inventory to net
realizable value and to record estimated losses on purchase commitments related
to the pricing decline on the JetFax 4. The Company had a fixed price order from
Xerox for JetFax 4 units, but the price at which the units could be sold in the
market had declined substantially due to competition from other manufacturers'
new product introductions. A settlement of the purchase commitment from Xerox
was negotiated in the quarter ended September 30, 1996, which resulted in a
reduction of the inventory reserve and a credit to cost of product revenues of
$280,000.

  Excluding the impact of these reserves, the product gross margin was 14.1% for
the twelve months ended December 31, 1996 as compared to 7.2% for the twelve
months ended March 31, 1996.  The lower product gross margin in the prior twelve
month period primarily reflected the impact of competitive pricing pressures in
the inkjet MFP market and the startup and higher initial production costs
associated with the June 1995 commercial release of the JetFax M5.

  Cost of Software and License Revenues.  The cost of software and license
revenues increased 22% to $716,000 for the twelve months ended December 31, 1996
from $587,000 for the twelve months ended March 31, 1996.  The year to year
increase in costs of software and license revenues was approximately equally
divided between higher costs at DocuMagix and incremental costs added with the
acquisition of the Crandell Group in July 1996.

  Research and Development.  Research and development expenses increased 39% to
$3.2 million for the twelve months ended December 31, 1996 from $2.3 million for
the twelve months ended March 31, 1996, but increased only slightly as a
percentage of total revenues to 15.8% from 15.2%, respectively. This increase
resulted primarily from: (i) the software development personnel added with the
Crandell Acquisition in July 1996; (ii) certain compensation expenses associated
with the continuing employment of the founders of the Crandell Group, which are
based on a percentage of ongoing desktop software sales; and (iii) quick
turnaround engineering prototype expenses for the development of an embedded
system.

  Selling and Marketing.  Selling and marketing expenses increased 36% to $7.1
million for the twelve months ended December 31, 1996 from $5.2 million for the
twelve months ended March 31, 1996, but increased only slightly as a percentage
of total revenues to 35.0% from 34.1%, respectively. Just over half of the
increase was due to higher expenses in the JetFax historical operations related
primarily to higher personnel costs and building the Company's network of
business equipment dealers; the balance was increased selling and marketing
expense at DocuMagix related to establishing the PaperMaster software product in
the retail channel.

  General and Administrative.   General and administrative expenses increased
38% to $2.3 million for the twelve months ended December 31, 1996 from $1.7
million for the twelve months ended March 31, 1996, but increased only slightly
as a percentage of total revenues to 11.2% from 10.8%, respectively.

  Interest and Other Income (Expense).  Interest and other income (expense) was
$(76,000) for the twelve months ended December 31, 1996 compared with $(259,000)
for the twelve months ended March 31, 1996. The $183,000 decrease in interest
and other income (expense) was related to interest on 10% senior secured
convertible notes which increased from $2.0 million to $3.0 million during the
twelve month period ended March 31, 1996. Such notes were either repaid or
converted in March 1996 into shares of Convertible Preferred Stock.

  Provision for Income Taxes.  Due to the Company's net losses, there were no
provisions for federal or state income taxes for the twelve month periods ended
December 31, 1996 and March 31, 1996.  The $107,000 and $35,000 income tax
provisions for the twelve month periods ended December 31, 1996 and March 31,
1996, respectively, were primarily related to foreign withholding taxes.

                                       20
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

   Net income (loss).  The net loss for the twelve months ended December 31,
1996 was $4.9 million compared to $5.9 million for the twelve months ended March
31, 1996. The $4.9 million loss for the twelve months ended December 31, 1996
was comprised of a $3.6 million loss attributable to DocuMagix and a $1.3
million loss related to the historical JetFax operations. The $5.9 million loss
for the twelve months ended March 31, 1996 was comprised of a $3.0 million loss
attributable to DocuMagix and a $2.9 million loss related to the historical
JetFax operations, of which $760,000 related to the write-down of inventory
discussed above in Cost of Product Revenues.


LIQUIDITY AND CAPITAL RESOURCES

  The Company has financed its operations to date principally through private
placements of debt and equity securities, proceeds from borrowings under a bank
line of credit, debt associated with the Crandell Acquisition, and most
recently, its initial public offering of common stock declared effective on June
10, 1997.  The total amount of equity raised through December 31, 1997 was $42.6
million through a series of private financing rounds at both JetFax and
DocuMagix, as well as the Company's June 1997 initial public offering.

  At December 31, 1997, the Company had $1.5 million available under its bank
credit facility under which there were no borrowings at December 31, 1997.  This
lending facility is collateralized by substantially all of the Company's assets.
The maximum amount available under the line of credit is the lesser of $1.5
million or 80% of the Company's eligible outstanding domestic accounts
receivable. The revolving line of credit was renegotiated on September 17, 1997,
terminates on August 23, 1998, and is subject to renegotiation at that time.
The line of credit contains certain covenants which include the requirements
that the Company maintain tangible net worth (as defined) of $3.0 million,
quarterly net income, a quick ratio of at least 1.0 to 1.0, a maximum debt to
net worth ratio (as defined) of 1.5 to 1.0, and certain minimum liquidity and
debt service coverage.  In addition, the agreement prohibits the payment of cash
dividends.  The Company was in compliance with all such covenants at December
31, 1997, except the quarterly net income covenant for which the Company
received a waiver to March 31, 1998.

  Cash and short term investments increased to $7.2 million at December 31, 1997
from $413,000 at December 31, 1996.  Inventories increased $1.6 million to $4.0
million at December 31, 1997 from $2.4 million at December 31, 1996, due
primarily to: (i) an increase in finished goods inventory of the JetFax M910 due
to softer sales than originally anticipated and (ii) stocking higher levels of
consumables and product upgrades.  Accounts receivable increased $2.3 million to
$4.8 million at December 31, 1997 from $2.5 million at December 31, 1996,
principally due to the increase in product sales and higher receivables related
to development contracts.  Accounts payable decreased $819,000 to $1.7 million
at December 31, 1997 from $2.5 million at December 31, 1996 related to a $1.0
million payment associated with the acquisition of the Crandell Group and a
reduction in the DocuMagix payables; the reductions were partially offset by
payables related to the higher inventory levels.

  Investing activities for the year ended December 31, 1997 used cash of
approximately $4.5 million for $0.7 million of property purchases, $3.0 million
purchases of short-term investments and $0.8 million of other assets. Financing
activities for the year ended December 31, 1997 provided cash of $16.5 million
resulting from $20.7 million of net proceeds from the sale of common stock
partially offset by $1.4 million of debt and equipment loan repayments and the
$2.8 million redemption of Series P Preferred Stock.

  The Company currently believes that the net proceeds of the initial public
offering, together with available borrowings under its line of credit, and funds
from current and anticipated operations, will be sufficient to meet the
Company's working capital and capital expenditure requirements for the next
twelve months.  If the Company acquires one or more businesses or products, the
Company's capital requirements could increase substantially.  In the event of
such an acquisition or should any unanticipated circumstances arise which
significantly increase the Company's capital requirements, there can be no
assurance that necessary additional capital will be available on terms
acceptable to the Company, if at all.

                                       21
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)


FACTORS THAT MAY AFFECT OPERATING RESULTS

  The statements contained in this Report on Form 10-K that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 (the ''Securities Act'') and Section 21E of the
Securities Exchange Act of 1934 (the "Exchange Act"), including statements
regarding the Company's expectations, hopes, intentions or strategies regarding
the future. When used herein, the words ''may,'' ''will,'' ''expect,''
''anticipate,'' ''continue,'' ''estimate,'' ''project,'' ''intend'' and similar
expressions are intended to identify forward-looking statements within the
meaning of the Securities Act and the Exchange Act.  Forward-looking statements
include: statements regarding events, conditions and financial trends that may
affect the Company's future plans of operations, business strategy, results of
operations and financial position.  All forward-looking statements included in
this document are based on information available to the Company on the date
hereof, and the Company assumes no obligation to update any such forward-looking
statements. Investors are cautioned that any forward-looking statements are not
guarantees of future performance and are subject to risks and uncertainties and
that actual results may differ materially from those included within the
forward-looking statements as a result of various factors. Factors that could
cause or contribute to such differences include, but are not limited to, those
described below, under the heading "Factors That May Affect Operating Results"
and elsewhere in this Report on Form 10-K.

  The Company operates in a dynamic and rapidly changing environment that
involves numerous risks and uncertainties.  The following section lists some,
but not all, of those risks and uncertainties which may have a material adverse
effect on the Company's business, financial condition or results of operations.
This section should be read in conjunction with the audited Consolidated
Financial Statements and Notes thereto included in Part IV -- Item 14 of this
Annual Report on Form 10-K and the audited Financial Statements and Notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations for the year ended December 31, 1996, contained in the
Company's Registration Statement on Form S-1, as amended (No. 333-23763), which
was declared effective on June 10, 1997.

  HISTORY OF OPERATING LOSSES; ACCUMULATED DEFICIT.  The Company had annual net
losses since inception. The Company's historical losses and certain preferred
stock dividends have resulted in an accumulated deficit of approximately $27.7
million as of December 31, 1997. There can be no assurance that the Company will
achieve profitability on a quarterly or annual basis in the future.

  POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS.  The Company in the past has
experienced, and in the future may experience, significant fluctuations in
quarterly operating results that have been or may be caused by many factors
including: the timing of introductions of new products or product enhancements
by the Company, its OEMs and their competitors; initiation or termination of
arrangements between the Company and its existing and potential significant OEM
customers or dealers and distributors; the size and timing of and fluctuations
in end user demand for the Company's branded products and OEM products
incorporating the Company's technology; inventories of the Company's branded
products or products incorporating the Company's technology carried by the
Company, its distributors or dealers, its OEMs or the OEMs' distributors that
exceed current or projected end user demand; the phase-out or early termination
of the Company's branded products or OEM products incorporating the Company's
technology; the amount and timing of development agreements, one-time software
licensing transactions and recurring licensing fees; non-performance by the
Company, its suppliers or its OEM or other customers pursuant to their plans and
agreements; seasonal trends; competition and pricing; customer order deferrals
and cancellations in anticipation of new products or product enhancements;
industry and technology developments; changes in the Company's operating
expenses; software and hardware defects; product delays or product quality
problems; currency fluctuations; and general economic conditions. The Company
expects that its operating results will continue to fluctuate significantly as a
result of these and other factors. A substantial portion of the Company's
operating expenses is related to personnel, development of new products,
marketing programs and facilities. The level of spending for such expenses
cannot be adjusted quickly and is based, in significant part, on the Company's
expectations of future revenues and anticipated OEM commitments. If such
commitments do not result in revenues or operating expenses are significantly
higher, the Company's

                                       22
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

business, financial condition and results of operations will be adversely
affected, which could have a material adverse effect on the price of the
Company's Common Stock.

  Furthermore, the Company has often recognized a substantial portion of its
revenues in the last month of a quarter, with such revenues frequently
concentrated in the last weeks or days of a quarter. The Company's branded
products are primarily sold through dealers, and such dealers often place orders
for products at or near the end of a quarter. As a result, because one or more
key orders that are scheduled to be booked and shipped at the end of a quarter
may be delayed until the beginning of the next quarter or cancelled, revenues
for future quarters are not predictable with any significant degree of accuracy.
For these and other reasons, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indicators of future performance. It is likely that
in future quarters, the Company's operating results, from time to time, will be
below the expectations of public market analysts and investors, which could have
a material adverse effect on the price of the Company's Common Stock.

  The accuracy of quarterly license revenues from OEMs reported by the Company
has been, and the Company believes will continue to be, dependent on the timing
and accuracy of product sales reports received from the Company's OEMs. These
reports are provided only on a quarterly basis (which may not coincide with the
Company's quarter) and are subject to delay and potential revision by the
Company's OEMs. Therefore, the Company is required to estimate all of the
recurring license revenues from OEMs for each quarter. As a result, the Company
will record an estimate of such revenues prior to public announcement of the
Company's quarterly results. In the event the product sales reports received
from the Company's OEMs are delayed or subsequently revised, the Company may be
required to restate its recognized revenues or adjust revenues for subsequent
periods, which could have a material adverse effect on the Company's business,
financial condition and results of operations and the price of the Company's
Common Stock.

  DEPENDENCE ON THE MFP MARKET.  The market for MFPs is relatively new and
rapidly evolving. The Company's future success is dependent to a significant
degree upon broad market acceptance of the type of MFPs on which the Company is
focusing its development efforts. This success will be dependent in part on the
ability of the Company and its OEM customers to develop MFPs that provide the
functionality, performance, speed and connectivity demanded by the market at
acceptable price points and to convince end users to broadly adopt MFPs for
office and home office use. There can be no assurance that the market for MFPs
will continue to develop, that the Company and its OEM customers will be
successful in developing MFPs that gain broad market acceptance, that the
Company will be able to offer in a timely manner its embedded system technology,
branded products or desktop software or that the Company's OEM customers will
choose the Company's technology for use in their MFPs. The failure of any of
these events to occur would have a material adverse effect on the Company's
business, financial condition and results of operations.

  RISKS ASSOCIATED WITH CHANGE IN FOCUS OF THE COMPANY'S BUSINESS.  The Company
has historically focused primarily on the development, manufacture and sale of
its branded MFPs and currently derives a substantial portion of its revenues
from the sale of its branded MFPs. The Company expects that its revenue growth
will be dependent, in part, on increased licensing of the Company's embedded
system technology and desktop software products. However, there can be no
assurance that the Company will realize growth in revenues from sales and
licensing of its embedded system technology or desktop software. If such growth
in revenues does not occur and if revenues from the sale of the Company's
branded MFPs were not to continue at past growth rates, due either to a change
in the Company's deployment of resources or otherwise, it could have a material
adverse effect on the Company's business, financial condition and results of
operations.

  RISKS ASSOCIATED WITH INCREASED FOCUS ON PC SOFTWARE BUSINESS.  The Company
expects that its business, financial condition and results of operations will be
more dependent on sales of its PC software for JetSuite MFP desktop and
PaperMaster personal document handling, which will be sold both separately and
bundled with the Company's branded products and embedded system technology. The
Company's on-going ability to develop its MFP desktop software products business
will depend upon several factors, including, 

                                       23
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

but not limited to, the commercial acceptance of the Company's MFP desktop
software products, upgrades and add-on software products, the ability of the
Company's personnel and distribution channels to sell and support MFP desktop
software products and the Company's ability to continue to integrate the recent
acquisition of DocuMagix, Inc. into the Company. Because the market for MFP
desktop software products is new and emerging, there can be no assurance that a
significant market, if any, will develop for sales of the Company's MFP desktop
software products, or for sales of upgrades and add-on software products, and
such a failure would likely have a material adverse effect on the Company's MFP
desktop software products business. There can be no assurance that the Company's
PC software products business will be successful. Any failure by the Company to
develop a successful PC software products business would have a material adverse
effect on the Company's business, financial condition and results of operations.

