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 December 31, 1997

                                       or

[ ]  TRANSITION  REPORT  PURSUANT  TO  SECTION  13 OR  15(d)  OF THE  SECURITIES
     EXCHANGE ACT OF 1934

     For the transition period from ____________ to ____________

                         Commission File Number 0-25036

                                 VIDEONICS, INC.
             (Exact name of Registrant as specified in its charter)

                California                                      77-0118151
         (State or jurisdiction of                           (I.R.S. Employer
         incorporation or organization)                      Identification No.)

1370 Dell Ave., Campbell, California                                95008
(Address of principal executive offices)                         (Zip Code)

Registrant's telephone number, including area code:            (408) 866-8300

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

Securities registered pursuant to Section 12(g) of the Act:

      Common Stock, without par value        Nasdaq National Market System

       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 the  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. [ ]

       At March 2, 1998,  the  aggregate  market  value of Common  Stock held by
non-affiliates of the Registrant was approximately $8,932,053.

       As of March 2, 1998,  there  were  5,784,899  shares of the  Registrant's
Common Stock outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

       Materials from the Registrant's  definitive  Proxy Statement  relating to
its 1998 Annual Meeting of  Shareholders  to be held on or about August 19, 1998
(the "Proxy  Statement")  have been  incorporated by reference into Part III, of
this Report.




<PAGE>

<TABLE>
                                                VIDEONICS, INC.

<CAPTION>
                                               TABLE OF CONTENTS
<S>                                                                                                              <C>
PART I

         ITEM 1.           BUSINESS.............................................................................. 3

         ITEM 2.           PROPERTIES............................................................................16

         ITEM 3.           LEGAL PROCEEDINGS.....................................................................16

         ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ..................................16

PART II

         ITEM 5.           MARKET FOR THE COMPANY'S COMMON EQUITY SECURITIES AND RELATED SHAREHOLDERS MATTERS....17

         ITEM 6.           SELECTED FINANCIAL DATA...............................................................18

         ITEM 7.           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                           OPERATIONS............................................................................19

         ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...........................................25

         ITEM 9.           CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..48

PART III

         ITEM 10.          DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.......................................48

         ITEM 11.          EXECUTIVE COMPENSATION................................................................48

         ITEM 12.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........................48

         ITEM 13.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................48

PART IV

         ITEM 14.          EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K......................49


</TABLE>
                                                     2
<PAGE>



                                     PART 1

       The following  discussion  in this section  "Business"  contains  forward
looking  statements  within the meaning of Section 27A of the  Securities Act of
1933,  as amended,  and Section 21E of the  Securities  Exchange Act of 1934, as
amended.  Actual  results could differ  materially  from those  projected in the
forward  looking  statements  as a result of the  factors  set  forth  below and
elsewhere in this Form 10-K.


ITEM 1.       BUSINESS

       Videonics,   Inc.,  a  California  corporation  organized  in  1986  (the
"Company"),  is a leader in the design,  development,  manufacture,  and sale of
affordable,  high quality, real time, digital video  post-production  equipment.
The  Company's  products  process,  edit,  and mix raw video  footage as well as
enhance such  footage  with audio,  special  effects,  and titles,  resulting in
professional  quality video production.  Videonics  equipment is used throughout
the world in the  post-production  of videos. As of December 31, 1997, more than
460,000 units of Videonics equipment have been sold worldwide.

       Videonics'    products    incorporate    general    purpose    computers,
special-purpose   microprocessor-based   systems,   and   internally   developed
application   specific   integrated   circuits  ("ASICs")  with  digital  signal
processing ("DSP") and other  capabilities.  The Company also implements much of
its  products'   functionality  in  software.  The  Company  believes  that  its
proprietary  technologies provide the infrastructure to develop a broad array of
video post-production solutions in a timely manner. By reducing the cost of high
performance  post-production  equipment,  Videonics  is  making  post-production
capabilities available to an expanding market of potential users.

The Video Production Process

       The video  production  process  consists of three steps:  pre-production,
production, and post-production.

       Pre-production  is the  planning of a video:  writing a script,  creating
storyboards   (sketches  which  show  how  a  scene  will  look  and  describing
transitions),  planning shots,  budgeting,  obtaining  props and locations,  and
scheduling.  Production  is the  shooting of the video  scenes,  with or without
sound.  Post-production  involves  assembling  and combining  video footage with
titles,  effects,  and  audio  elements  to  create  a  master  tape  ready  for
distribution.

       The need for video  post-production  processing arises from the fact that
it is very  difficult  to make  an  original  recording  serve  as the  finished
production.  Doing so would  require  that scenes be shot in the final order and
that no errors occur during the original recording session.  Each time a mistake
is made,  the user would have to position  the tape  precisely at the end of the
previous scene and reshoot the desired scene perfectly.  Titles and effects must
be  planned  ahead of time and  inserted  exactly  at the  appropriate  moments,
working from a complete,  thorough script. Since this scenario is impractical in
most  situations,  the user instead  shoots raw footage and  assembles the final
video  production  by using  post-production  equipment  to arrange  the desired
scenes and add effects,  titles,  and other  improvements.  For video makers who
desire a polished product, the post-production process is essential.

       Generally, post-production includes five major elements. Video editing is
the process of removing,  rearranging,  and recording  video footage from one or
more video sources onto a single video output medium  (e.g.,  videotape).  Video
mixing allows video from  multiple  sources to be combined in many ways beyond a
simple cut or fade.  Transition  effects,  such as dissolves or fades (one video
scene fades away as another appears), wipes and slides (a moving boundary

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sweeps in new video as the old video is pushed away),  and  compression  effects
(videos  shrink  away or expand to fill the  screen)  are all used as  "fillers"
between scenes.  Video special effects  manipulate  video images to add dramatic
elements. Special effects can be used to modify the video material, changing its
color,  flipping  the image,  and adding  picture  warping  effects to achieve a
different  mood or  appearance  such as  those  created  by a  picture  within a
picture.  A chroma  key helps to  superimpose  one  image  over  another  (e.g.,
enabling a TV weather  forecaster to stand in front of an animated weather map).
Video  titling is the  process of adding  text,  special  characters,  and basic
graphic  elements to the video.  Titles can be  superimposed  on the video or on
colored backgrounds.  Titles help tell the story,  identify people,  places, and
objects, add credits, and the like. A variety of colors, patterns, fonts, sizes,
and effects (e.g.,  scrolls and crawls) can be used. Audio mixing is the process
of combining  various sound  elements  such as native sound (the original  sound
recorded with the video), narration,  music, and sound effects (e.g., a crashing
window, a lion's roar, or an explosion).

The Markets For Video Post-Production Equipment

       The Company believes that the market for video post-production  equipment
generally  can be  separated  into  five  segments,  categorized  by the  users'
requirements  and  individual  expertise:  videographer;  business and industry;
videophile;  education;  and  broadcast  professional.  These  markets for video
post-production  equipment  cover a wide  range  of  users,  price  sensitivity,
expertise levels, applications, demographics, and objectives.

       Videographer.   Videographers   are  typically   full-time  or  part-time
entrepreneurs  producing  videotapes  on a  commercial  basis.  They may  record
special events such as weddings,  birthdays,  sporting  competitions,  religious
ceremonies, and other celebrations.  Videographers also perform substantial work
on a commercial  basis for business and industry.  For instance,  a videographer
may produce videos for customer  instruction  in the use of a product,  create a
"home" or "commercial  property" tour video for small residential and commercial
real estate  brokerage  concerns,  or make videos of vacation  destinations  for
travel agents.  Videographers  want their videos to have the same  appearance as
those produced by broadcast professionals.

       Business and Industry.  The business and industry  category includes both
internal and external  production  facilities  producing  video for  government,
corporate,  institutional, and other large organizations. An internal user could
include  the  in-house  production  department  of  a  large  corporation  or  a
charitable  organization.  The  external  user  could  be an  independent  video
production  facility marketing its expertise to large institutions which lack an
in-house video production  department.  A typical  corporate user in this market
might produce videos for  instruction in the use of the  corporation's  products
(e.g., how to install and use a cellular telephone or a new computer),  employee
training  manuals,  sales or promotional  aids for product  presentation,  video
informational brochures, or video newsletters from management to shareholders or
employees.

       Videophile.  The  videophile  is a video  enthusiast  or  hobbyist  whose
interest has led to the adoption of new video  technology  for personal use. The
videophile  generally shoots a video for personal  non-commercial  purposes with
the intention of editing raw video footage into a finished video production. The
videophile's  camcorders,  VCRs,  and editing  equipment are affordable and high
quality.  Occasionally,  videophiles  capitalize on their  growing  expertise by
becoming videographers.  A typical videophile may belong to a "video club" along
with other  video  making  enthusiasts  or merely  want to record  entertainment
events and historical milestones for family and friends.  Videophiles may create
a tape library in several different video formats and may want an easy method to
consolidate and edit tapes into a single,  standard format.  Videophiles require
affordable  post-production equipment that works with different tape formats and
is easy to use.

       Education.  The education market consists of the audio-visual departments
of educational  institutions,  which use video  internally to serve the needs of
the  institution  as well as teach

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students the art of video production.  While some uses in an educational setting
may be no  different  than those of business  and  industry,  other uses include
recording sporting events to improve a player's performance,  recording a debate
or dramatic performance to teach speaking or other acting skills, and replacing,
as in the case of a video yearbook, still photography with video.

       Broadcast Professional.  The broadcast professional is the most demanding
video  post-production  equipment user,  requiring equipment to meet the highest
quality  broadcast  standards  in  order to  create  finished  commercial  video
productions.  Industry  analysts have  estimated that there are more than 16,000
worldwide sites for equipment in this user category,  including  studio,  cable,
network,  and television  broadcasters  as well as  independent  post-production
facilities.  Users in this market are generally less  price-sensitive than those
in other  categories,  frequently  paying  from  $100,000  to  $2,000,000  for a
complete suite of video  post-production  equipment.  This specialized equipment
also requires a large investment in user training and studio facilities.

The Videonics Solution

       The  Company's  solution is to design,  develop,  manufacture  and market
products that incorporate  advanced  proprietary  digital video  technologies to
reduce significantly the cost and difficulty of creating high quality video. The
Company's  current  product  line  provides  solutions  for  each  stage  of the
post-production   process.   The   majority  of  the   Company's   products  are
single-purpose microprocessor-based systems that utilize DSP algorithms in ASICs
and  proprietary  software,  all  developed  by the  Company.  The Company  also
provides  post-production  solutions which operate on general purpose  computers
and local area networks.  These  solutions are generally  categorized as desktop
video.  Company-developed  software,  incorporated  in each  Videonics  product,
provides  easy-to-use  implementations  of sophisticated  video  post-production
processes.

       By using  proprietary  ASICs and  software to replace  more costly  video
post-production equipment, the Company has been able to significantly reduce the
cost of digital video post-production  products.  As a consequence,  the Company
has been  able to offer  its  products  at  attractive  prices  to users in this
market.  Moreover,  the Company's  products contain features that have minimized
the need for most video makers to purchase  more  expensive  systems in order to
create high quality video.

Strategy

       Videonics'  objective is to maintain and expand its position in the video
post-production  market.  The Company has implemented  this strategy by means of
its acquisitions,  as well as internally developed  technologies,  products, and
marketing  programs.  By reducing the cost of high  performance  post-production
equipment,  the  Company  makes  post-production  capabilities  available  to an
expanding   market  of  potential  users.   The  Company's   business   strategy
incorporates the following elements:

       Expand  Proprietary  Technology  Base.  The  Company  believes  that  its
proprietary   digital  video  hardware  and  software   technology   provides  a
competitive  advantage in achieving timely development of a broad array of video
post-production solutions. The Company intends to continue to devote significant
resources to expanding its library of circuits, proprietary ASICs and associated
software to develop  products that  incorporate  higher  levels of  performance,
functionality, and integration.

       Broaden  Product Line. The Company  intends to expand its product line in
order to broaden its potential market and to reduce its reliance on any specific
market  segment.  Videonics  has been an  innovator  in  developing  affordable,
full-featured  editing  products  primarily for the  videographer,  business and
industry,  and videophile  market  segments.  The Company seeks to

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leverage this expertise by developing  new products with enhanced  functionality
that establish price/performance  leadership in other market segments, including
broadcast and desktop video.  The acquisitions of Nova,  Abbate,  and KUB, along
with the development of the  PowerScript  Character  Generator,  are all tactics
used to accomplish this objective.

       Expand Worldwide Distribution. The Company intends to further develop its
United States market by targeting  specific  vertical  distribution  channels to
reach  the   broadcast   professional   and  business   and  industry   markets.
Internationally,  the Company is expanding its distribution channels in emerging
markets.  The Company  believes  that  distributing  products  through  domestic
dealers and  international  wholesalers is a  cost-effective  method of reaching
potential product users.

       Heighten Brand Name Awareness.  The Company  believes that its brand name
awareness will remain an important factor in the distribution channels where its
products are sold,  and it takes steps to heighten such  recognition by selected
advertising,  attendance  at industry  trade shows,  and  maintaining  a focused
public relations campaign.

       Leverage Manufacturing and Distribution. The Company's strategy is to use
its resources in a cost-effective manner.  Wherever practical,  the Company uses
third party services for activities such as manufacturing  and accessing certain
sales channels. For instance, except for start-up production and the specialized
signal  processing  products from Nova,  the Company  contracts with third party
manufacturers located in Mexico for most product manufacturing.

Technology

       Digital technology has been incorporated in all of the Company's products
developed in the 1990s.  This technology is principally  implemented by means of
Company-developed  DSP ASICs and software.  All of the Company's ASICs have been
developed  by the  Company's  resident  team of  designers.  The software is all
proprietary and has been developed by the Company's software engineers.

<TABLE>
      The  Company's   engineers  employ  proprietary   hardware  and  software
libraries in conjunction  with other  advances in technology,  such as fast turn
gate  arrays and VHDL  design  methodology,  to  prototype  new  products  in an
efficient manner.  One measure of the growth in the technical  sophistication of
the Company's  products is illustrated below in terms of the increasing  numbers
of  complex  gate  arrays in its  proprietary  ASICs and of lines of code in its
proprietary software algorithms in select products.
<CAPTION>

                        PROPRIETARY ASIC AND SOFTWARE CONTENT OF SELECTED PRODUCTS

                                             Approximate           Approximate Lines             Year
      Product                              ASIC Gate Count         of Software Code             Shipped
      -------                              ---------------         ----------------             -------
<S>                                           <C>                     <C>                        <C>
Sound Effects Mixer                                 0                   1,000                    1991
Thumbs Up Video Editor                          4,000                   6,000                    1992
Video TitleMaker 2000                          20,000                  25,000                    1994
Digital Video Mixer                            62,000                  15,000                    1994
Edit Suite                                      8,000                  28,000                    1995
PowerScript                                   142,000                 100,000                    1996
Effetto Pronto                                250,000                 600,000                    1997

</TABLE>

                                                6
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Selected Products

       The Company offers a broad range of digital video products, each designed
to meet specific video post-production needs. The products work with most of the
commonly used broadcast  standards,  videotape formats, and with most brands and
models of video equipment. The Company's products range in price from under $100
for  certain  software  products  to more than  $34,700  for  certain  broadcast
products.

