<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB

(Mark One)
[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
         SECURITIES EXCHANGE ACT OF 1934.

         For the fiscal year ended June 30, 1998

OR

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

         For the transition period from _______ to _______.


                        Commission File Number 000-23415

                           Princeton Video Image, Inc.
           (Name of Small Business Issuer as Specified in its Charter)

          New Jersey                                            22-3062052
(State or Other Jurisdiction of                              (I.R.S. Employer
 Incorporation or Organization)                             Identification No.)

                15 Princess Road, Lawrenceville, New Jersey 08648
               (Address of Principal Executive Offices) (Zip Code)

                                  609-912-9400
                (Issuer's Telephone Number, Including Area Code)

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

                                                         Name of Each Exchange
          Title of Each Class                             on Which Registered

                 None                                             None

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

                           Common Stock, no par value
                               Title of Each Class

         Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.


                                       -1-
<PAGE>   2
Yes [X]   No [ ]

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

         State issuer's revenue for its most recent fiscal year: $696,012 for
the fiscal year ended June 30, 1998.

         State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was sold, or the average bid and asked price of such common
equity, as of a specified date within the past 60 days: $29,665,376, based upon
the last sales price on September 8, 1998.

         State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 8,183,552 shares of Common
Stock, $.01 par value per share, were outstanding on September 8, 1998.

                       DOCUMENTS INCORPORATED BY REFERENCE

         The definitive Proxy Statement for the Annual Meeting of Shareholders
to be held on December 3, 1998, is incorporated by reference in Part III of this
Form.

                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS.

GENERAL

         Princeton Video Image, Inc. ("PVI" or the "Company") developed and is
marketing a real-time video insertion system that, through patented pattern
recognition technology, places computer-generated electronic advertising images
into live television broadcasts of sporting and other events. These electronic
images range from simple corporate names or logos to sophisticated multi-media
3-D animated productions. During the broadcast of a sporting event, for example,
these images can be placed to appear to be physically located in various high
visibility locations in a stadium or even on a playing field.

         PVI believes that its Live Video Insertion System (the "L-VIS System"),
which is an integrated hardware and software system, can benefit (i)
advertisers, through the placement of their ads in new, high visibility
locations and the ability to "narrow cast" by region and brand; (ii)
broadcasters and program producers, through

                                       -2-
<PAGE>   3
a new revenue stream from additional inventory of advertising space; and (iii)
teams and leagues, through increased revenue streams and greater flexibility and
control over in-stadium advertising. The L-VIS System has been used to insert
advertising images into live and pre-recorded television broadcasts including
baseball games, soccer matches, football games, motor sports, tennis matches,
telethons and entertainment broadcasting.

         The Company's objective is to become the leading provider of electronic
advertising to the television advertising market worldwide. The key elements of
the Company's strategy include (i) developing relationships with rights owners
such as the National Football League ("NFL"), National Basketball Association
("NBA"), Major League Baseball ("MLB"), FIFA (soccer's international governing
body) and specific teams and other sports governing bodies; (ii) developing
relationships with national network broadcasters such as NBC, CBS, ABC, ESPN,
and FOX; (iii) working with high-profile advertisers to assist them in
understanding and capitalizing on the use of the L-VIS System; and (iv)
developing L-VIS System software for additional sporting and other events.

         This document includes certain forward-looking statements made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Such forward-looking statements are identified by use of forward-looking
words such as "anticipates", "believes", "plans", "estimates", "expects", and
"intends" or words or phrases of similar expression. These forward-looking
statements are subject to various assumptions, risks and uncertainties that
could cause actual results to differ materially from those anticipated by the
statements made by the Company. Factors described in this Annual Report of Form
10-KSB, including without limitation those identified in this Item 1, "Business"
and in Item 6, "Management's Discussion and Analysis of Financial Conditions and
Results of Operations" could cause the Company's actual results to differ
materially from those expressed in any forward-looking statement by the Company.

         The Company was incorporated in New Jersey on July 23, 1990.

OVERVIEW OF THE TELEVISION ADVERTISING AND SPONSORSHIP MARKET

         Sports advertising and sponsorship is a significant market both inside
and outside the United States. Advertisers in the United States spent an
aggregate of approximately $9.95 billion to purchase television advertising and
sponsorship rights with respect to sporting events in 1997, according to
information from the following industry sources. The 1998 network and cable
television sports advertising markets in the United States were reported by Paul
Kagan Associates, Inc. ("Kagan Associates") to be approximately $3.4 billion and
$2.0 billion, respectively. The December 1997 IEG Sponsorship Report, a sports
newsletter published

                                       -3-
<PAGE>   4
biweekly by IEG, Inc., projected that $4.55 billion would be spent to sponsor
specific teams, stadium locations and sporting events in 1998. The Company
estimates that approximately $11.4 billion was spent on various forms of
television sports advertising and sponsorship in 1997 outside the United States.

         The cost of a television commercial spot is normally a function of the
nature and size of the expected audience of the event to be broadcast. A spot in
a national broadcast of a major sporting event, such as the Super Bowl or a
World Series game, sells for a price many times that of a spot in a regular
season game broadcast only locally or regionally. For example, the costs of a
30-second spot in the broadcast of a local 1997 regular season San Francisco
Giants baseball game, a 1997 nationally broadcast Monday night NFL football game
and the 1997 Super Bowl are approximately $5,000, $350,000 and $1,200,000,
respectively. Television broadcasters (including national television and cable
networks, regional cable networks, and local television and cable operators)
purchase television broadcast rights to sporting events from the holders of
those rights, which include individual teams as well as various leagues,
federations, associations and other organizations representing both professional
and amateur sports. Rights to specific games or events may be held by teams,
leagues, associations, or any combination thereof, depending on the arrangements
under which each sport is organized.

         The Company believes that the growth of sports sponsorship is largely
driven by the desire on the part of advertisers to be "in the game" by having
their brands and products visible during the broadcast of televised live events.
The development of video insertion technology has created a new method of
advertising in which the electronically inserted brand or message can appear, to
the television viewer, to be a part of the stadium where the event is taking
place. The L-VIS System can increase the signage capacity of the stadium or
venue from the television viewer's perspective. By exposing the television
viewer to the brand or message during the event, the advertiser is "in the game"
and can be more confident that its message will actually be seen by the viewer,
as the advertisement can be placed strategically to appear on the television
screen where traditional signage may not be practical or available.

         Sponsorship generally entails associating the sponsor's name with the
event or stadium as well as "signage rights," i.e., the prominent display of the
sponsor's name and products in specified locations in the stadium or broadcast.
Sponsors purchase sponsorship rights from the holders of those rights. Like
broadcast rights, the ownership of sponsorship rights depends on the specific
sport and the event or location. In some cases, the owner of the venue at which
an event is staged holds the sponsorship rights to the event. In other cases,
the team owner may own the sponsorship rights, including signage. Advertisers or
their representatives

                                       -4-
<PAGE>   5
negotiate sponsorship arrangements directly with sponsorship rights holders and
not with broadcasters. Since broadcasters historically have not shared in
sponsorship revenue, they traditionally have not assisted sponsorship programs.

         The success of the L-VIS System requires satisfactory commercial
arrangements among the advertisers, rights holders, broadcasters and the
Company. To date, only a limited number of broadcasters, broadcast rights
holders and advertisers have agreed to use the L-VIS System during live sports
broadcasts. Some press coverage of the Company's technology has raised concerns
about its desirability and potential misuse relating to subliminal advertising,
television tampering, ethics, and over commercialization. There can be no
assurance that the use of the Company's system will be accepted by television
viewers or that the Company will be able to combat effectively potential future
negative publicity regarding its or similar technology.

ABILITIES OF THE L-VIS SYSTEM

         The Company believes that the L-VIS System provides advantages when
compared to traditional 30-second advertising spots and other forms of
advertising because the L-VIS System:

         -        Allows for "in the game" advertising. The L-VIS System
                  allows an advertiser to be "in the game" by having their
                  brands and products visible during the broadcast of
                  televised live events;

         -        Reduces the effect of channel surfing and viewer muting.
                  Because the L-VIS System allows for "in the game" advertising,
                  the negative effect of "channel surfing," which often occurs
                  during traditional 30-second advertising spots, may be
                  reduced;

         -        Allows placement of advertising in high visibility
                  locations. The L-VIS System allows for the insertion of
                  images without affecting the actual playing surface or
                  other areas where advertising is inserted;

         -        Creates new inventory for advertising rights holders. The
                  L-VIS Systems allows for new advertising by providing for the
                  insertion of images in locations that are unavailable for
                  conventional billboards, such as the space in the vicinity of
                  football goal posts;

         -        Allows "narrow casting" of specific advertising to specific
                  geographical regions. The L-VIS System also allows for "narrow
                  casting" specific advertising to specific geographical
                  regions. Thus, where desired, a rights holder can sell the
                  same advertising space to different advertisers in different
                  markets; for instance,

                                       -5-
<PAGE>   6
                  the New York broadcast of a San Francisco Giants-New York Mets
                  MLB game can include a different inserted advertisement than
                  the San Francisco broadcast;

         -        Provides for animation and audio-video advertising. The
                  L-VIS System may be used, when appropriate, to insert
                  animation and audio-video advertising within the program
                  to enhance the impact of the advertising;

         -        Allows branding of an event. Insertions made during a live
                  broadcast will be captured, or branded, on recordings of the
                  event and may then be shown around the world in re-broadcasts
                  and highlight films of the event. An advertiser will benefit
                  from every re-broadcast, such as re-broadcasts which occur
                  during the sports segment of most news programs; and

         -        Provides advertising into otherwise advertising-free
                  environments. The Company's technology can be used to insert
                  advertising into otherwise advertising-free environments,
                  e.g., pay-per-view sports events. To date, the L-VIS System
                  has not been used for such purpose, and there can be no
                  assurance that it will ever be so used.

THE L-VIS SYSTEM TECHNOLOGY

         The L-VIS System is a system of proprietary hardware and software which
has been designed by the Company to insert electronic images into live televised
sports broadcasts. The inserted images may be two or three dimensional, static
or animated, opaque or semi-transparent and may be placed so that the inserted
images appear to exist on the playing field or in the stadium or venue where the
game or event is being played. If a player or other object moves in front of an
image that is inserted on a wall or a playing field, the L-VIS System is
programmed so that the passing object occludes that portion of the inserted
image. The L-VIS System can also be used to insert a free standing image so that
the image will occlude a player or other object which "passes behind" it.

         The Company's L-VIS System is based upon patented pattern recognition
technology. The L-VIS System may be located anywhere in the television
distribution chain, including the stadium where a broadcast typically
originates, the television studio to which a broadcast is relayed and the
microwave links or satellite ground stations where the broadcast is relayed for
distribution to the viewing public.

         The L-VIS System and its operator may be located at the site of the
event, at the network studios of the broadcaster or at an individual station or
cable system head-end carrying the broadcast. Before the broadcast, the
advertising images to be inserted are

                                       -6-
<PAGE>   7
prepared and the operator identifies the location in the broadcast scene where
the images will be inserted. The L-VIS System is designed to recognize the
broadcast scene in real time during the broadcast and to insert the image as
instructed each time the broadcast scene containing the insert location appears.
The operator controls which of several images is selected for insertion and when
it will be inserted.

         The Company has designed software that allows for the live use of the
L-VIS System in football, baseball, soccer, tennis and automobile racing
broadcasts. For instance, in baseball the Company's software allows images to be
inserted on the wall behind home plate, the outfield wall or the area above the
outfield wall. To the television viewer, a non-animated advertisement inserted
with the L-VIS System, such as an advertisement on the wall behind home plate,
appears to be part of the original scene, in proper perspective and fixed in the
scene as the camera pans, tilts and zooms, and as players move in front of the
image. Furthermore, because an inserted image is not present at the actual site
of a sporting event, any distraction caused to the players by other advertising
such as scrolling billboards will not be present.

STRATEGY

         The Company's objective is to become the leading provider of electronic
advertising to the sports television advertising market worldwide. The key
elements of the Company's strategy include:

         -        Developing relationships with rights owners. The Company
                  intends to develop relationships with rights owners such as
                  the NFL, MLB, NBA, FIFA, and specific teams and other sports
                  governing bodies;

         -        Developing relationships with broadcasters. The Company
                  intends to develop relationships with national network
                  broadcasters such as NBC, CBS, ABC, ESPN and FOX;

         -        Working with high-profile advertisers. To promote acceptance
                  of the L-VIS System, the Company has actively discussed the
                  L-VIS System's benefits and unique uses with a limited number
                  of high-profile sporting event advertisers and plans to expand
                  this effort significantly; and

         -        Enhancing and developing additional L-VIS System software. In
                  addition to enhancing existing software for use of the L-VIS
                  System during football games, baseball games, soccer games,
                  tennis matches and motor sports events, the Company is
                  developing, or intends to develop, software to permit use of
                  the L-VIS System during the broadcast of additional sports and
                  other events, including basketball games and golf.

                                       -7-
<PAGE>   8
OWNERSHIP OF VIDEO INSERTION RIGHTS IN THE NFL, COLLEGE FOOTBALL
AND MLB

         In the NFL, all television, video insertion and national sponsorship
rights are controlled by the league for all regular season games, the playoffs,
the Super Bowl and the Pro-Bowl. Such rights are controlled by individual NFL
teams with respect to all pre-season games. The NFL is under contract with ABC,
CBS, FOX and ESPN for the rights to broadcast various NFL football games during
the 1998 NFL season. Kagan Associates estimated that the national network
broadcasters holding rights to NFL games in 1997 generated an aggregate of
approximately $1.4 billion in revenues through the sale of television
advertisements with respect to their broadcast of regular season and playoff
games, including the 1997 Super Bowl on FOX.

         In college football, the television advertising, sponsorship and video
insertion rights to regular season games are held by various college football
conferences. The rights to the various college bowl games are owned by bowl
committees which are often non-profit corporations established to host a bowl
game. Both the conferences and the committees, like other rights holders,
contract with broadcasters for the national or local broadcast of their games.
Kagan Associates estimated that in 1997, ABC, NBC and CBS generated
approximately $170 million, $16.8 million and $61.6 million, respectively, in
advertising revenues relating to their regular season and college bowl game
broadcast rights.

         MLB holds all television, sponsorship and video insertion advertising
rights with respect to regular season nationally broadcast games, the All Star
Game, playoff games, the World Series and the international distribution of
regular season games. Kagan Associates estimated that the advertising revenues
received by the four major over-the-air broadcast networks with respect to MLB
totaled approximately $223 million in 1993, $37 million in 1994 (a strike
shortened season), $150 million in 1995, $303 million in 1996 and $321.9 million
in 1997. Generally, the local television rights, video insertion and sponsorship
rights to regular season baseball games are held individually by each of the 30
MLB teams. Typically, each team sells to over-the-air and cable broadcasters the
broadcast and television advertising rights to individual games or packages of
multiple games for a fixed fee and solicits potential sponsors using a media
sales group. The broadcasters earn revenues through the sale of 30-second spots
to local and national advertisers.

SALES AND MARKETING

         The Company expects to generate revenues from the sharing of
advertising revenue among the Company, rights holders and broadcasters and, in
certain circumstances, through the licensing of the Company's technology. As
discussed above, the right to

                                       -8-
<PAGE>   9
insert electronic images for advertising purposes into a live broadcast, and
hence the right to sell advertising using the L-VIS System, is held by different
groups depending, in most cases, on the sport involved and the status of the
game, i.e., pre-season, regular season or post-season, and whether the game is
to be broadcast internationally, nationally or locally. These rights may be sold
for specific games and/or entire seasons to another party, most notably a
broadcaster who pays the rights holder an up-front fee for such rights. In each
case, the Company must negotiate for the use of the L-VIS System with the rights
holder or holders, typically in exchange for a percentage of the advertising
revenue generated using the L-VIS System. Because the L-VIS System uses the live
feed from the broadcaster to insert its electronic images, such broadcaster must
also approve the use of the L-VIS System. Accordingly, arrangements with several
parties including the rights holder and the broadcaster must be established. The
L-VIS System has been used to broadcast, among other events, (i) the
international broadcast of Super Bowl XXXII in January 1998, (ii) the 1998 NFL
pre-season games of the Arizona Cardinals, Baltimore Ravens, Chicago Bears, New
York Giants and San Francisco 49ers, (iii) 1998 and 1997 MLB home games of the
San Francisco Giants and the San Diego Padres, and (iv) 1998 MLB home games of
the Philadelphia Phillies. There can be no assurance, however, that the Company
will be successful in establishing or maintaining a relationship with any party.

         The ultimate customers of the Company's L-VIS System are expected to be
sports advertisers and sponsors. Revenues are expected to flow from the
advertisers and sponsors to the rights holders who will pay a share of those
revenues to the Company. Because the right to use video insertion technology
and, thus, the right to sell advertising using the L-VIS System, is held, in
most cases, by the sports teams or their governing leagues, the Company expects
that these rights holders will be its contract partners. The Company expects to
provide the L-VIS System and support services to the rights holders and to be
paid by the rights holders a percentage of the advertising revenues derived from
use of the L-VIS System. The Company further expects that the rights holders
will enter into agreements with broadcasters to provide the services necessary
for use of the L-VIS System. The Company expects that advertising space using
the L-VIS System will be sold either by the rights owner or by the broadcaster,
depending on the specific arrangement between such parties, and that advertising
revenues will be shared among the rights owner, the broadcaster and the Company.
As a result, the Company relies, and will continue to rely, upon the marketing
and advertising staffs of the teams, leagues and broadcasters, which typically
target the manufacturers or producers of nationally distributed products.