  DEPENDENCE ON DEALERS AND DISTRIBUTORS.  The Company has derived a substantial
portion of its revenues from sales of its branded MFPs through dealers and
distributors. The Company expects that sales of these products through its
dealers and distributors will continue to account for a substantial portion of
its revenues for the foreseeable future. The Company currently maintains
distribution relationships with dealers associated with IKON Office Solutions
(formerly Alco Standard), a national group of office equipment dealers
(''IKON''). The Company has also derived substantial sales to A. Messerli AG
(''Messerli''), one of the Company's office equipment dealers located in
Switzerland. Each of the Company's dealers and distributors can cease marketing
the Company's products with limited notice and with little or no penalty. There
can be no assurance that the Company's dealers and distributors will continue to
offer the Company's products or that the Company will be able to recruit
additional or replacement dealers and distributors. The loss of one or more of
the Company's major dealers and distributors could have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company's dealers and distributors also offer competitive products
manufactured by third parties. There can be no assurance that the Company's
dealers and distributors will give priority to the marketing of the Company's
products as compared to its competitors' products. Any reduction or delay in
sales of the Company's products by its dealers and distributors could have a
material adverse effect on the Company's business, financial condition and
results of operations.

  DEPENDENCE ON OEMS.   The Company has derived a significant portion of its
revenues from licensing of its embedded system technology and software and from
development services to OEMs. The Company currently has OEM relationships with
Hewlett-Packard Company (''Hewlett-Packard''), Oki Data Corporation (''Oki
Data''), and Samsung Electronics Corporation (''Samsung''). The Company
anticipates that a significant portion of its revenues will be derived from OEMs
in the future and that the Company's revenues will be increasingly dependent
upon, among other things, the ability and willingness of OEMs to timely develop
and promote MFPs that incorporate the Company's technology. The ability and
willingness of these OEMs to do so is based upon a number of factors, such as
the timely development by the Company and the OEMs of new products with
additional functionality, increased speed and enhanced performance at acceptable
prices to end users; development costs of the OEMs; licensing and development
fees of the Company; compatibility with emerging industry standards;
technological advances; intellectual property issues; general industry
competition; and overall economic conditions. Many of these factors are beyond
the control of the Company and its OEMs. Many OEMs, including some of the
Company's OEM customers, are concurrently developing and promoting MFPs that do
not incorporate the Company's technology. In such cases, the OEMs may have
profitability or other incentives to promote internal solutions or competing
products in lieu of products incorporating the Company's technology. No
assurance can be given as to the ability or willingness of the Company's OEMs to
continue developing, marketing and selling products incorporating the Company's
technology. For example, the Company no longer receives royalties from the Xerox
WorkCenter 250 MFP, which incorporated the Company's embedded system technology,
as Xerox has ceased production of that model due to the product reaching the end
of its life cycle and pricing pressures from competitors' products. The loss of
any of the Company's significant OEMs could have a material adverse effect on
the Company's business, financial condition and results of operations.

  RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE.   The market for the Company's
products and services is characterized by rapidly changing technology, evolving
industry standards and needs, and frequent new product introductions. The
Company currently derives all of its revenues from the sale of its branded MFPs

                                       24
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

and related consumables, the licensing of its technology and software, and the
provision of related development services. The Company anticipates that these
sources of revenues will continue to account for substantially all of its
revenues for the foreseeable future. The market expects the Company and its OEMs
to develop and release, in a regular and timely manner, new MFPs with better
performance and improved features at competitive price points. As the complexity
of product development increases and the expected time-to-market continues to
decrease, the risk and difficulty in meeting such schedules increase as well as
the costs to the Company and its OEMs. In addition, the Company, its OEMs and
their competitors, from time to time, may announce new products, capabilities or
technologies that may replace or shorten the life cycles of the Company's
branded products and software and the OEM products incorporating the Company's
technology. The Company's success will depend on, among other things, market
acceptance of the Company's branded products, software and embedded system
technology and the demand for MFPs by the Company's OEM customers; the ability
of the Company and its OEM customers to respond to industry changes and market
demands in a timely manner; achievement of new design wins by the Company in the
Company's development of its branded products as well as the OEMs' development
of associated new MFPs; the ability of the Company and its OEM customers to
reduce production costs; and the regular and continued introduction of new and
enhanced technology, services and products by the Company and its OEMs on a
timely and cost-effective basis. There can be no assurance that the products and
technology of competitors of the Company or its OEMs will not render the
Company's branded products, technology, software or its OEMs' products
noncompetitive or obsolete. Any failure by the Company or its OEMs to anticipate
or respond adequately to the rapidly changing technology and evolving industry
standards and needs, or any significant delay in development or introduction of
new and enhanced products and services, could result in a loss of
competitiveness or revenues, which could have a material adverse effect on the
Company's business, financial condition and results of operations.

  RELIANCE ON LIMITED PRODUCT LINE.  The Company has been primarily engaged in
the development, manufacture and sale of MFPs and related technology and has
derived a substantial portion of its revenues from sales of its branded MFPs and
consumables. Dependence on a single product line makes the Company particularly
vulnerable to the successful introduction of competitive products. The Company
currently derives a substantial portion of its branded product revenues from
sales of the Series M900. Sales of the Series M900 began shipping commercially
in the third quarter of 1997. A reduction in demand for the Series M900, or the
Company's failure to timely introduce its next MFP, would have a material
adverse effect on the Company's business, financial condition and results of
operations.

  RISKS ASSOCIATED WITH PRODUCT DEVELOPMENT AND INTRODUCTION; PRODUCT DELAYS.
The Company's future success is dependent to a significant degree on its ability
to further develop its embedded system technology and software for MFPs in the
time frame required by its OEM and other customers and to develop technology
with the quality, speed and other specifications required by its OEM and other
customers. The Company in the past has experienced delays in product
development, and the Company may experience similar delays in the future. Prior
delays have resulted from numerous factors such as changing OEM product
specifications, delays in receiving necessary components, difficulties in hiring
and retaining necessary personnel, difficulties in reallocating engineering
resources and other resource limitation difficulties with independent
contractors, changing market or competitive product requirements and
unanticipated engineering complexity. The Company has experienced delays in one
of its current development projects in the past which have resulted in delays in
receiving payment. In addition, the Company's software and hardware have in the
past, and may in the future, contain undetected errors or failures that become
evident upon product introduction or as product production volumes increase.
There can be no assurance that errors will not be found; that the Company will
not experience problems or delays in meeting the delivery schedules for or in
the acceptance of products by the Company's OEMs or other customers; that there
will not be problems or delays in shipments of the Company's branded products or
OEMs' products; or that the Company's new products and technology will meet
performance specifications under all conditions or for all anticipated
applications. Given the short product life cycles in the MFP market, any delay
or difficulty associated with new product development, introductions or
enhancements could have a material adverse effect on the Company's business,
financial condition and results of operations.

                                       25
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

  HIGHLY COMPETITIVE INDUSTRY.  The market for MFPs and related technology and
software is highly competitive and characterized by continuous pressure to
enhance performance, to introduce new features and to accelerate the release of
new products. The Company's branded products compete primarily with the dominant
vendors in the fax market, all of whom have substantially greater resources than
the Company and include, among others, Canon Inc., Panasonic, a division of
Matsushita Electrical Industrial Co., Ltd., Pitney Bowes Inc., Ricoh Co. Ltd.,
Sharp Electronics Corporation and Xerox. The Company also competes on the basis
of vendor name and recognition, technology and software expertise, product
functionality, development time and price.

  The Company's technology, development services and software primarily compete
with solutions developed internally by OEMs. Virtually all of the Company's OEMs
have significant investments in their existing solutions and have the
substantial resources necessary to enhance existing products and to develop
future products. These OEMs have or may develop competing multifunction
technologies and software which may be implemented into their products, thereby
replacing the Company's proposed or current technologies, eliminating a need for
the Company's services and products to these OEMs. The Company also competes
with technologies, software and development services provided in the MFP market
by other systems and software suppliers to OEMs. With respect to MFP embedded
system technologies, the Company competes with, among others, Peerless Systems
Corporation, Personal Computer Products, Inc. and Xionics Document Technologies,
Inc. With respect to desktop software, the Company competes with, among others,
Caere Corporation, Simplify Development Corporation, Smith Micro Software, Inc.,
Visioneer Inc., Wordcraft International and Xerox.

  As the MFP market continues to develop, the Company expects that competition
and pricing pressures will increase from OEMs, existing competitors and other
companies that may enter the Company's existing or future markets with similar
or substitute products or technologies. Software solutions may also be
introduced by competitors that are less costly or provide better performance or
functionality. The Company anticipates increasing competition for its MFPs,
technologies and software under development. Most of the Company's existing
competitors, many of its potential competitors and all of the Company's OEMs
have substantially greater financial, technical, marketing and sales resources
than the Company. In the event that price competition increases, competitive
pressures could cause the Company to reduce the price of its branded products,
to reduce the amount of royalties received on new licenses and to reduce the
fees for its development services in order to maintain existing business and
generate additional product sales and license and development revenues, which
could reduce profit margins and result in losses and a decrease in market share.
No assurances can be given as to the ability of the Company to compete favorably
with the internal development capabilities of its current and prospective OEM
customers or with other third-party vendors, and the inability to do so would
have a material adverse effect on the Company's business, financial condition
and results of operations.

  EFFECT OF RAPID GROWTH ON EXISTING RESOURCES; POTENTIAL ACQUISITIONS.   The
Company has grown rapidly in recent years. A continuing period of rapid growth
could place a significant strain on the Company's management, operations and
other resources. The Company's ability to manage its growth will require it to
continue to invest in its operational, financial and management information
systems, procedures and controls, and to attract, retain, motivate and
effectively manage its employees. There can be no assurance that the Company
will be able to manage its growth effectively and to successfully utilize the
current management information system, and failure to do so would have a
material adverse effect on the Company's business, financial condition and
results of operations.

  The Company may, from time to time, pursue the acquisition of other companies,
assets or product lines that complement or expand its existing business.
Acquisitions involve a number of risks that could adversely affect the Company's
operating results, including the diversion of management's attention, the
assimilation of the operations and personnel of the acquired companies, the
amortization of acquired intangible assets and the potential loss of key
employees. JetFax has no present commitments nor is it engaged in any
discussions or negotiations with respect to possible acquisitions. No assurance
can be given that any acquisition by the Company will not materially and
adversely affect the Company or that any such acquisition will enhance the
Company's business.

                                       26
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

  DEPENDENCE ON OUTSIDE SUPPLIERS; DEPENDENCE ON SOLE SOURCE SUPPLIERS.   The
Company relies on various suppliers of components for its products. Many of
these components are standard and generally available from multiple sources.
However, there can be no assurance that alternative sources of such components
will be available at acceptable prices or in a timely manner. The Company
generally buys components under purchase orders and does not have long-term
agreements with its suppliers. Although alternate suppliers may be readily
available for some of these components, for other components it could take an
undetermined amount of time to qualify a replacement supplier and order and
receive replacement components. The Company does not always maintain sufficient
inventory to allow it to fill customer orders without interruption during the
time that would be required to obtain an adequate supply of single sourced
components. Although the Company believes it could develop other sources for
single source components, no alternative source currently exists and the process
could take several months or longer. Therefore, any interruption in the supply
of such components could have a material adverse effect on the Company's
business, financial condition and results of operations.

  Many of the components used in the Company's products are purchased from
suppliers located outside the United States. Foreign manufacturing facilities
are subject to risk of changes in governmental policies, imposition of tariffs
and import restrictions and other factors beyond the Company's control. There
can be no assurance that United States or foreign trading policies will not
restrict the availability of components or increase their cost. Any significant
increase in component prices or decrease in component availability could have a
material adverse effect on the Company's business, financial condition and
results of operations.

  Certain components used in the Company's products are available only from one
source. The Company is dependent on Oki America, Inc. (''Oki America''), as the
supplier of major components, including the printer engine, of the Series M900.
Oki America is also a competitor of the Company. The Company is also dependent
on American Microsystems, Inc. (''AMI'') to provide unique application specific
integrated circuits (''ASICs'') incorporating the Company's imaging and logic
circuitry, Motorola, Inc. (''Motorola'') to provide microprocessors, Pixel
Magic, Inc., a subsidiary of Oak Technology, Inc. (''Pixel''), to provide a
specialized imaging processor and Rockwell Semiconductor Systems (''Rockwell'')
to provide modem chips. If Oki America, AMI, Motorola, Pixel or Rockwell were to
limit or reduce the sale of such components to the Company, or if such suppliers
were to experience financial difficulties or other problems which prevented them
from supplying the Company with the necessary components, it could have a
material adverse effect on the Company's business, financial condition and
results of operations. These sole source providers are subject to quality and
performance issues, materials shortages, excess demand, reduction in capacity
and/or other factors that may disrupt the flow of goods to the Company or its
customers and thereby adversely affect the Company's business and customer
relationships. Any shortage or interruption in the supply of any of the
components used in the Company's products, or the inability of the Company to
procure these components from alternate sources on acceptable terms, could have
a material adverse effect on the Company's business, financial condition and
results of operations.

  DEPENDENCE ON INTELLECTUAL PROPERTY RIGHTS; RISK OF INFRINGEMENT.   The
Company's success is heavily dependent upon its proprietary technology. To
protect its proprietary rights, the Company relies on a combination of
copyright, trade secret and trademark laws and nondisclosure and other
contractual restrictions. The Company has no patents or patent applications
pending. As part of its confidentiality procedures, the Company generally enters
into nondisclosure agreements with its employees, consultants, OEMs and
strategic partners and limits access to and distribution of its designs,
software and other proprietary information. Despite these efforts, the Company
may be unable to effectively protect its proprietary rights and, in any event,
enforcement of the Company's proprietary rights may be expensive. The Company's
source code also is protected as a trade secret. However, the Company from time
to time licenses portions of its source code and designs to OEMs and also places
such source code and designs in escrow to be released to OEMs in certain
circumstances, which subjects the Company to the risk of unauthorized use or
misappropriation despite the contractual terms restricting disclosure. In
addition, it may be possible for unauthorized third parties to copy the
Company's products or to reverse engineer or obtain and use the Company's
proprietary information. Further, the laws of some foreign countries do not
protect the Company's proprietary rights to the same extent as do the laws of
the United States. There can be no

                                       27
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

assurance that the Company's means of protecting its proprietary rights will be
adequate or that the Company's competitors will not independently develop
similar technology.