Videographer

       Digital Video Mixer.  The Digital Video Mixer,  first shipped in February
1994, effectively provides a user with a portable video production facility. The
Digital  Video Mixer has four video inputs and offers over 200 effects at any of
ten  speeds;   these  effects   include   fades,   wipes,   slides,   dissolves,
picture-in-picture,  flips,  luminance  key,  color  generation,  zooms,  freeze
frames,  color and negative  reversals,  rolls,  the ability to superimpose  one
video  image  over  another,  and  a  split  screen.  The  Digital  Video  Mixer
incorporates four ASICs,  including an ASIC with a TBC feature that allows it to
produce  video  mixing.  A  reduced  view of all four  video  inputs on a single
"preview"  monitor  shows the action of all four  sources  without  the need for
additional monitors. The Digital Video Mixer offers a "picture-in-picture" which
allows two  moving  video  images to be placed on the  screen at once.  A unique
"compose"  function  allows  the user to create a complex  image  made up of any
number of still  images and  colored  rectangles,  along with a moving  video or
solid color  background.  The "chroma  key"  feature  allows the user to shoot a
subject against a solid color  background and replace that color with a separate
video source.  This is the same technique used to place a weather  forecaster in
front of a weather map. The product has S-video as well as composite connectors.
The Digital Video Mixer has won numerous  awards,  including the Outstanding New
Editing  Equipment Award for 1994 by Video Magazine,  the European Video Editing
Product of The Year for 1994-1995 by the European Video Awards Panel,  the Video
Post-Production  Product of The Year 1994-1995 by Video Camera Magazine U.K, and
the 1997 Audio Video International Product of The Year Award for Special Effects
Generator. The Digital Video Mixer has a U.S. suggested retail price of $1,199.

       Video  TitleMaker  3000.  First  shipped  in  September  1996,  the Video
TitleMaker  3000 is a step up from the TitleMaker  2000.  Its two-piece  design,
with a  separate  PC-style  keyboard,  makes it  easier  to type in  text.  User
productivity  is also  improved  with the superior  keyboard and more than three
times the processing  speed of the TitleMaker 2000. The product offers more than
200 font-size  combinations  (compared to 92 in TitleMaker 2000) and doubles the
amount of user memory to store over 16,000 characters. A clock/calendar function
allows  the  user  to  display  the  time  and  date  and  permits  the  user to
automatically  trigger  a page of titles at a  specified  time and date,  and to
repeat that action periodically. The product features the same video quality and
resolution as the  TitleMaker  2000 and includes its other  features:  1,000,000
colors;  fades,  rolls  and  crawls;  bold,  shadow,  and  outline;  ability  to
superimpose over video or colored or patterned backgrounds; full set of accented
and international characters; and storage as projects. The Video TitleMaker 3000
received the 1997 Consumer  Electronics Show Innovations Award.  TitleMaker 3000
carries a U.S. suggested retail price of $799 and is available in other language
versions.

       Personal  TitleMaker.   First  shipped in  November  1997,  the  Personal
TitleMaker is a character generator primarily aimed at the camcorder enthusiasts
looking for an entry-level  titler. The Personal  TitleMaker offers its users: a
choice of 7 high-resolution fonts; over 1,000,000 colors for titles, backgrounds
and  borders;  fades,  rolls and crawls;  ability to  superimpose  over video or
colored  or  patterned  backgrounds;  full  set of  accented  and  international
characters  and a GPI trigger  input  allows  remote  triggering  of titles from
external  controllers,  such as  Videonics'  Thumbs  Up editor  and Edit  Suite.
Personal TitleMaker carries a U.S. suggested retail price of $399.


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       MediaMotion.  MediaMotion is a  machine-control  plug-in software product
for non-linear (disk-based) video editing applications including Adobe Premiere.
MediaMotion  adds  the  ability  to  control  VCRs,  camcorders  and  other  GPI
triggerable devices from inside Adobe Premiere and Ulead's MediaStudio Pro. With
MediaMotion, a user can batch-digitize select portions of source tapes, allowing
unattended  recording to disk.  This saves time and disk space.  MediaMotion  is
available  for Windows  operating  systems at a U.S.  suggested  retail price of
$179.

       Python.  First  shipped in  November  1997,  Python  captures,  digitally
compresses,  and plays back  full-motion  video from any video source  including
camcorders,  VCRs, and cameras. Python is an external video capture device which
allows PC and laptop users to send video  e-mails,  create video Web pages,  and
add  full-motion  video  to  multimedia  presentations.  Python  creates  highly
compressed video files in real time, using the industry-standard  MPEG-1 format.
Python also captures  high-resolution JPEG still pictures.  Software for viewing
MPEG video and JPEG still  pictures  is widely  available  on most PCs. It has a
U.S. suggested retail price of $349.

Broadcast

       Effetto Pronto.  Shipped beta version units in limited  quantities in the
fourth quarter of 1997.  Effetto Pronto is slated for the video  industry's most
creative  professionals  who use desktop graphics and video production tools. It
combines software with add-in hardware for real-time rendering of video effects.
With  near-real-time  previewing of effects,  Effetto Pronto allows  significant
increases in productivity  and frees the creative  process by allowing  multiple
iterations  and rapid  re-edits.  Designed to be platform  independent,  Effetto
Pronto consists of Effetto, a QuickTime based compositing software and Pronto, a
dedicated  resolution  independent PCI hardware accelerator card. The Pronto PCI
accelerator card can process almost one million pixels of film, video,  graphics
and CG elements in real-time.

       Effetto Pronto offers virtually unlimited creative control,  with effects
and functions previously  unavailable in an integrated compositing package which
includes:  chrominance  and  luminance  keying;  a full  complement  of  special
effects; and a professional  character generator with complete animation control
over every letter of text.

       The Videonics'  Effetto Pronto system will have a U.S.  suggested  retail
price of $4,995.

       PowerScript.  First shipped in September 1996, PowerScript is an advanced
PostScript video character  generator designed for broadcast,  video production,
multimedia,  industrial, and videography applications.  It displays high quality
(10-bit  4:2:2  digital  video)  anti-aliased  titles and offers the  character,
graphics  display,  and  formatting  features  supported  by the  PostScript(TM)
display  technology.  Two high-end  versions of PowerScript  were added in 1997;
PowerScript  Studio  has  composite  and Y/C  video  inputs  and  outputs  while
PowerScript  Studio Component  offers analog  component  inputs and outputs,  in
addition  to  composite  and Y/C.  Both  models  are  available  in PAL and NTSC
versions.

       PowerScript  is a  standalone  character  generator  - it  makes  images,
characters,  and graphics  internally,  without the aid of an external computer.
Rotation,  sizing, stretch,  outlines, color,  transparency,  and other advanced
functions are imaged by its internal PostScript engine.

       While PowerScript is standalone,  it also includes  extensive  networking
capabilities  that allow users to connect the product to a separate  computer or
computer network. It supports industry-standard Internet protocols (TCP/IP, FTP,
PPP) and accepts serial or Ethernet connections.  These allow desktop computers,
using standard software and hardware, to transfer projects, fonts, graphics, and
other files. PowerScript images EPS-format graphic files, created using standard
graphic applications like Adobe Illustrator,  CorelDraw, and Adobe Photoshop, on
standard platforms,  including Macintosh,  Windows, DOS, UNIX, and Amiga. A wide

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range of additional  features include  expandable PC Card (PCMCIA) storage,  TBC
(time  base  corrector),  user-definable  styles,  roll  and  crawl,  transition
effects,  clock/calendar,  GPI trigger, video test patterns, and optional analog
component output.

       The Videonics' PowerScript product line has a U.S. suggested retail price
of $3,000 to $5,000 depending on the model.

       The  Company's  Nova product line includes  time base  correctors,  frame
synchronizers,  transcoders,  video converters and signal distribution products.
Nova's end users are in  broadcasting,  cable  television  ("CATV"),  multimedia
studios,  corporate A/V, video  conferencing  and  presentation,  and industrial
market areas.

       StudioFrame  Series.  First  shipped  in the  summer  of  1996,  the Nova
StudioFrame  Series is a modular,  flexible,  digital/analog  signal  processing
system.  StudioFrame  is designed to  accommodate  the evolving  video and audio
interfacing  requirements  of both today and  tomorrow.  Targeting  applications
where the highest video quality is demanded, the system can be easily configured
to accomplish a wide variety of ultra-transparent  signal  conversion/processing
functions. A comprehensive range of both digital and analog function modules are
available, including: Serial Digital Converters, Noise Reducers,  Synchronizers,
Time-Base-Correctors,  Distribution Amplifiers,  and Format Converters. The Nova
StudioFrame  Series  range in price  from  $1,345 to  $34,700  depending  on the
configuration.

                                       9
<PAGE>
Marketing

       The  primary  goal of the  Company's  marketing  efforts  is to  increase
awareness of the Company's  products and technology and of their advantages over
competing  products or technologies.  These objectives are accomplished  through
advertising programs directed at users of post-production  equipment, a targeted
public relations program,  trade show exhibitions,  and educational  programs in
video making.

       The Company  advertises  principally  in magazines  directed at broadcast
professionals,  videographers,  and video producers in the business, industrial,
and educational segments of the market. Videonics has received editorial mention
in  many of  these  publications.  The  Company  exhibited  its  products  at 19
different U.S. trade shows during 1997, including the Consumer Electronics Show,
the National Association of Broadcasters, and COMDEX.

       The Company's  standalone  products carry a standard two-year warranty on
both parts and labor. Each of the Company's computer based products carry either
a two-year  warranty on hardware and a 90 day warranty on software or a one-year
warranty on both hardware and software.  In 1995, the Company added a ProService
feature that  enabled  customers to receive  their  repaired  units within 48-72
hours in exchange for payment of rush  charges.  The Company's  HelpLine  allows
customers  to talk  directly  with  support  personnel  equipped  to answer user
questions.  This support is free to the Company's  customers except for the cost
of the phone call. The Company believes that it obtains  valuable  feedback from
offering this service, which it then uses in developing new products.

Sales

       Domestic Sales. The Company  wholesales its products in the United States
through a direct  sales  organization,  supported by  independent  manufacturers
representative  organizations.  In 1997, 1996, and 1995, respectively,  sales in
the United States accounted for approximately 67%, 58%, and 51% of the Company's
total  revenues.  The Company sells to a variety of sales channels which in turn
sell to end users.  The Company's  sales channels  include Value Added Resellers
(VARs) who  specialize  in selling to the  Broadcast  Market,  direct mail order
businesses,  audio/visual  specialty stores, camera and video shops,  industrial
dealers  which  service  business  and  industry,  catalogs,  and  certain  mass
merchants.   The  majority  of  the  Company's  sales  channels   specialize  in
audio-visual or video products and have product knowledgeable sales personnel.

       International  Sales. The Company has addressed the international  market
opportunity by selling its products through wholesale  distributors servicing 78
different  countries and by selling selected  products to several  international
private label customers.  The Company  currently has eight employees who service
and support its  international  private  label  customers  and country  specific
distributors.  The Company's international  distributors also sell the Company's
products under the Videonics and Nova brand names,  through  channels similar to
those used by the Company in the United States.  These distributors also provide
dealers with marketing  programs,  such as advertising and public relations,  as
well as customer service and technical support.

       Distribution  channels.  The Company sells to three categories of buyers,
both  internationally  and domestically:  videographer,  broadcast,  and desktop
video.

       Videographer  products  may be  defined  as free  standing,  easy to use,
inexpensive  products which address a particular  need,  such as video mixing or
titling.   These  products  are  sold  through  direct  mail  order  businesses,
audio/visual specialty stores, camera and video shops.

       Broadcast   products  may  be  defined  as  those  which   operate  in  a
professional  edit studio and may be used in  conjunction  with a master control
panel or a switcher,  or may also operate

                                       10
<PAGE>

as  stand  alone  units.   These  units  must  comply  with  industry  technical
specifications  for video  quality.  An  example  of this type of product is the
PowerScript Character Generator. Broadcast products are sold principally through
VARs and system houses which service the broadcast industry.

       Desktop video products,  such as Python and Effetto Pronto, use a general
purpose computer as their control element.  These products are sold through VARs
and  retailers  who may also  sell  general  purpose  computers,  software,  and
peripherals.

       Localized  marketing.  The Company works with its private label customers
and international distributors to provide extensive support by adapting both its
products and  accompanying  publications  for the local country of distribution.
Promotional  materials,  such as brochures,  are produced in the local language.
Universal  symbols,  rather than language  specific text, are used for many user
interface elements such as on-screen displays. All products are designed to meet
most  local  regulatory  standards.   In  Europe,  for  example,   products  are
manufactured for the PAL television standard. The Company's products are further
designed to support local  languages.  The Company's Video  TitleMaker  products
include  special  characters  and accents to support  French,  German,  Italian,
Spanish, Dutch, Russian,  Hungarian,  Polish, Greek, Romanian,  Turkish, and the
Scandinavian   languages.   The  Company's  product   architecture   facilitates
additional  localization by substituting one read only memory ("ROM")  component
for another  (e.g.,  a  Czech/Slovak  ROM for an English  ROM) to become a local
product.

       Private  label   relationships.   The  Company  believes  that  strategic
alliances  are  essential  to  compete  successfully  in certain  large  foreign
markets,  particularly Japan. The Company therefore distributes in Japan through
select  private label  relationships.  These  relationships  are with well known
electronics  manufacturers  having highly  developed  distribution  channels and
substantial brand name recognition in the country of distribution. This strategy
enables  the  Company to  concentrate  its  efforts on  technology  and  product
development, rather than making the heavy financial and time commitment required
to  build  distribution  channels  in  these  difficult-to-access  markets.  The
Company's  first  private  label  relationship  in  Japan  was  with  Matsushita
Electrical  Industrial Co., Ltd.  ("Matsushita.")  Matsushita purchased a custom
version of the Company's EditMaker product which was manufactured by the Company
and is sold under the Panasonic brand name.  While the Company has  discontinued
its  domestic  version  of this  product,  it has an ongoing  sales and  support
obligation to Matsushita.  The Company currently manufactures the Sony Titler, a
Japanese  language  character  generator  for  sale in  Japan  known as the Sony
XV-J1000.  Designed to Sony  specifications by the Company's product development
team in Campbell, California, the Sony Titler is manufactured by the Company and
shipped to Sony from the United  States.  The Sony  Titler  includes a front-end
processor, which translates from a standard keyboard into 6,930 unique Kanji and
Kana (Japanese) characters for subsequent video display (up to 110,880 different
font/size character variations).  This  software-intensive  product provides all
the  functionality  of its English  language  counterpart,  plus some additional
functions required by the Japanese  language.  Such features include the ability
to present  text  (titles)  in either a  horizontal  or a vertical  format.  The
Company's private label sales decreased significantly in 1997.