         In addition to relying upon the sales forces of the broadcasters and/or
the rights holders, the Company also promotes the advantages of the L-VIS System
directly to major advertisers.

                                       -9-
<PAGE>   10
The Company believes that promotion is important in influencing market
acceptance of the L-VIS System among potential advertisers. Certain press
coverage of electronic image insertion technology has raised concerns about its
desirability and potential misuse. For instance, an article has described
inserted advertising as subliminal and the technology has been described as
tampering with the television picture in a manner which may not be ethical. A
danger of over commercialization has also been voiced.

         The Company has initially focused its sales and marketing efforts on
those sports that account for a significant amount of the United States or
worldwide advertising and sponsorship expenditures. Following is an explanation
of the Company's sales and marketing strategy for several of its target markets:

         FOOTBALL

         In football, the L-VIS System software has been designed to insert
images in the vicinity of the goal posts either as a lead-in to commercial
breaks or during field goal and extra-point attempts. The Company expects these
insertions to account for substantially all of the Company's football revenue.
Insertions in the vicinity of the goal posts offer rights holders the ability to
sell advertising for a high visibility location where advertising was not
previously located.

         During NFL pre-season in August 1998, the L-VIS System was used in
games of the Arizona Cardinals, Baltimore Ravens, Chicago Bears, New York Giants
and San Francisco 49ers to insert promotional material and advertising in the
broadcasts. The L-VIS System was also used to insert electronic images on behalf
of The Coca-Cola Company, as the exclusive sponsor, during the international
broadcast of Super Bowl XXXII in January 1998.

         The ESPN sports network first used the L-VIS System in the broadcast of
football games during the 1995 fall college football season. The most prominent
uses by ESPN were in its December 1995 broadcasts of the Holiday Bowl and the
Peach Bowl. ABC used the L-VIS System to insert ABC logos into its New Year's
Eve 1995 broadcast of the Sugar Bowl from New Orleans. Since then, ESPN and
ESPN2 have used the L-VIS System to make insertions in more than a dozen college
football broadcasts. During the 1996 college football season, ESPN used the
L-VIS System in approximately 80% of its Western Athletic Conference football
broadcasts. The L-VIS System was not used during the broadcast of any 1997
college football season games.

         The Company intends to pursue additional arrangements for the use of
the L-VIS System with respect to the broadcast of NFL and college football
games. However, there can be no assurance that the Company will be successful in
creating greater interest for use of the L-VIS System with respect to the
broadcast of either NFL or

                                      -10-
<PAGE>   11
college football games.

         BASEBALL

         The Company focused its initial marketing efforts on the local MLB
market because the advertising rights in each local market are typically held by
the individual teams in that market. This provides a greater number of potential
customers than are available in many other sports. Because a normal baseball
game is divided into 18 half-innings, advertisements can be sold by the rights
holder using a half-inning advertising unit, which enables the rights holder to
know exactly how many advertising units may be sold and what its revenues will
be from the sale of such advertising. The Company has negotiated and intends to
continue negotiating for the right to consent to any pricing model before its
implementation.

         In 1995, the Company introduced the L-VIS System to broadcast
television, inserting advertisements into broadcasts of the Trenton Thunder
minor league baseball games broadcast by Comcast Cable of New Jersey. In 1996,
the Company contracted with the San Francisco Giants for use of the L-VIS System
for broadcasts of Giants home games on San Francisco station KTVU and
SportsChannel. In addition, FOX carried one of the Giants home games on its
"Game of the Week" program during which the L-VIS System was used. The Giants
pay a fee to the broadcaster for use of the video feed required by the L-VIS
System and to facilitate its utilization.

         Through the use of the L-VIS System by the San Francisco Giants, the
Company gained access to other MLB teams. The Giants and the San Diego Padres
used the L-VIS System throughout the 1997 MLB season and are using the L-VIS
System during the 1998 MLB season. In order to interest more teams in the
Company's technology, PVI installed a second system in San Diego during the 1997
season for use by visiting teams in broadcasts to their home cities. The Company
entered into an agreement with the Philadelphia Phillies pursuant to which the
L-VIS System was used throughout the 1998 MLB season with respect to the
broadcast of home games. However, there can be no assurance that the Company
will be successful in creating greater interest for use of the L-VIS System in
MLB.

         SOCCER

         Although revenues from soccer television advertising in the United
States historically have been very small, the Company has marketed, and intends
to continue marketing, the L-VIS System for use in soccer matches in Europe,
Latin America and Asia, where the popularity of soccer is significantly greater
than in the United States.

         The L-VIS System has been designed to insert an image onto the

                                      -11-
<PAGE>   12
center circle of a soccer field. The Company first used the L-VIS System to
insert advertising logos during live international broadcasts of the Parmalat
Cup soccer tournament in August 1995. RTBF, the French language national
broadcaster in Belgium, successfully used the L-VIS System in May 1996 to insert
three-dimensional images into the broadcast of the Belgian Cup. The Company also
used the L-VIS System to insert logos during the December 1996 World Cup
qualifying match between the Dutch and Belgian national teams and, through
Publicidad (discussed below), to insert advertisements in more than 100 soccer
matches in Mexico.

         FIFA currently opposes the insertion of advertising on to the field of
play. The L-VIS System has not been used in FIFA-sanctioned matches to insert
images on the field of play while a match is in progress. Instead, the L-VIS
System has been used before and after a match. The Company continues to explore
ways to encourage FIFA to grant permission to use the L-VIS System in
FIFA-sanctioned matches. For example, the Company has discussed using the L-VIS
System to insert advertising on sideboards during FIFA-sanctioned matches.
Without this permission, the Company's potential revenue from soccer will be
substantially reduced. There can be no assurance that FIFA will give such
permission.

         OTHER SPORTS

         Kagan Associates estimated that in 1997, 22.1% and 7.8% of the combined
sports advertising revenues generated by ABC, CBS, NBC and FOX were for
basketball and golf, respectively. Motor sports have also generated significant
revenues worldwide. In August 1998 the L-VIS System was used for the first time
in the broadcast of a motor sport event, the Brickyard 400. The Company intends
to improve its existing software for motor sports events and to develop software
to use the L-VIS System for broadcasts of basketball and golf during 1999-2000.
ESPN used the L-VIS System in international broadcasts of the 1997 and 1998
X-Games, which were taped in San Diego. There can be no assurance that the
Company will be successful in developing software that allows use of the L-VIS
System with basketball or golf, or if successful, will be able to gain market
acceptance with respect to such sports.

INTERNATIONAL BUSINESS STRATEGY

         The Company's strategy with respect to sporting and other events
originating outside of the United States is to enter into joint ventures and
licensing transactions principally with foreign broadcast and sports marketing
experts. The Company expects that the largest international market for the L-VIS
System initially will be for soccer matches and motor sports.

         In 1993, the Company entered into a 50/50 joint venture with Presencia
en Medios, pursuant to which the parties formed Publicidad Virtual, S.A. de
C.V., a Mexican limited liability

                                      -12-
<PAGE>   13
company ("Publicidad"), which was granted an exclusive, royalty-free license to
use, market and sub-license the L-VIS System throughout Mexico, Central and
South America and the Spanish-speaking markets in the Caribbean basin. The L-VIS
System has been used to place insertions into broadcasts of more than 200 soccer
matches, plus tennis matches and bullfights on behalf of clients of Publicidad.

         There can be no assurance that the Company will be able to enter into
or maintain favorable relationships with any partners or licensees, that any
partners or licensees will establish a market for the L-VIS System, that any
relationships will generate any revenue for the Company, or that any partners or
licensees will act in good faith and perform their obligations to the Company.
To the extent the Company enters into an exclusive arrangements in any market,
such partners or licensees' failure to generate revenues for the Company could
preclude the Company from generating any revenues in such geographical area or
with respect to a specific sport, as the case may be.

         There are certain risks inherent in doing business in international
markets, such as unexpected changes in regulatory requirements, tariffs and
other trade barriers, difficulties in staffing and managing foreign operations,
political instability, fluctuations in currency exchange rates, reduced
protection for intellectual property rights in some countries, seasonal
reductions in business activity during the summer months in Europe and certain
other parts of the world, and potentially adverse tax consequences, any of which
could have a material adverse impact upon the success of the Company's
international operations.

RESEARCH AND DEVELOPMENT

         The Company recently completed integrating the L-VIS System operating
software into a new "Flex-Card" hardware platform. This platform is more
powerful than the Company's prior platform and allows re-configuration. The
Company has designed the Flex-Card L-VIS System to provide multiple insertion
capability, multiple camera capability, an expanded zoom range and has created a
simplified graphical user-based interface. See Item 6, "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Research and
Development" regarding costs of research and development in each of the last two
fiscal years.

         The Company is continuing to improve existing software for use of the
L-VIS System during the broadcast of football games, baseball games, soccer
games, tennis matches and motor sports. Further, the Company is developing, or
intends to develop, software to permit use of the L-VIS System during the
broadcast of basketball games and golf. The Company also intends to make the
L-VIS System available for use with other events such as pay-per-view boxing and
concerts and award shows such as the Oscars

                                      -13-
<PAGE>   14
and the Grammys. There can be no assurance that the Company will be
able to prepare such software.

COMPETITION

         PVI knows of three other organizations that have developed and are
continuing to develop processes and equipment to pursue a business similar to
the Company's. These organizations are Symah Vision-SA ("Symah"), Orad Hi Tech
Systems Ltd. ("Orad") and SciDel Technologies Ltd. ("SciDel"). Symah is owned by
the LaGardere Group, which controls Matra-Hachette, a large French defense and
publishing company. Symah has demonstrated its system publicly and is actively
marketing its system in Europe. The Company believes that Symah's system has
been used in Europe during the broadcast of at least 60 sporting events. Orad
was founded in 1992 as part of the ORMAT Group, an Israeli company originally
established to create alternative energy power stations. The Orad system is
marketed by Imagine Video Systems which is partly owned by Orad and ISL, a Swiss
sports-marketing firm. SciDel is a subsidiary of Scitex, a large Israeli
corporation that provides services in the electronic imaging area primarily for
the printing and publishing industries. Both the Orad and SciDel systems have
been used during live commercial broadcasts. Apart from the patents or patent
applications that the Company owns or licenses, the Company believes each of
these competitors has one or more patents or patent applications relating to
real-time video insertion. Although the Company believes that use of the L-VIS
System does not infringe the United States or other patents of third parties,
there can be no assurance that competitors will not initiate a patent
infringement action against the Company. PVI is currently evaluating whether use
of the SciDel system infringes the Company's patents.

         In addition to these known competitors, the Company also expects
substantial competition from established broadcast business participants, if the
market for video insertion technology, including virtual advertisements, proves
successful. These potential competitors will likely have substantially greater
financial, technical, marketing and other resources and many more highly skilled
individuals than does the Company. Furthermore, such potential competitors may
have greater name recognition and extensive customer bases that could be
utilized to gain significant market share, to the Company's detriment. The
Company's competitors may be able to produce superior products, including
products with new features, undertake more extensive promotional activities,
offer more attractive terms to customers and adopt more aggressive pricing
policies than the Company. There is no assurance that the Company will be able
to compete effectively with current or future competitors.

         In addition to the products of these competitors, the L-VIS System will
compete with advertisers' use of traditional 30-second

                                      -14-
<PAGE>   15
advertising spots, which remain the standard in the television advertising
industry, and traditional signage and sponsorship programs. The Company's
revenues will be partially dependent upon television sports advertisers
allocating a portion of their advertising budgets to use the L-VIS System. There
can be no assurance that advertisers will allocate their advertising expenses in
the manner currently anticipated by the Company.

         The L-VIS System will also compete with advertisers' use of
conventional billboard products, including advertising placed on playing
surfaces (such as outfield walls, football fields and soccer fields) and
scrolling billboards, physically located at the site of an event, which can
display sequentially a series of static advertisements. These scrolling
billboards are currently marketed and used in professional baseball, basketball
and other sports. These products achieve an effect that is similar to those
L-VIS System insertions that are static and two-dimensional, and their use
generally does not require broadcaster participation.

         Approximately 21 MLB teams had scrolling billboards located behind home
plate in 1998. The existence of these scrolling billboards and other advertising
behind home plate currently limits the marketability of the L-VIS System in
baseball. The Company believes that one manufacturer of scrolling billboards
used in stadiums has included restraints in its contracts that inhibit or
prohibit the use of video insertion technology in television broadcasts. Other
agreements among advertisers, sponsors, syndicators, promoters, broadcasters and
cable operators may include similar provisions. These restrictions may have a
material adverse effect on the Company's business, financial condition and
results of operations.

         The Company expects to generate revenue primarily by attracting new
advertisers and sponsors to the sports advertising and sponsorship market and by
causing existing advertisers and sponsors to switch to use of the L-VIS System.
There can be no assurance that total advertising and sponsorship expenditures
will increase as a result of the availability of the L-VIS System. To the extent
that the Company is competing for television advertising and sponsorship dollars
that are currently allocated to traditional media, such as 30-second spots or
scrolling billboards, the competition is likely to become more intense. The
Company will be able to compete effectively with existing advertising and
sponsorship alternatives only with the cooperation of broadcasters and the
advertising sales departments of team owners and broadcasters, on which the
Company will rely for sales to advertisers. Because certain L-VIS System rights
holders may also own traditional television advertising rights or sponsorship
rights, which may provide such rights holders with a greater percentage of the
revenues received from the sale of such advertising or sponsorship rights than
does the sale of L-VIS System advertisements, incentives may exist in some cases
to sell

                                      -15-
<PAGE>   16
alternative advertising or sponsorship inventory prior to the sale
of L-VIS System advertising.

MANUFACTURING AND SUPPLY

         The Company has built 21 L-VIS System units (each, an "L-VIS Unit"), of
which approximately 14 are being used from time-to-time by customers, potential
customers or foreign marketing partners. An L-VIS Unit consists of standard
electronic equipment racks, containing both standard purchased components and
the Company's proprietary circuit boards, assembled and tested by Company
personnel. The Company is dependent upon a sole supplier, Lucent Technologies,
for certain of the hardware components. Although such hardware components are
stock items which are readily available to the public, there can be no assurance
that Lucent will continue to manufacture and sell the components. The Company is
not a party to any agreement with Lucent.

REGULATIONS

         The Company believes that no federal or state regulations currently
directly relate to or restrict the use of the L-VIS System. However, there can
be no assurance that there will not be any regulations or restrictions in the
future, which either directly, or indirectly through broadcaster regulations,
will adversely affect the use of the L-VIS System. Further, there can be no
assurance that regulatory agencies in foreign jurisdictions have not adopted, or
will not adopt in the future, regulations or restrictions affecting the use of
the L-VIS System. Such regulations or restrictions could have a material adverse
effect on the Company's business, financial condition and results of operation.

INTELLECTUAL PROPERTY

         PATENTS

         The Company has been assigned four issued U.S. patents.
Patent No. 5,264,933, which relates to the Company's basic pattern
recognition video insertion technology, was issued on November 23,
1993, will expire on November 23, 2010 and was assigned to the
Company on January 22, 1992.  Patent No. 5,543,856, which relates
to the use of remote insertion of images that might be useful in a
narrow casting application, was issued on August 6, 1996, will
expire on August 6, 2013 and was assigned to the Company on October
22, 1993.  Patent No. 5,627,915, which relates to a pattern
recognition system using templates, was issued on May 6, 1997, will
expire on January 31, 2015 and was assigned to the Company on
January 30, 1995. Patent No. 5,808,695, which relates to a method
of tracking scene motion for live video insertion systems, was
issued on September 15, 1998 and will expire on December 29, 2015
and was assigned to the Company on December 27, 1995. The Company

                                      -16-
<PAGE>   17
owns all right, title and interest in each of the patents.

         To date, the Company has filed counterpart patent applications for the
three issued U.S. patents in the European Patent Office and in various
non-European countries around the world where it expects to do business. One
patent has been allowed by the European Patent Office. Six new patent
applications are pending in various countries, including the United States, and
several more patent applications are in preparation.

         The Company believes its patents will be important in its future
business dealings, since it believes that any system that is able to deliver the
technical capabilities of the L-VIS System will depend on pattern recognition
technology and will, therefore, fall within the scope of PVI's issued patents.

         The validity and/or breadth of the Company's owned and licensed patents
generally may be tested in post-allowance court proceedings. There has been no
court test of any of the issued patents, the allowed patent or any of the
pending applications or foreign counterparts of the Company. The Company is
aware of other companies that have patents or patent applications in the field
of electronic video insertion technology. These companies or others may claim
that the Company infringes the patents or rights of such third parties, or these
third parties may infringe the Company's patents. In either event, if the
Company's patents or rights are brought before a court, litigation would involve
complex legal and factual issues, and the outcome, consequently, would be highly
uncertain. Furthermore, any patent litigation would entail considerable cost to
the Company, which would divert resources that otherwise could be used for its
operations and might be resolved in a manner that is unfavorable to the Company.
No assurance can be given that the Company or its licensors would be successful
in enforcing such rights, or that the Company's products or processes do not or
will not infringe the patent or intellectual property rights of a third party.
An adverse outcome in the defense of a patent infringement action could subject
the Company to significant liabilities to third parties, require the Company to
license disputed technology from third parties, if possible, or require it to
cease selling its products. In the event the Company's owned or licensed patents
were successfully challenged in court, its business, financial condition and
results of operations would be materially adversely affected.

         It is possible that one or more products developed by a competitor may
be marketed or used in a territory where the Company has patent protection.
Because an image inserted through use of video insertion technology often
appears as if it exists as a physical advertisement at the site of a sporting
event, it may be difficult to know whether, and which, video insertion
technology is being used with respect to any televised sporting event. Thus,
infringement of the Company's patents may be difficult to monitor.