  As the number of patents, copyrights, trademarks and other intellectual
property rights in the Company's industry increases, products based on the
Company's technology increasingly may become the subject of infringement claims.
The Company has in the past received communications from third parties asserting
that the Company's trademarks or products infringe the proprietary rights of
third parties or seeking indemnification against such infringement. The Company
is generally required to agree to indemnify its OEMs from third party claims
asserting such infringement. There can be no assurance that third parties will
not assert infringement claims against the Company or its OEMs in the future.
Any such claims, regardless of merit, could be time consuming, result in costly
litigation, cause product shipment delays or require the Company to enter into
royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company, or at all,
which could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, the Company may initiate
claims or litigation against third parties for infringement of the Company's
proprietary rights or to establish the validity of the Company's proprietary
rights. Litigation to determine the validity of any claims, whether or not such
litigation is determined in favor of the Company, could result in significant
expense to the Company and divert the efforts of the Company's technical and
management personnel from daily operations. In addition, the Company may lack
sufficient resources to initiate a meritorious claim. In the event of an adverse
ruling in any litigation regarding intellectual property, the Company may be
required to pay substantial damages, discontinue the use and sale of infringing
products, expend significant resources to develop non-infringing technology or
obtain licenses to infringing or substituted technology. The failure of the
Company to develop, or license on acceptable terms, a substitute technology
could have a material adverse affect on the Company's business, financial
condition and results of operations.

  DEPENDENCE ON KEY PERSONNEL.  The Company is largely dependent upon the skills
and efforts of its senior management, particularly Edward R. Prince, III (''Rudy
Prince''), its President and Chief Executive Officer, and Lon Radin, its Vice
President of Engineering, and other officers and key employees, some of whom
only recently have joined the Company. The Company maintains key person life
insurance policies on Rudy Prince and Lon Radin. None of the Company's officers
or key employees, other than Michael Crandell, Vice President of Software, are
covered by an employment agreement with the Company. The Company believes that
its future success will depend in large part upon its ability to attract and
retain highly skilled engineering, managerial, sales, marketing and operations
personnel, many of whom are in great demand. Competition for such personnel,
especially engineering, has recently increased significantly. The loss of key
personnel or the inability to hire or retain qualified personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations.

  INTERNATIONAL ACTIVITIES.  Revenues from sales to the Company's customers
outside the United States account for a substantial portion of the Company's
total revenues. The Company expects that revenues from customers located outside
the United States may increase in both absolute dollars and as a percentage of
total revenues in the future. The international market for the Company's branded
products and products incorporating the Company's technology and software is
highly competitive, and the Company expects to face substantial competition in
this market from established and emerging companies and technologies developed
internally by its OEM customers. Risks inherent in the Company's international
business activities also include currency fluctuations and restrictions, the
burdens of complying with a wide variety of foreign laws and regulations,
including Postal, Telephone and Telegraph (''PTT'') regulations, longer accounts
receivable cycles, the imposition of government controls, risks of localizing
and internationalizing products to local requirements in foreign countries,
trade restrictions, tariffs and other trade barriers, restrictions on the
repatriation of earnings and potentially adverse tax consequences, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations. Substantially all of the Company's
international sales are currently denominated in U.S. dollars and, therefore,
increases in the value of the U.S. dollar relative to foreign currencies could
make the Company's products less competitive in foreign markets. Because of the
Company's international activities, it faces certain currency exposure and
translation risks. For example, late in 1997 the Company established a

                                       28
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS (CONTINUED)

subsidiary in Germany which will increase the Company's exposure to foreign
exchange risk, and the Company purchases certain key components pursuant to
purchase contracts denominated in foreign currency. In connection therewith, the
Company has Yen cash deposits deposits designated as a hedge against the firm
purchases under supply contract.

  DEPENDENCE ON SINGLE MANUFACTURING FACILITY; RISKS RELATED TO POTENTIAL
DISRUPTION.  The Company's manufacturing operations are located in its facility
in Northern California. In addition, a number of the suppliers of components for
the Company's products and providers of outsourced assembly, upon which the
Company relies, are located in Northern California. Since the Company does not
currently operate multiple facilities in different geographic areas, or have
alternative sources for many of its components or outsourced assembly, a
disruption of the Company's manufacturing operations, or the operations of its
suppliers, resulting from sustained process abnormalities, human error,
government intervention or natural disasters such as earthquakes, fires or
floods could cause the Company to cease or limit its manufacturing operations
and consequently have a material adverse effect on the Company's business,
financial condition and results of operations.

  NO PRESENT INTENTION TO PAY DIVIDENDS; RESTRICTION ON PAYMENT OF DIVIDENDS.
The Company has never declared or paid cash dividends on its Common Stock and
intends to retain all available funds for use in the operation and expansion of
its business. The Company therefore does not anticipate that any cash dividends
will be declared or paid in the foreseeable future. In addition, the Company's
credit facility prohibits the payment of cash dividends without the consent of
the lender.

  READINESS FOR YEAR 2000.   The Company has and will continue to make certain
investments in its software systems and applications to ensure the Company's
information systems are year 2000 compliant. The financial impact to the Company
of the Company's year 2000 compliance effort has not been and is not anticipated
to be material to its financial position or results of operations in any given
year. The Company believes that its current products are year 2000 compliant.
The approach of Year 2000 presents significant issues for many computer systems,
since much of the software in use today may not accurately process data beyond
1999. The Company has recently implemented new information systems and
accordingly does not anticipate any internal Year 2000 issues from its own
information systems, databases or programs.  However, the Company could be
adversely impacted by Year 2000 issues faced by major distributors, suppliers,
customers, vendors and financial service organizations with which the Company
interacts.  The Company is currently taking steps to address the impact, if any,
of the Year 2000 issue on the operations of the Company: There can be no
assurances that the Company will be able to detect all potential failures of the
Company's and/or third parties' computer systems.  A significant failure of the
Company's or a third party's computer system could have a material adverse
effect on the Company's business, financial condition and results of operations.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

  The Company's financial statements are set forth on pages 38 through 56, which
follow Item 14.


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

  Not applicable.

                                       29
<PAGE>
 
                                    PART III


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

  The information concerning the directors of the Company is included in the
Company's Proxy Statement to be filed in connection with the Company's 1998
annual meeting of stockholders under the caption "Election of Directors" and is
incorporated herein by reference. The information concerning the executive
officers of the Company required by this item is as follows:


EXECUTIVE OFFICERS

 The executive officers of the Company, and their ages as of December 31, 1997,
are as follows:

<TABLE>
<CAPTION>
NAME                                                AGE    POSITION
----                                                ---    --------
<S>                                                 <C>    <C>
                                                           
Rudy Prince.......................................   40    President, Chief Executive Officer and
                                                           Chairman of the Board
                                                           
Michael Crandell..................................   41    Vice President of Software
                                                           
John H. Harris....................................   42    Vice President of International Operations
                                                           
Hansgregory C. Hartmann...........................   40    Vice President of Manufacturing
                                                           
Allen K. Jones....................................   50    Vice President of Finance, Chief Financial
                                                           Officer and Secretary
                                                           
Gary P. Kapner....................................   36    Vice President of North American Sales and
                                                           Service

Lon B. Radin......................................   47    Vice President of Engineering and Director
</TABLE>

  RUDY PRINCE co-founded the Company and has served as its President and Chief
Executive Officer and a member of the Board of Directors since August 1988. Mr.
Prince was appointed as the Chairman of the Board of Directors in October 1996.
From June 1985 to February 1988, Mr. Prince was the Vice President of Sales and
Marketing at Entropic Speech, Inc., a manufacturer of telecommunications
products. Prior to that, Mr. Prince served as Sales Manager with Digicon, Inc.,
a geophysical contractor (''Digicon''), from March 1980 to June 1985. From
August 1978 to March 1980, Mr. Prince served as a marketing representative with
the Data Processing Division of International Business Machines Corporation. Mr.
Prince holds a B.S. in Mechanical Engineering from the University of Texas at
Austin. Mr. Prince is the son of Edward R. Prince, Jr., a director of the
Company.

  MICHAEL CRANDELL joined the Company in July 1996 as the Vice President of
Software. From January 1993 to July 1996, Mr. Crandell served as the President
of the Crandell Group, the assets of which were purchased by the Company in July
1996. Prior to that, Mr. Crandell served as the President of Crandell
Development Corporation, a software development company from November 1984 to
December 1992. From 1981 to November 1984, Mr. Crandell worked as a Software
Engineer with Compucorp, Inc. Mr. Crandell holds a B.A. in Religious Studies
from Stanford University.

  JOHN H. HARRIS joined the Company in March 1990 as the Vice President of
International Operations. From July 1987 to February 1990, Mr. Harris served in
various sales management positions with Landmark Graphics Corporation, a
supplier of graphics workstations for the oil industry, most recently as the
Regional Sales Director. From May 1981 to June 1987, Mr. Harris served as the
North American Sales Manager and Far East Sales manager for Digicon. Mr. Harris
holds a B.A. in Marketing from the University of Houston.

  HANSGREGORY C. HARTMANN joined the Company in August 1995 as the Vice
President of Manufacturing. From June 1980 to August 1995, Mr. Hartmann held
various positions with Hewlett-Packard. From November 1992 to August 1995, he
was the Manager of the Channel Development and Information Services for U.S.
Channel Marketing in the Computer Products Organization of Hewlett-

                                       30
<PAGE>
 
Packard and, from September 1991 to November 1992, he was the Business
Development Manager for the North American Distribution Operation of Hewlett-
Packard. From July 1985 to September 1991, Mr. Hartmann served as the
Engineering Manager for the Personal Computer Distribution Operation of Hewlett-
Packard. Mr. Hartmann holds a B.S. in Electrical Engineering from the New Jersey
Institute of Technology and a M.S. in Manufacturing Systems Engineering from
Stanford University.

  ALLEN K. JONES joined the Company in May 1996 as the Vice President of
Finance, Chief Financial Officer and Secretary. From January 1976 to January
1996, Mr. Jones served in various positions with Varian Associates, Inc., a
diversified electronics company, most recently as the Vice President and
Controller from January 1995 to January 1996 and prior to that as the Vice
President and Treasurer from May 1990 to December 1994. Mr. Jones holds a B.S.
in Chemical Engineering from Cornell University and a M.B.A. from the Wharton
School of Finance at the University of Pennsylvania.

  GARY P. KAPNER joined the Company in September 1990 as the Technical Services
Manager. Since 1994, Mr. Kapner has been responsible for the JetFax products
sales in North America.  From June 1988 to September 1990, Mr. Kapner served as
National Technical Services Manager for Payfax, Inc. From May 1987 to 1988, Mr.
Kapner worked in the Product Diagnostic Center for NEC's Western Region Fax
Division.

  LON B. RADIN co-founded the Company and serves as the Vice President of
Engineering and a member of the Board of Directors of the Company. Dr. Radin
also served as the Chairman of the Board of Directors from August 1988 to
October 1996. From 1986 to 1988, Dr. Radin was the sole proprietor of L-Tel
Laboratories, a developer of digital fax telephone devices. From 1981 to 1986,
Dr. Radin served in various positions, most recently as the Director of Software
and Manager of Research with Time & Space Processing, Inc., a software developer
of telecommunications products for the defense industry. Prior to that Dr. Radin
served as a software services consultant for The Systems Group, an engineering
consulting firm from 1976 to 1981. Dr. Radin holds a B.S. in Physics and
Mathematics from the University of Michigan and a Ph.D. and an M.A. in
Mathematics from the University of California at Berkeley.


ITEM 11.  EXECUTIVE COMPENSATION

  The information required by this item is included under the caption "Executive
Compensation" and "Stock Option Grants and Exercise" in the Company's Proxy
Statement to be filed in connection with the Company's 1998 annual meeting of
stockholders and is incorporated herein by reference.


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  The information required by this item is included under the caption "Security
Ownership of Certain Beneficial Owners and Management" in the Company's Proxy
Statement to be filed in connection with the Company's 1998 annual meeting of
stockholders and is incorporated herein by reference.


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  The information required by this item is included under the caption "Certain
Transactions" in the Company's Proxy Statement to be filed in connection with
the Company's 1998 annual meeting of stockholders and is incorporated herein by
reference.

                                       31
<PAGE>
 
                                    PART IV


ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

 (a) The following documents are filed as part of this Report:

     1. Financial Statements.
        ---------------------
<TABLE>
<CAPTION>
                                                                                                   Page
                                                                                                   ----   
        <S>                                                                                        <C>
        Independent Auditors' Report -- Deloitte & Touche LLP.....................................  38
                                                                                                             
        Report of Independent Accountants -- Price Waterhouse LLP.................................  39       
                                                                                                             
        Consolidated Balance Sheets as of December 31, 1997 and 1996..............................  40       
                                                                                                             
        Consolidated Statements of Operations for the Year ended December 31, 1997, the Nine                 
         Months Ended December 31, 1996 and the Fiscal Year Ended March 31, 1996..................  41       
                                                                                                             
        Consolidated Statements of Stockholders' Equity (Deficit) for Year ended December 31,                
         1997, the Nine Months Ended December 31, 1996 and the Fiscal Year Ended March 31, 1996...  42       
                                                                                                             
        Consolidated Statements of Cash flows for the Year ended December 31, 1997, the Nine                 
         Months Ended December 31, 1996 and the Fiscal Year Ended March 31, 1996..................  43       
                                                                                                             
        Notes to Consolidated Financial Statements................................................  44       
</TABLE>

     2. Financial Statement Schedules.
        -------------------------------

        Schedule II -- Valuation and Qualifying Accounts (see page 57)

  Schedules not listed above have been omitted because the information required
to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.