        For 1997, 1996, and 1995, no one customer accounted for more than 10% of
revenues.

       Backlog.  The Company typically  operates with a small amount of backlog.
Accordingly,  the Company generally does not have a material backlog of unfilled
orders, and revenues in any quarter are substantially dependent on orders booked
in that quarter.  Any  significant  weakening in customer demand would therefore
have and has had in the past an almost immediate adverse impact on the Company's
operating results and on the Company's ability to maintain profitability.


                                       11
<PAGE>


Manufacturing and Suppliers

       Typically, the Company initiates small production runs of new products at
the  Company's   headquarters  in  Campbell,   California  before   transferring
manufacturing  to third party contract  manufacturers  located in Mexico.  Final
configuration and testing  ordinarily take place at the Company's  headquarters.
Generally, when received in Campbell, each of the products undergoes testing and
inspection  before final  shipment to customers.  The Company uses an integrated
materials management system for purchasing,  inventory control, cost accounting,
and invoicing. All products in the Nova product line are assembled,  tested, and
distributed from the Company's facility in Canton,  Connecticut.  As of December
31,  1997,  the  Company  employed  33 persons  directly  in  manufacturing  and
operations management in Campbell and has a permanent quality and test assurance
program at its contract  manufacturers'  locations in Mexico. Nova employed four
people  in  its  separate   manufacturing   and  operations   group  in  Canton,
Connecticut.

       The Company is dependent on sole source suppliers for certain  components
used in its products.  These components include certain key integrated circuits,
which  are  utilized  in  the   Company's   products,   ASICs  or  gate  arrays,
microprocessors,  filters, converters, and other parts. Although the Company has
generally  been  able to  procure  components  on a timely  basis,  an  extended
interruption  in the supply of any of the components  currently  obtained from a
single source could have a material  adverse  effect on the Company's  operating
results. While the Company believes alternative sourcing of these items could be
developed,  this might result in additional  cost in materials and overhead.  In
addition,  the Company buys most of its components from third party vendors on a
purchase order basis without any advance  contractual  commitments  and does not
carry significant inventories of these items. A shortage of any one part such as
ROM  semiconductor  devices,  or an  increase  in the  price  of a  part,  could
adversely affect  production of the Company's  products or reduce gross margins.
There can be no assurance that component  supplies will be adequate at all times
to ensure  that  customer  product  orders will be  manufactured  or filled in a
timely manner.

Research and Development

       The  Company  places  a  high  priority  on  research  and   development.
Development  efforts focus on video  quality,  system  performance,  feature set
expansion, user productivity,  improved processing,  and storage. In 1997, 1996,
and 1995,  the Company  invested $7.0 million,  $5.0 million,  and $3.1 million,
respectively,  constituting  35%,  17%,  and 9% of its  total  net  revenues  in
research and development,  respectively.  Because digitized video consumes large
amounts of data and requires  substantial  computer  power to process such data,
the  Company's  engineers  constantly  seek new methods to improve its products'
capacity  and  manipulation  of  video.   Maximizing  the  processing  of  video
information  contained  in video  random  access  memory  ("VRAM"),  through the
development of ASICs, is a focus of the Company's  development staff, as are the
compression and storage issues  necessitated  when  integrating and manipulating
large  amounts of video data.  As part of this ongoing  effort,  the Company has
made  significant  investments  in  advanced  computer  programming  tools.  The
Company's engineers work extensively with VHDL design methodology.  Any new ASIC
designs are maintained in VHDL libraries,  which product  designers may then use
to prototype subsequent new products.

       As of December  31, 1997,  the Company  employed 46 hardware and software
engineers with technical  skills in design and development of ASICs,  digital or
analog video signal generation-processing, or embedded software.

       During 1997, the Company  continued to experience  substantial  delays in
completing the successful  development  of products.  The Company  completed and
began shipping Python,  Personal TitleMaker and a beta version of Effetto Pronto
in the fourth quarter of 1997.  Shipments of Python and Effetto Pronto  occurred
later than originally planned,  resulting in a significant revenue shortfall for
1997,  which,  in turn,  significantly  affected  profitability  as the

                                       12
<PAGE>


Company suffered  substantial  operating losses. MX Pro, the Company's  advanced
Digital Mixer,  introduced in September of 1997 and scheduled to begin shipments
in the  fourth  quarter  of 1997,  has not  shipped  as of March 23,  1998.  The
PowerScript  Character  Generator in the NTSC video format,  introduced in 1995,
was  completed  for shipment in September of 1996.  After  extensive  field use,
major  revisions of  PowerScript's  software were made in 1997,  with additional
improvements  being  made in the first  quarter of 1998.  The ASIC and  software
technology of  PowerScript  will be utilized in other  products that the Company
currently has in development. As the complexity of the Company's product designs
and feature sets  continues to increase,  the Company may continue to experience
similar  product  development  delays which would have an adverse  effect on the
profitability of its operations. There can be no assurance that the Company will
be successful in the timely development of new products to replace or supplement
existing products or that the Company will be successful in integrating acquired
products  or  technologies  with its  current  business.  Delays in new  product
development have had an adverse material impact on the Company's growth in 1995,
1996 and 1997.  Similar adverse  effects on the Company's  results of operations
can be expected until new products are  successfully  introduced and accepted by
end users. See "Management's  Discussion and Analysis of Financial Condition and
Results of Operations."

       The Company's success depends,  in part, on its ability to anticipate new
technological  developments,  to develop expertise in such technologies,  and to
develop and introduce in a timely and cost-effective  manner additional features
and new products that satisfy  customer needs and desires.  As noted above,  the
Company has been unable to ship new products in a timely  fashion in 1995,  1996
and 1997, which has had a substantial adverse impact on the Company's results of
operations.  Such results have, in any event,  fluctuated  widely on a quarterly
basis.  There  can be no  assurance  that  any new  products  will be  developed
successfully, that the Company will be able to introduce additional new products
which  will  gain  acceptance  in  the   marketplace,   that  the  Company  will
successfully  assess new  technological  developments  and incorporate them into
future  or  current  products,  or that the  Company  will be able to do so in a
timely  fashion.  Any future  failure to develop or introduce  new products in a
timely  manner,  or  customer  rejection  of new  products,  may have a material
adverse effect on the Company's future results of operations.

Competition

       In  the  videographer   and  desktop  video  markets,   the  Company  has
encountered competition from smaller and comparably-sized  companies which offer
functionally similar products,  as well as from larger companies,  such as Sony,
Matsushita,  and JVC, which market both traditional  analog equipment as well as
new digital video  post-production  devices.  A number of competitors  exist who
have substantially greater resources than the Company and who make digital video
editing  products and other  post-production  devices for  operation on personal
computers   and    workstations.    Although   these   desktop    computer   and
workstation-based  vendors sell more  sophisticated  products  primarily for the
broadcast  professional and business and industrial markets and at significantly
higher  price  points than the  Company's  products,  it is  possible  that such
vendors may at some future time introduce products which target the same markets
as the Company's products.

       The character  generation and graphics  imaging  systems market is highly
competitive  and is  characterized  by rapid  technological  change and evolving
industry standards. Rapid obsolescence of products,  frequent development of new
products and significant price erosion are all features of the industry in which
the Company operates.  The Company anticipates  increased  competition from both
existing  companies and new market  entrants.  The Company is currently aware of
several major and a number of smaller  competitors.  In the standalone character
generator area, the Company believes its primary competitors are Chyron,  For-A,
Knox, and AVS. Many of these  companies have  significantly  greater  financial,
technical,  manufacturing and marketing resources than the Company. In addition,
certain product categories and market segments, on a region-by-region  basis, in
which the Company does or

                                       13
<PAGE>

may  compete,  are  dominated by certain  vendors.  As a result,  the  Company's
ability to compete in these areas may be limited.

       The Company  believes  that the markets for the  Company's  products will
remain  highly  competitive.  The Company  believes  that its ability to compete
depends on factors  both within and outside its control,  including  the success
and  timing  of new  product  developments  introduced  by the  Company  and its
competitors,  product  performance  and  price,  market  presence  and  customer
support.  There can be no  assurance  that the  Company  will be able to compete
successfully  with respect to these factors.  Maintaining any advantage that the
Company may have over its competitors will require continuing investments by the
Company in research and  development,  sales and marketing and customer  service
and support.  In addition,  as the Company enters new markets,  whether  through
acquisitions,  alliances  with other  companies  or on its own,  the Company may
encounter distribution channels,  technical requirements and competitive factors
that differ from those in the markets in which it currently operates.  There can
be no assurance  the Company will be able to compete  successfully  in these new
markets.  In addition,  increased  competition  in any of the Company's  current
markets  could  result in price  reductions,  reduced  margins or loss of market
share,  any of  which  could  materially  and  adversely  affect  the  Company's
business,  financial  condition  and  results  of  operations.  There  can be no
assurance that the Company will be able to compete  successfully against current
or future competitors.


Proprietary Rights

       The  Company  relies on a  combination  of trade  secret,  copyright  and
trademark laws, and contractual  agreements to safeguard its proprietary  rights
in technology and products.  In addition,  the Company has several patents.  The
Company has registered the Videonics brand name and certain  product  trademarks
in the  United  States,  as well as in some of its  international  markets.  The
Company  routinely  enters into  confidentiality  and  assignment  of inventions
agreements with each of its employees and nondisclosure  agreements with its key
customers and vendors.

       While the Company  relies on these  measures  to protect its  proprietary
rights,  there can be no assurance  that the Company's  technology is adequately
protected by such measures or that the technology will not be reverse-engineered
by third parties without  violation of the Company's  proprietary  rights.  Such
protection may not preclude  competitors from developing  products with features
and prices  similar to or even  better  than those of the  Company.  The Company
believes that its products and other proprietary rights do not infringe upon the
proprietary rights or products of third parties. In 1997, the Company reached an
agreement  with a third party patent  holder in which  royalties  are payable on
certain of the Company's  products.  Payment of these royalties will not have an
adverse  material  effect on the  Company's  financial  condition  or results of
operations.  There can be no assurance,  however,  that other third parties will
not assert  infringement  claims  against the Company in the future or that such
claims  will not result in costly  litigation  or require the Company to license
intellectual property rights from third parties.  There can be no assurance that
any such licenses would be available on terms  acceptable to the Company,  if at
all.

       The Company believes that, because the pace of technological change is so
rapid in the digital video  electronics  industry,  the best  protection for its
proprietary  rights is its  continued  substantial  investment  in research  and
development to apply the latest advances in data storage and data compression to
the integration of video  post-production  functions.  The Company believes that
any legal protection afforded by patent,  copyright,  and trade secret laws will
be less of a factor on the  Company's  ability to compete  than the  ability and
creativity  of its  research and  development  staff to develop  products  which
satisfy customer needs.  Moreover,  the Company believes that market positioning
and rapid market entry are equally important to the success of its products.

                                       14
<PAGE>


Employees

       As of March 2, 1998, the Company had 122 full-time  employees,  including
38 in research and development, 37 in sales and marketing, 36 in operations, and
11 in finance and administration. None of the Company's employees is represented
by a labor union or is covered by collective bargaining agreements.  The Company
believes that its employee relations are good. The Company has never experienced
a work stoppage.


                                       15
<PAGE>


ITEM 2.         PROPERTIES.

       The Company's principal administrative, sales and marketing, research and
development,  and operating  facilities are located in Campbell,  California and
consist of approximately  29,900 square feet under a lease which expires on July
31, 1999.  The Company also has a research and  development  facility in Millis,
Massachusetts  which  has 2,500  square  feet  under a lease  which  expires  on
February  28,  1999.  The Company has an  administrative,  sales and  marketing,
research and development,  and operating  facility in Canton,  Connecticut.  The
building is  approximately  5,000 square feet and under a lease which expires on
October 31, 1998.  The Company has an  administrative,  sales and  marketing and
research and development facility in Belmont,  California which has 6,050 square
feet under a sublease which expires on December 31, 1998.


ITEM 3.         LEGAL PROCEEDINGS.

       The Company is not currently involved in any material legal proceedings.


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

       No matter was  submitted to a vote of the Company's  shareholders  during
the fourth quarter of the fiscal year ended December 31, 1997.

                                       16
<PAGE>


                                     PART II


ITEM 5.   MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

<TABLE>
       The Company's  Common Stock has been listed on the Nasdaq National Market
System  under the symbol  "VDNX"  since its initial  public  offering  which was
declared  effective  on  December  15,  1994.  Prior to that date,  there was no
established  public trading market for the Company's Common Stock. The following
table sets  forth the  quarterly  high and low sales  price  information  of the
Common Stock during the fiscal years ended December 31, 1997 and 1996.

<CAPTION>

                                           Q1                Q2                Q3               Q4
                                           --                --                --               --
<S>                                      <C>               <C>               <C>               <C>
FY97                  High               $ 9.50            $ 7.50            $ 5.88            $7.13
                      Low                $ 4.13            $ 3.82            $ 4.88           $ 4.13

FY96                  High               $13.00            $12.25            $10.88           $10.00
                      Low                $ 7.00            $ 7.50            $ 7.75           $ 7.25
</TABLE>


       As of March 2,  1998,  there  were  approximately  2,200  holders  of the
Company's Common Stock. The closing sales price of the Company's Common Stock on
March 2, 1998 was $2.875 per share.


       Other than the  distributions  to S corporation  shareholders for certain
income tax  liabilities  associated  with the Company's  1994  earnings  through
December  14,  1994,,  the Company has never  declared or paid  dividends on its
Common Stock and does not  anticipate  paying any  dividends in the  foreseeable
future.  The Company currently  intends to retain its earnings,  if any, for the
operation and development of its business.


                                       17
<PAGE>


<TABLE>

ITEM 6.         SELECTED FINANCIAL DATA

       The selected financial data set forth below with respect to the Company's
statements  of  operations  for each of the years in the five year period  ended
December 31, 1997,  and with respect to the balance sheets at December 31, 1997,
1996,  1995, 1994 and 1993 are derived from financial  statements that have been
audited by Coopers & Lybrand L.L.P., independent accountants. The financial data
should  be read in  conjunction  with the  Company's  Financial  Statements  and
related  Notes and with  "Management's  Discussion  and  Analysis  of  Financial
Condition  and Results of  Operations"  included  elsewhere in this Report.  The
balance sheets as of December 31, 1997 and 1996, and the statement of operations
for each of the  three  years in the  period  ended  December  31,  1997 and the
independent auditors' report thereon, are included in Item 8 of this Report.