                                      -17-
<PAGE>   18
The Company's failure to detect such an infringement may have a material adverse
effect on its business, financial condition and results of operations. In the
event the Company becomes aware of a potential patent infringement, it may be
forced to litigate to enforce its patent rights. Engaging in an enforcement
action may be protracted and expensive and may have a material adverse effect on
the Company's business, financial condition and results of operations.

         Although the Company has no cause for belief that use of the L-VIS
System would infringe the United States or other patents of third parties, there
can be no assurance that competitors will not initiate a patent infringement
action against the Company. GDM, a Spanish media company that licensed the L-VIS
System for use in broadcasts in Spain and Portugal during a trial period which
ended December 1996, received a letter from a Symah affiliate asserting that use
of the L-VIS System in Spain would infringe one of Symah's patents. Although the
Company and GDM have been advised that use of the L-VIS System would not
infringe Symah's patent, there can be no assurance that Symah will not assert
infringement claims against the Company or its European licensees in the future.

         One of the patents of which the Company is aware is U.S. Patent
5,353,392 (the "'392 Patent"). The '392 Patent derives from the same patent
application as does the patent asserted by the Symah affiliate against the L-VIS
System in Spain. The '392 patent has not been asserted against the Company. The
Company believes that the L-VIS System does not infringe the '392 Patent.
However, the Company has not received during the past two years an opinion as to
the non-infringement of the '392 Patent. There can be no assurance that changes
in the L-VIS System, changes in applicable patent law or rulings by the U.S.
Patent and Trademark Office or the courts would not cause the L-VIS System to be
found to infringe the '392 Patent, which could have a material adverse effect on
the Company's business, financial condition and results of operations. If the
L-VIS System were found to infringe the '392 Patent or any other patent, the
Company may be required to modify the L-VIS System or enter into an arrangement
to license such patent, if possible. There can be no assurance that the Company
would be able, under such circumstances, to modify the L-VIS System or enter
into a license arrangement.

         If the L-VIS System were found to infringe any patent, the Company may
be required to modify the L-VIS System or enter into an arrangement to license
such patent, if possible. There can be no assurance that the Company would be
able, under such circumstance, to modify the L-VIS System or enter into a
license arrangement. The Company also relies in large part on unpatented trade
secrets, improvements and proprietary technology. Despite the Company's efforts
to safeguard and maintain its proprietary rights, there can be no assurance that
it will be successful in doing so or that its competitors will not independently
develop, reverse engineer or

                                      -18-
<PAGE>   19
patent technologies that are substantially equivalent or superior
to its technologies.

         LICENSE GRANTS

         The Company has entered into the following license agreements relating
to the L-VIS System:

         David Sarnoff Research Center, Inc. David Sarnoff Research Center, Inc.
("Sarnoff") has granted the Company a worldwide license to practice Sarnoff's
technology related to the electronic recognition of landmarks, including an
exclusive license covering the specific fields of television advertising and
television sports. The Company has also been granted a non-exclusive license for
use of the Sarnoff technology in all other fields relating to sports or
advertising, including video production, local video insertion, private
networks, medical and scientific applications and uses by the United States
Department of Defense or any other United States government agency. The Sarnoff
license will remain in effect until terminated by the Company, provided that the
Company remains current with respect to its royalty obligations to Sarnoff. The
Company may terminate the license at any time.

         During the term of the exclusive license for television advertising and
television sports applications, the Company is obligated to pay Sarnoff
royalties based upon a percentage of the Company's gross revenues. Royalties
accrue as earned, but the Company is not required to make any royalty payments
until the earlier of the date on which its cumulative gross revenues reach $20
million or January 1, 1999. In any event, commencing on January 1, 1999, the
Company will be required to pay minimum royalties each quarter. Royalties have
begun to accrue under the Sarnoff license (less than $100,000) but have not been
paid.

         General Electric Company. General Electric Company ("GE") granted the
Company a five-year non-exclusive, worldwide license relating to all GE patents
on equipment for electronic recognition of selected landmarks; altering images
in television programs for advertising purposes; or any purpose in television
programs the principal focus of which is sports, as of July 1996.

         Theseus Research, Inc. Theseus Research, Inc. ("Theseus") has granted
the Company a non-exclusive, worldwide license to use and sell Theseus' patented
technology for the warping of images in real time. During the term of the
Theseus license, the Company is required to pay Theseus a royalty on net sales
of products, if any, that incorporate the Theseus technology. The Company has
paid Theseus an up front license fee of $50,000, which is creditable against
future obligations. The Company may terminate the Theseus license at any time.

         TRADEMARKS

                                      -19-
<PAGE>   20
         L-VIS(TM) is a trademark of the Company. The Company has filed a U.S.
trademark registration application for L-VIS, the mark under which the Company
is marketing its live video insertion products. This mark has been published for
opposition in the Official Gazette of the United States Patent and Trademark
Office. Following publication, a notice of opposition was filed and the Company
is currently in discussions with the filer of such notice. The Company believes
that its trademark position is adequately protected. However, there can be no
assurance that the Company will be able to resolve matters favorably with the
filer of such notice.

         COPYRIGHT AND TRADE SECRET

         The Company relies upon copyright and trade secret protection to
maintain the proprietary nature of the computer software it develops that is not
patented.

EMPLOYEES

         As of September 8, 1998, the Company had 46 full-time employees, 22 of
whom were engaged in, or directly supported, the Company's hardware and software
research, development and product engineering activities, 8 of whom assembled
and operated L-VIS Systems for potential customers, 10 of whom were engaged in
marketing activities and 6 of whom were engaged in administrative activities. In
addition, the Company utilizes part-time employees and outside contractors and
consultants as needed. None of the Company's employees is represented by a labor
union, and the Company believes that its relations with its employees are good.

         Currently, each of the Company's employees is required to execute an
agreement pursuant to which he or she assigns to the Company all patent rights
and technical or other information which pertain to the Company's business and
are developed by the employee during his or her employment with the Company, and
agrees not to disclose any trade secret or confidential information without the
prior consent of the Company.

ITEM 2.           DESCRIPTION OF PROPERTY.

         The Company leases 16,000 square feet of office space in Lawrenceville,
New Jersey, and 4,300 square feet of office space in New York City. The
Lawrenceville facility is the main operations center of the Company, including
product, hardware and software design, manufacturing and product assembly,
product test and documentation, customer training and customer technical
support. The New York City office is the corporate marketing center. The lease
in Lawrenceville expires in September 2002, and the New York City lease expires
in May 2000.

ITEM 3.           LEGAL PROCEEDINGS.


                                      -20-
<PAGE>   21
         The Company is not a party to any material legal proceedings.

ITEM     4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITIES HOLDERS.

         Not Applicable.

                                     PART II

ITEM 5.           MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.

         (a) Prior to December 1997 there was no market for the Company's Common
Stock. Since December 16, 1997 the Common Stock has traded on the Nasdaq
National Market under the symbol "PVII." The following table sets forth, for the
calendar periods indicated, the range of high and low sale prices for the Common
Stock of the Company on the Nasdaq National Market:

<TABLE>
<CAPTION>
Period                                          High             Low
------                                          ----             ---
<S>                                            <C>              <C>
1997
4th Quarter (commencing December 16, 1997)..   $9 1/2           $7 1/8

1998
1st Quarter.................................   $9 1/2           $6 1/4
2nd Quarter.................................    8 3/4            4 1/4
</TABLE>

         As of September 8, 1998, there were 390 holders of record of the Common
Stock, with beneficial shareholders in excess of 400. On September 8, 1998, the
last sale price reported on the Nasdaq National Market for the Common Stock was
$3.625 per share. The market prices of equity securities of technology
companies, such as PVI, have experienced substantial price volatility in recent
years for reasons both related and unrelated to the individual performance of
specific companies. To date, there has been a relatively small number of shares
of Common Stock trading publicly. Shareholders may experience difficulty selling
or otherwise disposing of shares of Common Stock at favorable prices, or at all.

         The continued listing of the Common Stock on the Nasdaq National Market
will be conditioned upon the Company's meeting certain asset, stock price and
other criteria set forth by such quotation system. If the Company fails any
listing criteria, the Common Stock may be delisted from quotation on such
system. The effects of delisting include the limited release of the market
prices of the Company's securities and limited news coverage of the Company. In
addition to the risk of possible delisting, low price stocks are subject to the
additional risks of federal and state regulatory requirements and the potential
loss of effective trading markets, including the "penny stock" rules under the
Securities Enforcement and Penny Stock Reform Act of 1990. In particular, if the
Common Stock were delisted from trading on an appropriate

                                      -21-
<PAGE>   22
market, including the Nasdaq National Market, and the trading price of the
Common Stock were less than $5.00 per share, the Common Stock could be subject
to Rule 15g-9 under the Exchange Act, which requires that broker-dealers satisfy
special sales practice requirements, including making individualized written
suitability determinations and receiving any purchaser's written consent, prior
to any transaction. Delisting and such additional regulatory requirements may
restrict investors' interest in the Common Stock and materially adversely affect
the trading market and prices for the Common Stock and the Company's ability to
issue additional securities or to secure additional financing.

         The Company has neither paid nor declared any dividends on the Common
Stock since its inception. The Company expects that it will retain all earnings,
if any, generated by its operations for the development and growth of its
business and does not anticipate paying any cash dividends to its shareholders
in the foreseeable future. The payment of future dividends on the Common Stock
and the rate of such dividends, if any, will be determined in light of any
applicable contractual restrictions limiting the Company's ability to pay
dividends, the Company's earnings, financial condition, capital requirements and
other factors deemed relevant by the Company's Board of Directors. Furthermore,
pursuant to its Restated Certificate of Incorporation, the Company is prohibited
from paying any dividends on the Common Stock until all accumulated dividends in
respect of the Series A Preferred Stock and Series B Preferred Stock have been
paid. As of June 30, 1998, the accrued dividends with respect to the shares of
Series A Preferred Stock and Series B Preferred Stock totaled $99,250 and
$113,950, respectively.

         The Company is required to redeem the Series A Preferred Stock on a pro
rata basis, at a price of $4.50 per share plus all accrued but unpaid dividends,
out of 30% of the amount, if any, by which the Company's annual net income after
taxes in any year exceeds $5 million, as shown on its audited financial
statements. Subject to the prior redemption of all of the Series A Preferred
Stock, the Company is required to redeem the Series B Preferred Stock, on a pro
rata basis, at a price of $5.00 per share plus all accrued but unpaid dividends
out of 20% of the amount, if any, by which the Company's annual net income after
taxes in any year exceeds $5 million, as shown on its audited financial
statements. See "See Note 10, Common and Preferred Stock, of Notes to Financial
Statements."

         (b) The Company commenced an initial public offering of its Common
Stock pursuant to a registration statement on Form SB-2 (Registration No.
333-37725) (the "Registration Statement"), which was declared effective by the
Securities and Exchange Commission on December 16, 1997. From the effective date
of the Registration Statement to June 30, 1998, the approximate amount of net
offering proceeds used was $2,354,000 for L-VIS System manufacturing and

                                      -22-
<PAGE>   23
deployment, $627,000 for research and development, $3,329,000 for repayment of
indebtedness and expenses related thereto (see Note 9 of Notes to Financial
Statements), $0 for capital expenditures, $873,000 for sales and marketing, and
$1,030,000 for working capital and general corporate purposes.

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

OVERVIEW

         Since its inception in 1990, the Company has devoted substantially all
of its sources to the development of the L-VIS System, an electronic video
insertion system that was designed to modify broadcasts to television viewers by
inserting electronic video images, primarily advertisements. The Company has
incurred substantial operating losses since its inception. As of June 30, 1998,
the Company had an accumulated deficit of approximately $28,626,000 and expects
to incur substantial additional losses for the foreseeable future. This deficit
is the result of research and development expenses incurred in the development
and commercialization of the L-VIS System, expenses related to field testing of
the L-VIS System and its deployment pursuant to customer contracts, operating
expenses relating to manufacturing, sales and marketing activities of the
Company, and general administrative costs.

         The Company intends to continue its efforts to enhance the L-VIS
System and develop additional software applications. In order to increase its
revenue generating user base and to expand into national and international
markets, the Company plans an increase in its sales and marketing staff during
the fiscal year ending June 1999. The sales and marketing staff is responsible
not only for agreements with teams, leagues and broadcasters, but also for
promoting the L-VIS System to advertisers in order to create market awareness.
While any purchase of advertising will be done through the rights holder or the
broadcaster, the Company hopes to create advertiser interest and demand by
promoting the L-VIS System directly to potential advertisers. Therefore, the
Company expects to incur substantial additional losses and to experience
substantial negative cash flow from operating activities through the next 12
months or until such later time as it achieves revenues sufficient to finance
its ongoing capital expenditures and operating expenses. The Company's ability
to produce positive cash flow will be determined by numerous factors, including
its ability to reach agreements with, and retain, customers for use of the L-
VIS System, as well as various factors outside of its control.

         The Company expects to generate revenue from ads sold by rights holders
that use the L-VIS System. These revenues are expected to be shared with the
rights holders. Accordingly, in order to generate revenues from the use of the
L-VIS System, the

                                      -23-
<PAGE>   24
Company will need to enter into agreements with rights holders. The agreements
can take various forms, although the agreements to date in the United States
have been revenue sharing agreements under which the Company received a
percentage of the fee paid by the advertisers. The Company realizes revenues
when the advertisement runs over the air. Due to the seasonal nature of the
sporting events themselves, the Company's revenue will fluctuate seasonally.
However, this seasonality may be moderated by the multi-sport capabilities of
the L-VIS System and its use in nonsporting events.

         In addition to the revenue arising from advertising, a second revenue
source is the strategic licensing of the L-VIS System to third parties. These
licenses may be territorial in nature or they may cover individual major
broadcast events. In the case of a territorial license, the licensee is
responsible for generating business within the territory and the Company will
share in the business through one or more means including royalties, license
fees, and/or equity participation in the licensee. In the case of individual
events, the Company may receive a flat fee or a fee based on revenues generated
by the licensee, depending on the nature of the license.

RESULTS OF OPERATIONS

COMPARISON OF FISCAL YEAR ENDED JUNE 30, 1998 AND FISCAL YEAR ENDED JUNE 30,
1997

         REVENUES. Revenues include receipts from advertising use of the L-VIS
System as well as from license fees for use of the L-VIS System outside the
United States. Total revenue increased 229% to $696,012 during the fiscal year
ended June 30, 1998 ("Fiscal 1998") from $211,634 for the fiscal year ended June
30, 1997 ("Fiscal 1997"). Of this total, advertising revenue increased 300% to
$324,789 in Fiscal 1998 from $81,108 in Fiscal 1997 as a result of several
factors including the use of the L-VIS System in the international broadcast of
Super Bowl XXXII, increased advertisement sales by the San Diego Padres and the
San Francisco Giants in MLB and use of the L-VIS System during ESPN's broadcast
of the domestic and international X-Games. Revenues from license fees increased
184% to $371,223 in Fiscal 1998 from $130,526 in Fiscal 1997 as a result of the
full year amortization of income from several licensing transactions in Latin
America and the recognition of $137,500 in non-recurring revenue from the
settlement of a dispute with a former licensee of the L-VIS System.

         L-VIS SYSTEM COSTS. L-VIS System costs include the costs associated
with the material production, depreciation and operational support of the L-VIS
System units, including training costs for operators and the shipping of L-VIS
System units to international and domestic venues. L-VIS System costs increased
93% to $2,456,019 in Fiscal 1998 from $1,274,890 in Fiscal 1997 for

                                      -24-
<PAGE>   25
several reasons, including (i) an increase in costs and supplies due to
increased use of the L-VIS System in baseball, pre-season NFL football games and
the international broadcast of Super Bowl XXXII, (ii) an increase in time spent
providing product support to L-VIS System units in the field, and (iii) costs
associated with the initial production run and use of the flex board system
introduced into L-VIS System units.

         RESEARCH AND DEVELOPMENT. Research and development expenses include the
costs associated with all personnel, materials and contract personnel engaged in
research and development activities to increase the capabilities of the L-VIS
System hardware platforms, including platforms for overseas use, and to create
improved software programs for individual sports. Research and development
expenses decreased less than 1% to $1,719,703 in Fiscal 1998 from $1,722,598 in
Fiscal 1997 as a result of a shift in spending from the development of an
enhanced search system for the basic L-VIS System platform and other ongoing
research and development projects to product costs. This shift was due to the
December 1997 attainment of technological feasibility of the flex board based
L-VIS System, which had been under development during prior fiscal years, and
the use of such system. In addition, camera head technology was used with the
L-VIS System for the first time in the second half of Fiscal 1998, causing a
shift in the related expenses from research and development to L-VIS System
costs.

         SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses include selling and marketing expenses, including
salaries of sales and marketing personnel, their travel expenses, advertising
and expenses associated with customer support, and general and administrative
expenses, including salaries of support personnel, allocated rent and operating
costs and legal and accounting fees. Selling, general and administrative
expenses increased 54% to $4,652,384 in Fiscal 1998 from $3,028,895 in Fiscal
1997, as a result of numerous factors including (i) the hiring of marketing
consultants to explore potential expansion in certain European and other
international markets and the non-cash charges incurred related to the issuance
of options to these consultants, (ii) increased expenses related to the hiring
of marketing, administrative and financial personnel to support the New York and
Lawrenceville offices, (iii) the increase in expenses related to the expansion
of the Company's headquarters and manufacturing facilities in Lawrenceville, New
Jersey, (iv) the increased expenses related to the retention of investor and
public relations firms aimed at improving investor and market communications,
(v) non-cash compensation charges associated with the granting of options and
warrants, and (vi) the fee paid to NFL International for the exclusive right to
include electronic virtual signage in the international broadcast of Super Bowl
XXXII in January 1998.