     3. Exhibits.
        ---------

<TABLE>
<C>         <S>
     3.1**  Certificate of Incorporation of Registrant filed on August 3, 1988, as currently in effect.
     3.2**  Certificate of Amendment of Certificate of Incorporation, as filed on October 31, 1990.
     3.3**  Certificate of Amendment of Certificate of Incorporation, as filed on August 13, 1991.
     3.4**  Certificate of Amendment of Certificate of Incorporation, filed on February 12, 1996.
     3.5**  Certificate of Amendment of Certificate of Incorporation filed on February 12, 1996.
     3.6**  Certificate of Amendment of Certificate of Incorporation filed on November 4, 1996.
     3.7**  Amended Certificate of Designation of Series A Preferred Stock, as currently in effect.
     3.8**  Certificate of Designation of Series B Preferred Stock, as currently in effect.
     3.9**  Certificate of Designation of Series C Preferred Stock, as currently in effect.
    3.10**  Certificate of Designation of Series D Preferred Stock, as currently in effect.
    3.11**  Certificate of Designation of Series E Preferred Stock, as currently in effect.
    3.12**  Amended Certificate of Designation of Series E Preferred Stock, as currently in effect.
    3.13**  Certificate of Designation of Series P Preferred Stock, as currently in effect.
    3.14**  Certificate of Designation of Series F Preferred Stock, as currently in effect.
    3.15**  Form of Restated Certificate of Incorporation of Registrant to be filed upon the closing of
            the Offering made under this Registration Statement.
    3.16**  Amended and Restated Bylaws of Registrant, as currently in effect.
    3.17**  Form of Amended and Restated Bylaws to be adopted effective as of the closing of the
            Offering made under this Registration Statement.
     4.1**  Specimen Common Stock Certificate.
    10.1**  Form of Indemnification Agreement between Registrant and each of its directors and officers.
    10.2**  1989 Stock Option Plan, as amended and restated, and forms of Stock Option Agreements
            thereunder.
    10.3**  1995 Stock Plan, as amended and restated, and form of Stock Option Agreement thereunder.
    10.4**  1997 Director Stock Option Plan and form of Stock Option Agreement thereunder.
    10.5**  1997 Employee Stock Purchase Plan and forms of agreements thereunder.
</TABLE>

                                       32
<PAGE>
 
<TABLE>
<C>         <S>
   10.6**   Lease Agreement dated December 1, 1992 between Registrant and Lincoln Menlo Phase I
            Associates Limited for Menlo Park, California office.
   10.7**   Lease dated December 18, 1991 between Crandell Development Corporation and Robert S. Grant
            for Santa Barbara, California office.
   10.8**   Registration Rights Agreement dated March 5, 1997 by and among the Registrant and Rudy
            Prince, Lon B. Radin and Virginia Snyder.
   10.9**   Stock and Warrant Purchase Agreement dated as of August 31, 1988 by and among Registrant
            and Purchasers of 299,995 shares of Series A Preferred, as amended February 1994.
   10.10**  Preferred Stock Purchase Agreement dated as of December 16, 1988 by and among Registrant
            and purchasers of 336,000 shares of Series A Preferred, as amended February 1994.
   10.11**  Preferred Stock Purchase Agreement dated as of June 22, 1989 by and between Registrant and
            David A. Brewer.
   10.12**  Form of Subscription and Stock Purchase Agreement dated January 1991 by and between
            Registrant and certain purchasers of Series A Preferred Stock.
   10.13**  Form of Subscription and Stock Purchase Agreement dated July 1989 by and between Registrant
            and certain purchasers of shares of Series B Preferred Stock.
   10.14**  Form of Subscription and Stock Purchase Agreement dated December 1989 by and between
            Registrant and certain purchasers of shares of Series B Preferred Stock.
   10.15**  Form of Subscription and Stock Purchase Agreement dated August/September 1990 by and
            between Registrant and certain purchasers of shares of Series C Preferred Stock.
   10.16**  Subscription and Stock Purchase Agreement for the purchase of shares of Series C Preferred
            Stock dated September 6, 1990 by and between Registrant and Draper Associates Polaris Fund.
   10.17**  Subscription and Stock Purchase Agreement dated September 7, 1990 by and between Registrant
            and Adlar Turnkey Manufacturing Corporation.
   10.18**  Form of Subscription and Stock Purchase Agreement for shares of Series D and Series E
            Preferred Stock and Warrants dated July 1991 by and between Registrant and certain
            purchasers of shares of Series D and Series E Preferred Stock.
   10.19**  Series E Preferred Stock Purchase Agreement dated August 18, 1991, as amended as of January
            30, 1996, by and between Registrant and Ailicec California Corporation.
   10.20**  Series F Preferred Stock Purchase Agreement dated as of March 5, 1996 by and between
            Registrant and purchasers of Series F Preferred Stock.
   10.21**  Purchase and Debt Restructuring Agreement dated as of August 3, 1994 by and between
            Registrant and Ailicec International Enterprises Limited.
   10.22**  Note Purchase Agreement dated August 3, 1994 by and between Registrant and certain
            purchasers of notes and warrants for the purchase of Common Stock.
   10.23**  Warrant to Purchase Stock dated December 31, 1994 by and between Registrant and Ailicec
            International Enterprises Limited.
   10.24**  Common Stock Purchase Warrant dated December 16, 1996, and an amendment thereto dated
            February 13, 1997, by and between Registrant and Michael Crandell.
   10.25**  Common Stock Purchase Warrant dated December 16, 1996, and an amendment thereto dated
            February 13, 1997, by and between Registrant and Larry Crandell.
   10.26**  Asset Purchase Agreement dated July 31, 1996, as amended December 16, 1996, by and between
            Registrant and the Crandell Group, Inc.
  10.27+**  Development Agreement dated September 25, 1991 and amended as of February 12, 1997 by and
            between Registrant and Ailicec International Enterprises Limited.
   10.28**  Common Stock Purchase Option dated as of March 29, 1996 by and between Registrant and
            Steven J. Carnevale.
   10.29**  Common Stock Purchase Option dated as of March 29, 1996 by and between Registrant and
            Thomas B. Aikin.
   10.30**  Promissory Note to Lon B. Radin dated March 1, 1992 from Registrant.
  10.31+**  Development and Supply Agreement dated June 30, 1995 by and between Registrant and Samsung
            Electronics Corporation.
  10.32+**  Software License Agreement dated September 30, 1996 by and between Registrant and Oki Data
            Corporation.
  10.33+**  Supply and License Agreement dated November 1, 1996 by and between Registrant and Pixel
            Magic, Inc.
  10.34+**  Facsimile Product Development Agreement dated June 9, 1994 by and between Registrant and
            Xerox Corporation.
  10.35+**  Facsimile Product Development Agreement dated November 23, 1994 by and between Registrant
            and Xerox Corporation.
</TABLE>

                                       33
<PAGE>
 
<TABLE>
<C>         <S>
  10.36+**  Master Development, Purchase and Distribution License Agreement dated effective as of
            January 31, 1997 by and between Registrant and Hewlett-Packard Company.
  10.37**   Employment Agreement dated July 31, 1996 between Registrant and Michael Crandell.
  10.38**   Security Agreement dated July 31, 1996 by and between Registrant and the Crandell Group,
            Inc.
  10.39+**  OEM Purchase Agreement dated February 22, 1995, as amended February 21, 1997, by and
            Between Registrant and Oki America, Inc.
  10.40**   Loan and Security Agreement dated August 23, 1996 by and between Registrant and Cupertino
            National Bank & Trust and the amendment thereto dated March 11, 1997 and the amendment
            Thereto dated March 31, 1997.
  10.41**   Form of Dealer Agreement.
  10.42+**  Agreement dated November 30, 1994 by and between the Crandell Group, Inc. and Intel
            Corporation as amended May 11, 1995, assigned and delegated to Registrant as of July 30,
            1996 and as further amended December 23, 1996.
   10.43    First Amendment dated September 15, 1997 to Lease Agreement dated April 4, 1997 between
            Registrant and Lincoln Menlo Phase I Associates Limited for Menlo Park, California office.
   10.44    Second Amendment dated December 2, 1997 to Lease Agreement dated April 4, 1997 between
            Registrant and Lincoln Menlo Phase I Associates Limited for Menlo Park, California office,
            as amended September 15, 1997.
   10.45    Sublease dated August 1, 1997 between Registrant and Systems & Software Consortium, Inc.
            Santa Barbara, California office.
   10.46    Lease Agreement between Registrant and Landlord, K. Dalbey and M Tachouet dated March 28,
            1997 for Beaverton, Oregon office.
   10.47    Lease Agreement between DocuMagix and Metropolitan Life Insurance Company dated November 1,
            1995 for San Jose, California office.
   21.1     Subsidiaries of Registrant.
   23.1     Independent Auditors' Consent and Report on Schedule -- Deloitte & Touche LLP (see page 87).
   23.2     Consent of Independent Accountants -- Price Waterhouse LLP
   24.1     Power of Attorney (see Signature Page).
   27.1     Financial Data Schedule.
</TABLE>
-------------
** Incorporated by reference to the identically numbered exhibits filed in
   response to Item 16(a), "Exhibits", of the Company's Registration Statement
   on Form S-1, as amended, (File No. 333-23763), which was declared effective
   on June 10, 1997.

+  Portions of the exhibit have been omitted pursuant to a request for
   confidential treatment and the omitted portions have been separately filed
   with the Commission.

   (b) Reports on Form 8-K.  On December 22, 1997 the Company filed Report on 
       -------------------
       Form 8-K in connection with its acquisition of DocuMagix, Inc which
       contained disclosures under Item 2. Acquisition or Disposition of Assets
       and Item 7. Financial Statements and Exhibits.

   (c) Exhibits Pursuant to Item 601 of Regulation S-K.  The exhibits required
       ----------------------------------------------- 
       by this Item are listed under 14(a)(3) above.

   (d) Financial Statement Schedules.   The financial statement schedule 
       -----------------------------
       required by this Item is listed under Item 14(a)(2) above.

                                       34
<PAGE>
 
INDEPENDENT AUDITORS' REPORT


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


  We have audited the accompanying consolidated balance sheets of JetFax, Inc.
and subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for the
year ended December 31, 1997, the nine-month period ended December 31, 1996 and
the year ended March 31, 1996. 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. The consolidated financial
statements give retroactive effect to the 1997 merger of JetFax, Inc. with
DocuMagix, Inc., which has been accounted for as a pooling-of-interests as
described in Note 2 to the consolidated financial statements.  We did not audit
the consolidated statements of operations, stockholder's equity (deficit), and
cash flows of DocuMagix, Inc. for the year ended June 30, 1996, which are
combined with JetFax , Inc.'s statements for the year ended March 31, 1996, and
reflect net revenues of $2,709,000 and net loss of $2,495,000. Those statements
were audited by other auditors whose report has been furnished to us, and our
opinion, insofar as it relates to the amounts included for DocuMagix, Inc. for
the fiscal year ended March 31, 1996, is based solely on the report of such
other auditors.

  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 and the report of such other auditors provide a
reasonable basis for our opinion.

  In our opinion, based on our audits and on the report of the other auditors,
such consolidated financial statements present fairly, in all material respects,
the financial position of JetFax, Inc. and subsidiaries at December 31, 1997 and
1996, and the results of their operations and their cash flows for the year
ended December 31, 1997, the nine-month period ended December 31, 1996 and the
year ended March 31, 1996 in conformity with generally accepted accounting
principles.


DELOITTE & TOUCHE LLP

San Jose, California
January 30, 1998
(February 23, 1998 as to the last
sentence of Note 6)

                                       35
<PAGE>
 
REPORT OF INDEPENDENT ACCOUNTANTS


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

In our opinion, the accompanying balance sheet and related statements of
operations and redeemable preferred stock and shareholders' equity (deficit) and
of cash flows present fairly, in all material respects, the financial position
of DocuMagix, Inc. at June 30, 1996, and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation.  We believe that our audit provides a
reasonable basis for the opinion expressed above.

PRICE WATERHOUSE LLP

San Jose, California
October 25, 1996

                                       36
<PAGE>
 
                         JETFAX, INC. AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

                                        
<TABLE>
<CAPTION>
 
                                                                               
                                                                             DECEMBER 31,      DECEMBER 31, 
                                                                                1997              1996     
                                                                            -------------      ------------
<S>                                                                         <C>                <C> 
Current assets:
 Cash and cash equivalents...........................................         $  4,200         $   413 
 Short-term investments..............................................            3,024              -- 
 Trade receivables, net of allowances of: $656 in 1997 and
  $559 in 1996.......................................................            4,820           2,542 
 Inventories.........................................................            4,029           2,454 
 Prepaid expenses....................................................              277             162 
                                                                               -------         ------- 
     Total current assets............................................           16,350           5,571       
Property--net........................................................            1,160             715 
Other assets.........................................................            1,346             806 
                                                                               -------         -------  
Total assets.........................................................          $18,856          $7,092 
                                                                               =======          ======
LIABILITIES, REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
 Accounts payable....................................................           $1,672          $2,491  
 Accrued liabilities.................................................            1,864           1,286 
 Short-term borrowings...............................................               --             950 
 Current portion of long-term note payable...........................               --             302 
                                                                               -------         -------             
     Total current liabilities.......................................            3,536           5,029 
                                                                               -------         -------               
Long-term note payable less current portion..........................               --             198 
Deferred revenue.....................................................               49              -- 
Redeemable preferred stock, $0.01 par value; none authorized and
 outstanding in 1997 and 344,350 shares outstanding in 1996..........               --           2,726 
                                                                                   
 Commitments (Note 7)................................................

Stockholders' equity (deficit):
  Convertible preferred stock, $0.01 par value; 5,000,000   shares
   authorized, shares outstanding: none in 1997 and 6,293,978
   in 1996...........................................................               --              63
 
  Common stock, $0.01 par value; 35,000,000 shares authorized,
   shares outstanding: 11,741,383 in 1997 and 1,789,086 in 1996......              117              18
  Additional paid-in capital.........................................           42,881          21,317 
  Accumulated deficit................................................          (27,727)        (22,259) 
                                                                               -------         -------               
                                                                               
     Total stockholders' equity (deficit)............................           15,271            (861) 
                                                                               -------         -------                
Total liabilities, redeemable preferred stock and stockholders'
    equity (deficit).................................................          $18,856         $ 7,092 
                                                                               =======         =======
</TABLE> 

                See notes to consolidated financial statements.

                                       37
<PAGE>
 
                         JETFAX, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                             NINE MONTHS         FISCAL 
                                              YEAR ENDED        ENDED          YEAR ENDED
                                             DECEMBER 31,    DECEMBER 31,       MARCH 31,
                                                 1997           1996              1996  
                                             ------------    -----------       ----------
<S>                                              <C>            <C>             <C>      
Revenues:                                                                                  
 Product.......................................   $16,281        $10,205         $11,143
 Software and technology license fees..........     4,493          3,200           3,413
 Development fees..............................     2,246          1,468             720
                                                  -------        -------         -------
     Total revenues............................    23,020         14,873          15,276
                                                  -------        -------         -------
Costs and expenses:                                                                     
 Cost of product revenues......................    11,886          8,441          11,102
 Cost of software and license revenues.........       770            517             587
 Research and development......................     5,355          2,554           2,318
 Selling and marketing.........................     6,046          5,212           5,216
 General and administrative....................     3,031          1,726           1,652
 Acquisition and related expenses..............     2,106             --              --
                                                  -------        -------         -------
     Total costs and expenses..................    29,194         18,450          20,875
                                                  -------        -------         -------
Loss from operations...........................    (6,174)        (3,577)         (5,599)
                                                  -------        -------         -------
Other income (expense):                                                                 
 Interest income...............................       310             40              29
 Interest expense..............................      (120)           (26)           (290)
 Other income (expense)........................       (79)           (14)              2
                                                  -------        -------         -------
     Total other income (expense)..............       111             --            (259)
                                                  -------        -------         -------
Loss before income taxes.......................    (6,063)        (3,577)         (5,858)
Provision for income taxes.....................        96            107              35
                                                  -------        -------         -------
Net loss.......................................    (6,159)        (3,684)       $(5,893)
                                                                                ======= 
Series P Redeemable Preferred Stock dividends..       (68)          (116)  
                                                  -------        -------   
Net loss applicable to common stockholders.....   $(6,227)       $(3,800) 
                                                  =======        =======   
Net loss per share:
 Basic.........................................    $(0.61)        $(0.46)
                                                   =======       =======
 Diluted.......................................    $(0.61)        $(0.46)
                                                   =======       =======
Shares used in computation:
 Basic.........................................    10,170          8,203
                                                   =======       =======
 Diluted.......................................    10,170          8,203
                                                   =======       =======
 
</TABLE>
                See notes to consolidated financial statements.