<CAPTION>
                                                                   Year Ended December,
                                           1997             1996          1995           1994            1993
                                           ----             ----          ----           ----            ----
                                                               (in thousands, except per share data)
<S>                                       <C>              <C>            <C>            <C>             <C>
Statement of Operations Data:
Net revenues                              $19,955          $29,195        $33,561        $31,498         $13,885
Operating income (loss)                   (12,984)  (3)        401          4,811          5,627             809
Net income (loss)                         (13,441)  (3)        744          3,746          5,993  (1)        605
Net income (loss) per share                 (2.34)  (3)       0.13           0.65           1.39  (1)       0.16
Net income (loss) per share,
excluding charge for
purchased research and  development         (2.34)  (3)       0.13           0.88  (2)      1.39  (1)       0.16
Shares used in computing per share
 amounts                                    5,744            5,933          5,791          4,324           3,842


                                             1997            1996           1995            1994            1993
                                             ----            ----           ----            ----            ----
Balance Sheet Data:
Working capital (deficiency)               $ 9,902         $21,412        $20,127        $18,394           ($493)
Total assets                                15,694          27,958         27,350         22,279           5,524
Shareholders' equity (deficit)              12,606          25,731         24,149         19,403             214
Dividends declared per share (4)               -               -             -              0.71            0.01

<FN>
----------
(1)  In connection  with its December 15, 1994,  initial  public  offering,  the
     Company  terminated  its S  corporation  status and recorded a one time tax
     benefit of $650,000, which is reflected in the Company's 1994 results. On a
     pro  forma  basis,  utilizing  a 38  percent  tax  rate and  excluding  net
     operating  losses,  pro forma net income and pro forma net income per share
     for the period  ending  December  31, 1994 would have been  $3,424,000  and
     $0.79, respectively.

(2)  Results for 1995  include a one-time  charge of  $1,965,000  for  purchased
     in-process  research and  development  related to the  acquisition of Nova.
     Without this one-time charge,  the net income of $3,746,000 would have been
     $5,075,000  or $0.88  per  share.  See  Note 3 of  Notes  to the  Financial
     Statements.

(3)  Results for 1997 include:  a $1.9 million  write-off of  intangible  assets
     related to Nova Systems;  a $1.4 million increase in inventory reserves for
     components  rendered obsolete by product  revisions of which  approximately
     $458,000  related to  PowerScript  and $265,000  related to KUB Systems and
     $700,000  related to obsolete  and slow moving  assets at Nova  Systems;  a
     $274,000 increase in warranty reserves for PowerScript  hardware updates; a
     tax  charge  of  $5.9  million  due to  the  establishment  of a  valuation
     allowance against the company's  deferred tax assets; and a $100,000 charge
     for the reduction of  approximately 12 percent of the company's work force.
     The total of these charges equals $9.6 million.

(4)  See Part II, Item 5 of this Report regarding the distributions of dividends
     to the  Company's  S  corporation  shareholders  to cover  certain of their
     income tax liabilities resulting from the Company's earnings.
</FN>
</TABLE>

                                       18
<PAGE>


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

       The following  discussion in this section  "Management's  Discussion  and
Analysis of  Financial  Condition  and  Results of  Operations"  contains  trend
analysis and other forward looking  statements within the meaning of Section 27A
of the  Securities  Act of 1933, as amended,  and Section 21E of the  Securities
Exchange Act of 1934, as amended.  Actual results could differ  materially  from
those projected in the forward looking statements as a result of the factors set
forth below and elsewhere in this Form 10-K.

Overview

       Videonics  is a  designer  of  affordable,  high-quality,  digital  video
post-production  equipment.   Videonics  products  are  used  by  videographers,
business,  industry,  education  and  videophiles;  they  are  also  used in the
broadcast, cable, video presentation and video conferencing markets. The company
manufactures  standalone  and  personal-computer-based   hardware  and  software
products  that capture,  edit and mix raw video footage and add special  effects
and titles.  Products include edit  controllers,  video and audio mixers,  video
processors, character generators,  multimedia software, computer-based animation
and video compositing systems, frame synchronizers,  time base correctors, video
format converters,  transcoders,  distribution amplifiers, routing switchers and
audio/visual delay systems.

       In 1995,  the Company  improved its gross profit  through  volume related
purchasing,  improved  manufacturing,  and a lower  proportional  amount  of OEM
revenues.  The Company  began  shipping its Edit Suite  product in June 1995. In
September 1995, the Company hired all the personnel,  acquired substantially all
the assets and certain  liabilities  of Nova,  a  manufacturer  of video  signal
processing  equipment in the broadcast market, and incurred a one time charge of
approximately $2.0 million for purchased in-process research and development. In
addition,  in September of 1995,  the Company  hired the  personnel and acquired
substantially all the assets of Abbate, a developer of desktop video products.

       In 1996,  the Company  continued  to  diversify  into the  broadcast  and
desktop markets with the  acquisition of the assets of KUB Systems,  a developer
of desktop  digital video  production  equipment for the  broadcast  market.  In
addition,  the Company made significant changes in the structure of its Research
and Development  department  which included the addition of a new Vice President
of R&D.  The  TitleMaker  3000  and the  PowerScript  Character  Generator  were
introduced  at the end of the  third  quarter  of 1996  resulting  in the  first
quarterly  increase  in  revenues  in five  quarters.  However,  after  shipping
PowerScript to a wide base of customers,  deficiencies in the user interface and
certain signal timing issues in specific  applications were discovered that made
the product difficult to sell. With additional costs in Research and Development
and  Sales and  Marketing  related  to the  Company's  diversification  into the
broadcast and desktop markets,  combined with lower sales of the Company's older
Videographer products and a delay in bringing additional new products to market,
the Company  expected losses for the first quarter of 1997, with results for the
remainder of the year dependent on planned  shipment and customer  acceptance of
new products.

       In 1997,  the  Company  continued  to improve the  PowerScript  Character
Generator.  New  versions of the  operating  software  which  enhanced  the user
interface  and  operating  speed of the product  were  released in 1997.  Signal
timing  issues were  addressed  with the  introduction  of two new higher priced
versions of PowerScript  (PowerScript  Studio and PowerScript  Studio Component)
targeted at higher end customers.  In 1997, the Company announced four major new
products which were expected to ship in 1997: Effetto Pronto,  MXPro, Python and
Personal TitleMaker. As of December 31, 1997, the Company had brought Python and
Personal  TitleMaker  to market  in  commercial  quantities.  Since  Python  and
Personal  TitleMaker were shipped in the fourth quarter of 1997, the first three
quarters of 1997 did not contain  revenues  from any of the  aforementioned  new
products.  With  additional  costs in  Research  and

                                       19
<PAGE>

Development  and Sales and Marketing  related to the  Company's  diversification
into the broadcast and desktop  markets,  declining sales of the Company's older
Videographer  products and delays in shipment of new  products,  the Company had
operating  losses in each quarter of 1997. The Company expects losses during its
first and second  quarter of 1998,  with  results for the  remainder of the year
dependent on planned shipment and customer acceptance of new products. To reduce
expenses,  the Company  reduced its  personnel by twelve  percent on January 15,
1998.


<TABLE>
Results of Operations

       The  following   table  sets  forth  certain  items  from  the  Company's
statements of income as a percentage of net revenues for the periods indicated:
<CAPTION>

                                                                             YEAR ENDED DECEMBER 31,
                                                                1997               1996             1995
                                                                ----               ----             ----
<S>                                                            <C>                 <C>              <C>
Net revenues                                                   100.0%              100.0%           100.0%
Cost of revenues                                                69.7                52.3             51.1
  Gross profit                                                  30.3                47.7             48.9
Operating expenses
  Research & development                                        34.8                17.2              9.4
  Selling & marketing                                           40.3                23.1             15.4
  General & administrative                                       8.9                 4.7              3.6
  Amortization of intangible assets                              2.0                 1.3              0.3
  Write-off of intangible assets                                 9.4                  -                -
  Charge for purchased R&D                                         -                  -               5.8
                                                               -----               -----            -----
  Total operating expenses                                      95.4                46.3             34.5
                                                               -----               -----            -----
     Operating income (loss)                                   (65.1)                1.4             14.4
Other income, net                                                1.3                 1.2              2.1
                                                               -----               -----            -----
  Income (loss) before income taxes                            (63.8)                2.6             16.5
Provision for income taxes                                       3.6                 0.1              5.3
                                                               -----               -----            -----
     Net income (loss)                                         (67.4)%               2.5%            11.2%
                                                               =====               =====            =====
</TABLE>


Comparison of Years Ended December 31, 1997 and 1996

       Net Revenues.  Net revenues  decreased 32% to $20.0 million in 1997, from
$29.2 million in 1996. This decrease is primarily  attributable to reduced sales
of older  Videographer  products,  and the  absence of major new  product  sales
during the first three  quarters of the year.  International  revenues  for 1997
were $6.6 million or 33% of net revenues compared to $12.3 million or 42% of net
revenues in 1996. The percentage  decrease in  international  revenue in 1997 is
due primarily to decreased  sales of older  Videographer  products and delays in
the introduction of Python and other new products in the international market.

       Gross  Profit.  Gross profit  decreased  57% to $6.1 million in 1997 from
$13.9 million in 1996. Gross profit, as a percentage of net revenues,  decreased
to 30% in 1997 from 48% in 1996.  The  percentage  decrease  in gross  profit is
principally  attributable to charges for the following:  a $1.4 million increase
in inventory  reserves for components  rendered obsolete by product revisions of
which  approximately  $458,000  related to PowerScript,  $265,000 related to KUB
Systems and $700,000 related to obsolete and slow moving assets at Nova Systems;
and a $274,000 increase in warranty  reserves for PowerScript  hardware updates.
Additionally,  fixed  manufacturing  overhead,  such as salaries and  facilities
costs, have been spread over lower revenues.

       Research and Development: Research and development expenses increased 38%
to $7.0 million during 1997 compared to $5.0 million in 1996, and increased as a
percentage  of net


                                       20
<PAGE>

revenues to 35% in 1997 from 17% in 1996. The increased  expenses were primarily
due to the Company's  hiring of additional  hardware and software  engineers who
are working on the  development  of the Company's  new  products,  combined with
increased salary levels. In addition,  research and development expenses include
the  personnel  of KUB  Systems  for the full 1997 year  compared  to only seven
months in 1996. The Company  anticipates that research and development  expenses
should  decrease  slightly in 1998 due to  reductions in personnel and decreased
usage of consultants  and should also decline as a percentage of net revenues as
sales of new  products  take hold and  increase  the overall net revenues of the
Company.

       Selling and Marketing.  Selling and marketing  expenses  increased 19% to
$8.0 million in 1997  compared to $6.7 million in 1996,  and increased to 40% in
1997 compared to 23% in 1996, as a percentage of net revenues.  This increase in
selling and marketing  expenses was  primarily a result of increased  personnel,
advertising  and  promotional  expenses  as the  Company  diversifies  into  the
broadcast  and desktop  markets and the  expenses of the German sales office for
the full year compared to only three months of 1996.

       General and Administrative. General and administrative expenses increased
30% to $1.8 million in 1997  compared to $1.4 million in 1996,  and increased to
9% in 1997 compared to 5% in 1996 as a percentage of net revenues. This increase
was  primarily  due to a charge of $375,000 to bad debt  reserves  for  specific
accounts,  the inclusion of KUB Systems expenses for the full 1997 year compared
to only seven months in 1996, and increased salary levels.

       Write-off of  Intangibles:  In 1997, the Company  wrote-off the remaining
unamortized  value of the  purchased  technology  and  goodwill  established  in
connection  with the  acquisition  of Nova Systems.  The write-off  totaled $1.9
million  and was  primarily  due to  continued  losses and lack of  commercially
successful new product introductions.

       Interest Income,  net.  Interest income decreased 28% to $261,000 in 1997
compared to $361,000 in 1996,  primarily  as a result of a  significantly  lower
average cash balance.

       Provision for Income Taxes.  At December 31, 1997 the Company  incurred a
tax charge of $718,000 on a pretax  loss of $12.7  million.  This charge was the
result of the  establishment of a $5.9 million  valuation  allowance against the
Company's  deferred tax assets offset partially by an income tax benefit of $4.6
million the Company  recorded on its pretax loss. The Company has  established a
valuation  allowance  against  its  deferred  tax assets due to the  uncertainty
surrounding the realization of such assets.  If it is determined that it is more
likely  than not that the  deferred  tax assets are  realizable,  the  valuation
allowance  will be reduced.  In 1996, the effective rate of 2% was below the 36%
rate which the Company had utilized in  calculating  its tax  provision  for the
first three quarters of 1996 and less than its 32% rate for 1995. The rate of 2%
for 1996 was  primarily  the result of higher  than  expected  federal and state
research  tax  credits  on  significantly  increased  research  and  development
spending, and lower than expected taxable income.

       Factors  That May  Affect  Future  Results  of  Operations:  The  Company
believes  its future  results of  operations  will likely be impacted by factors
such as delays in  development  and shipment of the  Company's  new products and
major new versions of existing  products,  market acceptance of new products and
upgrades,  growth in the marketplace in which it operates,  competitive  product
offerings,  and adverse  changes in general  economic  conditions  in any of the
countries in which the Company does  business.  The  Company's  results in prior
years  have  been  affected  by these  factors,  particularly  with  respect  to
developing and introducing new products such as PowerScript,  Effetto Pronto, MX
Pro and Python.

       Due to the factors noted above,  the Company's  future earnings and stock
price may be subject to  significant  volatility,  particularly  on a  quarterly
basis.  Any shortfall in revenue or earnings from levels  expected by securities
analysts  or  anticipated  by the Company  based upon  product  development  and
introduction schedules could have an immediate and significant

                                       21
<PAGE>

adverse  effect on the trading price of the Company's  common stock in any given
period. Additionally, the Company may not learn of such shortfalls until late in
the fiscal  quarter,  which could result in an even more  immediate  and adverse
effect on the trading price of the Company's common stock.  Finally, the Company
participates  in a highly dynamic  industry,  which often results in significant
volatility  of the  Company's  common stock price.  See "Business - Research and
Development".

       Year  2000  Issues:  The Year 2000  problem  is the  result  of  computer
programs  being  written  using  two  digits  rather  than  four to  define  the
applicable  year.  The  Company's  plan for the Year 2000  problem  entails  the
research  and testing of its  computer  systems.  The plan calls for  compliance
verification  with external vendors supplying the Company's  software.  To date,
the Company has not  encountered  any material Year 2000 issues  concerning  its
respective  computer  programs.  The  Company  plans to  complete  its Year 2000
research and testing by the end of 1998. All costs  associated with carrying out
the Company's plan for the Year 2000 problem are being expensed as incurred. The
costs associated with the Year 20000 problem,  as presently  estimated,  are not
expected to have a material adverse effect on the Company's business,  financial
condition and results of operations.