                                      -25-
<PAGE>   26
         INTEREST AND OTHER FINANCIAL EXPENSE. Interest and other financial
expense increased to $1,814,178 in Fiscal 1998 from $0 in Fiscal 1997 due to the
interest costs incurred in connection with the Company's October 1997 bridge
loan financing.

         INTEREST AND OTHER INCOME. Interest and other income increased 924% to
$861,948 in Fiscal 1998 from $84,088 in Fiscal 1997 as a result of an increase
in funds available to invest from the proceeds of the Bridge Loan in October
1997 and the initial public offering of stock in December 1997.

         NET LOSS. As a result of the foregoing factors, the Company's
net loss increase 58% to $9,128,374 in Fiscal 1998 from $5,774,711
in Fiscal 1997.

YEAR 2000 RISK COMPLIANCE

         Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. Beginning in the
year 2000, these date code fields need to recognize four digit entries in order
to identify correctly dates in the 21st century. If not corrected, many computer
applications could fail or create erroneous results at the year 2000.

         Based on a preliminary assessment, the Company believes that its 
current accounting and administrative software products are Year 2000 compliant
and does not anticipate any internal Year 2000 issues arising from the use of
its own internal information systems, databases or programs. The Company is in
the process of a more detailed assessment of its internally designed software
applications, computer systems and operations in order to determine their Year
2000 readiness and signal any potential problem areas. However, based on the
preliminary assessment, future costs related to Year 2000 compliance for
internal systems are not expected to be material.

                                      -26-
<PAGE>   27
         The Company's proprietary L-VIS System relies on time (i.e. hour and
minute) sensitive software coding, but is not date sensitive and is, therefore,
not believed by the management of the Company to be subject to Year 2000
problems. The manufacture and use of the L-VIS System, however, requires the
cooperation of external suppliers and outside broadcasters. The Company intends
to implement a formal review process of the Year 2000 readiness of its external
suppliers and the broadcasters whose cooperation is necessary in the use of the
L-VIS System in both live and prerecorded events. This will involve approaching
all suppliers and broadcasters to ascertain whether their products, equipment
and services are Year 2000 compliant and, if not, what efforts they are making
in this regard. To the extent that its suppliers and broadcasters and/or its
own internal information systems, databases and administrative software
products are not Year 2000 compliant, the planned operations of the Company
could be significantly disrupted. This could have a material adverse effect on
the Company's business, financial condition and planned results of operations.
Management is currently unable to quantify the impact of this potential
disruption on its future earnings.

LIQUIDITY AND CAPITAL RESOURCES

         The Company has incurred significant operating losses and negative cash
flows in each year since it commenced operations, due primarily to start-up
costs, the costs of developing the L-VIS System and the cost of building L-VIS
Systems. As a result of operating losses, the net cash used in operating
activities increased to $8,493,778 in Fiscal 1998 from $4,095,264 in Fiscal
1997. This increase was due in large part to a $1.8 million non-recurring
interest expense, commissions, fees and other charges relating to the Company's
October 1997 bridge loan financing. In addition, in Fiscal 1998 the company
recorded non-cash compensation charges in the amount of $473,562 associated with
the granting of options and warrants.

         Net cash used in investing activities increased to $2,336,324 in Fiscal
1998 from $2,313,612 in Fiscal 1997. Proceeds from the maturity of the Company's
investments provided cash of $0 and $3,000,000 in Fiscal 1998 and Fiscal 1997,
respectively, attributable to the Company's change in investment strategy. The
Company increased its purchases of property and equipment to $2,093,702 in
Fiscal 1998 from $523,221 in Fiscal 1997, primarily as a result of building 10
additional L-VIS Systems needed to meet the demands of an increased number of
customers, both domestically and in the international market as well as for
internal development purposes.

         Net cash proceeds from financing activities increased from $1,050,636
to $31,597,036 for the years ended June 30, 1997 and 1998, respectively for
several reasons. In its efforts to raise money to meet current obligations, the
Company collected $1,264,485 of stock subscriptions receivable in July 1997. To
meet the Company's short term financing needs in advance of the initial public
offering, the Board of Directors of the Company approved a $3,000,000 Bridge
financing which closed in October 1997. As the Bridge Financing matured upon
consummation of the initial public offering in December 1997, the entire
proceeds of the Bridge Financing plus accrued interest was repaid in December
1997. The Company completed an initial public offering of 4,000,000 shares of
common stock on December 16, 1997. The net proceeds from the sale of such
shares, after deducting underwriting discounts and commissions and estimated
expenses payable by the Company, were approximately $25,050,000. On December 31,
1997, the Company sold 600,000 shares of common stock pursuant to the
Underwriters' exercise of an over-allotment option. The net proceeds from the
sale of the over-allotment shares, after deducting underwriting discounts and
commissions and estimated expenses payable by the Company, were approximately
$3,900,000.

                                      -27-
<PAGE>   28
         Since inception, the Company has financed its operations from (i) the
net proceeds of approximately $19,700,000 from private placements of Common
Stock, warrants and redeemable preferred stock, (ii) the payment of a $2,000,000
licensing fee by Presencia in consideration of the license granted by the
Company to Publicidad, (iii) the proceeds of a bridge loan financing which
closed in October 1997, (iv) the proceeds from the initial public offering of
its Common Stock which closed in December 1997, (v) revenues and license fees
relating to use of the L-VIS System, and (vi) investment income earned on cash
balances and short term investments.

         The Company believes that its existing available cash, cash equivalents
and short-term investments will be sufficient to meet its capital needs for a
period of eighteen months, although there can be no assurance that the Company
will not require additional funds sooner. The Company's actual working capital
requirements will depend on numerous factors, including the progress of the
Company's research and development programs, the Company's ability to maintain
its customer base and attract new customers to use the L-VIS System, the level
of resources the Company is able to allocate to the development of greater
marketing and sales capabilities, technological advances and the status of its
competitors. In the event adequate revenues are not generated, the Company will
be required either to raise additional debt and/or equity capital to fund its
cash requirements or to reduce substantially the scale of its operations. There
can be no assurance that the Company will be able to raise such additional
capital.

         As of June 30, 1998, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $19,400,000 which expire in the
years 2006 through 2013. Based upon the Company's initial public offering of
Common Stock in December 1997, the Company has undergone an additional
"ownership change" within the meaning of Section 382 of the Internal Revenue
Code of 1986, as amended (the "Code"). Under Section 382 of the Code, upon
undergoing an ownership change, the Company's right to use its then existing net
operating loss carryforwards as of the date of the ownership change is limited
during each future year to a percentage of the fair market value of the
Company's then outstanding capital stock immediately before the ownership change
and if other ownership changes have occurred prior to this ownership change, the
utilization of such losses may be further limited. The timing and manner in
which the net operating loss carryforwards may be utilized in any year by the
Company will be severely limited by Section 382 of the Code.

EFFECT OF INFLATION

         Domestic inflation has not had a significant impact on the
Company's sales or operating results.  However, inflation may have

                                      -28-
<PAGE>   29
an impact upon business in a number of international markets.

ITEM 7.  FINANCIAL STATEMENTS.

         The financial statements required to be filed pursuant to this Item 7
are appended to this Annual Report on Form 10-KSB. A list of the financial
statements filed herewith is found at "Index to Financial Statement and
Schedules" on page F-1.

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

          Not Applicable.

                                    PART III

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

         For information concerning this Item, see the information under
"Election of Directors," "Executive Officers" and "Section 16(a) Beneficial
Owner Reporting Compliance" in the Company's Proxy Statement to be filed with
respect to the Annual Meeting of Shareholders to be held on December 3, 1998,
which information is incorporated herein by reference.

ITEM 10.  EXECUTIVE COMPENSATION.

         For information concerning this Item, see the information under
"Executive Compensation" in the Company's Proxy Statement to be filed with
respect to the Annual Meeting of Shareholders to be held on December 3, 1998,
which information is incorporated herein by reference.


ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         For information concerning this Item, see the information under
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's Proxy Statement to be filed with respect to the Annual Meeting of
Shareholders to be held on December 3, 1998, which information is incorporated
herein by reference.

ITEM 12.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         For information concerning this Item, see the information under
"Certain Relationships and Related Transactions" in the Company's Proxy
Statement to be filed with respect to the Annual Meeting of Shareholders to be
held on December 3, 1998, which

                                      -29-
<PAGE>   30
information is incorporated herein by reference.

ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K.

         (a)      Exhibits.

                  The exhibits required to be filed pursuant to this Item 13(a)
are listed on the "Index to Exhibits" attached hereto, which is incorporated
herein by reference.

         (b)      Reports on Form 8-K.

         No reports on Form 8-K were filed during the last quarter of the fiscal
year ended June 30, 1998.


                                      -30-
<PAGE>   31
                                    SIGNATURE

         In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, as amended, the registrant caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.


                                             PRINCETON VIDEO IMAGE, INC.



                                             By: /s/ Brown F Williams
                                                 -----------------------
                                                 Brown F Williams
                                                 Chairman of the Board



                                             Date: September 21, 1998
<PAGE>   32
         In accordance with the Securities Exchange Act of 1934, as amended,
this report has been signed by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.



Signature                               Title                        Date


/s/ Brown F Williams              Chairman of the Board            September
-------------------------         (principal executive             21, 1998
Brown F Williams                  officer)

/s/ Douglas J. Greenlaw           President, Chief                 September
-------------------------         Executive Officer and            25, 1998
Douglas J. Greenlaw               Director

                                   
/s/ Lawrence Epstein              Chief Financial                  September
-------------------------         Officer and                      25, 1998   
Lawrence Epstein                  Treasurer                                    
                                  (principal                                   
                                  financial officer                            
                                  and principal                                
                                  accounting officer)                          
                                  
/s/ John B. Torkelsen             Director                         September
------------------------                                           25, 1998
John B. Torkelsen                                                    


/s/ Lawrence Lucchino             Director                         September    
------------------------                                           14, 1998     
Lawrence Lucchino

                                                                                
/s/ Jerome J. Pomerance           Director                         September
------------------------                                           23, 1998
Jerome J. Pomerance                                                 


/s/ Enrique F. Senior             Director                         September
------------------------                                           25, 1998
Enrique F. Senior                                                   
 
                                                           
/s/ Eduardo Sitt                  Director                         September
------------------------                                           25, 1998
Eduardo Sitt
<PAGE>   33
                                INDEX TO EXHIBITS

Exhibit
Number                     Description
-------           -------------------------------------------------------
3.1   --          Restated Certificate of Incorporation (Incorporated by
                  reference to Exhibit 3.1 to the Company's Registration
                  Statement on Form SB-2 (Registration No. 333-37725) which
                  became effective on December 16, 1997).

3.2   --          Restated Bylaws, as amended (Incorporated by reference to
                  Exhibit 3.1 to the Company's Current Report on Form 8-K
                  filed with the Securities and Exchange Commission on
                  February 11, 1997).

10.1+ --          Amended 1993 Stock Option Plan (Incorporated by reference
                  to Exhibit 10.1 to the Company's Registration Statement
                  on Form SB-2 (Registration No. 333-37725) which became
                  effective on December 16, 1997).

10.2  --          Form of Employee Confidentiality, Invention Assignment
                  and Non-Compete Agreement (Incorporated by reference to
                  Exhibit 10.2 to the Company's Registration Statement on
                  Form SB-2 (Registration No. 333-37725) which became
                  effective on December 16, 1997).

10.3  --          Form of Consultant Confidentiality, Invention Assignment
                  and Non-Compete Agreement (Incorporated by reference to
                  Exhibit 10.3 to the Company's Registration Statement on
                  Form SB-2 (Registration No. 333-37725) which became
                  effective on December 16, 1997).

10.4* --          Research Agreement dated November 1, 1990 between the
                  Company and David Sarnoff Research Center, Inc., as
                  amended by Agreement dated August 9, 1991, letter dated
                  July 1, 1992, Letter Agreement dated July 9, 1992, letter
                  dated November 30, 1992 and Agreement dated June 26, 1995
                  and effective as of December 31, 1993 (Incorporated by
                  reference to Exhibit 10.4 to the Company's Registration
                  Statement on Form SB-2 (Registration No. 333-37725) which
                  became effective on December 16, 1997).

10.5* --          License Agreement dated as of July 24, 1996 between the
                  Company and the General Electric Company (Incorporated by
                  reference to Exhibit 10.5 to the Company's Registration
                  Statement on Form SB-2 (Registration No. 333-37725) which
                  became effective on December 16, 1997).

10.6  --          Letter Agreement dated May 1, 1993 between the Company
                  and Grupo Sitt, as amended by Letter Agreement dated June
                  25, 1993 (Incorporated by reference to Exhibit 10.6 to
<PAGE>   34
                  the Company's Registration Statement on Form SB-2
                  (Registration No. 333-37725) which became effective on
                  December 16, 1997).

10.7--            License Agreement dated as of March 1, 1994 between the
                  Company and Publicidad Virtual, S.A. de C.V.
                  (Incorporated by reference to Exhibit 10.7 to the
                  Company's Registration Statement on Form SB-2
                  (Registration No. 333-37725) which became effective on
                  December 16, 1997).

10.8  --          Letter Agreement dated February 3, 1995 between the
                  Company and Capital Cities/ABC, Inc., as amended by
                  Letter Agreement dated August 29, 1996 between the
                  Company and ESPN, Inc. and by letter dated April 22, 1996
                  (Incorporated by reference to Exhibit 10.8 to the
                  Company's Registration Statement on Form SB-2
                  (Registration No. 333-37725) which became effective on
                  December 16, 1997).

10.9  --          License Agreement dated December 18, 1995 between the
                  Company and Theseus Research, Inc. (Incorporated by
                  reference to Exhibit 10.9 to the Company's Registration
                  Statement on Form SB-2 (Registration No. 333-37725) which
                  became effective on December 16, 1997).

10.10 --          Second Amended and Restated Registration Rights Agreement
                  dated as of February 2, 1996, as amended by agreement
                  dated October 20, 1997 and by agreement dated October 30,
                  1997 (Incorporated by reference to Exhibit 10.10 to the
                  Company's Registration Statement on Form SB-2
                  (Registration No. 333-37725) which became effective on
                  December 16, 1997).

10.11+ --         Employment Agreement dated January 24, 1997 between the
                  Company and Brown F Williams (Incorporated by reference
                  to Exhibit 10.11 to the Company's Registration Statement
                  on Form SB-2 (Registration No. 333-37725) which became
                  effective on December 16, 1997).

10.12+ --         Employment Agreement dated January 24, 1997 between the
                  Company and Douglas J. Greenlaw (Incorporated by
                  reference to Exhibit 10.12 to the Company's Registration
                  Statement on Form SB-2 (Registration No. 333-37725) which
                  became effective on December 16, 1997).

10.13+ --         Employment Agreement dated March 4, 1997 between the
                  Company and Samuel A. McCleery (Incorporated by reference
                  to Exhibit 10.13 to the Company's Registration Statement
                  on Form SB-2 (Registration No. 333-37725) which became
                  effective on December 16, 1997).
<PAGE>   35
10.14  --         Lease Agreement dated April 21, 1997 between the Company
                  and 1325 Limited Partnership (Incorporated by reference
                  to Exhibit 10.14 to the Company's Registration Statement
                  on Form SB-2 (Registration No. 333-37725) which became
                  effective on December 16, 1997).

10.15  --         Lease Agreement dated July 16, 1997 between the Company
                  and Princeton South at Lawrenceville One (Incorporated by
                  reference to Exhibit 10.20 to the Company's Registration
                  Statement on Form SB-2 (Registration No. 333-37725) which
                  became effective on December 16, 1997).

10.16  --         Nonrecourse Promissory Note dated July 31, 1997 of Brown
                  F Williams in favor of the Company (Incorporated by
                  reference to Exhibit 10.21 to the Company's Registration
                  Statement on Form SB-2 (Registration No. 333-37725) which
                  became effective on December 16, 1997).

10.17  --         Pledge Agreement dated July 31, 1997 between the Company
                  and Brown F Williams (Incorporated by reference to
                  Exhibit 10.22 to the Company's Registration Statement on
                  Form SB-2 (Registration No. 333-37725) which became
                  effective on December 16, 1997).

10.18 --          Nonrecourse Promissory Note dated July 31, 1997 of Samuel
                  A. McCleery in favor of the Company (Incorporated by
                  reference to Exhibit 10.23 to the Company's Registration
                  Statement on Form SB-2 (Registration No. 333-37725) which
                  became effective on December 16, 1997).

10.19  --         Pledge Agreement dated July 31, 1997 between the Company
                  and Samuel A. McCleery (Incorporated by reference to
                  Exhibit 10.24 to the Company's Registration Statement on
                  Form SB-2 (Registration No. 333-37725) which became
                  effective on December 16, 1997).

10.20  --         Assignment dated January 22, 1992 by Roy Jonathon Rosser
                  and Martin Leach to the Company regarding a patent
                  (Incorporated by reference to Exhibit 10.25 to the
                  Company's Registration Statement on Form SB-2
                  (Registration No. 333-37725) which became effective on
                  December 16, 1997).

10.21  --         Assignment dated October 22, 1993 by Roy Jonathon Rosser
                  and Brown F Williams to the Company regarding a patent
                  (Incorporated by reference to Exhibit 10.26 to the
                  Company's Registration Statement on Form SB-2
                  (Registration No. 333-37725) which became effective on
                  December 16, 1997).