                                       38
<PAGE>
 
                         JETFAX, INC. AND SUBSIDIARIES

           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

                      (in thousands, except share amounts)
<TABLE>
<CAPTION>
                         
                                                  CONVERTIBLE                      
                                                PREFERRED STOCK              COMMON STOCK      ADDITIONAL
                                           ---------------------------   ---------------------   PAID-IN    ACCUMULATED   
                                              SHARES           AMOUNT      SHARES      AMOUNT    CAPITAL      DEFICIT     TOTAL
                                           -----------       ---------   ---------    --------  ---------   ---------   -------- 
<S>                                         <C>              <C>         <C>          <C>       <C>         <C>         <C>
Balances, April 1, 1995..................    2,848,288         $   29    1,166,348    $    12   $  6,242    $(11,757)   $(5,474)
Exercise of Common Stock options.........           --             --       55,760         --          5          --          5
Repurchase of DocuMagix Common                          
 Stock...................................           --             --       (2,743)        --         (3)         --         (3)
Sale of DocuMagix Common and                           
 Preferred Stock exchanged for                           
 Common Stock in merger..................           --             --      506,185          5      4,896          --      4,901
Issuance of Series F Convertible                       
 Preferred Stock for cash of $7,547                      
 and conversion of debt of $1,929,                      
 net of issuance costs of $675...........    3,445,690             34           --         --      8,766          --      8,800
Additional paid in capital from                        
 Conversion of debt into Series P                        
 Redeemable Preferred Stock, net                        
 of issuance costs of $13................           --             --           --         --        379          --        379
Cumulative dividends on Series F                       
 Convertible ($70) and Series P                          
 Redeemable ($27) Preferred Stock........           --             --           --         --         70         (97)       (27)
Net loss.................................           --             --           --         --         --      (5,893)    (5,893)
                                           -----------       ---------   ---------    --------  ---------   ---------   -------
Balances, March 31, 1996.................    6,293,978             63    1,725,550         17     20,355     (17,747)     2,688
Exercise of Common Stock options.........           --             --       41,125          1          7          --          8
Sale of DocuMagix Common and                            
 Preferred Stock exchanged for                           
 Common Stock in merger..................           --             --       22,411         --        236          --        236
Sale of DocuMagix warrants...............           --             --           --         --          6          --          6
Cumulative dividends on Series F                        
 Convertible ($713) and Series P                         
 Redeemable ($116) Preferred                            
 Stock...................................           --             --           --         --        713        (829)      (116)
Net loss.................................           --             --           --         --         --      (3,683)    (3,683)
                                           -----------       ---------   ---------    --------  ---------   ---------   --------  
Balances, December 31, 1996..............    6,293,978             63    1,789,086         18     21,317     (22,259)      (861)
Employee Stock Transactions..............           --             --       16,948         --         77          --         77
Exercise of Common Stock Options.........           --             --      105,374          1         27          --         28
Exercise of Common Stock Warrants........           --             --      516,782          5        269          --        274
Cumulative dividends on Series F                        
 Convertible ($240) and Series P                         
 Redeemable ($68) Preferred Stock........           --             --           --         --        240        (308)       (68)
Warrant compensation expense (Note 2)....           --             --           --         --        625          --        625
Issuance of Common Stock in                             
 connection with Initial Public Offering.           --             --    2,750,000         27     19,329          --     19,356
Conversion of Convertible Preferred                    
 Stock to Common Stock at IPO............   (6,293,978)           (63)   6,293,978         63         --          --         --
Conversion of Series F Cumulative                      
 Dividends...............................           --             --      162,703          2         (2)         --         --
Issuance of Common Stock for                           
 DocuMagix warrants......................           --             --        2,190         --         --          --         --
Issuance of Common Stock in exchange                   
 For DocuMagix convertible note..........           --             --      103,853          1        999          --      1,000
Adjustment to conform fiscal year of                   
 DocuMagix...............................           --             --          469         --         --         999        999
Net loss.................................           --             --           --         --         --      (6,159)    (6,159)
                                           -----------       ---------   ---------    --------  ---------   ---------  -------- 
Balances, December 31, 1997..............           --         $   --  $11,741,383    $   117    $42,881    $(27,727)  $ 15,271
                                           ===========       =========  ==========    ========  =========   =========  =======
 
</TABLE>
                See notes to consolidated financial statements.

                                       39
<PAGE>
 
                         JETFAX, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
 
 
                                                                                                       NINE MONTHS      FISCAL
                                                                                         YEAR ENDED       ENDED       YEAR ENDED
                                                                                        DECEMBER 31,   DECEMBER 31,    MARCH 31,
                                                                                            1997           1996           1996
                                                                                        -------------  -------------  ------------
<S>                                                                                     <C>            <C>            <C>
Cash flows from operating activities:
 Net loss                                                                                    $(6,159)       $(3,684)       $(5,893)
 Adjustments to reconcile net loss to net cash used for operating activities:
  DocuMagix net loss for the quarter ended March 31, 1997                                        999             --             --
  Depreciation and amortization.....................................................             539            208            313
  Warrant compensation expense......................................................             625             --             --
  Provision for (reversal of) inventory reserves and purchase commitment............             292           (339)           977
  Changes in assets and liabilities:
   Trade receivables................................................................          (2,375)          (255)          (748)
   Inventories......................................................................          (1,769)           997         (2,020)
   Prepaid expenses.................................................................            (115)           (29)           (64)
   Accounts payable.................................................................            (819)        (2,251)         2,225
   Deferred revenue.................................................................              49             --             --
   Accrued liabilities..............................................................             578           (344)           429
                                                                                             -------        -------        -------
      Net cash used for operating activities........................................          (8,155)        (5,697)        (4,781)
                                                                                             -------        -------        -------
Cash flows from investing activities:
 Purchase of property...............................................................            (742)          (541)          (265)
 Purchase of short-term investments.................................................          (3,024)            --             --
 Increase in other assets...........................................................            (783)           (80)           (21)
 Acquisition of Crandell Group......................................................              --           (305)            --
                                                                                             -------        -------        -------
      Net cash used for investing activities........................................          (4,549)          (926)          (286)
                                                                                             -------        -------        -------
Cash flows from financing activities:
 Proceeds from sale of Common Stock.................................................          19,735             18              8
 Repayment of related party notes payable...........................................              --            (61)           (70)
 Line of credit borrowings, net.....................................................              --            450             --
 Equipment term note borrowings.....................................................              --            250             --
 Proceeds from issuance of notes payable............................................             500            500          1,010
 Repayment of notes payable.........................................................            (950)            --         (1,362)
 Redemption of Preferred Stock--Series P, net.......................................          (2,794)            --             --
 Proceeds from Series F Convertible Preferred Stock--net............................              --            650          6,222
 Proceeds from DocuMagix Preferred Stock--net.......................................              --             --          4,125
 Restricted investments.............................................................              --             --            100
                                                                                             -------        -------        -------
      Net cash provided by financing activities.....................................          16,491          1,807         10,033
                                                                                             -------        -------        -------
Increase (decrease) in cash and cash equivalents....................................           3,787         (4,816)         4,966
Cash and cash equivalents, beginning of year........................................             413          5,229            263
                                                                                             -------        -------        -------
Cash and cash equivalents, end of year..............................................         $ 4,200        $   413        $ 5,229
                                                                                             =======        =======        =======
Supplemental cash flow information:
 Interest paid......................................................................         $   120        $     9        $   211
                                                                                             =======        =======        =======
 Taxes paid--foreign withholding....................................................         $    96        $   105        $    35
                                                                                             =======        =======        =======
Supplemental noncash investing and financial information:
 Accounts receivable--stockholder, offset against accounts payable--stockholder.....                                       $    75
                                                                                                                           =======
 Conversion of note payable to stockholder, to Series P Redeemable Preferred Stock
  issuable..........................................................................                                       $ 2,287
                                                                                                                           =======
 Conversion of convertible notes payable into Series D and F Redeemable Convertible
  Preferred Stock...................................................................                                       $ 1,929
                                                                                                                           =======
 Receivable--Series F Redeemable Convertible Preferred Stock........................                                       $   650
                                                                                                                           =======
 Conversion of Convertible Preferred Stock to Common Stock at Initial Public 
  Offering..........................................................................         $    63
                                                                                             =======
 Issuance of Series G Convertible Preferred Stock for technology....................                        $   225
                                                                                                            =======
 Cumulative dividends on Series F Convertible and Series P Redeemable Preferred 
  Stock.............................................................................         $   308        $   829       $     97
                                                                                             =======        =======       ========
 Acquisition of Crandell Group (Note 3):
  Fair value of assets acquired (includes intangibles of $540 and property of $15)..                        $   555
                                                                                                            =======
  Cash paid.........................................................................                           (305)
                                                                                                            =======
  Note payable to seller............................................................                       $    250
                                                                                                           ========
 Issuance of Common Stock in exchange for DocuMagix outstanding Common and 
  Preferred Stock...................................................................                       $    236      $   4,896
                                                                                                           ========      =========
 Issuance of Common Stock in exchange for DocuMagix convertible note................         $ 1,000
                                                                                             =======
</TABLE>
                See notes to consolidated financial statements.
                                        

                                       40
<PAGE>
 
                                  JETFAX, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996

1.  NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

NATURE OF BUSINESS

  JetFax, Inc. was incorporated in Delaware in August 1988 and since that time
has engaged in the development, manufacture and sale of its branded
multifunction products (MFPs) and entered into agreements with a number of
manufacturers (OEMs) of MFPs for the customization and integration of the
Company's embedded system technology and desktop software in several OEM
products.

  The Company acquired DocuMagix, Inc. on December 5, 1997 in a transaction
accounted for as a pooling-of-interests.  All financial data of the Company has
been restated to include the historical information of DocuMagix, Inc.

FISCAL PERIOD END

  Effective December 31, 1996, the Company changed its fiscal year end from
March 31 to a 52-53 week reporting year ending on the first Saturday on or after
December 31. The 40-week period from April 1, 1996 to January 4, 1997 is
referred to herein as the nine months ended December 31, 1996. Fiscal year 1997
includes 52 weeks. For presentation purposes, the Company refers to its
reporting years ended January 3, 1998 and January 4, 1997 as ending on December
31, 1997 and 1996, respectively.

PRINCIPLES OF CONSOLIDATION

  The consolidated financial statements include the accounts of JetFax, Inc. and
its wholly owned subsidiaries (collectively, the Company).  All significant
intercompany balances and transactions have been eliminated.

CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES

  The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Estimates include the level of
the allowance for potentially uncollectible accounts receivable, reserves for
inventories, accrued losses on purchase commitments, accrued OEM licensing
revenues, product development revenues recognized on the percentage-of-
completion basis, accrued warranty costs, and a valuation allowance for net
deferred tax assets.

  The Company sells and licenses its products and technology primarily to end
users (through independent distributors and dealers) and OEMs in the United
States, Canada, Asia and Europe. In addition, the Company performs development
services for certain of its OEMs. The Company performs ongoing credit
evaluations of its customers' financial condition and limits its exposure to
losses from bad debts by limiting the amount of credit extended whenever deemed
necessary and generally does not require collateral.

Certain components used in the Company's products are available only from one
source. In particular, the Company currently purchases its printer engine and
certain semiconductor devices from separate single sources of supply.  Any
shortage or interruption in the supply of any of the components used in the
Company's products, or the inability of the Company to procure these components
from alternate sources on acceptable terms, could have a material adverse effect
on the Company's business, financial condition and results of operations.

                                       41
<PAGE>
 
                                  JETFAX, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996

  The Company operates in a very dynamic industry.  The Company believes that
changes in any of the following areas could have a negative impact on the
Company's future financial position and results of operation:  difficulties in
successfully combining the businesses of the Company and DocuMagix;  the fact
that the Company's markets are characterized by rapidly changing technology,
evolving industry standards and frequent introductions of new products and
enhancements, and the Company's ability to respond to such changes;
difficulties which the Company may experience in completing the development of
turnkey designs for OEM customers, its color technology or other products;  the
fact that the multifunction and color markets targeted by the Company are at an
early stage of development;  the highly competitive nature of the markets for
the Company's products;  the phase-out or early termination of the Company's
branded products or OEM products incorporating the Company's technology;  the
Company's ability to attract and retain skilled personnel;  the Company's
reliance on third party suppliers for components used in the Company's products;
the quarterly variability in the Company's bookings and design wins;  and the
Company's reliance on a relatively small number of OEM customers for a large
percentage of its revenue.

FOREIGN CURRENCY TRANSLATION AND HEDGING

  The Company's foreign subsidiary in Germany uses the U.S. dollar as the
functional currency. Accordingly, assets and liabilities are translated using
period-end exchange rates, except for inventories and property, plant and
equipment, which are translated using historical rates.  Revenues and costs are
translated using historical rates. The resulting translation gains and losses
are included in income as they are incurred. Foreign currency transaction gains
and losses resulting from transactions denominated in other than the U.S. dollar
are included in income as incurred.  The Company's foreign losses were $58,000
for the year ended December 31, 1997 and were insignificant in the periods ended
December 31, 1996 and March 31, 1996.

  On occasion, the Company enters into firm purchase contracts with suppliers
that are denominated in a foreign currency. The Company has occasionally
purchased foreign currencies and held them during the contract term as a
designated hedge of the purchase commitment. The foreign currency gains and
losses from the foreign currency deposit are deferred and recognized as an
offset to the foreign currency gains and losses from the firm purchase
commitment.  At December 31, 1997, the Company had Yen deposits of 115,000,000
which were designated as a hedge against Yen denominated firm purchase
commitments of 213,000,000 for which deliveries are anticipated over the next
five months.

CONCENTRATION OF CREDIT RISK

  Financial instruments that potentially subject the Company to concentrations
of credit risk consist of cash equivalents, short-term investments and accounts
receivable. Credit risk with respect to trade receivables is spread over a
number of geographically diverse customers, who make up the Company's customer
base. At December 31, 1997 and 1996, the same customer accounted for 35% and 9%
of total accounts receivable, respectively.

CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

  Cash equivalents are highly liquid debt instruments acquired with an original
maturity of three months or less. The recorded carrying amounts of the Company's
cash and cash equivalents approximate their fair market value. Short-term
investments are high quality financial instruments with a maturity of from three
to fifteen months.  The short-term investments are carried at cost, which
approximates fair value.