Comparison of Years Ended December 31, 1996 and 1995

       Net Revenues.  Net revenues  decreased 13% to $29.2 million in 1996, from
$33.6  million in 1995.  This  decrease is primarily  attributable  to decreased
sales of older Videographer  products and the absence of new products during the
first three quarters of the year, partially offset by the additional revenues of
Nova Systems.  International  revenues for 1996 were $12.3 million or 42% of net
revenues  compared  to  $16.4  million  or 49%  of net  revenues  in  1995.  The
percentage decrease in international  revenue in 1996 is due primarily to delays
in the  introduction of PowerScript and other new products in the  international
market.

       Gross  Profit.  Gross profit  decreased 15% to $13.9 million in 1996 from
$16.4 million in 1995. Gross profit, as a percentage of net revenues,  decreased
to 48% in 1996 from 49% in 1995.  The  percentage  decrease  in gross  profit is
principally  attributable to spreading  fixed  manufacturing  overhead,  such as
salaries and facilities costs, over lower revenues.

        Research and Development:  Research and development  expenses  increased
60% to $5.0 million  during 1996 compared to $3.1 million in 1995, and increased
as a percentage  of net revenues to 17% in 1996 from 9% in 1995.  The  increased
expenses were primarily due to the Company's hiring of consultants and engineers
in 1996, who are working on the  development  of the Company's new products.  In
addition,  research and development  expenses  include the personnel of Nova and
Abbate for the full 1996 year and the  personnel of KUB Systems since June 1996.
The Company anticipates that research and development  expenses will continue to
increase in absolute terms due to ongoing and future product development.

       Selling and Marketing.  Selling and marketing  expenses  increased 30% to
$6.7 million in 1996  compared to $5.2 million in 1995,  and increased to 23% in
1996 compared to 15% in 1995, as a percentage of net revenues.  This increase in
selling and marketing  expenses was  primarily a result of increased  personnel,
advertising  and  promotional  expenses  as the  Company  diversifies  into  the
broadcast and desktop markets.

       General and Administrative. General and administrative expenses increased
13% to $1.4 million in 1996  compared to $1.2 million in 1995,  and increased to
5% in 1996 compared to 4% in 1995 as a percentage of net revenues. This increase
was primarily due to the addition of personnel.

       Interest Income,  net.  Interest income decreased 51% to $361,000 in 1996
compared to $732,000 in 1995,  primarily as a result of the Company's investment
in tax exempt  securities  for the full year 1996 combined with a  significantly
lower average cash balance.

                                       22
<PAGE>

       Provision for Income Taxes.  The  Company's  December 31, 1996  effective
rate of 2% was below the 36% rate which the Company had utilized in  calculating
its tax  provision  for the first  three  quarters of 1996 and less than the 32%
rate for 1995.  The rate of 2% was  primarily the result of higher than expected
federal and state  research  credits on  significantly  increased  research  and
development spending, and lower than expected 1996 taxable income.

<TABLE>

Quarterly Results of Operations

       The following table sets forth certain  quarterly  financial  information
for the periods  indicated.  This  information  has been derived from  unaudited
financial  statements that, in the opinion of management,  have been prepared on
the same basis as the audited  information,  and includes  all normal  recurring
adjustments  necessary for a fair presentation of such information.  The results
of operations for any quarter are not  necessarily  indicative of the results to
be expected for any future period.

<CAPTION>

                                                   1997                                1996
                                     ----------------------------------   ----------------------------------
(in thousands, except                   Q1       Q2       Q3        Q4       Q1       Q2       Q3       Q4
 per share data)                        --       --       --        --       --       --       --       --

<S>                                   <C>      <C>       <C>     <C>        <C>     <C>      <C>      <C>
Net revenues                          $4,501   $5,467    $5,360  $4,627     $7,059  $7,055   $6,770   $8,311
Gross profit                             959    2,290     2,444     362      3,501   3,422    3,219    3,786
Operating income  (loss)              (3,508)  (1,747)   (1,707) (6,022)       604     236      (41)    (399)
Net income (loss)                     (2,412)  (1,221)   (1,168) (8,640)       449     212       31       52
Net income (loss) per share            (0.42)   (0.21)    (0.20)  (1.50)      0.08    0.04     0.01     0.01
Shares used in computing per
  share amounts                        5,730    5,736     5,741   5,772      5,900   5,946    5,942    5,946
----------
</TABLE>

       The  Company  has  experienced   significant  quarterly  fluctuations  in
operating  results and anticipates that these  fluctuations will continue in the
future.  The  fluctuation  in  revenues  in  the  periods  reflected  above  are
attributable   to  various   factors,   including  the  timing  of  new  product
introductions  and shipments,  variations in product mix sold, and private label
sales.  Particularly  in 1997 and  1996,  the  Company's  delay in the  sales of
previously  announced  new products had a  significant  effect on the  Company's
results of  operations,  and there can be no assurance  that the Company will be
able to  introduce  and timely  sell new  products  on a basis  which will avoid
quarterly  fluctuations  in the future,  or even that such new products  will be
successful in the marketplace.

       The Company typically operates with a small backlog. Therefore, quarterly
revenues and operating results have generally  depended on the volume and timing
of orders received during the quarter.  Backlog is not an accurate  predictor of
what the  Company's  revenues  will be in  future  periods,  and there can be no
assurance that the Company will be profitable in any particular quarter.

Liquidity and Capital Resources

       From the  Company's  inception  until  its  initial  public  offering  in
December  1994,  which  resulted in net proceeds of $15.8  million,  the Company
financed its operations through private sales of equity, shareholder loans, cash
flow from operations,  and bank borrowings.  At December 31, 1997, the Company's
principal source of liquidity is cash of $992,000 dollars.  In January 1998, the
Company  borrowed  $619,000 from a major  shareholder at an interest rate of 8.5
percent,  terms which the Company  considered more favorable than those it could
obtain from other commercial sources.

                                       23
<PAGE>


       Operating Activities.  In 1997, net cash used in operating activities was
$5.6 million,  resulting  primarily from an operating loss of $6.6 million after
adjusting for non-cash items, an increase in inventories of $2.3 million, offset
by a decrease in accounts  receivable  of $1.7  million.  Inventories  increased
primarily  in  anticipation  of new product  shipments  and lower than  expected
shipments of new products in 1997.  Receivables  decreased  primarily because of
decreased  sales.  In  1996,  net cash  used in  operating  activities  was $1.4
million, resulting primarily from an increase in inventories of $3.2 million, an
increase  in prepaid and other  current  assets of  $203,000,  a decrease in the
provision  for excess and obsolete  inventory of $240,000  offset by a profit of
$744,000,  depreciation  and  amortization  of $1.2  million,  and a decrease in
accounts receivable of $428,000. Inventories increased primarily in anticipation
of new product  shipments and lower than  expected  shipments of new products in
1996. In 1995, net cash provided by operating activities was $339,000, resulting
from a profit of $3.8 million,  which included a non-cash charge of $2.0 million
for  purchased   in-process   research  and  development  related  to  the  Nova
acquisition.  In 1995,  operating  profit  excluding  the non-cash  charge,  was
partially  offset by an increase in accounts  receivable  of $1.7 million and an
increase in inventories of $3.3 million.  Receivables increased due to third and
fourth  quarter  1995  sales  promotions  with  extended  terms and  inventories
increased in anticipation of new product shipments.

       Investing  Activities.  Capital equipment  expenditures in 1997, 1996 and
1995 were $1.6 million, $1.3 million, and $958,000  respectively,  primarily for
computers,  software and engineering  equipment used in research and development
and other  activities.  The Company  currently  anticipates  that  additions  to
property and equipment will require capital expenditures of $1.5 million through
the end of 1998.  In 1997,  the  Company  had  redemptions  of $1.5  million  of
marketable securities.  In 1996, the Company had net redemptions of $3.2 million
of marketable  securities.  In May 1996, the Company acquired  substantially all
the assets and assumed certain  liabilities of KUB Systems for $350,000 in cash.
In 1995, the Company purchased $4.7 million of marketable  securities and had no
redemptions.  In September  1995,  the Company  acquired  substantially  all the
assets and certain liabilities of Nova for $5.0 million in cash, $4.0 million of
which was paid at closing and $1.0 million  through a promissory note payable in
two installments of $500,000 each in March 1996 and September 1996, with accrued
interest.

       Financing  Activities.  In 1997, the Company  received  $154,000 from the
exercise of stock options under the  Company's  stock option plan. In 1996,  the
Company received $100,000 from the exercise of stock options under the Company's
stock option plan.  Additionally,  the Company paid the $1.0 million  promissory
note issued in  connection  with the Nova  acquisition.  In 1995,  the only cash
generated  from  financing  activities  was $135,000  from the exercise of stock
options under the Company's stock option plan.

       The  Company   believes  that  its  current  cash,   borrowings   from  a
shareholder,  together with its operating cash flows, will be sufficient to meet
the  Company's  requirements  for working  capital,  and  capital  expenditures,
through the end of 1998.

                                       24
<PAGE>


ITEM 8.         FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

       Balance  sheets  of the  Company  as of  December  31,  1997 and 1996 and
statements of income,  shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1997, together with the related notes and
the report of Coopers & Lybrand L.L.P.,  independent accountants,  are set forth
on the  following  pages.  Other  required  financial  information  is set forth
herein, as more fully described in Item 14 hereof.




                                       25
<PAGE>



                                 VIDEONICS, INC.

                                   ----------








                              FINANCIAL STATEMENTS

                      as of December 31, 1997 and 1996 and
                           for each of the three years
                      in the period ended December 31, 1997


                                       26
<PAGE>



                        REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors
Videonics, Inc.
Campbell, California

We have audited the accompanying  consolidated balance sheets of Videonics, Inc.
and subsidiaries as of December 31, 1997 and 1996, and the related statements of
operations,  shareholders'  equity and cash flows for each of the three years in
the  period  ended  December  31,  1997.  These  financial  statements  are  the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all  material  respects,   the  financial   position  of  Videonics,   Inc.  and
subsidiaries as of December 31, 1997 and 1996, and the results of its operations
and its cash flows for each of the three years in the period ended  December 31,
1997, in conformity with generally accepted accounting principles.



                                            Coopers & Lybrand L.L.P.



San Jose, California
January 30, 1998


                                       27
<PAGE>


<TABLE>

                                              VIDEONICS, INC.
                            CONSOLIDATED BALANCE SHEETS, December 31, 1997 and 1996
                                              (in thousands)

<CAPTION>


                                                                                                          1997               1996
                                                                                                        --------            --------
                                   ASSETS
<S>                                                                                                     <C>                 <C>
Current assets:
      Cash and cash equivalents                                                                         $    992            $  6,538
      Marketable securities                                                                                                    1,500
      Accounts receivable, net                                                                             1,291               3,406
      Inventories                                                                                          9,938               9,309
      Deferred income taxes                                                                                                    1,299
      Prepaid income taxes                                                                                   550               1,094
      Prepaids and other current assets                                                                      219                 493
                                                                                                        --------            --------
                           Total current assets                                                           12,990              23,639

Property and equipment, net                                                                                2,438               2,037
Other assets                                                                                                 266                  14
Intangible assets, net                                                                                                         2,268
                                                                                                        --------            --------
                           Total assets                                                                 $ 15,694            $ 27,958
                                                                                                        ========            ========

                          LIABILITIES

Current liabilities:
      Accounts payable                                                                                  $  1,442            $  1,090
      Accrued expenses                                                                                     1,646               1,137
                                                                                                        --------            --------
                         Total current liabilities                                                         3,088               2,227
                                                                                                        --------            --------

Commitments and contingencies (Note 7)

                      SHAREHOLDERS' EQUITY

Preferred stock, no par value:
      Authorized:  10,000 shares in 1997 and 1996;
      Issued and outstanding:  None

Common stock, no par value:
      Authorized:  30,000 shares in 1997 and 1996
      Issued and outstanding:  5,785 shares in 1997 and 5,705
      shares in 1996
                                                                                                          20,613              20,297
Retained earnings (accumulated deficit)                                                                   (8,007)              5,434
                                                                                                        --------            --------

                   Total shareholders' equity                                                             12,606              25,731
                                                                                                        --------            --------

                           Total liabilities and shareholders'  equity                                  $ 15,694            $ 27,958
                                                                                                        ========            ========

<FN>

              The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>


                                       28
<PAGE>



<TABLE>

                                                  VIDEONICS, INC.
                                       CONSOLIDATED STATEMENTS OF OPERATIONS
                                       (in thousands, except per share data)


<CAPTION>


                                                                                      Year Ended December 31,
                                                                            -------------------------------------------
                                                                                1997           1996           1995
                                                                            -------------  -------------  -------------
<S>                                                                          <C>            <C>            <C>
Net revenues                                                                 $    19,955    $    29,195    $    33,561

Cost of revenues                                                                  13,900         15,266         17,160
                                                                            -------------  -------------  -------------

                   Gross profit                                                    6,055         13,929         16,401
                                                                            -------------  -------------  -------------

Operating expenses:
      Research and development                                                     6,951          5,027          3,138
      Selling and marketing                                                        8,041          6,741          5,181
      General and administrative                                                   1,779          1,367          1,208
      Amortization of intangible assets                                              393            393             98
      Write-off of intangible assets                                               1,875
      Charge for purchased in-process research and development                                                   1,965
                                                                            -------------  -------------  -------------

                                                                                  19,039         13,528         11,590
                                                                            -------------  -------------  -------------

                   Operating income (loss)                                       (12,984)           401          4,811

      Interest, net                                                                  261            361            732
                                                                            -------------  -------------  -------------

                  Income (loss)  before  income taxes                            (12,723)           762          5,543


Provision for income taxes                                                           718             18          1,797
                                                                            -------------  -------------  -------------

                 Net income (loss)                                          $    (13,441)  $        744   $      3,746
                                                                            =============  =============  =============

Net income (loss) per share - basic                                         $      (2.34)  $       0.13   $       0.69
                                                                            =============  =============  =============

Shares used in per share calculation - basic                                       5,744          5,616          5,413
                                                                            =============  =============  =============

Net income (loss) per share - diluted                                       $      (2.34)  $       0.13   $       0.65
                                                                            =============  =============  =============

Shares used in per share calculation - diluted                                     5,744          5,933          5,791
                                                                            =============  =============  =============

<FN>
              The accompanying notes are an integral part of these consolidated financial statements.
</FN>

</TABLE>
                                                                 29

<PAGE>


<TABLE>

                                                           VIDEONICS, INC.
                                           CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                     for the three years in the period ended December 31, 1997
                                                (in thousands, except per share data)