10.22  --         Assignment dated January 30, 1995 by Roy Rosser, Subhodev
                  Das, Yi Tan and Peter von Kaenel to the Company regarding
<PAGE>   36
                  a patent (Incorporated by reference to Exhibit 10.27 to
                  the Company's Registration Statement on Form SB-2
                  (Registration No. 333-37725) which became effective on
                  December 16, 1997).

10.23+ --         Employment Agreement, dated as of February 5, 1998,
                  between the Company and Lawrence Epstein (Incorporated by
                  reference to Exhibit 10.1 to the Company's Current Report
                  on Form 8-K filed with the Securities and Exchange
                  Commission on February 11, 1998).

10.24+ --         Letter Agreement dated May 22, 1998 between the Company
                  and Douglas J. Greenlaw amending Employment Agreement
                  dated January 24, 1997.

21.1   --         Subsidiaries of the Registrant (Incorporated by reference
                  to Exhibit 21.1 to the Company's Registration Statement
                  on Form SB-2 (Registration No. 333-37725) which became
                  effective on December 16, 1997).

27.1   --         Financial Data Schedule.
-----------

         * Confidentiality has been granted with respect to a portion
of this exhibit.

         + Denotes a management contract or compensation plan or arrangement
required to be filed as an exhibit pursuant to Item 13(a) of this Form 10-KSB.

<PAGE>   37

                          INDEX FINANCIAL STATEMENTS


Report of Independent Accountants .....................................  F-2

Financial Statements:
  Balance Sheet .......................................................  F-3
  Statements of Operations ............................................  F-4
  Statements of Cash Flows ............................................  F-5
  Statements of Changes in Shareholders' (Deficit)/Equity .............  F-7

Notes to Financial Statements ......................................... F-17







                                     F-1
<PAGE>   38

                        REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
Shareholders of Princeton Video Image, Inc.:

In our opinion, the accompanying balance sheet and the related statements of
operations, changes in shareholders' (deficit)/equity, and cash flows for each
of the two years in the period ended June 30, 1998 and for the period July 23,
1990 (date of inception) to June 30, 1998 present fairly, in all material
respects, the financial position of Princeton Video Image, Inc. at June 30,
1998, and the results of their operations and their cash flows for each of the
two years in the period ended June 30, 1998 and for the period July 23, 1990
(date of inception) to June 30, 1998 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.

                                             PricewaterhouseCoopers LLP


Princeton, New Jersey
September 2, 1998



                                     F-2
<PAGE>   39
Princeton Video Image, Inc.
(A Development Stage Company)
Balance Sheet

<TABLE>
<CAPTION>
                                                                   June 30,
                                                                     1998
                                                               -----------------
<S>                                                            <C>
ASSETS
Current Assets:
 Cash and cash equivalents..................................   $      21,552,627
 Restricted marketable securities held to maturity..........             138,317
 Trade accounts receivable..................................             193,262
 Other current assets.......................................             230,247
                                                               -----------------
       Total current assets.................................          22,114,453
Property and equipment, net.................................           2,547,484
Intangible assets, net......................................             493,236
Other assets................................................             271,192
                                                               -----------------
       Total assets                                            $      25,426,365
                                                               =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
 Accounts payable and accrued expenses......................   $       1,301,169
 Unearned revenue...........................................             269,164
                                                               -----------------
       Total current liabilities............................           1,570,333
Unearned revenue............................................             874,080
                                                               -----------------
       Total liabilities....................................           2,444,413
                                                               -----------------
Commitments and contingencies (Note 11)
Redeemable preferred stock:
 Cumulative, Series A, conditionally redeemable, $4.50 par
  value, authorized 167,000 shares; issued and outstanding
  67,600 shares, redemption value equal to carrying value
  (par plus all accrued but unpaid dividends)...............             403,450
 Cumulative, Series B, conditionally redeemable, $5.00 par
  value, authorized 93,300 shares; issued and outstanding
  86,041 shares, redemption value equal to carrying value
  (par plus all accrued but unpaid dividends)...............             544,155
                                                               -----------------
       Total redeemable preferred stock.....................             947,605
Shareholders' Equity:
 Common stock, no par value; $.005 stated value; authorized
  40,000,000 shares; 8,173,552 shares issued and
  outstanding...............................................              40,867
 Additional paid-in capital.................................          51,443,856
 Less:     Related party notes receivable...................           (824,498)
 Deficit accumulated during the development stage...........        (28,625,878)
                                                               -----------------
       Total shareholders' equity...........................          22,034,347
                                                               -----------------
                  Total liabilities, redeemable preferred 
                   stock and shareholders' equity...........   $      25,426,365
                                                               =================

See accompanying notes to financial statements
</TABLE>



                                      F-3
<PAGE>   40
Princeton Video Image, Inc.
(A Development Stage Company)
Statement of Operations for the years ended
June 30, 1998 and 1997 and for the period
July 23, 1990 (date of inception) to June 30, 1998

<TABLE>
<CAPTION>
                                                                                CUMULATIVE FROM
                                                FOR THE YEARS ENDED             JULY 23, 1990 TO
                                                     JUNE 30,                        JUNE 30,
                                           -------------------------------   
                                                1998          1997                    1998
                                                ----          ----                    ----
<S>                                      <C>              <C>                    <C> 

License fees                              $   371,223      $   130,526            $  1,501,749
Advertising revenue                           324,789           81,108                 415,497
                                           ----------       ----------            ------------     
     Total revenue                            696,012          211,634               1,917,246

Costs and expenses:
 Selling, general and administrative        4,652,384        3,028,895              13,937,088
 Research and development                   1,719,703        1,722,598              11,283,644
 L-VIS System costs                         2,456,019        1,274,890               4,909,332
                                           ----------       ----------            ------------
     Total costs and expenses               8,828,106        6,026,383              30,130,064

Operating loss                             (8,132,094)      (5,814,749)            (28,212,818)
Interest and other financial expense       (1,814,178)              --              (1,814,178)
Interest and other income                     861,948           84,088               1,401,118
                                           ----------       ----------            ------------
Net loss                                   (9,084,324)      (5,730,661)            (28,625,878)
Accretion of preferred stock
 dividends                                    (44,050)         (44,050)               (213,200)
                                           ----------       ----------            ------------ 
Net loss applicable to common stock       $(9,128,374)     $(5,774,711)           $(28,839,078)
                                          ===========      ===========            ============ 

 Basic and diluted net loss per share
  applicable to common stock              $     (1.55)     $     (2.52)
                                          ===========      =========== 

 Weighted average number of
  shares of common stock
   outstanding                              5,890,530        2,287,884
                                          ===========      ===========
</TABLE>


See accompanying notes to financial statements



                                      F-4
<PAGE>   41
Princeton Video Image, Inc.
(A Development Stage Company)
Statement of Cash Flows for the years ended
June 30, 1998 and 1997 and for the period
July 23, 1990 (date of inception) to June 30, 1998

<TABLE>
<CAPTION>
                                                             FOR THE YEARS ENDED         CUMULATIVE FROM
                                                                   JUNE 30,              JULY 23, 1990 TO     
                                                         ----------------------------        JUNE 30,
                                                            1998             1997              1998
                                                            ----             ----              ----
<S>                                                     <C>              <C>             <C>

Cash flows from operating activities:
  Net loss............................................   $(9,084,324)     $(5,730,661)    $(28,625,878)
  Adjustments to reconcile net loss to net
    cash used in operating activities
     Amortization of unearned income..................      (371,223)        (130,526)        (501,749)
     Depreciation expense.............................       793,043          478,982        1,792,643
     Amortization of intangibles......................        76,143           57,490          188,490
     Charges associated with option and warrant
       grants and related party note receivable.......       473,562          227,262        1,531,699
     Equity in net loss of affiliate                              --               --            9,048
     Increase (decrease) in cash resulting
       from changes in:
       Trade accounts receivable......................      (106,269)         (78,293)        (193,262)
       Current assets.................................      (192,715)          77,244         (230,247)
       Other assets...................................      (142,074)            (572)        (271,192)
       Accounts payable and accrued expenses..........       418,340          379,044        1,394,986
       Unearned revenue...............................        53,500          391,492        1,644,992
       Customer deposits..............................      (425,000)         125,000               --
       Miscellaneous other............................        23,239          108,274          142,593
                                                         -----------      -----------     ------------
       Net cash used in operating activities              (8,483,778)      (4,095,264)     (23,117,877)

Cash flows from investing activities:
  Purchase of held-to-maturity investments............       (61,997)         (75,535)      (5,351,555)
  Proceeds from held-to-maturity investments..........            --        3,000,000        5,200,000
  Purchases of property and equipment.................    (2,093,702)        (523,221)      (4,372,116)
  Increase in intangible assets.......................      (180,625)         (87,632)        (775,834)
  Investments in joint venture........................            --               --           (9,048)
                                                         -----------      -----------     ------------
        Net cash (used in) provided by
          investing activities........................    (2,336,324)       2,313,612       (5,308,553)
                                                         -----------      -----------     ------------
</TABLE>

See accompanying notes to financial statements

                                      F-5
<PAGE>   42

Princeton Video Image, Inc.
(A Development Stage Company)
Statement of Cash Flows for the years ended
June 30, 1998 and 1997 and for the period
July 23, 1990 (date of inception) to June 30, 1998

<TABLE>
<CAPTION>
                                                         FOR THE YEARS ENDED     CUMULATIVE FROM 
                                                               JUNE 30,          JULY 23, 1990 TO
                                                       ------------------------      JUNE 30,
                                                           1998         1997          1998
                                                       -----------   ----------  ----------------
<S>                                                    <C>           <C>           <C>
Cash flows from financing activities:
 Proceeds from Bridge Financing loans                    1,353,000           --      1,353,000
 Repayments of Bridge Financing loans                   (1,353,000)          --     (1,353,000)
 Proceeds from sale of Bridge Financing warrants, net    1,479,822           --      1,479,822
 Proceeds from issuances of preferred stock                     --           --        734,405
 Proceeds from sales of common stock, net               29,022,227    1,050,636     46,669,843
 Cash advanced for related party notes receivable         (169,498)          --       (169,498)
 Collections of stock subscriptions receivable           1,264,485           --      1,264,485
                                                       -----------   ----------    -----------
    Net cash provided by
     financing activities                               31,597,036    1,050,636     49,979,057
 Net increase (decrease) in cash and 
    cash equivalents                                    20,776,934     (731,016)    21,552,627

Cash and cash equivalents at beginning of
 period                                                    775,693    1,506,709             --
                                                       ===========   ==========    ===========
Cash and cash equivalents at end of period             $21,552,627   $  775,693    $21,552,627
                                                       ===========   ==========    ===========

Supplemental cash flow information:
 Interest paid in connection with Bridge
  Financing loan                                       $ 1,647,000
 Fair value of warrants issued in settlement 
  of accrued obligation                                $    97,074
 Exercise of warrants in exchange for
  related party note receivable                        $   655,000

</TABLE>


See accompanying notes to financial statements



                                      F-6
<PAGE>   43

Princeton Video Image, Inc.
(A Development Stage Company)
Statements of Changes in Shareholders' (Deficit)/Equity
for the period July 23, 1990 (date of inception)
to June 30, 1998

<TABLE>
<CAPTION>
                                               
                                                              Related Party                                           Deficit
                               Common Stock      Additional    Note and          Treasury Stock                      Accum During 
                             Number of            Paid-In     Stock Subsc     Number of               Unearned       Development
                              Shares   Amount     Capital     Receivable       Shares     Amount    Compensation         Stage   
                             ----------------------------------------------------------------------------------------------------
<S>                          <C>       <C>       <C>          <C>             <C>         <C>       <C>               <C>
Issuance of common
stock for patent rights
and cash, July 1990.
$.0025 per share             400,000  $ 2,000    $ (1,000)                         

Issuance of common
stock for services
and cash                      52,000      260      71,240

Issuance of units
consisting of 2 shares
of common stock and
warrants to purchase
6 shares of stock at
$6.25 per share, May
1991, $2.50 per unit          64,000      320     159,630

Net loss from July 23,
1990 through June 30, 1992                                                                                            $(375,669)
                           
                             ----------------------------------------------------------------------------------------------------

BALANCE AT JUNE 30, 1992     516,000    2,580     229,870                --          --       --              --       (375,669)

Return of common stock
to treasury, April 1992
at no cost                                                                    (41,200)  $ (206)

Reissuance of treasury
shares for technology,
April 1992                                        103,000                      41,200      206

Issuance of 32,000
warrants for technology,
July 1992, exercise
price of $2.50 per share                           32,000






                                  Total                                                  
                              Shareholders'
                            Equity (Deficit)
                            ----------------

<S>                        <C>       
Issuance of common
stock for patent rights
and cash, July 1990.
$.0025 per share           $   1,000   

Issuance of common
stock for services
and cash                      71,500

Issuance of units
consisting of 2 shares
of common stock and
warrants to purchase
6 shares of stock at
$6.25 per share, May
1991, $2.50 per unit         159,950

Net loss from July 23,
1990 through June 30, 1992  (375,669)                                                                                        
                           
                             ___________

BALANCE AT JUNE 30, 1992    (143,219)    

Return of common stock
to treasury, April 1992
at no cost                      (206)                                                 

Reissuance of treasury
shares for technology,
April 1992                   103,206            

Issuance of 32,000
warrants for technology,
July 1992, exercise
price of $2.50 per share      32,000   

</TABLE>            

See accompanying notes to financial statements
 


                                      F-7
<PAGE>   44

Princeton Video Image, Inc.
(A Development Stage Company)
Statements of Changes in Shareholders' (Deficit)/Equity
for the period July 23, 1990 (date of inception)
to June 30, 1998



<TABLE>
<CAPTION>


                                                  Related Party                                        Deficit
                        Common Stock   Additional   Note and        Treasury Stock                  Accum During        Total
                      Number of          Paid-In   Stock Subsc   Number of             Unearned    Development      Shareholders'
                       Shares   Amount   Capital    Receivable     Shares   Amount   Compensation     Stage       Equity (Deficit)
                    _______________________________________________________________________________________________________________
<S>                  <C>      <C>      <C>       <C>            <C>        <C>       <C>           <C>           <C>        
Issuance of units
consisting of 200
shares of common
stock and warrants
to purchase 134
shares of common
stock at $1.13 per
share, August 1992,
$225.00 per unit     308,000   1,540    344,960                                                                       346,500

Issuance of 480
units consisting
of 200 shares of
common stock and
100 shares of
Conditionally
Redeemable Series A
Preferred Stock,
December 1992,
$900.00 per unit     96,000      480    215,520                                                                       216,000

Issuance of 480
units consisting of
200 shares of
common stock and
100 shares of
Conditionally
Redeemable Series A
Preferred Stock,
March 1993,
$900.00 per unit     39,200      196     88,004                                                                        88,200

Payments related to
issuance of common
stock                                  (102,908)                                                                      (102,908)

Accretion of
preferred stock
dividends                                (8,000)                                                                        (8,000)

Net loss                                                                                                (1,819,277) (1,819,277)
                    _______________________________________________________________________________________________________________

Balance at
June 30, 1993       959,200    4,796    902,446                                                         (2,194,946) (1,287,704)

</TABLE>


                                        
                 See accompanying notes to financial statements
                                        
                                        
                                        


                                      F-8
<PAGE>   45

Princeton Video Image, Inc.
(A Development Stage Company)
Statements of Changes in Shareholders' (Deficit)/Equity
for the period July 23, 1990 (date of inception)
to June 30, 1998

<TABLE>
<CAPTION>

                                                                                           RELATED PARTY      TREASURY STOCK  
                                                          COMMON STOCK       ADDITIONAL    NOTE AND
                                                        NUMBER OF            PAID-IN       STOCK SUBSC      NUMBER OF
                                                        SHARES     AMOUNT    CAPITAL       RECEIVABLE       SHARES       AMOUNT 
                                                        -------------------------------------------------------------------------
<S>                                                     <C>        <C>       <C>           <C>              <C>          <C>
BALANCE AT JUNE 30, 1993                                959,200    4,796       902,446             --              --          --

Issuance of common stock and warrants to purchase
132,074 shares of common stock at $12.12 per share,
August 1993                                              61,906      309       658,309

Exercise of warrants at $12.12 per share in January
1994                                                     82,542      413       949,587

Issuance of 86 units consisting of 2,000 shares of
common stock, 1,000 shares of Conditionally
Redeemable Series B Preferred Stock and warrants to
purchase 2,000 shares of common stock at $12.50 per
share, February 1994, $30,000.00 per unit               172,000      860     1,970,381

Unearned compensation related to issuance of 80,000
options, February 1994, exercise price of $11.25 per
share                                                                          360,000

Issuance of common stock on account, March 1994,
$12.50 per share                                         48,000      240       598,328     $(598,568)

Issuance of common stock and warrants to purchase
450,000 shares of common stock at $12.50 per share,
April 1994                                               120,00      600     1,445,015


<CAPTION>
                                                                        DEFICIT
                                                                        ACCUM DURING    TOTAL
                                                        UNEARNED        DEVELOPMENT     SHAREHOLDERS'
                                                        COMPENSATION    STAGE           EQUITY (DEFICIT)
                                                        ------------------------------------------------
<S>                                                     <C>             <C>             <C>
BALANCE AT JUNE 30, 1993                                         --     (2,194,946)    (1,287,704)

Issuance of common stock and warrants to purchase
132,074 shares of common stock at $12.12 per share,
August 1993                                                                               658,618

Exercise of warrants at $12.12 per share in January
1994                                                                                      950,000