ACCOUNTS RECEIVABLE

  Accounts receivable include unbilled amounts of $1,469,723 and $364,000
relating to development revenues at December 31, 1997 and 1996, respectively
(see "Revenue Recognition" below).

INVENTORIES

  Inventories are stated at the lower of cost (first-in, first-out) or market.
The Company's products

                                       42
<PAGE>
 
                                  JETFAX, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996

typically experience short life cycles, and the Company estimates the market
value of its inventory based on the anticipated selling prices adjusted for
completion and selling costs. Should the Company experience a substantial
unanticipated decline in the selling price of its products and/or demand
thereof, a valuation adjustment and corresponding charge to operations could
result. In addition, the Company uses subcontractors for the manufacture of
certain of its products and/or components and occasionally enters into purchase
commitments for such purchases. Consequently, the Company evaluates its exposure
relative to such contracts and the estimated selling prices of the related
products, adjusted for completion and selling costs, and accrues for losses, if
anticipated.

PROPERTY

  Property is stated at cost or, for items under capital lease, at the present
value of future minimum lease payments at the lease inception. Depreciation and
amortization are computed using the straight-line method over estimated useful
lives of one to five years or the lease term, whichever is appropriate.

OTHER ASSETS

  Other assets as of December 31, 1997 and 1996 include intangible assets
(acquired software, licensing contracts and covenants not to compete) of
$1,346,020 and $806,131, net of accumulated amortization of $205,071 and
$54,302, respectively.  Amortization is computed using the straight line method
over the estimated useful life of five years.

INCOME TAXES

  The Company accounts for income taxes under an asset and liability approach.
Deferred tax liabilities are recognized for future taxable amounts and deferred
tax assets are recognized for future deductions net of a valuation allowance to
reduce deferred tax assets to amounts that are more likely than not to be
realized.

REVENUE RECOGNITION

  Revenues from product sales to resellers, international distributors, OEMs and
end users are recognized upon shipment.  OEMs, end users, and international
distributors have no rights of return while resellers have limited return
rights.  Allowances for potential returns and exchanges from resellers are
provided at the time of sale based on historical returns and exchange
experience.  The Company defers revenue on sales to domestic distributors and
recognizes the revenue when the distributor sells the product to resellers.
The Company provides a ninety day warranty for parts and service on its hardware
products as well as ongoing technical support to the dealer network. The Company
provides a limited amount of telephone technical support to its software
customers.  Estimated cost of warranty work and post contract software customer
support obligations are accrued when the revenue is recognized.

  The Company enters into development agreements with OEM customers for which it
receives development fees with certain payments contingent upon attaining
contract milestones. Development fee revenues are derived from customizing the
Company's embedded system technology and software for inclusion in specific
applications for its OEMs' products. The Company's development contracts with
certain OEM customers have enabled JetFax to accelerate its product development
efforts.  The Company classifies all development costs related to such contracts
as research and development expenses because such development fees have only
partially funded the Company's product development activities, and the Company
generally retains ownership of the technology developed under these agreements.
The agreements typically provide for license and royalty payments to the Company
based on the OEM customers' subsequent use of the technology in their products.
Revenues from product development agreements are recognized using the percentage
of completion method. Estimates are reviewed and revised periodically throughout
the lives of the contracts. Any revisions are recorded in the accounting period
in which the revisions are made. Royalties are recognized as earned, and include
OEM product licensing revenues which are primarily determined based on the
number of OEM units sold. Such revenues are initially recorded based on an
estimate of such number of units and are adjusted upon the receipt of actual
unit sales data from 

                                       43
<PAGE>
 
                                  JETFAX, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996

OEMs in the accounting period in which the information is received.

RESEARCH AND DEVELOPMENT

  Research and development costs include costs and expenses associated with the
design and development of new products. To the extent that such costs include
the development of computer software, the Company follows the working model
approach to determine technological feasibility of the software product. Costs
incurred subsequent to establishing technological feasibility have been
immaterial and, accordingly, all software development costs have been included
in research and development expenses for the periods presented herein.

STOCK-BASED COMPENSATION

  The Company accounts for stock-based awards to employees using the intrinsic
value method in accordance with APB No. 25, "Accounting for Stock Issued to
Employees".

BASIC AND DILUTED NET LOSS PER SHARE

  Basic and diluted net loss per share has been computed using the weighted
average of common shares outstanding.  The Company completed its intial public
offering of its common stock in June 1997.  Basic and diluted per share amounts
presented for periods prior to the IPO represent the pro forma computation
including the common equivalent shares from convertible preferred stock which
converted in connection with the IPO.  Common stock equivalents from options,
warrants and redeemable preferred stock have been excluded from the computation
during all periods presented as their effect is antidilutive due to the
Company's net losses. Accordingly, options and warrants to purchase
approximately 2,600,000 common shares at a weighted average exercise price of
$1.52 per share and redeemable preferred stock convertible into 344,350 shares
of common stock were outstanding at December 31, 1996 and excluded from the
calculation of net loss per basic and diluted share; and options and warrants to
purchase approximately 2,850,000 common shares at a weighted average exercise
price of $3.63 per share were outstanding at December 31, 1997 and excluded from
the calculation of net loss per basic and diluted share.  Such options and
warrants will be included, using the treasury stock method, in periods where the
Company reports net income and the average fair market value of the Company's
common stock exceeds the exercise price. The net loss applicable to common
stockholders and the shares used for the computation of basic and diluted loss
per share are the same.

RECENT ACCOUNTING PRONOUNCEMENTS

  In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income", which
requires that an enterprise report, by major components and as a single total,
the change in its net assets during the period from nonowner sources; and No.
131, "Disclosures about Segments of an Enterprise and Related Information",
which establishes annual and interim reporting standards for an enterprise's
business segments and related disclosures about its products, services,
geographic areas, and major customers.  Adoption of these statements will not
impact the Company's consolidated financial position, results of operations or
cash flows.  Both statements are effective for the Company in 1998.


2. BUSINESS COMBINATION

  On December 5, 1997, the Company acquired DocuMagix, Inc. (DocuMagix) in a
merger transaction pursuant to an Agreement and Plan of Reorganization
(Agreement) entered into with DocuMagix on November 11, 1997.  Under the
Agreement, the Company issued 793,957 shares of its common stock in exchange for
all outstanding common and preferred shares of DocuMagix, and all rights with
respect to DocuMagix common stock under outstanding employee options were
converted into rights with respect to

                                       44
<PAGE>
 
                                  JETFAX, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996

the Company's common stock using the common stock exchange ratio of 0.004572.
In addition, the Company issued 2,190 shares of its common stock to certain
holders of DocuMagix warrants in exchange for such warrants and 103,853 shares
of the Company's common stock were exchanged for $1.0 million of outstanding
convertible notes payable by DocuMagix . The merger has been accounted for as a
pooling of interests and, accordingly, the consolidated financial statements for
all periods have been restated to reflect the combined operations of the two
companies.  The Company's fiscal year end is December (since it changed its
fiscal year end from March to December beginning with the nine-month period
ended December 31, 1996) while DocuMagix has used a June fiscal year.
Accordingly, the consolidated statements of operations combine the Company's
consolidated statements of operations for the year ended December 31, 1997, the
nine months ended December 31, 1996 and the year ended March 31, 1996 with
DocuMagix's statements of operations for the year ended December 31, 1997, the
nine months ended March 31, 1997 and the year ended June 30, 1996, respectively.
As a result, DocuMagix's results for the quarter ended March 31, 1997 have been
included in both the nine month period ended December 31, 1996 and the year
ended December 31, 1997. DocuMagix's unaudited revenues and net loss for this
period are $438,000 and $999,000, respectively.  The table below shows the
composition of combined net revenues and net loss for each of the periods
indicated (in thousands).  For DocuMagix the periods indicated represent the
Company's reporting period into which the DocuMagix financial information was
combined.

<TABLE>
<CAPTION>
                                                                                  
                                                                                                   FISCAL     
                                                      YEAR ENDED         NINE MONTHS ENDED       YEAR ENDED   
                                                     DECEMBER 31,          DECEMBER 31,          MARCH 31,    
                                                         1997                  1996                 1996      
                                                  -------------------  ---------------------  ---------------- 
<S>                                                <C>                  <C>                      <C>
REVENUES:
---------
JetFax                                                  $20,808                  $12,862            $13,187
DocuMagix                                                 2,212                    2,011              2,089
                                                        -------                  -------            -------
Combined                                                $23,020                  $14,873            $15,276
                                                        =======                  =======            =======
NET LOSS:
---------
JetFax                                                  $(3,012)                $(1,042)            $(2,929)
DocuMagix                                                (3,147)                 (2,642)             (2,964)
                                                        -------                 -------             -------
Combined                                                $(6,159)                $(3,684)            $(5,893)
                                                        =======                 =======             =======
</TABLE>
                                                                                

  The consolidated balance sheets at December 31, 1997 and December 31, 1996
combine the accounts of the Company as of those dates with the accounts of
DocuMagix as of December 31, 1997 and March 31, 1997, respectively. In
connection with the restatement of the consolidated financial statements to give
effect to the pooling of interests transaction with DocuMagix, Inc., the Company
adjusted DocuMagix, Inc.'s financial statements to conform its revenue
recognition policies to those of JetFax (the adjustment deferred revenue
recognition on sales to distributors).  The effect of the adjustment was to
reduce revenue and increase net loss for the year ended December 31, 1997 and
the year ended March 31, 1996 by $15,000 and $12,000 and $620,000 and $469,000,
respectively, and to increase revenue and decrease net loss by $438,000 and
$351,000, respectively, for the nine months ended December 31, 1996.


  In July 1996, the Company acquired the assets of the Crandell Group, Inc. (the
Crandell Group), a company in the business of developing and marketing software
products, including certain products used in fax applications, some of which
have previously been licensed by and used in JetFax products. The two principals
of the Crandell Group (the Principals) entered into two-year employment
agreements with JetFax. The Company paid $250,000 upon the closing and $250,000
in July 1997, and incurred $55,000 of acquisition costs for a total purchase
price of $555,000.  The purchase price was allocated $540,000 to proprietary
software, licensing contracts and covenants not-to-compete (included in Other
Assets, see Note

                                       45
<PAGE>
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996

1) and $15,000 to property and equipment.  The Company was obligated to make
royalty payments to the shareholder/employees contingent upon continued
employment and recorded acquisition expense of $ 1,056,000 and $228,000 for such
payments for the years ended December 31, 1997 and 1996, respectively. as
compensation within research and development expense.  The Company's obligation
to make these payments terminated upon the closing of the Company's initial
public offering (IPO) in June 1997 in consideration of a one-time acquisition
expense of $1.0 million. In connection with a 1996 amendment to the above
agreements, the Company issued a warrant to the Principals to acquire 100,000
shares of common stock at an exercise price of $1.75 per share.  Because the
terms of the warrant were not fixed until the Company's IPO, the Company treated
the warrant as variable and recorded $625,000 of compensation expense during
1997 included in acquisition expenses.  The results of operations for the
Crandell Group prior to its acquisition by the Company are not material and,
accordingly, pro forma information is not disclosed.


3.  INVENTORIES

  Inventories consist of (in thousands):

<TABLE> 
<CAPTION>
                                                                                    
                                                                               DECEMBER 31,  DECEMBER 31,
                                                                                  1997           1996
                                                                               -----------   ------------
<S>                                                                             <C>           <C>
   Materials and supplies..................................................       $1,776          $1,153
   Work-in-process.........................................................          143             235
   Finished goods..........................................................        2,110           1,066
                                                                                   -----           ----- 
   Total...................................................................       $4,029          $2,454
                                                                                  ======          ====== 
</TABLE> 

4.  PROPERTY

  Property consists of (in thousands):

<TABLE>
<CAPTION>
                                                                               DECEMBER 31,  DECEMBER 31,
                                                                                  1997           1996
                                                                               -----------   ------------
<S>                                                                             <C>           <C>
   Furniture and fixtures..................................................      $1,472         $1,011
   Software................................................................         467            364
   Leasehold improvements..................................................         234             56
                                                                                  -----          ----- 
   Total...................................................................       2,173          1,431
   Accumulated depreciation and amortization...............................      (1,013)          (716)
                                                                                  -----          ----- 
   Property-net............................................................      $1,160           $715
                                                                                 ======           ====
</TABLE>

5.  ACCRUED LIABILITIES

  Accrued liabilities consist of (in thousands):

<TABLE> 
<CAPTION> 
                                                                               DECEMBER 31,  DECEMBER 31,
                                                                                  1997           1996
                                                                               -----------   ------------
<S>                                                                             <C>           <C>
   Compensation and related benefits.......................................     $  509         $446  
   Acquisition related accruals............................................        375           --     
   Royalties...............................................................        215          152     
   Product warranty........................................................         94          140     
   Other...................................................................        671          548
                                                                                ------       ------ 
   Total...................................................................     $1,864       $1,286      
                                                                                ======       ======
</TABLE> 

                                       46
<PAGE>
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996

6.  LINE OF CREDIT AND NOTES PAYABLE

  Line of credit and notes payable consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                                               DECEMBER 31,  DECEMBER 31,
                                                                                  1997           1996
                                                                               -----------   ------------
<S>                                                                             <C>           <C>
Short-term borrowings:
  Convertible notes payable................................................        $  --         $ 500
  Line of credit...........................................................           --           450
                                                                                   -----         ----- 
    Total short-term borrowings                                                    $  --         $ 950
                                                                                   =====         ===== 
  Equipment term loan......................................................        $  --         $ 250
  Note payable.............................................................           --           250
                                                                                   -----         ----- 
     Total notes payable...................................................                        500
  Current portion..........................................................          (--)         (302)
                                                                                   -----         ----- 
  Long-term portion........................................................        $ --          $ 198
                                                                                   =====         =====               
</TABLE>

                                                                                
  The Company has a line of credit agreement under which it may borrow up to
$1.5 million at the bank's prime rate (8.5% at January 3, 1998) plus 1%.
Borrowings are limited to 80% on eligible domestic receivables, are secured by
all assets of the Company and are subordinate to stockholder notes and lien
positions. The line expires in August 23, 1998. No borrowings were outstanding
under the line of credit at December 31, 1997.

  The line of credit contains certain covenants which, among other things,
require the Company to maintain tangible net worth (as defined) of $3.0 million,
quarterly net income, a quick ratio of 1.0 to 1.0, a maximum debt to net worth
ratio (as defined) of 1.5 to 1.0 after December 31, 1996 and certain minimum
liquidity and debt service coverage. In addition, the agreement prohibits the
payment of cash dividends. At December 31, 1997, the Company was not in
compliance with the quarterly net income covenant and, on February 23, 1998,
received a waiver of this covenant through March 31, 1998 from the lender.