<CAPTION>
                                                                                           Retained
                                                                Common Stock                Earnings
                                                           -----------------------        (Accumulated     Shareholders'
                                                            Shares      Amount              Deficit)         Equity
                                                            -----    -----------        ------------       -----------
<S>                                                         <C>       <C>                <C>               <C>
Balances, December 31, 1994                                 5,351     $   18,459         $       944       $    19,403
      Issuance of common stock from exercise of
          options                                             167            135                                   135
      Amortization of deferred compensation                                   48                                    48
      Tax benefit from exercise of nonqualified stock
          options                                                            817                                   817
      Net income                                                                                3746             3,746
                                                            -----    -----------        ------------       -----------
Balances, December 31, 1995                                 5,518         19,459                4690            24,149
      Issuance of common stock from exercise of
          options                                             187            100                                   100
      Amortization of deferred compensation                                   48                                    48
      Tax benefit from exercise of nonqualified stock
          options                                                            690                                   690
      Net income                                                                                 744               744
                                                            -----    -----------        ------------       -----------
Balances, December 31, 1996                                 5,705         20,297               5,434            25,731
      Issuance of common stock from exercise of
          options                                              80            154                                   154
      Amortization of deferred compensation                                   36                                    36
      Tax benefit from exercise of nonqualified stock
          options                                                            126                                   126
      Net loss                                                                               (13,441)          (13,441)
                                                            -----    -----------        ------------       -----------
Balances, December 31, 1997                                 5,785    $    20,613        $     (8,007)      $    12,606
                                                            =====    ===========        ============       ===========

<FN>
              The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
                                                                 30

<PAGE>

<TABLE>

                                                           VIDEONICS, INC.
                                                CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                           (in thousands)
<CAPTION>

                                                                                                    Year Ended December 31,
                                                                                        -------------------------------------------
                                                                                          1997             1996             1995
                                                                                        --------         --------         --------
<S>                                                                                     <C>              <C>              <C>
Cash flows from operating activities:
  Net income (loss)                                                                     $(13,441)        $    744         $  3,746
  Adjustments to reconcile net income (loss) to net cash
     provided by (used in) operating activities:
  Loss on disposal of property and equipment                                                  76
  Depreciation and amortization                                                            1,563            1,190              788
  Provision for doubtful accounts                                                            375              (10)              28
  Provision for excess and obsolete inventories                                            1,641             (240)             336
  Charge for purchased in-process research and development                                                                   1,965
  Deferred income taxes                                                                    1,299              111             (760)
  Write-off of intangible assets                                                           1,875
  Changes in assets and liabilities:
     Accounts receivable                                                                   1,740              428           (1,713)
     Inventories                                                                          (2,270)          (3,232)          (3,305)
     Prepaid income taxes                                                                    670             (150)             563
     Prepaids and other current assets                                                       274             (203)             (37)
     Other                                                                                  (252)              (3)              12
     Accounts payable                                                                        352             (136)            (690)
     Accrued expenses                                                                        509               97             (594)
                                                                                        --------         --------         --------
                Net cash provided by (used in) operating activities                       (5,589)          (1,404)             339
                                                                                        --------         --------         --------

Cash flows from investing activities:
   Purchases of property and equipment                                                    (1,611)          (1,303)            (958)
   Net cash paid in acquisition                                                                              (350)          (3,920)
   Purchases of marketable securities                                                                      (1,500)          (4,708)
   Proceeds from  marketable securities                                                    1,500            4,708
   Acquisition of intangible assets                                                                                            (94)
                                                                                        --------         --------         --------
    Net cash provided by (used in) investing activities                                     (111)           1,555           (9,680)
                                                                                        --------         --------         --------

Cash flows from financing activities:
   Repayment of notes payable                                                                              (1,000)
   Proceeds from issuance of common stock                                                    154              100              135
                                                                                        --------         --------         --------
Net cash provided by (used in) financing activities                                          154             (900)             135
                                                                                        --------         --------         --------
Decrease in cash and cash equivalents                                                     (5,546)            (749)          (9,206)
Cash and cash equivalents at beginning of year                                             6,538            7,287           16,493
                                                                                        --------         --------         --------

Cash and cash equivalents at end of year                                                $    992         $  6,538         $  7,287
                                                                                        ========         ========         ========
Supplemental  disclosure of cash flow  information:
     Cash paid during the period for:
             Interest                                                                                    $     31         $     16
             Income taxes                                                               $      5         $     44         $  1,924
Supplemental schedule of non-cash financing activities:
      Tax benefit from exercise of nonqualified stock options                           $    126         $    690         $    817

<FN>
              The accompanying notes are an integral part of these consolidated financial statements.
</FN>
                                                                 31
</TABLE>

<PAGE>


                                 VIDEONICS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   ----------

 1.   Business:

      Videonics,  Inc.  (the  Company)  was  incorporated  on July 3, 1986.  The
      Company is a designer  of digital  video  post-production  equipment.  The
      Company's  products  are  used  by  videographers,   business,   industry,
      education and  videophiles;  they are also used in the  broadcast,  cable,
      video   presentation   and  video   conferencing   markets.   The  Company
      manufactures standalone and personal-computer-based  hardware and software
      products  that edit and mix raw video  footage,  add  special  effects and
      titles, and process audio and video signals.


 2.   Summary of Significant Accounting Policies:

         Principles of Consolidation:

         The  consolidated   financial   statements   include  the  accounts  of
         Videonics,  Inc. and its wholly  owned  subsidiaries.  All  significant
         intercompany accounts and transactions have been eliminated.

         Use of Estimates:

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

         Revenue Recognition:

         The Company recognizes  revenues from gross sales, less a provision for
         estimated  future  customer  returns and  exchanges,  upon  shipment of
         product.

         Research and Development Expenditures:

         Research and  development  expenditures  are charged to  operations  as
         incurred.

         Advertising:

         The  Company  expenses  the  production  costs  of  advertising  as the
         expenses are incurred.  The  production  costs of  advertising  consist
         primarily  of magazine  advertisements,  agency  fees and other  direct
         production costs.


                                   Continued
                                       32
<PAGE>
                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------


 2.   Summary of Significant Accounting Policies, continued:

         Advertising, continued:

         Advertising  expense for the period ended December 31, 1997,  1996, and
         1995 was $1,412,000, $947,000, and $502,000, respectively.

         Income Taxes:

         The Company accounts for income taxes under the liability method. Under
         the  liability   method,   deferred  tax  assets  and  liabilities  are
         determined  based on differences  between  financial  reporting and tax
         bases of assets and  liabilities and are measured using the enacted tax
         rates and laws that will be in effect when the differences are expected
         to  reverse.  The  Company  is  required  to adjust  its  deferred  tax
         liabilities  in the  period  when tax  rates or the  provisions  of the
         income tax laws  change.  Valuation  allowances  are  established  when
         necessary to reduce  deferred tax assets to the amounts  expected to be
         realized.

         Cash and Equivalents:

         Cash  equivalents  consist of highly liquid  investments  with original
         maturities at time of purchase of three months or less.

         Marketable Securities:

         Marketable   securities  are  classified  as   available-for-sale   and
         therefore  are  carried at fair  value.  Unrealized  holding  gains and
         losses  on such  securities  are  reported  net of  related  taxes as a
         separate component of shareholders'  equity.  Realized gains and losses
         on sales of all such  securities  are reported in earnings and computed
         using the specific identification cost method.

         Inventories:

         Inventories   are  stated  at  the  lower  of   standard   cost  (which
         approximates actual cost on a first-in, first-out basis) or market.

                                   Continued
                                       33

<PAGE>
                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------


 2.   Summary of Significant Accounting Policies, continued:

         Property and Equipment:

         Property  and  equipment  are  stated  at  cost  and  depreciated  on a
         straight-line  basis  over the  estimated  useful  lives of the  assets
         ranging from two to five years. Leasehold improvements are amortized on
         a  straight-line  basis over the lesser of the term of the lease or the
         estimated useful life of the asset.

         Goodwill and Intangible Assets:

         Capitalized   purchased   technology   and  goodwill   relating  to  an
         acquisition (see Note 3) are amortized over a seven year life.

         Product Warranty:

         Since 1994, the Company  warrants all parts and labor on domestic sales
         for two years. The Company provides for the estimated cost to repair or
         replace these products at the time of sale.

         Concentrations of Credit Risk:

         Financial   instruments  that   potentially   subject  the  Company  to
         significant  concentrations of credit risk consist  principally of cash
         and cash equivalents and trade accounts receivable.

         The Company  maintains  its cash and cash  equivalents  with  financial
         institutions  located in California and in high grade  commercial paper
         with original maturities of less than three months. As part of its cash
         management  process,  the Company performs periodic  evaluations of the
         relative credit standing of these financial institutions.

         The  Company's   customer  base  is  dispersed  across  many  different
         geographic  areas  throughout  the world and  consists  principally  of
         distributors  and  dealers in the  electronics  industry.  The  Company
         performs  ongoing credit  evaluations of its customers and maintains an
         allowance for potential credit losses.  The Company generally  receives
         confirmed  letters  of  credit  or  cash  in  advance  of  shipping  to
         distributors located outside North America.

                                   Continued
                                       34
<PAGE>
                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

 2.   Summary of Significant Accounting Policies, continued:

         Stock Based Compensation:

         The Company accounts for stock based  compensation  using the intrinsic
         value method  prescribed by APB Opinion No. 25,  "Accounting  for Stock
         Issued to Employees." Accordingly,  compensation cost for stock options
         is measured as the excess,  if any, of the quoted  market  price of the
         Company's  stock at the date of the grant over the  amount an  employee
         must  pay  to  acquire   the  stock.   The   Company  has  adopted  the
         disclosure-only   provisions  of  Statement  of  Financial   Accounting
         Standards No. 123, "Accounting for Stock-Based Compensation."

         Net Income (Loss) Per Share:

         The Company has adopted Financial  Accounting  Standards No. 128 ("SFAS
         128"),  "Earnings  Per  Share"  and,  accordingly,  all  prior  periods
         presented  have been  restated.  Basic net  income  (loss) per share is
         calculated by dividing income (loss)  available to common  shareholders
         by the weighted  average  number of common shares  outstanding  for the
         period.  Diluted net income per share is  calculated  by  dividing  net
         income available to common  shareholders by the weighted average number
         of common and dilutive common equivalent shares  outstanding during the
         period.  Dilutive  common  equivalent  shares  consist of common  stock
         issuable upon the exercise of stock options  (using the treasury  stock
         method).  The adoption of this standard did not have a material  impact
         on the Company's net income (loss) per share.

         Fair Value of Financial Instruments:

         Carrying  amounts  of certain of the  Company's  financial  instruments
         including  cash and cash  equivalents,  accounts  receivable,  accounts
         payable and other  accrued  liabilities  approximate  fair value due to
         their  short   maturities.   Estimated   fair  values  for   marketable
         securities,  which  are  separately  disclosed  elsewhere  are based on
         quoted market prices for the same or similar instruments.

                                   Continued
                                       35

<PAGE>
                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

 2.   Summary of Significant Accounting Policies, continued:

         Recent Accounting Pronouncements:

         In June 1997, the Financial Accounting Standards Board issued Statement
         of Financial  Accounting  Standards  No. 130 ("SFAS  130"),  "Reporting
         Comprehensive  Income".  This statement  establishes  requirements  for
         disclosure  of  comprehensive  income  and  becomes  effective  for the
         Company for the fiscal year  beginning  after  December 15, 1997,  with
         reclassification  of  earlier  financial   statements  for  comparative
         purposes.  Comprehensive  income  generally  represents  all changes in
         shareholders'   equity  except  those  resulting  from  investments  or
         contributions  by shareholders.  The Company is evaluating  alternative
         formats  for  presenting  this  information,  but does not expect  this
         pronouncement to materially impact the Company's results of operations.

         In June 1997, the Financial Accounting Standards Board issued Statement
         of Financial  Accounting  Standards No. 131 ("SFAS 131"),  "Disclosures
         about  Segments  of  an  Enterprise  and  Related  Information".   This
         statement establishes standards for disclosure about operating segments
         in annual  financial  statements  and selected  information  in interim
         financial   reports.   It  also   establishes   standards  for  related
         disclosures  about  products and services,  geographic  areas and major
         customers.  This statement supersedes Statement of Financial Accounting
         Standards  No. 14,  "Financial  Reporting  for  Segments  of a Business
         Enterprise". The new standard becomes effective for the Company for the
         fiscal year  beginning  after  December  15, 1997,  and  requires  that
         comparative  information  from earlier  years be restated to conform to
         the  requirement  of this  standard.  The  Company  is  evaluating  the
         requirements  of SFAS 131 and the  effects,  if any,  on the  Company's
         current reporting and disclosures.


 3.   Acquisition of Nova Systems:

      Effective  September 7, 1995, the Company acquired  substantially  all the
      assets and certain liabilities of Nova Systems (Nova). Nova is a developer
      and  manufacturer  of  video  frame   synchronizers,   digital  time  base
      correctors and video signal processing  equipment used for video and audio
      post production in the broadcast,  cable,  video  presentation,  and video
      conferencing  markets.  Under the terms of the  acquisition,  the  Company
      agreed to pay Nova $4,000,000 in cash and $1,000,000 in a note payable due
      in two  installments  of $500,000 on March 7, 1996 and  September 6, 1996,
      with accrued  interest at a rate of 6% per annum.  In accordance  with the
      acquisition   agreement,   the  purchase   price  is  subject  to  certain
      adjustments.  Adjustments  have been established at $200,000 and are shown
      as a receivable  from the seller and serve to reduce the  purchase  price.
      The acquisition  has been accounted for as a purchase  transaction and the
      results of operations of Nova have been included with those of the Company
      since September 7, 1995.

                                   Continued
                                       36


<PAGE>

                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

 3.   Acquisition of Nova Systems, continued:

      The purchase price consisted of (in thousands):

                    Cash paid                       $ 4,000
                    Notes payable to seller           1,000
                    Receivable from seller             (200)
                                                    -------
                                                    $ 4,800
                                                    =======



      The purchase price was allocated to assets and liabilities  acquired based
      on the  underlying  fair value of assets and  liabilities  as follows  (in
      thousands):

                    Cash                                          $   80
                    Accounts receivable                              134
                    Inventory                                        517
                    Other assets                                      13
                    Property and equipment                            35
                    Intangible assets                              2,665
                    Purchased research and development             1,965
                    Accounts payable                                (247)
                    Accrued expenses                                (362)
                                                                  ------
                                                                  $4,800
                                                                  ======



      Intangibles consist of purchased technology and goodwill of $2,443,000 and
      $222,000,  respectively,  which are being amortized over a period of seven
      years. In 1997, the Company  wrote-off the remaining  unamortized value of
      the purchased  technology and goodwill  established in connection with the
      acquisition  of Nova Systems.  The write-off  totaled  $1,875,000  and was
      primarily due to continued losses and lack of commercially  successful new
      product introductions.