Issuance of 86 units consisting of 2,000 shares of
common stock, 1,000 shares of Conditionally
Redeemable Series B Preferred Stock and warrants to
purchase 2,000 shares of common stock at $12.50 per
share, February 1994, $30,000.00 per unit                                               1,971,241

Unearned compensation related to issuance of 80,000
options, February 1994, exercise price of $11.25 per
share                                                   $  (360,000)

Issuance of common stock on account, March 1994,
$12.50 per share

Issuance of common stock and warrants to purchase
450,000 shares of common stock at $12.50 per share,
April 1994                                                                              1,445,615
</TABLE>

     See accompanying notes to financial statements




                                      F-9
<PAGE>   46

Princeton Video Image, Inc.
(A Development Stage Company)
Statements of Changes in Shareholders' (Deficit)/Equity
for the period July 23, 1990 (date of inception)
to June 30, 1998

<TABLE>
<CAPTION> 
                                                                                    Related Party
                                             Common Stock             Additional       Note and
                                        Number of                       Paid-In       Stock Subsc
                                          Shares         Amount         Capital        Receivable
                                        ----------------------------------------------------------
<S>                                     <C>               <C>         <C>            <C>
Issuance of common stock in April 1994
     at $12.50 per share                   24,000           120         299,880

Issuance of common stock in June 1994
     at $15.00 per share                   60,000           300         830,022

Amortization of unearned compensation
     related to issuance of options     

Accretion of preferred stock dividends                                  (29,000)

Net loss
                                        ----------------------------------------------------------
BALANCE AT JUNE 30, 1994                1,527,648         7,638       7,984,968      (598,568)

Issuance of common stock, warrants to
     purchase 70,000 shares of
     common stock at $15.00 per share
     and warrants to purchase 70,000
     shares of common stock at
     $20.00 per share, July 1994          140,000           700       2,082,600

Issuance of common stock in April 1995
     at $12.50 per share                   11,746            59         146,767


<CAPTION>
                                                                                         Deficit
                                           Treasury Stock                             Accum During           Total    
                                        Number of                       Unearned       Development        Shareholders'
                                          Shares       Amount         Compensation        Stage          Equity (Deficit)
                                        ---------------------------------------------------------------------------------
<S>                                        <C>           <C>            <C>            <C>                 <C>
Issuance of common stock in April 1994
     at $12.50 per share                                                                                      300,000

Issuance of common stock in June 1994
     at $15.00 per share                                                                                      830,322

Amortization of unearned compensation
     related to issuance of options                                       60,000                               60,000

Accretion of preferred stock dividends                                                                        (29,000)

Net loss                                                                               (4,263,754)         (4,263,754)
                                        --------------------------------------------------------------------------------
BALANCE AT JUNE 30, 1994                     --            --           (300,000)      (6,458,700)            635,338

Issuance of common stock, warrants to
     purchase 70,000 shares of
     common stock at $15.00 per share
     and warrants to purchase 70,000
     shares of common stock at
     $20.00 per share, July 1994                                                                            2,083,300

Issuance of common stock in April 1995
     at $12.50 per share                                                                                      146,826
</TABLE>

See accompanying notes to financial statements



                                      F-10
<PAGE>   47

Princeton Video Image, Inc.
(A Development Stage Company)
Statements of Changes in Shareholders' (Deficit)/Equity
for the period July 23, 1990 (date of inception)
to June 30, 1998

<TABLE>                    
<CAPTION>
                                                                                                Related Party
                                                             Common Stock        Additional        Note and
                                                          Number of               Paid-In        Stock Subsc
                                                           Shares      Amount     Capital         Receivable
                                                          --------------------------------------------------
<S>                                                       <C>         <C>        <C>              <C>
Exercise of warrants at $12.50 per share, May 1995          105,300      527      1,298,231       (124,000)

Compensation expense in connection with note
 receivable, May 1995                                                                24,800

Unearned compensation related to issuance of 20,000
 options, June 1995, Exercise price of $15.00 per share                             120,000

Receipt of stock subscription receivable                                                           598,568

Amortization of unearned compensation related to
 issuance of options  

Accretion of preferred stock dividends                                              (44,050)

Net loss
                                                          --------------------------------------------------
BALANCE AT JUNE 30, 1995                                  1,784,694    8,924     11,613,316       (124,000) 

<CAPTION>
                                                                                                   Deficit     
                                                             Treasury Stock                      Accum During        Total
                                                          Number of                 Unearned      Development     Shareholders'
                                                           Shares      Amount     Compensation       Stage       Equity (Deficit)
                                                          -----------------------------------------------------------------------
<S>                                                       <C>         <C>        <C>              <C>               <C>
Exercise of warrants at $12.50 per share, May 1995                                                                   1,174,758
Compensation expense in connection with note
 receivable, May 1995                                                                                                   24,800 
Unearned compensation related to issuance of 20,000
 options, June 1995, Exercise price of $15.00 per share                           (120,000) 
Receipt of stock subscription receivable                                                                               598,568
Amortization of unearned compensation related to
 issuance of options                                                               180,000                             180,000
Accretion of preferred stock dividends                                                                                 (44,050)
Net loss                                                                                           (3,441,669)      (3,441,669)
                                                          ----------------------------------------------------------------------- 
BALANCE AT JUNE 30, 1995                                       -          -       (240,000)        (9,900,369)       1,357,871
</TABLE>

See accompanying notes to financial statements



                                      F-11
<PAGE>   48

Princeton Video Image, Inc.
(A Development Stage Company)
Statements of Changes in Shareholders' (Deficit)/Equity
for the period July 23, 1990 (date of inception)
to June 30, 1998

<TABLE>
<CAPTION>
                                                    Common Stock                          Related Party           Treasury Stock
                                                ---------------------      Additional       Note and           ---------------------
                                                Number of                   Paid-In        Stock Subsc         Number of
                                                  Shares       Amount       Capital        Receivable            Shares       Amount
                                                ---------      ------      ----------     -------------        ---------      ------
<S>                                            <C>            <C>         <C>            <C>                  <C>            <C>
BALANCE AT JUNE 30, 1995                        1,784,694       8,924      11,613,316          (124,000)              --        --

Issuance of .041 units consisting of
2,000 shares of common stock, 1,000
shares of Conditionally Redeemable
Series B Preferred Stock and warrants to
purchase 2,000 shares of common stock at
$12.50 per share, October 1995,
$30,000.00 per unit                                    82           1           1,025


Issuance of common stock, October 1995,
$12.50 per share                                      128           1           1,600

Issuance of common stock and warrants to
purchase 10,932 shares of common stock
at $12.50 per share, October 1995                     888           4          11,096                        

Exercise of warrants at $12.50 per share
in October 1995                                     2,000          10          19,990                       

Issuance of common stock, February 1996,
$17.50 per share                                  282,266       1,411       4,558,798                         

Issuance of 24,000 warrants to joint venture
partner March 1996, exercise price of
$15.00 per share                                                              120,000

Exercise of warrants at $1.13 per share,
April 1996                                            938           5           1,050                        

</TABLE>



<TABLE>
<CAPTION>
                                                                       Deficit
                                                                     Accum During              Total
                                                  Unearned           Development           Shareholders'
                                                Compensation            Stage             Equity (Deficit)
                                                ------------         -------------        ----------------
<S>                                            <C>                  <C>                   <C>            
BALANCE AT JUNE 30, 1995                          (240,000)           (9,900,369)              1,357,871

Issuance of .041 units consisting of
2,000 shares of common stock, 1,000
shares of Conditionally Redeemable
Series B Preferred Stock and warrants to
purchase 2,000 shares of common stock at
$12.50 per share, October 1995,
$30,000.00 per unit                                                                                1,026


Issuance of common stock, October 1995,
$12.50 per share                                                                                   1,601

Issuance of common stock and warrants to
purchase 10,932 shares of common stock
at $12.50 per share, October 1995                                                                 11,100

Exercise of warrants at $12.50 per share
in October 1995                                                                                   20,000

Issuance of common stock, February 1996,
$17.50 per share                                                                               4,560,209

Issuance of 24,000 warrants to joint venture
partner March 1996, exercise price of
$15.00 per share                                                                                 120,000

Exercise of warrants at $1.13 per share,
April 1996                                                                                         1,055
</TABLE>


See accompanying notes to financial statements





                                      F-12
<PAGE>   49

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CHANGES IN SHAREHOLDERS' (DEFICIT)/EQUITY
FOR THE PERIOD JULY 23, 1990 (DATE OF INCEPTION)
TO JUNE 30, 1998

<TABLE>
<CAPTION>
                                                                                                               Related Party
                                                                                Common Stock      Additional     Note and
                                                                             Number of              Paid-In     Stock Subsc
                                                                              Shares    Amount      Capital     Receivable
                                                                     -------------------------------------------------------
<S>                                                                      <C>       <C>          <C>           <C>
Exercise of warrants at $6.25 per share, May 1996                          170,000    850        1,061,650

Issuance of 15,794 warrants for services performed
during 1996, exercise price of $15.00 per
share                                                                                               71,075

Amortization of unearned compensation related to
issuance of options

Accretion of preferred stock dividends                                                             (44,050)

Net loss
                                                                      ------------------------------------------------------

BALANCE AT JUNE 30, 1996                                                 2,240,996 11,205       17,415,550      (124,000)

Exercise of warrants at $2.50 per share, August 1996                         8,000     40           19,960

Exercise of warrants at $2.50 per share, September 1996                      4,000     20            9,980

Exercise of warrants at $1.13 per share, May 1997                           97,930    490          109,681

Issuance of common stock on account, May 1997,
$3.75 per share                                                            587,514  2,937        2,172,013    (1,264,485)



<CAPTION>           
                                                                                                       Deficit
                                                            Treasury Stock                          Accum During       Total
                                                           Number of                Unearned        Development    Shareholders'
                                                            Shares    Amount      Compensation         Stage       Equity (Deficit)
                                                      -----------------------------------------------------------------------------
<S>                                                       <C>        <C>         <C>             <C>              <C>

Exercise of warrants at $6.25 per share, May 1996                                                                  1,062,500

Issuance of 15,794 warrants for services performed
during 1996, exercise price of $15.00 per share                                                                       71,075

Amortization of unearned compensation related to
issuance of options                                                              240,000                             240,000

Accretion of preferred stock dividends                                                                               (44,050)

Net loss                                                                                           (3,910,524)    (3,910,524)
                                                     ------------------------------------------------------------------------------

BALANCE AT JUNE 30, 1996                                  --         --               --          (13,810,893)     3,491,862

Exercise of warrants at $2.50 per share,
August 1996                                                                                                           20,000

Exercise of warrants at $2.50 per share,
September 1996                                                                                                        10,000

Exercise of warrants at $1.13 per share,
May 1997                                                                                                             110,171

Issuance of common stock on account,
May 1997, $3.75 per share                                                                                            910,465

</TABLE>


     See accompanying notes to financial statements



                                      F-13
<PAGE>   50

Princeton Video Image, Inc.
(A Development Stage Company)
Statements of Changes in Shareholders' (Deficit)/Equity
for the period July 23, 1990 (date of inception)
to June 30,1998


<TABLE>
<CAPTION>                                   
                                               Common Stock                        Related Party  
                                            ------------------     Additional        Note and    
                                            Number of               Paid-In        Stock Subsc  
                                             Shares     Amount      Capital         Receivable   
                                            ---------  -------    -----------     --------------  
<S>                                         <C>        <C>        <C>             <C>
Issuance of 4,206 warrants for services   
 performed during 1997, exercise
 price of $15.00 per share                                             18,927        

Accretion of preferred stock dividends                                (44,050)  

Compensation expense associated with
 extension of employee stock options                                  208,335

Net loss                                    
                                            ---------  -------    -----------     ------------ 
BALANCE AT JUNE 30, 1997                    2,938,440  $14,692    $19,910,396     $(1,388,485)

Receipt of proceeds from stock 
 subscriptions                                                                      1,264,485
                                                                              
Exercise of warrants @ $2.50 per share,                                   
 July 1997                                    262,000    1,310        653,690        (655,000)

Compensation expense in connection with
 notes receivable                                                     360,250

Compensation expense related to issuance
 of 20,000 options, September 30, 1997,
 exercise price of $2.50 per share                                     80,000             




<CAPTION>                                                                              
                                             Treasury Stock                         Deficit
                                            -----------------                     Accum During        Total
                                             Number of             Unearned       Development      Shareholders'
                                              Shares   Amount    Compensation        Stage        Equity(Deficit)
                                            ---------  ------    ------------    -------------    ---------------
<S>                                         <C>        <C>       <C>             <C>              <C>
Issuance of 4,206 warrants for services               
 performed during 1997, exercise
 price of $15.00 per share                                                                               18,927
                                                                                                        
Accretion of preferred stock dividends                                                                  (44,050)

Compensation expense associated with
 extension of employee stock options                                                                    208,335
       
Net loss                                                                           (5,730,661)       (5,730,661) 
                                            ---------  ------    ------------    -------------    ---------------
BALANCE AT JUNE 30, 1997                                                         $(19,541,554)      $(1,004,951) 

Receipt of proceeds from stock
 subscriptions                                                                                        1,264,485

Exercise of warrants @ $2.50 per share,
 July 1997                                    

Compensation expense in connection with
 notes receivable                                                                                       360,250

Compensation expense related to issuance
 of 20,000 options, September 30, 1997,
 exercise price of $2.50 per share                                                                       80,000
</TABLE>


    See accompanying notes to financial statements          





                                      F-14
<PAGE>   51

Princeton Video Image, Inc.
(A Development Stage Company)
Statements of Changes in Shareholders' (Deficit)/Equity
for the period July 23, 1990 (date of inception)
to June 30, 1998

<TABLE>
<CAPTION>
                                                         Common Stock                Related Party  Treasury Stock
                                                       ----------------   Additional   Note and     ---------------
                                                       Number of           Paid-In    Stock Subsc   Number of           Unearned
                                                        Shares   Amount    Capital    Receivable     Shares   Amount  Compensation
                                                       ----------------------------------------------------------------------------
<S>                                                    <C>        <C>    <C>         <C>            <C>       <C>     <C>
Exercise of warrants @ $1.13 per share, July 1997         51,062     255     57,189

Issuance of 36,970 shares with respect to anti-           
dilution rights in July 1997                              36,970     185       (185)

Issuance of 20,000 warrants for services performed
during 1997, exercise price of $4.50 per share                               90,000

Issuance of 1,572 warrants for services performed
during 1997, exercise price of $15.00 per share                               7,074

Exercise of warrants @ $2.50 per share, July 1997         20,000     100     49,900

Issuance of 300,000 warrants in connection with
October 1997 Bridge Financing, net                                        1,479,822

Issuance of 4,600,000 shares of common stock @ $7.00
per share in connection with the initial public 
offering, net of offering costs                        4,600,000  23,000 28,889,033

Cash advanced for related party note receivable,
December 1997                                                                        (169,498)

Exercise of bridge warrants in January, 1998             275,000   1,375      1,375
</TABLE>

<TABLE>
<CAPTION>

                                                           Deficit
                                                        Accum During            Total
                                                         Development         Shareholders'
                                                            Stage          Equity (Deficit)
                                                        ----------------------------------
<S>                                                     <C>                <C>
Exercise of warrants @ $1.13 per share, July 1997                              57,444

Issuance of 36,970 shares with respect to anti-
dilution rights in July 1997                                                       --

Issuance of 20,000 warrants for services performed
during 1997, exercise price of $4.50 per share                                 90,000

Issuance of 1,572 warrants for services performed
during 1997, exercise price of $15.00 per share                                 7,074

Exercise of warrants @ $2.50 per share, July 1997                              50,000

Issuance of 300,000 warrants in connection with
October 1997 Bridge Financing, net                                          1,479,822

Issuance of 4,600,000 shares of common stock @ $7.00
per share in connection with the initial public 
offering, net of offering costs                                            28,912,033

Cash advanced for related party note receivable,
December 1997                                                                (169,498)

Exercise of bridge warrants in January, 1998                                    2,750
</TABLE>


See accompanying notes to financial statements



                                      F-15
<PAGE>   52

Princeton Video Image, Inc.
(A Development Stage Company)
Statements of Changes in Shareholders' (Deficit)/Equity
for the period July 23, 1990 (date of inception)
to June 30, 1998


<TABLE>
<CAPTION>
                                                                                                               Related Party
                                                                          Common Stock          Additional     Note and
                                                                       Number of                Paid-In        Stock Subsc
                                                                       Shares        Amount     Capital        Receivable  
                                                                       -----------------------------------------------------
<S>                                                                   <C>           <C>       <C>            <C>
Compensation expense associated with the issuance of 
9,600 options for consulting services in January 1998                                          33,312


Accretion of preferred stock dividends                                                        (44,050)


Shares reacquired in connection with related party note
receivable                                                              (9,920)      (50)    (123,950)        124,000


Net loss
                                                                      -----------------------------------------------------

BALANCE AT JUNE 30, 1998                                              8,173,552     $40,867  $51,443,856     $(824,498)    
                                                                      =====================================================



<CAPTION>
                                                                                                       Deficit
                                                               Treasury Stock                        Accum During        Total
                                                            Number of                 Unearned       Development      Shareholders'
                                                             Shares        Amount    Compensation       Stage        Equity(Deficit)
                                                           -------------------------------------------------------------------------
<S>                                                       <C>            <C>        <C>          <C>             <C>

Compensation expense associated with the issuance of 
9,600 options for consulting services in January 1998                                                                  33,312


Accretion of preferred stock dividends                                                                                (44,050)


Shares reacquired in connection with related party note
receivable                                                                                                                 --


Net loss                                                                                            (9,084,324)      (9,084,324)   
                                                            -----------------------------------------------------------------------

BALANCE AT JUNE 30, 1998                                         --         --           --       $(28,625,878)     $22,034,347    
                                                            =======================================================================
</TABLE>



See accompanying notes to financial statements



                                      F-16
<PAGE>   53

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS


1.    ORGANIZATION:

Princeton Video Image, Inc. ("the Company"), was incorporated on July 23, 1990
in the State of New Jersey. The Company has developed the L-VIS System which
utilizes proprietary software and hardware to insert images into a live
television sports broadcast so that the images appear to actually exist in the
stadium where the game is being played. The Company is marketing this system to
rightsholders for use in real time insertion of an image into television
transmissions of a live sporting event. The Company intends to market its
systems on a worldwide basis through licensing agreements or the formation of
joint ventures.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

DEVELOPMENT STAGE COMPANY
The accompanying financial statements have been prepared in accordance with the
provisions of Statement of Financial Accounting Standard No. 7, "Accounting and
Reporting by Development Stage Enterprises."

CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of petty cash on hand, checking accounts,
money market funds, and all highly liquid debt instruments purchased with a
maturity of three months or less.

INVESTMENTS
Investments in and the operating results of joint ventures in which the Company
has a 50% interest or otherwise exercises significant influence are accounted
for on the basis of the equity method of accounting.

PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation.
Depreciation is provided using the straight-line method over the estimated
useful lives of the respective assets, principally three to seven years. Gains
or losses on depreciable assets retired or sold are recognized in the statement
of operations in the year of disposal.

INTANGIBLE ASSETS
Legal costs incurred to apply for patents are capitalized and amortized using
the straight line method over an estimated useful life of 7 years.

INCOME TAXES
The Company accounts for income taxes by recognizing deferred tax assets and
liabilities for the expected future tax consequences of temporary differences
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect for the years in which the differences are expected
to reverse.



                                      F-17
<PAGE>   54

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)


REVENUE
Non-refundable license fees are recognized as revenue when earned, which is when
all related commitments have been satisfied (see Note 5). Additionally, under
the terms of certain existing agreements, the Company retains title to the L-VIS
System and receives a non-refundable fee which reflects reimbursement for the
construction cost of the system delivered to the licensee. These fees are
recorded as license revenue on a straight-line basis over the shorter of the
license term or useful life of the equipment.

Advertising revenue is recognized when earned, which is when the respective
advertisements are inserted into a television broadcast.

RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred. Costs associated with
the development of the Company's proprietary computer system which are incurred
prior to technological feasibility are recorded as research and development
expenses.

PER SHARE DATA
In December 1997, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" ("SFAS 128") to calculate net loss per
share applicable to common stock. All prior periods presented have been
retroactively restated to conform to the SFAS 128 requirements. SFAS 128
requires the presentation of basic and diluted per share amounts. Basic per
share amounts are computed by dividing net loss applicable to common stock by
the weighted average number of common shares outstanding during the period.
Diluted per share amounts are computed by dividing net loss applicable to common
stock by the weighted average number of common shares outstanding plus the
dilutive effect of common share equivalents.

Since the Company incurred net losses for all periods presented, both basic and
diluted per share calculations are the same. Accordingly, options and warrants
to purchase 2,519,637 and 2,321,574 shares of common stock that were outstanding
at June 30, 1998 and 1997, respectively, were not included in diluted per share
calculations, as their effect would be antidilutive.

RISKS AND UNCERTAINTIES
The Company is subject to a number of risks common to companies in similar
stages of operations including, but not limited to, the lack of assurance of the
marketability of the product, the need to raise additional funds, the risk of
technological obsolescence and the limited source of supply of certain
components of the L-VIS System. In addition, to the extent that the Company's
internally designed software applications, computer systems and operations
and/or its external suppliers and outside broadcasters are not Year 2000
compliant, the planned operations of the Company could be significantly
disrupted. This disruption could have a material adverse effect on the
Company's business, financial conditions and planned results of operations.

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 dates of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.



                                      F-18
<PAGE>   55

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

NEW PRONOUNCEMENTS
The Financial Accounting Standards Board issued Financial Accounting Standard
No. 130, "Reporting Comprehensive Income" ("SFAS 130") in June 1997.
Comprehensive income represents the change in net assets of a business
enterprise as a result of nonowner transactions. Management does not believe
that the future adoption of SFAS 130 will have a material effect on the
Company's financial position and results of operations. SFAS 130 is effective
for fiscal years beginning after December 15, 1997. The Company will adopt SFAS
130 for the year ending June 30, 1999.

Also in June 1997, the Financial Accounting Standards Board issued Financial
Accounting Standard No. 131, "Disclosures about Segments of an Enterprise and
Related Information" ("SFAS 131"). SFAS 131 requires that a business enterprise
report certain information about operating segments, products and services,
geographic areas of operation, and major customers in complete sets of financial
statements and in condensed financial statements for interim periods. SFAS 131
is effective for fiscal years beginning after December 15, 1997. The Company
will adopt SFAS 131 for the year ending June 30, 1999.

In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of"
("SFAS" No. 121"). SFAS No. 121, effective for the Company's fiscal year 1997,
established criteria for recognizing, measuring and disclosing impairments of
long-lived assets, including intangibles and goodwill. The adoption of SFAS No.
121 has not had a significant impact on the Company's results of operations,
financial position or cash flows.

3.     RESTRICTED MARKETABLE SECURITIES HELD TO MATURITY:

At June 30, 1998, the Company had investments in U.S. Treasury Notes which, at
the time of purchase, had a maturity greater than three months but less than one
year and are restricted as to use under the terms of two existing letters of
credit. The Company intends to hold these debt instruments to maturity and has,
accordingly, classified them as marketable securities held to maturity at their
amortized cost basis. Unrealized holding losses totaled $2,334 at June 30, 1998.

4.    INVESTMENTS IN JOINT VENTURES:

In 1993, the Company formed a joint venture, Publicidad Virtual S.A. de C.V.,
("Publicidad"), with Presencia en Medios, S.A. de C.V. ("Presencia"), a Mexican
corporation, for purposes of marketing the Company's technology in Latin America
and the Spanish language markets in the Caribbean basin. The Company and
Presencia each own 50% of the voting shares and share equally in the net
earnings of Publicidad. At June 30, 1998, the Company's investment in Publicidad
amounted to $0, reflecting the Company's equity in Publicidad. The Company has
not recognized losses in excess of its investment in Publicidad as it has no
commitment to fund Publicidad's operations.

Under the terms of the joint venture agreement, Presencia manages the day-to-day
operations of Publicidad and is obligated to make such loans or additional
contributions as are necessary to carry out the business. The Company has no
further obligation to the joint venture. In 1994, Publicidad, through additional
contributions made by Presencia, paid the Company $2,000,000 for an exclusive,
royalty-free license granting Publicidad the right to commercially market the
Company's technology in Latin America and the Spanish-speaking Caribbean. (See
Note 5).



                                      F-19
<PAGE>   56

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

5.    LICENSE FEES:

In connection with the Publicidad joint venture, the Company received a
non-refundable fee of $2,000,000. The Company recognized 50% of this fee
($1,000,000 based upon its percentage ownership in Publicidad) in 1996 when all
the deliverables as defined in the agreement were met. The Company recognized an
additional $100,000 of license fees as revenue in both 1997 and 1998. The
remaining $800,000 of unearned revenue, of which $100,000 is included in current
liabilities and the remainder in long-term at June 30, 1998, is being amortized
into income over a 10 year period which began on July 1, 1996.

Under the terms of certain existing agreements, the Company retains title to the
L-VIS System and receives a non-refundable fee which reflects the construction
cost of the L-VIS system delivered to the licensee. These fees are recorded as
license revenue on a straight-line basis over the shorter of the license term or
the useful life of the equipment. Amortization of license revenue related to
these agreements amounted to $271,223 and $30,526 for the years ended June 30,
1998 and 1997, respectively. The remaining unearned revenue related to these
agreements was $343,244 at June 30, 1998, of which $169,164 is current.



6.    PROPERTY AND EQUIPMENT:

The costs and accumulated depreciation of property and equipment at June 30,
1998 is summarized as follows:



<TABLE>
<S>                                                        <C>        
     Furniture and fixtures                                $   197,028
     Leasehold improvements                                     29,053
     Office equipment                                        1,070,274
     L-VIS Systems                                           1,705,150
     Research and development equipment and software           484,831
     Spare parts                                               711,618
                                                           -----------

          Total property and equipment                       4,197,954

     Less:  accumulated depreciation                        (1,650,470)
                                                           -----------

     Property and equipment, net                           $ 2,547,484
                                                           ===========
</TABLE>


Depreciation expense amounted to $793,043 and $478,982 for the years ended June
30, 1998 and 1997, respectively.



                                      F-20
<PAGE>   57

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)


7.    INTANGIBLE ASSETS:

The costs and accumulated amortization at June 30, 1998 is summarized as
follows:



<TABLE>
<S>                                        <C>      
     Patents                               $ 182,358
     Patent Applications in Progress         453,709
                                           ---------

          Total Intangible Assets            636,067

     Less:  accumulated amortization        (142,831)
                                           ---------

     Intangible Assets, net                $ 493,236
                                           =========
</TABLE>


Amortization expense amounted to $76,143 and $57,490 for the years ended June
30, 1998 and 1997, respectively. On May 6, 1997 the Company was granted a patent
relating to a pattern recognition system to detect specific objects in a video
field.



8.    INCOME TAXES:

Temporary differences which give rise to significant deferred tax assets and
liabilities at June 30, 1998 are as follows:



<TABLE>
<S>                                                 <C>
     Deferred tax assets:
       Capitalized start-up costs                   $   423,046
       Fixed assets                                     110,701
       Deferred revenue and other                       453,811
       Net operating loss carryforwards               6,602,623
       State taxes                                    1,974,890
       Valuation allowance - Federal                 (7,426,697)
       Valuation allowance - State                   (1,974,890)
                                                    -----------

               Total deferred tax assets                163,484

     Deferred tax liabilities:
       Intangibles                                      163,484
                                                    -----------

               Total deferred tax liabilities           163,484
                                                    -----------

                  Net deferred taxes                $         0
                                                    ===========
</TABLE>



                                      F-21
<PAGE>   58

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

Due to the uncertainty of the realization of the deferred tax assets, a full
valuation allowance has been provided.

As of June 30, 1998, the Company has net operating loss carryforwards for U.S.
federal income tax purposes of approximately $19,400,000 which expire in the
years 2006 through 2013. The timing and manner in which the net operating loss
carryforwards may be utilized in any year by the Company will be severally
limited by Internal Revenue Code Section 382.



9.    BRIDGE FINANCING:

In October 1997, the Company entered into a $3,000,000 Bridge Financing
arrangement whereby the Company issued 30 units, each unit consisting of i) one
promissory note payable with a principal amount of $100,000 and bearing interest
at 10% and ii) warrants with a five year term to purchase 10,000 shares of
common stock at an exercise price of $.01 per share. The promissory notes
matured and warrants became fully vested upon the consummation of the initial
public offering of the Company's common stock in December 1997. The fair value
of the warrants, which approximated $1,647,000 at the closing date, was recorded
as an increase to additional paid-in capital. Upon maturity of the promissory
notes, the Company remitted the $3,000,000 principal balance and approximately
$59,000 of accrued interest. The difference between the $3,000,000 of proceeds
received from the Bridge Financing and the $1,353,000 of the proceeds allocated
to the promissory notes was amortized to interest expense over the term of the
promissory notes. Additionally, the Company incurred approximately $270,000 of
commissions and fees in connection with the Bridge Financing which were deferred
and amortized over the term of the promissory notes.



10.   COMMON AND PREFERRED STOCK:

COMMON STOCK

Pursuant to its Restated Certificate of Incorporation, the Company is prohibited
from paying any dividends on the Common Stock until all accumulated dividends in
respect of the Series A Preferred Stock and Series B Preferred Stock have been
paid.

In May 1995, certain investors in the Company, which included a member of the
Company's current Board of Directors, signed notes ("the Notes") for $124,000 in
consideration for amounts owed under a stock subscription agreement. The
underlying shares of common stock were held by the transfer agent awaiting
payment of the Note. These Notes contained no recourse provisions by which the
Company could enforce collection and, accordingly, a $24,800 charge to general
and administrative expense was recorded in fiscal year 1995 for the excess of
the fair value of the Company's common stock in May 1995 over the purchase price
of the common stock associated with the underlying subscription agreement.
Additionally, the Company did not receive amounts owed upon the maturity of the
Notes in May 1997. The Notes were renewed in May 1997 and in March 1998, an
agreement was reached between the investors and the Company whereby the Notes
were canceled and the 9,920 underlying shares of 




                                      F-22
<PAGE>   59

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

common stock were released by the transfer agent.

In February 1996, the Company issued 282,266 shares of common stock in a private
placement offering (the "February 1996 Offering") for $17.50 per share and
received proceeds of $4,560,209.

In May 1997, in order to raise funds to meet current obligations, the Company
issued 587,514 shares of common stock in a special rights offering ("the Rights
Offering") whereby existing shareholders could purchase one share of common
stock at $3.75 per share for every four shares of common stock held. The Company
received proceeds of $910,465 and stock subscriptions receivable totaling
$1,264,485. Prior to the Rights Offering, warrantholders exercised 97,930
warrants at $1.13 per share in order to increase their participation in the
Rights Offering. All outstanding stock subscriptions receivable were remitted to
the Company in the first fiscal quarter of 1998.

In July 1997, certain investors in the Company, which included a member of the
Company's current Board of Directors signed notes (`the July Notes") for $60,263
in consideration for amounts owed under the Rights Offering stock subscription
agreement. The July Notes which bore an interest rate of 9% and a maturity date
of July 1997, contained no recourse provisions by which the Company could
enforce collection. However, no charge was recorded in July 1997, as the fair
value of the Company's common stock in July 1997 approximated the purchase price
of the common stock associated with the Rights Offering subscription agreement.
The July Notes plus all accrued interest were repaid in full in December 1997.

On September 3, 1997, in preparation for the planned initial public offering of
the Company's common stock, the Board of Directors of the Company declared a 2
for 1 stock split of the Company's common stock. All references in the financial
statements to share and per share numbers and amounts and warrant and option
data have been restated to give retroactive effect to the stock split.

On December 16, 1997, the Company completed its initial public offering of
4,000,000 shares of its common stock at a price of $7.00 per share (the
"Offering"). The net proceeds from the Offering, after deducting underwriting
discounts and commissions and estimated expenses payable by the Company were
approximately $25,050,000. Additionally, in connection with the underwriting
services provided in the Offering, the underwriters received warrants with a
five year term to purchase 400,000 shares of common stock at an exercise price
of $8.40.

On December 31, 1997, the Company issued 600,000 shares of common stock at $7.00
per share to the underwriters of the Offering pursuant to the exercise of an
over-allotment option granted in connection with the Offering. The net proceeds
from the exercise of this option, after deducting underwriting discounts and
commissions and estimated expenses payable by the Company were approximately
$3,900,000.



                                      F-23
<PAGE>   60

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)


PREFERRED STOCK

The Company is authorized to issue up to 1,000,000 shares of the preferred stock
in one or more series. The Company's Board of Directors is authorized to fix the
relative rights, preferences, privileges and restrictions thereof, including
dividend rights, dividend rates, conversion rights, terms of redemption,
redemption prices, liquidation preferences, the number of shares constituting
any series and the designation of such series. The issuance of preferred stock
with voting and conversion rights may adversely affect the voting power of the
holders of the Company's Series A Preferred Stock, Series B Preferred Stock,
Series C Preferred Stock and Common Stock, including the loss of voting control.
Other than the shares of Series A Preferred Stock and Series B Preferred Stock,
there are no shares of preferred stock currently issued and outstanding.


Series A Preferred Stock

The Company has issued a total of 67,600 shares of Series A Redeemable Preferred
Stock with a par value of $4.50 per share and a six percent per annum dividend
rate. Dividends shall be paid either in cash or common stock of the Company. The
Company has the right at any time after the date of original issuance of the
Series A Preferred Stock to redeem the Series A Preferred Stock in whole or in
part at a price of $4.50 per share plus all accrued but unpaid dividends. The
Company is required to redeem this preferred stock in cash at par plus all
accrued but unpaid dividends from thirty percent of the amount by which the
Company's annual net income after taxes exceeds $5,000,000.

Dividends on the shares of Series A Preferred Stock are cumulative and must be
paid in the event of liquidation and before any distribution to holders of
common stock. Cumulative dividends in arrears at June 30, 1998 totaled $99,250
(or $1.47 per share).

The Series A Preferred Stock has no liquidation preference, no conversion rights
and no registration rights.

Series B Preferred Stock

The Company has issued a total of 86,041 shares of Series B Redeemable Preferred
Stock with a par value of $5.00 per share and a six percent per annum dividend
rate. Dividends shall be paid either in cash or common stock of the Company. The
Company has the right at any time after the date of original issuance of the
Series B Preferred Stock, but subject to the prior redemption of all of the
Series A Preferred Stock, to redeem the Series B Preferred Stock in whole or in
part at a price of $5.00 per share plus all accrued but unpaid dividends. The
Company is required, subject to the prior redemption of all of the Series A
Preferred Stock, to redeem this preferred stock in cash at par plus all accrued
but unpaid dividends from twenty percent of the amount by which the Company's
annual net income after taxes in any year exceeds $5,000,000.

Dividends on the shares of Series B Preferred Stock are cumulative and must be
paid in the event of liquidation and before any distribution to holders of
common stock. No 




                                      F-24
<PAGE>   61

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

dividends may be paid with respect to this stock until all cumulative dividends
in respect of Series A Preferred Stock have been paid. Cumulative dividends in
arrears at June 30, 1998, totaled $113,950 (or $1.32 per share).