  In February 1997, DocuMagix issued $500,000 of convertible notes (the
Convertible Notes) with an expiration date of the earliest (a) December 31,
1997; (b) upon the closing of an underwritten public offering of shares of
common stock of DocuMagix; or (c) immediately prior to the closing of an
acquisition of DocuMagix by merger or otherwise. An additional $500,000 of
convertible notes were issued in 1997 and the outstanding balance of $1,000,000
was canceled in exchange for 103,853 shares of JetFax common stock in connection
with the merger with JetFax in December 1997 (see Note 2).


7.  LEASE COMMITMENTS

  The Company leases its primary facility under an operating lease expiring
through January 2003. Rent expense is recognized on a straight-line basis over
the term of the lease. The lease agreement requires the Company to pay property
taxes and maintenance costs. For the year ended December 31, 1997, the nine
months ended December 31, 1996 and the fiscal year ended March 31, 1996, rent
expense was $522,724, $246,166 and $249,858, respectively. Future minimum annual
rental payments for facilities leases are: 1998, $780,970, 1999, $754,926, 2000,
$563,174, 2001, $550,988 and $ 596,903 thereafter.

                                       47
<PAGE>
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996


8.  STOCKHOLDERS' EQUITY

  In June 1997, the Company completed an initial public offering of 2,750,000
shares of its common stock (selling shareholders sold an additional 750,000
shares in the offering) at a price of $8.00 per share.  Concurrent with the
offering, each of the 6,293,978 shares of convertible preferred stock then
outstanding were converted into the same number of common shares and the 344,350
shares of Series P Redeemable Preferred Stock were redeemed for $2.8 million
from the proceeds of the offering.  In addition, 389,512 shares of common stock
were issued upon the net exercise of warrants and 162,703 shares of common stock
were issued upon conversion of cumulative unpaid dividends on Series F preferred
stock.

PREFERRED STOCK

  The number of shares of preferred stock authorized  to be issued is 5,000,000.
The Board of Directors is authorized to issue the preferred stock from time to
time in one or more series and to fix the rights, privileges and restrictions of
the shares of such series.  As of December 31, 1997, no shares of preferred
stock were outstanding.

STOCK OPTION AND PURCHASE PLANS

  The Company has an employee stock option plan and a nonemployee director
option plan under which the Company may grant options to purchase up to
3,400,000 and 270,000 shares of common stock, respectively.  At December 31,
1997, 1,519,534 and 150,000 shares, respectively, remain available for future
grant under these plans.  The terms for exercising options are determined by the
Board of Directors and options expire at the earlier of ten years and one month
or such shorter terms as may be provided in each stock option agreement. In
connection with the merger of DocuMagix (see Note 2), the Company assumed
outstanding DocuMagix options using the common stock exchange ratio.  At
December 31, 1997, options to purchase 5,330 shares of the Company's common
stock at a weighted average exercise price of $33.27  were outstanding pursuant
to the DocuMagix options.

  The Company has reserved 500,000 shares of common stock for issuance pursuant
to the 1997 Employee Stock Purchase Plan.  The plan permits employees to
purchase shares at 85% of the lower of the fair market value of the common stock
at the beginning or end of each six-month offering period.  At December 31,
1997, 16,948 shares have been issued under the plan.

                                       48
<PAGE>
 
                                  JETFAX, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996

  Stock option activity and balances, excluding DocuMagix option activity which
is immaterial, are summarized as follows:


<TABLE>
<CAPTION>
                                                                                                   WEIGHTED   
                                                                                                   AVERAGE    
                                                                                                   EXERCISE   
                                                                                     NUMBER          PRICE     
                                                                                    OF SHARES      PER SHARE   
                                                                                    ----------     ----------   
<S>                                                                                <C>          <C>
Balance, April 1, 1995...........................................................      181,910        $0.160
Granted (weighted average fair market value $0.20)...............................       31,000         0.200
Canceled.........................................................................      (27,500)        0.200
Exercised........................................................................      (55,760)        0.100
                                                                                     ---------        ------
Balance, March 31, 1996..........................................................      129,650        $0.190
Granted (weighted average fair market value $0.57)...............................    1,009,000         0.550
Canceled.........................................................................      (62,740)        0.270
Exercised........................................................................      (41,125)        0.200
                                                                                     ---------        ------
Balance, December 31, 1996.......................................................    1,034,785        $0.540
Granted (weighted average fair market value $7.38)...............................    1,107,100         7.416
Canceled.........................................................................      (73,509)        4.349
Exercised........................................................................     (105,374)        0.272
                                                                                     ---------        ------
Balance, December 31,1997........................................................    1,963,002        $4.288
                                                                                     =========        ======
</TABLE>

<TABLE>
<CAPTION>
                                        OPTIONS OUTSTANDING                     OPTIONS EXERCISABLE
-------------------------------------------------------------------------- -------------------------------
                         NUMBER           WEIGHTED          WEIGHTED           NUMBER          WEIGHTED
     RANGE OF        OUTSTANDING AT       AVERAGE            AVERAGE       EXERCISABLE AT       AVERAGE
     EXERCISE         DECEMBER 31,       REMAINING          EXERCISE        DECEMBER 31,       EXERCISE
      PRICES              1997          LIFE (YEARS)          PRICE             1997             PRICE
------------------  ----------------  ----------------  -----------------  ---------------  ---------------
<S>                  <C>                <C>               <C>                 <C>               <C>
$0.20 - $0.30           501,785              8.05               $0.29           183,358             $0.29
 0.50 -  1.75           399,667              8.80                0.92           139,335              0.83
 4.00 -  5.88           207,050              9.72                5.58             3,193              4.31
 7.00 -  7.13            92,500              9.26                7.03                --                --
 8.00 -  9.88           762,000              9.76                8.00                --                --
-------------         ---------              ----                ----           -------             -----
$0.20 - $9.88         1,963,002              9.10               $4.29           325,886             $0.56
=============         =========              ====               =====           =======             =====
</TABLE>
                                                                                
  As discussed in Note 1, the Company uses the intrinsic value method specified
by Accounting Principles Board Opinion No. 25 to calculate compensation expense
associated with issuing stock options and, accordingly, has recorded no such
expense in the consolidated financial statements, as such issuances have been at
the fair value of the Company's common stock at the date of grant.

  Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation", (SFAS 123) requires the disclosure of pro forma net income
and earnings per share had the Company adopted the fair value method as of the
beginning of the year ended March 31, 1996. Under SFAS 123, the fair value of
stock-based awards to employees is calculated through the use of the minimum
value method for all periods prior to the initial public offering, and
subsequently through the use of option pricing models, even though such models
were developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which significantly differ from the
Company's stock option awards. These models also require subjective assumptions,
including future stock price volatility and expected time to exercise, which
greatly affect the calculated values. The Company's stock option calculations
were made using the Black-Scholes option pricing model with the following
weighted average assumptions: expected life, 12 months following vesting; stock
volatility, 65% subsequent to the initial public filing in June 1997; risk-free
interest rates, 5.76% for options granted during the year ended December 31,
1997, 6.29% for options granted during the nine months ended December 31, 1996
and 6.02% for options granted during the 

                                       49
<PAGE>
 
                                  JETFAX, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996


year ended March 31, 1996; and no dividends during the expected term. The
Company's calculations are based on a multiple option valuation approach and
forfeitures are recognized as they occur. If the computed fair values of the
stock-based awards (including awards under the Purchase Plan) had been amortized
to expense over the vesting period of the awards, pro forma net loss available
to common stockholders would have been $6,706,000 ($0.66 per share) for the year
ended December 31, 1997, $3,813,000 ($0.46 per share) for the nine months ended
December 31, 1996 and would not change for the year ended March 31, 1996.
However, because options vest over several years and grants prior to April 1,
1995 have been excluded from these calculations, the pro forma adjustments for
the year ended December 31, 1997, the nine months ended December 31, 1996 and
for the year ended March 31, 1996 are not indicative of future period pro forma
adjustments, assuming grants are made in those years, when the calculation will
apply to all applicable stock options.

  The Company has reserved or otherwise committed to issue shares of Common
Stock as follows:


<TABLE>
<CAPTION>
                                                                                 DECEMBER 31,
                                                                                     1997
                                                                                 -------------
<S>                                                                           <C>
   Exercise of warrants.......................................................     $890,499
                                                                                   ========
</TABLE>
                                                                                


9.  INCOME TAXES

    No federal and state income taxes were provided for the years ended December
31, 1997, the nine months ended December 31, 1996 and the year ended March 31,
1996 due to the Company's net losses. Foreign withholding taxes of approximately
$96,000, $105,000 and $35,000 were paid during the year ended December 31, 1997,
the nine months ended December 31, 1996 and the year ended March 31, 1996,
respectively. The Company's effective tax rate differs from the federal
statutory rate as follows (in thousands):


<TABLE>
<CAPTION>
 
                                                                                                  
                                                                                                   
                                                                YEAR       NINE MONTHS        FISCAL         
                                                                ENDED          ENDED        YEAR ENDED  
                                                             DECEMBER 31,   DECEMBER 31,     MARCH 31,   
                                                                1997           1996           1996     
                                                            ------------  --------------  ------------  
<S>                                                        <C>             <C>               <C>
Taxes computed at federal statutory rate of 35%..........   $(2,156)          $(1,289)        $(2,063)
Change in valuation allowance............................     2,156             1,289           2,063
Foreign withholding taxes................................        96               105              35
Other....................................................        --                 2              --
                                                            -------           -------         -------
Total provision..........................................   $    96           $   107         $    35
                                                            =======           =======         =======
</TABLE>
                                                                                
  Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes, as well as operating loss
and tax credit carryforwards. Significant components of the Company's net
deferred income tax asset are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                     
                                                                           December 31, December 31, 
                                                                             1997         1996       
                                                                          ------------  -----------   
<S>                                                                      <C>           <C>
Deferred tax asset:
   Net operating loss carryforwards....................................        $7,031       $6,326
   Tax credit carryforwards............................................           291          413
   Accounts receivable allowances......................................           124          142
   Depreciation........................................................           101           91
   Inventory valuation.................................................            91           78
                                                                                      
</TABLE>

                                       50
<PAGE>
 
                                  JETFAX, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996


<TABLE>
<CAPTION> 

<S>                                                                      <C>           <C>
   Nondeducted expense accrual.........................................           256           74
   Warranty reserve....................................................            38           40
   Capitalized research and development................................           230           41
   Vacation accrual....................................................            86           37
   Other...............................................................           291          106
                                                                              -------      -------
Total deferred tax assets..............................................         8,539        7,348
Valuation allowance....................................................        (8,539)      (7,348)
                                                                              -------      -------
                                                                              $            $  
                                                                              =======      =======
</TABLE>
                                                                                
  As a result of the Company's history of operating losses, management believes
that the recognition of the deferred tax asset is considered less likely than
not. Accordingly, the Company has fully reserved its net deferred tax assets as
of December 31, 1997 and 1996.

  At December 31, 1997, net operating loss carryforwards attributable to JetFax,
Inc. of approximately $13.9 million and $4.2 million (not including amounts
related to the Company's DocuMagix subsidiary) were available to offset future
Federal and state taxable income, respectively, and research and development tax
credits of $170,000 and $121,000 were available to offset future Federal and
state income taxes, respectively. Current Federal and California tax law
includes certain provisions limiting the annual use of net operating loss
carryforwards in the event of certain defined changes in stock ownership, as
defined. The Company's ability to utilize its net operating loss and tax credit
carryforwards could be limited according to these provisions. Management
believes such limitation could result in the loss of carryforward benefits which
expire from 2004 through 2012. The use of the above loss carryforwards is
dependent upon the Company's ability to achieve profitability. The Company's net
operating loss carryforwards attributable to it's DocuMagix subsidiary are
limited according to these provisions to approximately $380,000 per year or
approximately $5.7 million and $1.9 million in total through the applicable
federal and California carryforward periods, respectively.


10.  EMPLOYEE BENEFIT PLAN

  The Company has a 401(k) tax deferred savings plan for all eligible employees.
Participants may contribute a percentage of their compensation, which may be
limited by the plan administrator or applicable tax laws. The Company may make
discretionary matching contributions. Such matching contributions were
immaterial for the year ended December 31, 1997, the nine months ended December
31, 1996 and the fiscal year ended March 31, 1996.


11.  CUSTOMER AND GEOGRAPHIC INFORMATION

  Two customers accounted for 19% and 13%,respectively, of total revenues for
the year ended December 31, 1997. Two customers accounted for 18% and 9%,
respectively, of total revenues for the nine months ended December 31, 1996. One
customer accounted for 11% of total revenues for the year ended March 31, 1996.

The following is a summary of revenues by geographic region (in thousands):


<TABLE>
<CAPTION>
                                                                         YEAR       NINE MONTHS       FISCAL      
                                                                         ENDED          ENDED        YEAR ENDED   
                                                                     DECEMBER 31,   DECEMBER 31,     MARCH 31,    
                                                                         1997           1996           1996       
                                                                     ------------   ------------   -------------   
<S>                                                                 <C>            <C>            <C>
   United States..................................................        $16,386        $10,905          $9,556
   Europe.........................................................          4,545          2,369           4,444
                                                                                                 
</TABLE>

                                       51
<PAGE>
 
                                  JETFAX, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997, NINE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED
                                 MARCH 31, 1996


<TABLE>
<CAPTION> 

<S>                                                                 <C>            <C>            <C>
   Asia...........................................................          1,098          1,322             844
   Other..........................................................            991            277             432
                                                                          -------        -------         -------
   Total..........................................................        $23,020        $14,873         $15,276
                                                                          =======        =======         =======
</TABLE>
                                                                                


12. RELATED PARTY TRANSACTIONS

  Related party transactions and balances not otherwise disclosed herein were as
follows (in thousands):


<TABLE>
<CAPTION>
                                                                          DECEMBER 31,   DECEMBER 31,  
                                                                             1997           1996       
                                                                         ------------    -----------    
<S>                                                                      <C>            <C>
   Sales to related party..............................................           $167           $63
   Purchases from related party........................................             12            --
</TABLE>

  The Company has also granted a stockholder a nonexclusive royalty-free license
to utilize certain of its intellectual property.