      The amount  allocated to  purchased  in-process  research and  development
      totaling $1,965,000 was expensed on the acquisition date as the technology
      had not reached  technological  feasibility and had no alternative  future
      use. Net of income taxes, this charge was equal to $0.23 per share.

                                   Continued
                                       37

<PAGE>

                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

 4. Acquisition of KUB Systems:

      Effective  May 24, 1996,  the Company hired all the personnel and acquired
      certain  assets and certain  liabilities  of KUB Systems  (KUB).  KUB is a
      developer and manufacturer of advanced digital video production  equipment
      for the  broadcast,  post-production,  and  institution  video  production
      markets. Under the terms of acquisition,  the Company paid KUB $350,000 in
      cash. The acquisition has been accounted for as a purchase transaction and
      the  results of  operations  of KUB have been  included  with those of the
      Company since May 24, 1996, the date the purchase was consummated.

      The purchase price consisted of (in thousands):

               Cash paid                                          $350

      The purchase  price was  allocated to assets and  liabilities  acquired as
follows (in thousands):

                    Inventory                                      $276
                    Other current assets                              6
                    Property                                        133
                    Accrued expenses                                (65)
                                                                   ----
                                                                   $350
                                                                   ====



 5.  Marketable Securities:

      At December 31, 1996 marketable securities consist of municipal securities
      which  were held by one  investment  bank,  bearing  interest  at 4.0% per
      annum.  At  December  31, 1997 and 1996,  there were no realized  gains or
      losses on the disposal of marketable securities.


                                   Continued
                                       38
<PAGE>


                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

 6.   Balance Sheet Detail:

<TABLE>
      Accounts receivable comprise (in thousands):
<CAPTION>

                                                                                   December 31,
                                                                         --------------------------------
                                                                             1997               1996
                                                                         ------------       -------------
<S>                                                                       <C>                <C>
              Trade accounts receivable                                   $    1,546         $     3,529
              Less allowance for doubtful accounts                              (255)               (123)
                                                                          ----------         -----------
                                                                          $    1,291         $     3,406
                                                                          ==========         ===========
</TABLE>

<TABLE>

      Inventories comprise (in thousands):
<CAPTION>

                                                                                   December 31,
                                                                         --------------------------------
                                                                             1997               1996
                                                                         ------------       -------------
<S>                                                                       <C>                <C>
              Raw materials                                               $    7,649         $     6,210
              Work in process                                                    437               1,437
              Finished goods                                                   1,852               1,662
                                                                          ----------         -----------
                                                                          $    9,938         $     9,309
                                                                          ==========         ===========
</TABLE>

<TABLE>
      Property and equipment comprise (in thousands):
<CAPTION>

                                                                                      December 31,
                                                                            --------------------------------
                                                                                1997               1996
                                                                            ------------       -------------
<S>                                                                          <C>                <C>
           Machinery and equipment                                           $    3,933         $     3,013
           Furniture and fixtures                                                    86                 126
           Leasehold improvements                                                   179                 103
           Tooling                                                                1,747               1,270
                                                                             ----------         -----------
                                                                                  5,945               4,512
           Less accumulated depreciation and amortization                        (3,507)             (2,475)
                                                                             ----------         -----------
                                                                             $    2,438         $     2,037
                                                                             ==========         ===========
</TABLE>


                                   Continued
                                       39

<PAGE>

                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

 6.   Balance Sheet Detail, continued:

<TABLE>
      Intangible assets comprise (in thousands):

<CAPTION>
                                                                                  December 31,
                                                                        --------------------------------
                                                                            1997                1996
                                                                        -------------       ------------
<S>                                                                      <C>                 <C>
              Purchased technology                                       $     2,443         $    2,443
              Goodwill                                                           316                316
                                                                         -----------         ----------
                                                                               2,759              2,759
              Less accumulated amortization                                     (884)              (491)
              Write-off of intangible assets                                  (1,875)
                                                                         -----------         ----------
                                                                         $         -         $    2,268
                                                                         ===========         ==========
</TABLE>

<TABLE>
      Accrued expenses comprise (in thousands):
<CAPTION>

                                                                                   December 31,
                                                                         --------------------------------
                                                                             1997               1996
                                                                         -------------      -------------
<S>                                                                       <C>                <C>
              Accrued advertising                                         $       221        $       137
              Accrued vacation                                                    258                154
              Salaries payable                                                    239                201
              Accrued acquisition reserve                                         250                250
              Warranty reserve                                                    198                 74
              Other accrued expenses                                              480                321
                                                                         -------------       ------------
                                                                          $     1,646        $     1,137
                                                                         ============        ===========
</TABLE>



 7.   Commitments and Contingencies:

      The  Company  leases  a  building  for its  principal  facility  under  an
      operating lease which expires in July 1999.  Under the terms of the lease,
      the  Company  is   responsible   for  utilities,   taxes,   insurance  and
      maintenance. At December 31, 1997, future minimum lease payments under all
      noncancelable operating leases were as follows (in thousands):

               1998                                                 $    399
               1999                                                      142
                                                                   ----------
                                                                    $    541
                                                                   ==========

                                   Continued
                                       40
<PAGE>


                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

 7.   Commitments and Contingencies, continued:

      Rent  expense  for the years  ended  December  31,  1997,  1996,  and 1995
      amounted to $423,000, $396,000, and $239,000, respectively.

      The Company has received  communications  from a third party patent holder
      asserting  patent  rights  embracing  certain of the  Company's  products.
      Management believes that the ultimate resolution of these matters will not
      have a material  adverse  effect on the Company's  financial  condition or
      results of operations.


 8.   Income Taxes:

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

                                        1997            1996           1995
                                   -------------   ------------   -------------

       Current:
                Federal             $      (380)    $     (110)    $     2,117
                State                         -             17             440
       Deferred:
                Federal                     995            239            (640)
                State                       103           (128)           (120)
                                   -------------   ------------   -------------
                                    $       718     $       18     $     1,797
                                   =============   ============   =============


                                   Continued
                                       41
<PAGE>

                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

 8.   Income Taxes, continued:

<TABLE>

      The Company's  effective tax rate on income before income tax differs from
      the U.S. federal statutory regular tax rate as follows:

<CAPTION>
                                                                      1997           1996           1995
                                                                  ------------   ------------   ------------
<S>                                                                 <C>             <C>            <C>
        Federal statutory income tax rate                           (34.0)%          34.0%          34.0%
        State income tax rate, net of federal benefit                (2.9)            5.7           5.3
        Tax exempt interest                                                         (13.4)         (1.6)
        Foreign net operating loss                                    1.3             5.7
        Federal and state tax credits                                (6.4)          (32.8)         (1.9)
        Other                                                         1.6             3.2          (3.4)
        Increase in valuation allowance                              46.0
                                                                  ---------      ---------      --------
                                                                      5.6%            2.4%         32.4%
                                                                  =========      =========      ========
</TABLE>


      The tax effects of  temporary  differences  that give rise to  significant
      portions of the deferred tax assets are presented below (in thousands):

                                                        1997           1996
                                                    -------------  -------------

           Intangible assets                         $     1,366    $       848
           Inventory reserves                                891            149
           Depreciation                                       45             99
           Net operating loss carryforward                 2,198
           Tax credit carryforward                           815
           Other accrued liabilities and reserves            537            203
                                                    -------------  -------------
           Subtotal                                        5,852          1,299
           Less valuation allowance                       (5,852)
                                                    -------------  -------------
           Net deferred tax asset                    $         -    $     1,299
                                                    =============  =============



      At December  31,  1997,  the  Company has federal and state net  operating
      losses of $5,500,000 and  $3,200,000,  respectively,  which expire in 2012
      and 2002, respectively.  The Company also has federal and state tax credit
      carryforwards  of $580,000  and  $235,000,  respectively,  which expire in
      2012.

                                   Continued
                                       42
<PAGE>


 8.   Income Taxes, continued:

      In accordance with generally accepted accounting  principles,  a valuation
      allowance  must be  established  for a deferred tax asset if its uncertain
      that a tax  benefit  may be  realized  from the asset in the  future.  The
      Company  has  established  a  valuation  allowance  to the  extent  of its
      deferred tax assets since it is not certain that a benefit can be realized
      in the  future  due to  the  Company's  operating  losses.  The  Company's
      valuation allowance increased from zero at December 31, 1996 to $5,852,000
      at December 31, 1997.


<TABLE>
 9.   Net Income (Loss) Per Share:

         In  accordance  with  the  disclosure   requirements  of  SFAS  128,  a
         reconciliation  of the numerator and  denominator  of basic and diluted
         net income  (loss) per share is  provided  as  follows  (in  thousands,
         except per share amounts):
<CAPTION>

                                                                               1997          1996         1995
                                                                             --------      --------     --------
<S>                                                                          <C>           <C>          <C>
                    Numerator - Basic and Diluted
                             Net income (loss)                               $(13,441)     $    744     $  3,746
                                                                             --------      --------     --------
                          Net income (loss) available to common
                          stockholders
                                                                             $(13,441)     $    744     $  3,746
                                                                             ========      ========     ========
                    Denominator - Basic
                          Weighted average common shares outstanding            5,744         5,616        5,413
                                                                             --------      --------     --------
                                 Basic net income (loss) per share           $  (2.34)     $   0.13     $   0.69
                                                                             ========      ========     ========
                    Denominator - Diluted
                          Denominator - Basic                                   5,744         5,616        5,413
                          Effect of Dilutive Securities:
                                 Common Stock Options                            --             317          378
                                                                             --------      --------     --------
                    Diluted weighted average common shares                      5,744         5,933        5,791
                                                                             --------      --------     --------
                                 Diluted net income (loss) per share         $  (2.34)     $   0.13     $   0.65
                                                                             ========      ========     ========

</TABLE>

                                   Continued
                                       43

<PAGE>
                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------


10.   Shareholders' Equity:

      At December 31, 1997, the Company has reserved  1,000,000 shares of common
      stock for issuance  under its 1996 Amended Stock Option Plan. In addition,
      the Company has reserved 900,000 shares of common stock for issuance under
      its 1987  Stock  Option  Plan (1987  Plan).  The 1987 Plan had been set to
      terminate, in accordance with its terms, on January 1, 1997. Effective May
      1997,  the Company's  Board of Directors  authorized  the amendment of the
      1987 Plan to permit the grant of  nonstatutory  stock  options  beyond the
      expiration  date for  replacement or  substitution  of options  previously
      granted  under the 1987 Plan that have  expired or  terminated.  The Plans
      provide  for the  granting of  incentive  stock  options to  officers  and
      employees  of the  Company and  nonqualified  incentive  stock  options to
      employees,  officers and  directors of the Company at prices not less than
      the fair market value of the  Company's  common stock.  Options  generally
      vest over a  three-to-four  year  period  and are  canceled  90 days after
      termination of employment.

<TABLE>
      A summary of stock option activity follows:
<CAPTION>

                                                                 Outstanding Options                     Weighted
                                        Shares       ----------------------------------------------      Average
                                      Available        Number         Exercise                           Exercise
                                      for Grant      of Shares         Price              Total          Price
                                      ---------      ---------         -----              -----          -----
<S>                                   <C>           <C>            <C>               <C>                 <C>
    Balances, December 31, 1994         227,160       667,590        $.33-$9.35      $      799,891      $1.20
          Options granted               (92,450)       92,450      $11.75-$14.75          1,227,575      13.28
          Options canceled                1,800        (1,800)      $1.67-$14.75            (10,788)      6.00
          Options exercised                          (167,313)       $.33-$11.75           (135,244)      0.81
                                      ---------     ---------                        --------------

    Balances, December 31, 1995         136,510       590,927        $.33-$14.75          1,881,434       3.18
          Additional shares
            reserved                  1,000,000
          Options granted              (859,128)      859,128       $7.50-$9.00           6,752,363       7.86
          Options canceled              147,958      (147,958)       $.47-$14.75         (1,413,857)      9.56
          Options exercised                          (186,918)       $.33-$7.50            (100,468)      0.54
                                      ---------     ---------                        --------------

    Balances, December 31, 1996         425,340     1,115,179        $.33-$14.75          7,119,472       6.38
          Options granted              (929,534)      929,534       $3.81-$5.00           4,536,769       4.88
          Options canceled              881,362      (881,362)      $3.81-$9.00          (6,987,932)      7.93
          Options exercised                           (80,149)       $.33-$7.50            (154,128)      1.92
                                      ---------     ---------                        --------------

    Balances, December 31, 1997         377,168     1,083,202                        $    4,514,181      $4.17
                                      =========     =========                        ==============

</TABLE>

      Compensation  of  approximately  $114,000  had  been  attributed  to stock
      options  granted  after March 1994 and prior to the sale of the  Company's
      common  stock  in  an  initial  public  offering.   The  compensation  was
      recognized  as a charge  to  income  over the  three-year  vesting  period
      commencing in October 1994 and terminating in September 1997.

                                   Continued
                                       44
<PAGE>


                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

10.   Shareholders' Equity, continued:

      On August 19,  1997,  the Company  offered  employees  the right to cancel
      certain  outstanding stock options at original exercise prices and receive
      new  options  with a new  exercise  price.  Options to purchase a total of
      733,072  shares at original  exercise  prices ranging from $7.50 to $14.75
      per share were  canceled and new options were issued at an exercise  price
      of $5.00 per share, the fair market value of the stock on August 19, 1997.
      Vesting  under  the new  options  commenced  on the  date of the  original
      options first vest date with an  additional  year added to the new options
      vesting period,  increasing their original vesting period from three years
      to four years.

<TABLE>

      Had compensation cost for the years ended December 31, 1997, 1996 and 1995
      been determined based on the fair value at the grant date, consistent with
      the  provisions  of  SFAS  No.  123 and  been  included  in the  Company's
      operations,  the  Company's  net income  (loss) and net income  (loss) per
      share for the years ended December 31, 1997, 1996 and 1995 would have been
      reduced to the pro forma amounts indicated below:
<CAPTION>

                                                                    1997                1996           1995
                                                               ---------------      -------------  -------------
<S>                                                             <C>                  <C>            <C>
        Net income (loss) - pro forma                           $    (15,557)        $       126    $     3,625
                                                               ===============      =============  =============
        Net income (loss) per share -  pro forma                $      (2.71)        $      0.02    $      0.63
                                                               ===============      =============  =============
</TABLE>


      The impact on pro forma income  (loss) and pro forma net income (loss) per
      share in the table  above may not be  indicative  of the  effect in future
      years as options  vest over  several  years and the Company  continues  to
      grant stock options to employees. This policy may or may not continue.

<TABLE>
      The weighted  average fair value of options granted in 1997, 1996 and 1995
      was $2.22,  $4.10, and $7.13,  repectively.  The fair value of each option
      grant is  estimated  on the date of grant using the  Black-Scholes  method
      with the following weighted average assumptions by subgroup:

<CAPTION>
                                                       1997                1996                1995
                                                ------------------  ------------------   -----------------
<S>                                                <C>                 <C>                  <C>
         Risk-free interest rate                   5.71%-6.09%         5.36%-6.36%          5.58%-7.25%
         Expected life                                  5                   3                   3
         Expected dividends                             -                   -                   -
         Volatility                                    0.75               0.75                 0.75
</TABLE>


      The weighted  average  expected life was  calculated  based on the vesting
      period and the exercise behavior of the Company's employees. The risk-free
      interest  rate  was  calculated  in  accordance  with the  grant  date and
      estimated expected life.


                                   Continued
                                       45
<PAGE>

                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

10.   Shareholders' Equity, continued:

<TABLE>

      The options  outstanding  and currently  exercisable  by exercise price at
      December 31, 1997 and 1996 are as follows:
<CAPTION>

                                                                                      Options
                                                                                     Currently
                                          Options Outstanding                        Exercisable
                             ------------------------------------------     ---------------------------
                                                Weighted
                                Number          Average        Weighted         Number        Weighted
                             Outstanding       Remaining       Average       Exercisable      Average
              Exercise       December 31,     Contractual     Exercise      December 31,      Exercise
                Price            1997            Life           Price           1997           Price
                -----            ----            ----           -----           ----           -----
<S>                             <C>               <C>           <C>            <C>              <C>
            $0.46-$0.46         179,573           4.33          $0.47          179,573          $0.47
            $2.00-$4.88         192,560           8.37          $4.25           63,367          $4.04
            $5.00-$5.00         705,069           9.63          $5.00          283,547          $5.00
            $7.50-$8.88           6,000           8.77          $8.54            2,250          $7.96
                              ---------                                        -------
                              1,083,202           8.52          $4.17          528,737          $3.36
                              =========                                        =======

</TABLE>

<TABLE>
<CAPTION>
                                                                                      Options
                                                                                     Currently
                                          Options Outstanding                        Exercisable
                             ------------------------------------------     ---------------------------
                                                Weighted
                                Number          Average        Weighted         Number        Weighted
                             Outstanding       Remaining       Average       Exercisable      Average
              Exercise       December 31,     Contractual     Exercise      December 31,      Exercise
                Price            1996            Life           Price           1996           Price
                -----            ----            ----           -----           ----           -----
<S>                             <C>               <C>           <C>            <C>              <C>
            $0.33-$0.47         231,283           4.82          $0.46          231,283          $0.46
            $2.00-$4.50          47,600           7.41          $3.86           35,251          $3.83
            $7.50-$7.50         511,962           9.18          $7.50          115,725          $7.50
            $7.87-$9.00         263,334           9.30          $8.61           29,672          $8.80
            $9.35-$14.75         61,000           8.07         $11.36           35,001         $11.15
                              ---------                                        -------
                              1,115,179           8.17          $6.36          446,932          $3.94
                              =========                                        =======

</TABLE>

11.   Segment Information:

      The  Company is  engaged in a single  industry  segment  encompassing  the
      development  and marketing of computer based video  products.  The Company
      markets and services its products in North America  through its own direct
      sales organization and through sales representatives.  The Company markets
      its  products  in  foreign   countries   outside  North  America   through
      distributors and its wholly owned subsidiary in Germany.


                                   Continued
                                       46

<PAGE>
                                 VIDEONICS, INC.
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

                                   ----------

11.   Segment Information, continued:

      The Company's German office is primarily a sales office. Revenue, loss and
      assets employed by the Company's  foreign  subsidiary were not material to
      the consolidated financial statements.

<TABLE>
      Geographic net export sales information is shown below (in thousands):
<CAPTION>

                                                                                  December 31,
                                                                ------------------------------------------------
                                                                     1997             1996             1995
                                                                --------------   --------------   --------------
<S>                                                              <C>              <C>              <C>
        Revenues from unaffiliated customers:
              United States                                      $     13,317     $     16,852     $     17,210
              Europe                                                    2,007            4,774            6,823
              Asia                                                      2,637            3,925            6,865
              Americas (excluding the United States)                    1,994            3,644            2,663
                                                                --------------   --------------   --------------

                                                                 $     19,955     $     29,195     $     33,561
                                                                ==============   ==============   ==============

</TABLE>


      For the years ended  December 31, 1997,  1996,  and 1995,  no one customer
      accounted  for more than 10% of revenues  during the periods.  The Company
      has no significant assets in foreign countries.


12.   401(k) Plan:

      In August 1994, the Company adopted a 401(k) employee savings plan wherein
      the employee can contribute up to specified  Internal  Revenue Code limits
      and the Company  matches,  at a rate of 50%, the first $800 contributed by
      the  employee.   The  employee's   entitlement  to  the  Company  matching
      contributions is fully vested on the date of contribution.  The Company at
      its  sole  discretion  with  the  Board of  Directors'  approval  can make
      incremental contributions. To date, the Company has not made discretionary
      contributions. The Company's matching contributions charged against income
      totaled  approximately  $51,000,  $52,000, and $38,000 for the years ended
      December 31, 1997, 1996, and 1995, respectively.


                                       47
<PAGE>

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

       Not applicable.


                                    PART III


ITEM 10.        DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

       Information  concerning  the  directors  and  executive  officers  of the
Company is set forth under the caption  "Election of Directors"  with respect to
directors and under the caption "Management" with respect to executive officers,
contained in the Company's Proxy Statement (the "Proxy  Statement")  relating to
its 1998 Annual  Meeting of  Shareholders  to be held on or about August 19,1998
and is incorporated  by reference into this Report.  The Proxy Statement will be
filed with the  Securities  and  Exchange  Commission  in  accordance  with Rule
14a-6(B)  promulgated  under  the  Securities  Exchange  Act of  1934.  With the
exception  of the  foregoing  information  and  other  information  specifically
incorporated  by reference  into this Report,  the Proxy  Statement is not being
filed as a part hereof.

ITEM 11.        EXECUTIVE COMPENSATION

       The information required by this item is incorporated by reference to the
information under the caption  "Executive  Compensation"  contained in the Proxy
Statement.

ITEM 12.        SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

       Information  concerning  the  Common  Stock  beneficially  owned  by each
director and executive officer of the Company,  by all officers and directors of
the Company as a group, and by each  shareholder  known by the Company to be the
beneficial owner of 5% of the outstanding  Common Stock, is incorporated  herein
by reference to the information under the caption "Security Ownership of Certain
Beneficial Owners and Management" contained in the Proxy Statement.

ITEM 13.        CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

       Information  responsive to this item is incorporated  herein by reference
to the information  under the caption  "Certain  Transactions"  contained in the
Proxy Statement.


                                       48
<PAGE>


                                     PART IV

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

         (a)      1.       Financial Statements

<TABLE>
<CAPTION>

         The following financial statements are included in Item 8:
<S>                        <C>
                  -        Report of Independent Accountants

                  -        Balance Sheets at December 31, 1997 and 1996

                  -        Statements of Income for the Years Ended December 31, 1997, 1996, and
                           1995

                  -        Statement of Shareholders' Equity for the Years Ended December 31,
                           1997, 1996, and 1995

                  -        Statements of Cash Flows for the Years Ended December 31, 1997, 1996,
                           and 1995

                  -        Notes to Financial Statements

                  2.       Financial Statement Schedules
</TABLE>

         The following financial statement schedule is included in Item 14(d):


                  Schedule II -- Valuation and Qualifying Accounts


         Schedules  other than the one listed above have been omitted  since the
         required  information  is not present in amounts  sufficient to require
         submission  of the  schedule,  or because the  information  required is
         included in the financial statements or notes thereto.

<TABLE>
                  3.       Exhibits
<CAPTION>
         Exhibit No.
         -----------
<S>                        <C>
              3.01         Amended and Restated Articles of Incorporation of Videonics, Inc.,
                           dated December 19, 1994. (3)

              3.02         Amended and Restated Bylaws of Videonics, Inc. as Adopted by the
                           Board of Directors on October 27, 1994 (3)

             10.01         Lease, dated July 6, 1994 between H-K Associates and Videonics, Inc.
                           at 1370 Dell Avenue, Campbell, California. (1)

             10.02         Lease, dated September 27, 1995 between Canton Gateway Office Park
                           and Videonics, Inc. at 50 Albany Turnpike, Canton, Connecticut. (4)


                                          49

<PAGE>



             10.03         Sublease, dated July 11, 1996 between Diba, Inc. and Videonics, Inc.
                           at 270 Harbor Boulevard, Belmont, California. (4)

             10.04         Stock Option Plan, and related agreements. (2)

             10.05         Asset Purchase Agreement relating to the acquisition of Nova Systems,
                           Inc., by Videonics, Inc., dated September 7, 1995. (5)

             10.06         Asset Purchase Agreement relating to the acquisition of KUB Systems,
                           Inc., by Videonics, Inc., dated May 24, 1996. (6)

              10.7         Letter of Employment Agreement with Steve L. Peters. (4)

              10.8         Promissory Note issued in connection with loan by Videonics, Inc. to
                           Steve L. Peters. (4)

             +10.9         Letter of Employment Agreement with Yeshwant Kamath dated November
                           17, 1997.

              21.1         Subsidiaries

              23.1         Consent of Coopers & Lybrand L.L.P., Independent Accountants.

              27.1         Financial Data Schedule

</TABLE>

         (b)      Reports on Form 8-K

       The Company filed no reports on Form 8-K with the  Commission  during the
fiscal quarter ended December 31, 1997.
----------

(1)       Filed as an Exhibit to the  Company's  Registration  Statement on Form
          S-1 (No. 33-85734) as declared effective by the Commission on December
          15, 1994, and incorporated herein by reference.

(2)       Incorporated by reference to Registration Statement (No. 333-21003) on
          Form S-8.

(3)       Filed as an exhibit to the  Company's  Annual  Report on Form 10-K for
          the  year  ended  December  31,  1994,  and  incorporated   herein  by
          reference.

(4)       Filed as an exhibit to the  Company's  Annual  Report on Form 10-K for
          the  year  ended  December  31,  1996,  and  incorporated   herein  by
          reference.

(5)       Filed as an Exhibit to the Company's  Current Report on Form 8-K dated
          September 7, 1995, and incorporated herein by reference.

(6)       Filed as an Exhibit to the Company's  Current Report on Form 8-K dated
          June 6, 1996, and incorporated herein by reference.

+         Confidential   treatment  of  certain   portions  of  this  Letter  of
          Employment  Agreement  has been  applied for with the  Securities  and
          Exchange Commissions.

                                       50
<PAGE>


                                   SIGNATURES


       Pursuant  to the  requirements  of Section 13 or 15(d) of the  Securities
Exchange  Act of 1934,  the  Company has duly caused this Report to be signed on
its behalf by the undersigned,  thereunto duly  authorized,  on this 27th day of
March, 1998.

                                 VIDEONICS, INC.


   By: /s/ Michael L. D'Addio                By: /s/ James A. McNeill
       -----------------------------             -------------------------------
       Michael L. D'Addio                        James A. McNeill
       Chief Executive                           Vice President of Finance,
       Officer                                   Chief Financial Officer and
                                                 Assistant Secretary


<TABLE>
       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 Company
and in the capacities and on the date indicated.

<CAPTION>
Name and Signature                             Title                                    Date
------------------                             -----                                    ----
<S>                                            <C>                                      <C>
/s/ Michael L. D'Addio                         Chairman of the Board                    March 27, 1998
---------------------                          and CEO
Michael L. D'Addio


/s/ B. Yeshwant Kamath                         President                                March 27, 1998
---------------------
B. Yeshwant Kamath


/s/ Mark C. Hahn                               Vice President and Chief                 March 27, 1998
---------------------------------              Technical Officer
Mark C. Hahn


/s/ Carl E. Berg                               Director                                 March 27, 1998
---------------------------------
Carl E. Berg


/s/ N. William Jasper, Jr.                     Director                                 March 27, 1998
---------------------------------
N. William Jasper, Jr.

</TABLE>

                                       51
<PAGE>


<TABLE>
                                                VIDEONICS, INC.

                             INDEX TO FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS
<CAPTION>

                                                                                                            Page in
                                                                                                           Form 10-K
<S>                                                                                                              <C>
Financial statements:

         Report of Independent Accountants.......................................................................27

         Balance Sheets .........................................................................................28

         Statements of Income  ..................................................................................29

         Statements of Shareholders' Equity......................................................................30

         Consolidated Statements of Cash Flows...................................................................31

         Notes to Financial Statements...........................................................................32

Schedules:
                     Report of Independent Accountants...........................................................54

         II          Valuation and Qualifying Accounts...........................................................55

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

Exhibits:

       10.9          Letter of Employment Agreement with Yeshwant Kamath dated November 17, 1997.................__

       21.1          Subsidiaries................................................................................__

       23.1          Consent of Coopers & Lybrand L.L.P., Independent Accountants................................__

       27.1          Financial Data Schedule.....................................................................__


</TABLE>
                                       52
<PAGE>




                                 VIDEONICS, INC.

                           ANNUAL REPORT ON FORM 10-K

                          YEAR ENDED DECEMBER 31, 1997

                                   ITEM 14(d)

                          FINANCIAL STATEMENT SCHEDULE




                                       53
<PAGE>


                   INDEPENDENT ACCOUNTANTS' REPORT ON SCHEDULE


Our report on the financial  statements of Videonics,  Inc. and  subsidiaries is
included  on page 27 of this Form 10-K.  In  connection  with our audits of such
financial  statements,  we have also  audited  the related  financial  statement
schedule listed in the index on page 52 of this Form 10-K.

In our  opinion,  the  financial  statement  schedule  referred  to above,  when
considered  in  relation  to the basis  financial  statements  taken as a whole,
present  fairly,  in all  material  respects,  the  information  required  to be
included therein.


                                           Coopers & Lybrand L.L.P.







San Jose, California
January 30, 1998


                                       54

<PAGE>

<TABLE>

                                                VIDEONICS, INC.
                               SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

                                       Valuation and Qualifying Accounts

                                                (in thousands)
<CAPTION>

                                                Balance at        Charged to                          Balance
                                                 Beginning         Costs and                        at End of
Description                                      of Period         Expenses        Deductions         Period
-----------                                      ---------         --------        ----------         ------
<S>                                                 <C>               <C>            <C>               <C>
Year ended December 31, 1997
   Allowance for doubtful accounts:                 $123              $375           $(243)            $ 255

Year ended December 31, 1996
   Allowance for doubtful accounts:                 $173              $(10)           $(40)            $ 123

Year ended December 31, 1995
   Allowance for doubtful accounts:                 $150              $ 28            $ (5)            $ 173


</TABLE>

                                       55
<PAGE>





                                 VIDEONICS, INC.

                           ANNUAL REPORT ON FORM 10-K

                          YEAR ENDED DECEMBER 31, 1997

                                   ITEM 14(c)

                                    EXHIBITS