                                       52
<PAGE>
 
13.  QUARTERLY RESULTS -- UNAUDITED

<TABLE>
<CAPTION>

(in thousands, except per share amounts)                       THREE MONTHS ENDED
                                                 -----------------------------------------------
                                                  MAR. 31,    JUNE 30,   SEPT. 30,   DEC.  31,
                                                    1997        1997        1997        1997
                                                 ----------  ----------  ----------  ----------
<S>                                             <C>         <C>         <C>         <C>
Total revenues.................................  $ 5,655     $ 5,374      $ 6,295       $ 5,696
Loss from operations...........................  $(1,547)    $(1,900)     $  (289)      $(2,438)
Net loss applicable to common stockholders.....  $(1,672)    $(1,957)     $  (234)      $(2,364)
Net loss per share:
 Basic.........................................  $ (0.20)    $ (0.21)     $ (0.02)      $ (0.20)
 Diluted.......................................  $ (0.20)    $ (0.21)     $ (0.02)      $ (0.20)
Shares used in computing per share amounts:
 Basic.........................................    8,233       9,196       11,599        11,649
 Diluted.......................................    8,233       9,196       11,599        11,649
</TABLE>

<TABLE>
<CAPTION>
                                                                                        THREE MONTHS ENDED
                                                                             ---------------------------------------
                                                                               JUNE 30,      SEPT. 30,     DEC.  31,
                                                                                1996           1996          1996
                                                                             ----------     ----------    ----------
<S>                                                                         <C>            <C>           <C>
Total revenues.....................................................          $ 4,714        $ 4,726        $ 5,433
Loss from operations...............................................          $(1,391)       $(1,216)       $  (970)
Net loss applicable to common stockholders.........................          $(1,407)       $(1,322)       $(1,071)
Net loss per share:
 Basic.............................................................          $ (0.18)       $ (0.16)       $ (0.13)
 Diluted...........................................................          $ (0.18)       $ (0.16)       $ (0.13)
Shares used in computing per share amounts:
 Basic.............................................................            8,000          8,197          8,217
 Diluted...........................................................            8,000          8,197          8,217

</TABLE>

                                       53
<PAGE>
 
                                                                     SCHEDULE II

                                                                                
                                  JETFAX, INC.
                       VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)

<TABLE> 
<CAPTION> 

                                                                             
                                                               BALANCE AT     CHARGED TO               BALANCE AT    
                                                              BEGINNING OF     COST AND    DEDUCTION/    END OF       
                                                                PERIOD        EXPENSES     WRITE-OFF     PERIOD       
                                                             ------------    ----------   ----------   --------       
<S>                                                          <C>             <C>          <C>          <C> 
YEAR ENDED DECEMBER 31, 1997:
  Accounts receivable allowance...........................      $559          $ 133        $ (36)       $656
                                                                ====          =====        =====        ====
NINE MONTHS ENDED DECEMBER 31, 1996:
  Accounts receivable allowance...........................      $426          $ 153        $ (20)       $559
                                                                ====          =====        =====        ====
  Accrued loss on inventory purchase commitment...........      $649          $(280)       $(369)         --
                                                                ====          =====        =====        ====
YEAR ENDED MARCH 31, 1996:
  Accounts receivable allowance...........................      $143          $ 285        $  (2)       $426
                                                                ====          =====        =====        ====
  Accrued loss on inventory purchase commitment...........        --          $ 760       $ (111)       $649
                                                                ====          =====       ======        ====

</TABLE> 

                                       54
<PAGE>
 
                                SIGNATURES



          Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the registrant has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized, in the city
of Menlo Park, State of California on the 3rd day of April, 1998.


                                              JETFAX, INC



                                    By    /s/   Edward R. Prince, III
                                       ----------------------------------------
                                               EDWARD R. PRINCE, III,
                                       PRESIDENT, CHIEF EXECUTIVE OFFICER AND
                                               CHAIRMAN OF THE BOARD

                                        

                               POWER OF ATTORNEY

     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Edward R. Prince, III and Allen K. Jones,
and each of them, his attorneys-in-fact, each with the power of substitution,
for him in any and all capacities, to sign any amendments to this Report on Form
10-K and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.



<TABLE> 
<CAPTION> 
          SIGNATURES                          TITLE                                     DATE
          ----------                          -----                                     ----
<S>                                <C>                                             <C> 

    /s/ Edward R. Prince, III       President, Chief Executive Officer              April 3, 1998     
--------------------------------       and Chairman of the Board                                     
     (EDWARD R. PRINCE, III )          (Principal Executive Officer)                                   
                                                                                                       
        /s/ Allen K. Jones          Vice President of Finance, Chief               April 3, 1998    
--------------------------------       Financial Officer, and Secretary                                  
        (ALLEN K. JONES )              (Principal Financial and                                      
                                        Accounting Officer )                                        
                                                                                                      
        /s/ Thomas B. Akin          Director                                       April 3, 1998      
--------------------------------                                                                      
        (THOMAS B. AKIN )                                                                             
                                                                                                      
       /s/ Douglas Y. Bech          Director                                       April 3, 1998      
--------------------------------                                                                      
        (DOUGLAS Y. BECH )                                                                            
                                                                                                      
     /s/ Steven J. Carnevale        Director                                       April 3, 1998      
--------------------------------                                                                      
      (STEVEN J. CARNEVALE )                                                                          
                                                                                                      
          /s/ Chung Chiu            Director                                       April 3, 1998      
--------------------------------                                                                      
          (CHUNG CHIU )                                                                               
                                                                                                      
    /s/ Edward R. Prince, Jr.       Director                                       April 3, 1998      
--------------------------------                                                                      
     (EDWARD R. PRINCE, JR. )                                                                         
                                                                                                      
         /s/ Lon B. Radin           Director                                       April 3, 1998      
--------------------------------                                                                      
         (LON B. RADIN )                                                                              
                                                                                                      
       /s/ Albert E. Sisto          Director                                       April 3, 1998      
--------------------------------                                                                      
        (ALBERT E. SISTO)

</TABLE> 

                                       55
<PAGE>
 

                                EXHIBIT INDEX

<TABLE>
<C>         <S>
     3.1**  Certificate of Incorporation of Registrant filed on August 3, 1988, as currently in effect.
     3.2**  Certificate of Amendment of Certificate of Incorporation, as filed on October 31, 1990.
     3.3**  Certificate of Amendment of Certificate of Incorporation, as filed on August 13, 1991.
     3.4**  Certificate of Amendment of Certificate of Incorporation, filed on February 12, 1996.
     3.5**  Certificate of Amendment of Certificate of Incorporation filed on February 12, 1996.
     3.6**  Certificate of Amendment of Certificate of Incorporation filed on November 4, 1996.
     3.7**  Amended Certificate of Designation of Series A Preferred Stock, as currently in effect.
     3.8**  Certificate of Designation of Series B Preferred Stock, as currently in effect.
     3.9**  Certificate of Designation of Series C Preferred Stock, as currently in effect.
    3.10**  Certificate of Designation of Series D Preferred Stock, as currently in effect.
    3.11**  Certificate of Designation of Series E Preferred Stock, as currently in effect.
    3.12**  Amended Certificate of Designation of Series E Preferred Stock, as currently in effect.
    3.13**  Certificate of Designation of Series P Preferred Stock, as currently in effect.
    3.14**  Certificate of Designation of Series F Preferred Stock, as currently in effect.
    3.15**  Form of Restated Certificate of Incorporation of Registrant to be filed upon the closing of
            the Offering made under this Registration Statement.
    3.16**  Amended and Restated Bylaws of Registrant, as currently in effect.
    3.17**  Form of Amended and Restated Bylaws to be adopted effective as of the closing of the
            Offering made under this Registration Statement.
     4.1**  Specimen Common Stock Certificate.
    10.1**  Form of Indemnification Agreement between Registrant and each of its directors and officers.
    10.2**  1989 Stock Option Plan, as amended and restated, and forms of Stock Option Agreements
            thereunder.
    10.3**  1995 Stock Plan, as amended and restated, and form of Stock Option Agreement thereunder.
    10.4**  1997 Director Stock Option Plan and form of Stock Option Agreement thereunder.
    10.5**  1997 Employee Stock Purchase Plan and forms of agreements thereunder.
    10.6**  Lease Agreement dated December 1, 1992 between Registrant and Lincoln Menlo Phase I
            Associates Limited for Menlo Park, California office.
    10.7**  Lease dated December 18, 1991 between Crandell Development Corporation and Robert S. Grant
            for Santa Barbara, California office.
    10.8**  Registration Rights Agreement dated March 5, 1997 by and among the Registrant and Rudy
            Prince, Lon B. Radin and Virginia Snyder.
    10.9**  Stock and Warrant Purchase Agreement dated as of August 31, 1988 by and among Registrant
            and Purchasers of 299,995 shares of Series A Preferred, as amended February 1994.
    10.10** Preferred Stock Purchase Agreement dated as of December 16, 1988 by and among Registrant
            and purchasers of 336,000 shares of Series A Preferred, as amended February 1994.
    10.11** Preferred Stock Purchase Agreement dated as of June 22, 1989 by and between Registrant and
            David A. Brewer.
    10.12** Form of Subscription and Stock Purchase Agreement dated January 1991 by and between
            Registrant and certain purchasers of Series A Preferred Stock.
    10.13** Form of Subscription and Stock Purchase Agreement dated July 1989 by and between Registrant
            and certain purchasers of shares of Series B Preferred Stock.
    10.14** Form of Subscription and Stock Purchase Agreement dated December 1989 by and between
            Registrant and certain purchasers of shares of Series B Preferred Stock.
    10.15** Form of Subscription and Stock Purchase Agreement dated August/September 1990 by and
            between Registrant and certain purchasers of shares of Series C Preferred Stock.
    10.16** Subscription and Stock Purchase Agreement for the purchase of shares of Series C Preferred
            Stock dated September 6, 1990 by and between Registrant and Draper Associates Polaris Fund.
    10.17** Subscription and Stock Purchase Agreement dated September 7, 1990 by and between Registrant
            and Adlar Turnkey Manufacturing Corporation.
</TABLE> 

<PAGE>

<TABLE> 
<CAPTION> 


  <C>      <S> 
   10.18**  Form of Subscription and Stock Purchase Agreement for shares of Series D and Series E
            Preferred Stock and Warrants dated July 1991 by and between Registrant and certain
            purchasers of shares of Series D and Series E Preferred Stock.
   10.19**  Series E Preferred Stock Purchase Agreement dated August 18, 1991, as amended as of January
            30, 1996, by and between Registrant and Ailicec California Corporation.
   10.20**  Series F Preferred Stock Purchase Agreement dated as of March 5, 1996 by and between
            Registrant and purchasers of Series F Preferred Stock.
   10.21**  Purchase and Debt Restructuring Agreement dated as of August 3, 1994 by and between
            Registrant and Ailicec International Enterprises Limited.
   10.22**  Note Purchase Agreement dated August 3, 1994 by and between Registrant and certain
            purchasers of notes and warrants for the purchase of Common Stock.
   10.23**  Warrant to Purchase Stock dated December 31, 1994 by and between Registrant and Ailicec
            International Enterprises Limited.
   10.24**  Common Stock Purchase Warrant dated December 16, 1996, and an amendment thereto dated
            February 13, 1997, by and between Registrant and Michael Crandell.
   10.25**  Common Stock Purchase Warrant dated December 16, 1996, and an amendment thereto dated
            February 13, 1997, by and between Registrant and Larry Crandell.
   10.26**  Asset Purchase Agreement dated July 31, 1996, as amended December 16, 1996, by and between
            Registrant and the Crandell Group, Inc.
  10.27+**  Development Agreement dated September 25, 1991 and amended as of February 12, 1997 by and
            between Registrant and Ailicec International Enterprises Limited.
   10.28**  Common Stock Purchase Option dated as of March 29, 1996 by and between Registrant and
            Steven J. Carnevale.
   10.29**  Common Stock Purchase Option dated as of March 29, 1996 by and between Registrant and
            Thomas B. Aikin.
   10.30**  Promissory Note to Lon B. Radin dated March 1, 1992 from Registrant.
  10.31+**  Development and Supply Agreement dated June 30, 1995 by and between Registrant and Samsung
            Electronics Corporation.
  10.32+**  Software License Agreement dated September 30, 1996 by and between Registrant and Oki Data
            Corporation.
  10.33+**  Supply and License Agreement dated November 1, 1996 by and between Registrant and Pixel
            Magic, Inc.
  10.34+**  Facsimile Product Development Agreement dated June 9, 1994 by and between Registrant and
            Xerox Corporation.
  10.35+**  Facsimile Product Development Agreement dated November 23, 1994 by and between Registrant
            and Xerox Corporation.
  10.36+**  Master Development, Purchase and Distribution License Agreement dated effective as of
            January 31, 1997 by and between Registrant and Hewlett-Packard Company.
  10.37**   Employment Agreement dated July 31, 1996 between Registrant and Michael Crandell.
  10.38**   Security Agreement dated July 31, 1996 by and between Registrant and the Crandell Group,
            Inc.
  10.39+**  OEM Purchase Agreement dated February 22, 1995, as amended February 21, 1997, by and
            Between Registrant and Oki America, Inc.
  10.40**   Loan and Security Agreement dated August 23, 1996 by and between Registrant and Cupertino
            National Bank & Trust and the amendment thereto dated March 11, 1997 and the amendment
            Thereto dated March 31, 1997.
  10.41**   Form of Dealer Agreement.
  10.42+**  Agreement dated November 30, 1994 by and between the Crandell Group, Inc. and Intel
            Corporation as amended May 11, 1995, assigned and delegated to Registrant as of July 30,
            1996 and as further amended December 23, 1996.
  10.43     First Amendment dated September 15, 1997 to Lease Agreement dated April 4, 1997 between
            Registrant and Lincoln Menlo Phase I Associates Limited for Menlo Park, California office.
  10.44     Second Amendment dated December 2, 1997 to Lease Agreement dated April 4, 1997 between
            Registrant and Lincoln Menlo Phase I Associates Limited for Menlo Park, California office,
            as amended September 15, 1997.
  10.45     Sublease dated August 1, 1997 between Registrant and Systems & Software Consortium, Inc.
            Santa Barbara, California office.
</TABLE> 
  
<PAGE>
 

<TABLE>
<C>         <S>
   10.46    Lease Agreement between Registrant and Landlord, K. Dalbey and M Tachouet dated March 28,
            1997 for Beaverton, Oregon office.
   10.47    Lease Agreement between DocuMagix and Metropolitan Life Insurance Company dated November 1,
            1995 for San Jose, California office.
   21.1     Subsidiaries of Registrant.
   23.1     Independent Auditors' Consent and Report on Schedule -- Deloitte & Touche LLP (see page 87).
   23.2     Consent of Independent Accountants -- Price Waterhouse LLP
   24.1     Power of Attorney (see Signature Page).
   27.1     Financial Data Schedule.
</TABLE>
-------------
** Incorporated by reference to the identically numbered exhibits filed in
   response to Item 16(a), "Exhibits", of the Company's Registration Statement
   on Form S-1, as amended, (File No. 333-23763), which was declared effective
   on June 10, 1997.

+  Portions of the exhibit have been omitted pursuant to a request for
   confidential treatment and the omitted portions have been separately filed
   with the Commission.

   (b) FINANCIAL STATEMENT SCHEDULES

   Schedule II -- Valuation and Qualifying Accounts

   Schedules not listed above have been omitted because the information 
required to be set forth therein is not applicable or is shown in the 
consolidated financial statements or notes thereto.