The Series B Preferred Stock has no liquidation preference, no conversion rights
and no registration rights.

Changes in the preferred stock accounts were as follows:


<TABLE>
<CAPTION>
                                                   Series A                     Series B
                                           Number of                   Number of
                                            Shares        Amount         Shares         Amount        Total
                                        -------------  ------------  --------------  ------------  ------------
<S>                                     <C>            <C>           <C>             <C>           <C> 
Balance at June 30, 1992

Stock issued for cash, December 1992         48,000       $216,000                                    $216,000
Stock issued for Cash, March 1993            19,600         88,200                                      88,200
Accretion of preferred stock dividends                       8,000                                       8,000
                                             ------       --------                                    --------

Balance at June 30, 1993                     67,600        312,200                                     312,200
                                             ------       --------       -------       --------       --------

Stock issued for cash, February 1994                                      86,000       $430,000        430,000

Accretion of preferred stock dividends                      18,250                       10,750         29,000
                                             ------       --------       -------       --------       --------

Balance at June 30, 1994                     67,600        330,450        86,000        440,750        771,200
                                             ------       --------       -------       --------       --------

Accretion of preferred stock dividends                      18,250                       25,800         44,050
                                             ------       --------       -------       --------       --------

Balance at June 30, 1995                     67,600        348,700        86,000        466,550        815,250
                                             ------       --------       -------       --------       --------

Stock issued for cash, September 1995                                         41            205            205

Accretion of preferred stock dividends                      18,250                       25,800         44,050
                                             ------       --------       -------       --------       --------

Balance at June 30, 1996                     67,600        366,950        86,041        492,555        859,505
                                             ------       --------       -------       --------       --------

Accretion of preferred stock dividends                      18,250                       25,800         44,050
                                             ------       --------       -------       --------       --------

Balance at June 30, 1997                     67,600        385,200        86,041        518,355        903,555
                                             ------       --------       -------       --------       --------

Accretion of preferred stock dividends                      18,250                       25,800         44,050
                                             ------       --------       -------       --------       --------

Balance at June 30, 1998                     67,600       $403,450        86,041       $544,155       $947,605
                                             ======       ========       =======       ========       ========
</TABLE>



                                      F-25
<PAGE>   62

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)



CO-INVESTMENT RIGHTS, ANTI-DILUTION RIGHTS AND RIGHT OF FIRST REFUSAL

In connection with the August 1993 Offering, the Company granted anti-dilution
rights to Presencia with respect to any offering of common stock issued at a
price less than the per share purchase price paid by Presencia in the August
1993 Offering. Such rights allow Presencia to receive a sufficient number of
shares of common stock to allow Presencia to maintain its percentage ownership
interest in the Company for no additional consideration. Pursuant to these
anti-dilution rights and the Rights Offering in May 1997, Presencia was entitled
to be issued an additional 36,970 shares of common stock for no additional
consideration. These shares were issued to Presencia in July 1997 and were
accounted for as a cost of the Rights Offering. This anti-dilution right
terminated upon the initial public offering of the Company's common stock in
December 1997.

In connection with the July 1994 offering of common stock and warrants to
Blockbuster Entertainment Corporation ("Blockbuster"), the Company granted
co-investment rights to Blockbuster with respect to certain offerings of
securities by the Company. Such rights allowed Blockbuster to purchase, on terms
at least as favorable as those on which the offered securities were to be sold,
a sufficient number of the offered securities to allow Blockbuster to maintain
its percentage ownership interest in the Company. This coinvestment right
terminated with the initial public offering of the Company's common stock in
December 1997.

Additionally, pursuant to the July 1994 offering of Common Stock and warrants to
Blockbuster, the Company granted Blockbuster the right to purchase all, but not
less than all, of certain securities offered to a third party or parties for the
purchase price at which the securities were offered to the third party or
parties. This right did not apply to certain offers of securities by the
Company, including offers which the Company makes for strategic business
purposes relating to the Company's business, technology or products. This right
of first refusal terminated upon the initial public offering of the Company's
common stock in December 1997.

WARRANTS AND OPTIONS:

WARRANTS

The Company had outstanding a total of 1,202,130 warrants to purchase common
stock at June 30, 1998. The exercise prices range from $2.50 to $20.00 per share
and the expiration of such warrants range from 1997 to 2002. The following is a
description of warrant activity to date:

In connection with the May 1991 issuance of common stock, the Company issued
warrants with a five-year term to purchase 192,000 shares of common stock at an
exercise price of $6.25 per share. In May 1996, warrants for 170,000 shares of
common stock were exercised and the remainder expired.



                                      F-26
<PAGE>   63

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

In August 1991, warrants with a five year term to purchase 8,000 shares of
common stock at an exercise price of $2.50 per share were granted as
consideration for consulting services provided to the Company. These warrants
were exercised in August 1996.

In September 1991, warrants with a five year term to purchase 4,000 shares of
common at an exercise price of $2.50 per share were granted to an outside
director. These warrants vested ratably over the period September 1991 through
September 1993 and expire five years after the vesting date. These warrants were
exercised in September 1996.

In November 1991, warrants with a five year term to purchase 80,800 shares of
common stock at an exercise price of $2.50 per share were granted to an employee
of the Company. These warrants vested as follows: (i) 20,000 in November 1991,
(ii) 13,600 each in November 1992, November 1993 and November 1994 and (iii)
20,000 in September 1993. Each series of warrants expires five years after the
applicable vesting date. 20,000 and 13,600 of these warrants expired in November
1996 and 1997, respectively.

In July 1992, warrants with a five year term to purchase 262,000 shares of
common stock at an exercise price of $2.50 per share were issued to two
employees of the Company. These warrants were exercised in July 1997 (see Note
10).

In July 1992, warrants with a five year term to purchase 32,000 shares of common
stock at an exercise price of $2.50 per share were issued to David Sarnoff
Research Center, Inc. The estimated fair value of the warrants of $32,000 was
recorded as research and development expense in fiscal year 1993. These warrants
expired in July 1997.

In July 1992, warrants with a five year term to purchase 20,000 shares of common
stock at an exercise price of $2.50 per share were issued to a financial advisor
in connection with the August 1992 and December 1992 equity offerings. These
warrants were exercised in July 1997.

In July 1992, warrants with a five year term to purchase 30,000 shares of common
stock at an exercise price of $1.13 per share were issued to a financial advisor
in connection with August and December 1992 equity offerings. In May 1997 and
July 1997, respectively, warrants for 14,850 and 15,150 shares of common stock
were exercised.

In connection with the August 1992 issuance of common stock, the Company issued
warrants with a five year term to purchase 206,360 shares of common stock at an
exercise price of $1.13 per share. In May 1997 and April 1996, respectively,
warrants for 83,080 and 938 shares of common stock were exercised. The remaining
warrants expired in August 1997.

In connection with the August 1993 issuance of common stock, the Company issued
warrants with a one year term to purchase 132,074 shares of common stock at an
exercise price of $12.12 per share. In January 1994, warrants for 82,542 shares
of 



                                      F-27
<PAGE>   64

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

common stock were exercised. The remaining warrants expired in August 1994.

In connection with the February 1994 issuance of common stock and Series B
Preferred Stock, the Company issued warrants to purchase 172,000 shares of
common stock at an exercise price of $12.50 per share. In May 1995 and October
1995, warrants for 105,300 and 2,000 shares of common stock were exercised,
respectively. The remaining warrants for 64,700 shares of common stock have
expired.

In connection with the April 1994 issuance of common stock, the Company issued
warrants with a five year term to purchase 450,000 shares of common stock at an
exercise price of $12.50 per share.

In connection with the July 1994 issuance of common stock to Blockbuster
Entertainment Corporation ("Blockbuster"), the Company issued warrants with a
five year term to purchase 70,000 shares of common stock at an exercise price of
$15.00 per share. Additionally, the Company granted warrants to purchase 70,000
shares of common stock at an exercise price of $20.00 per shares. These warrants
vest upon the future occurrence of any of the following events: (i) Blockbuster
provides consulting services to the Company which materially enhances the
Company's technology relating to real time insertion; (ii) Blockbuster and the
Company enter into a joint venture for the purpose of exploiting the Company's
system in the entertainment industry for non-television applications; or (iii)
the Miami Dolphins are the first National Football League team to support the
use of the Company's system in connection with broadcast of its games. These
warrants expire three years after the vesting date.

In April 1995, warrants with a five year term to purchase 29,200 shares of
common stock at an exercise price of $13.75 per share were issued to a financial
advisor in connection with the February 1994 equity offering. Additionally,
warrants with a five year term to purchase 6,000 shares of common stock at an
exercise price of $16.50 per share were issued to the same financial advisor in
connection with the April 1994 equity offering. These warrants expire five years
after the closing date of the related offering.

In October 1995, in connection with the exercise of Presencia's co-investment
rights in common stock and Series B Preferred Stock, the Company issued to
Presencia warrants with a one year term to purchase 82 shares of common stock at
an exercise price of $12.50 per share. These warrants expired in fiscal year
1996. Additionally, the Company issued to Presencia warrants with a five year
term to purchase 10,932 shares of common stock at an exercise price of $12.50
per share. These warrants expire in April 1999.

In February 1996, warrants with a five year term to purchase 28,226 shares of
common stock at an exercise price of $19.25 per share were issued to the
underwriter of the February 1996 equity offering.

In March 1996, warrants with a five year term to purchase 24,000 shares of
common stock at an exercise price of $15.00 were issued to Presencia as
consideration for costs incurred by Presencia relating to the License Agreement
between the Company and 



                                      F-28
<PAGE>   65

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

Presencia. The estimated fair value of the warrants of $120,000 was recorded as
general and administrative expenses in fiscal year 1996.

During 1997 and 1996, respectively, the Company issued warrants with a five year
term to purchase 4,206 and 15,794 shares of common stock at an exercise price of
$15.00 as consideration for consulting services provided to the Company. The
estimated fair value of the warrants of $18,927 and $71,075 was recorded as
general and administrative expense in fiscal year 1997 and 1996, respectively.

In September 1997, warrants with a five year term to purchase 1,572 shares of
common stock at an exercise price of $15.00 per share were issued in settlement
of an obligation of $7,074 accrued at June 30, 1997 relating to consulting
services provided to the Company.

In September 1997, warrants with a three year term to purchase 20,000 shares of
common stock at an exercise price of $4.50 per share were issued in settlement
of an obligation of $90,000 accrued during 1996, when the consulting services
were provided to the Company.

In October 1997, the Company issued warrants with a five year term to purchase
300,000 shares of common stock at an exercise price of $0.01 per share in
connection with a Bridge Financing (see Note 9). As of June 30, 1998, 275,000 of
these warrants had been exercised.

On May 28, 1998, the Board of Directors of the Company approved a modification
of the terms of certain outstanding warrants. The modification, which affected
approximately 548,358 warrants, reduced the exercise price of such warrants to
$8.00 per share and extended the exercise period for an additional five years.

STOCK OPTION PLAN

The Company adopted a Stock Option Plan (the "Plan") in July 1993 for employees,
officers, directors, consultants and independent contractors of the Company. The
Plan initially reserved 360,000 shares of common stock for issuance upon the
exercise of stock options. The Plan was amended in 1995, 1996 and 1997 to
reserve additional shares. As of June 30, 1998, 1,560,000 shares were reserved
for the Plan.

The Plan is administered by the Board of Directors, which determines the
distribution of all options. The Plan provides for the granting of options
intended to qualify as "incentive stock options" ("ISOs") as defined in Section
422A of the Internal Revenue Code of 1986, as amended, and non-qualified stock
options ("NQSOs") to key employees of the Company as well as NQSOs to
non-employee directors, independent contractors and consultants who perform
services for the Company. The exercise price of all ISOs granted under the Plan
may not be less than the fair market value of the shares at the time the option
is granted. Options may be for a period of not more than 



                                      F-29
<PAGE>   66

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

ten years from the date of grant and generally vest ratably over a three year
period. Options are not assignable or otherwise transferable except by will or
the laws of descent and distribution.


Information with respect to options under the Plan is as follows:

<TABLE>
<CAPTION>
                                                                                                  Weighted             Weighted
                                                                                                  Average               Average
                                                          Number of                              Exercise             Fair Value
                                       Available           Options          Option Price         Price per            Per Option
                                       for Grant         Outstanding             Range              Share               Granted
                                       ---------         -----------        ------------         ---------            ----------

<S>                                    <C>               <C>                <C>                  <C>                  <C> 
Balance at June 30, 1996                35,366              624,634         $10.00-$17.50         $13.77        
                                       -------            --------- 
                                                                                                                  
Authorized                             900,000                                                                    
Granted                               (638,040)             638,040                                 $18.85               $ 16.57
Exercised                                   --                   --                                     --        
Forfeitures                            161,750             (161,750)                                $15.90
                                       -------            --------- 

                                                                                                                  
Balance at June 30, 1997               459,076            1,100,924         $10.00-$20.00           $16.38        
                                       -------            --------- 
                                                                                                                  
Authorized                                                                                                        
Granted                               (356,290)             356,290                                 $ 7.97                $ 3.39 
Exercised                                   --                   --                                               
Forfeitures                            139,707             (139,707)                                $18.48
                                       -------            --------- 

Balance at June 30, 1998               242,493            1,317,507         $2.50-$17.50            $ 8.35        
                                       =======            ========= 

                                                                                                                  
Exercisable at June 30, 1998                                850,938                                 $ 8.60        
Exercisable at June 30, 1997                                559,788                                 $13.93        
</TABLE>


The weighted average remaining contractual lives of outstanding options at June 
30, 1998 was 6.1 years.

The Company applies the provisions of Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock-based compensation plans. Accordingly, no compensation
has been recognized in the financial statements with respect to options and
warrants issued with an exercise price at or above the fair market value of the
stock on the grant date. Had compensation costs for such options and warrants
been determined based on the fair value approach promulgated by Statement of
Financial Standards No. 123 "Accounting for Stock Based Compensation", the
Company's net loss applicable to Common Stock 




                                      F-30
<PAGE>   67

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

would have been increased to $(14,098,692) ($(2.39) per share) and $(8,018,443)
($(3.50) per share) for the years ended June 30, 1998 and June 30, 1997,
respectively.

The pro forma compensation expense of $4,970,318 and $2,243,732 for 1998 and
1997, respectively, was calculated on the fair value of each option using the
minimum value method for those options issued prior to October 17, 1997 (the
date of initial filing with the SEC) and using the Black Scholes method for
those options issued on October 17, 1997 and later. The following weighted
average assumptions were used in the calculations:

<TABLE>
<CAPTION>
                                    1998               1997
                                 ---------          ---------

<S>                              <C>                <C>  
Risk free interest rate               6.10%              6.50%

Expected option lives            6.1 years          9.5 years

Expected volatility               62.0% **                  0
</TABLE>

       ** For options granted October 17, 1997 and later


In connection with certain options granted in February 1994 relating to a
consulting services agreement with a member of the Company's current Board of
Directors, the Company recorded unearned compensation expense in the amount of
$360,000. This unearned compensation was amortized over the 24 month vesting
period. In connection with certain options granted in June 1995 relating to a
consulting services agreement, the Company recorded unearned compensation in the
amount of $120,000, which was expensed when the service was provided in 1996.
During 1997, the Company extended the terms of certain options issued to
employees. As a result, the Company recorded a charge of $208,335, which
represents the fair value of the Company's common stock at the new measurement
date in excess of the exercise price of the underlying option.

In September 1997, the Company granted 20,000 fully vested options with an
exercise price of $2.50 per share to an employee to replace certain warrants
which had expired in 1996. As a result, the Company recorded a charge of $80,000
in September 1997 which represents the fair value of the stock in excess of the
exercise price of the option.

On October 1, 1997, the Board of Directors of the Company approved a
modification of the terms of all stock options held by individuals who, as of
that date, were current employees of the Company, except executive officers. The
modification, which affected approximately 320,380 options, reduced the exercise
price of such options to $8.00 per share. No compensation expense was recorded
in connection with this transaction as the exercise price of such options
exceeded the fair market value of the Company's stock on the date of this
transaction.


                                      F-31
<PAGE>   68

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)


In January 1998, the Board of Directors of the Company approved the creation of
an employee bonus pool of 100,000 incentive stock options, pursuant to the
Company's Stock Option Plan to be awarded during calendar year 1998, on a
discretionary basis, in recognition of extraordinary performance.


In January 1998, the Board of Directors of the Company approved the grant of
options with a ten year term to purchase up to 59,600 shares of common stock to
a third party consultant. Of those options granted, 9,600 were fully vested upon
grant in consideration for consulting services previously rendered. Accordingly,
the Company recorded a charge of $33,312 in the third quarter of 1998 which
represents the fair value of the vested options. The remaining 50,000 options
will vest upon the earlier of i) the consultant providing ten years of
continued consulting services or ii) the attainment of certain performance
criteria. Charges for such unvested options will be recorded in proportion to
progress made on such performance criteria. There was no charge recorded in
fiscal year 1998 for the unvested portion of this option grant.

On May 28, 1998, the Board of Directors of the Company approved a modification
of the terms of certain stock options held by individuals who, as of that date,
were current officers or directors of the Company. The modification, which
affected approximately 350,000 options, reduced the exercise price of such
options to $8.00 per share. No compensation expense was recorded in connection
with this transaction as the exercise price of such options exceeded the fair
market value of the Company's stock on the date of this transaction.

11.   COMMITMENTS AND CONTINGENCIES:

GE AGREEMENT
In July 1991, the Company entered into a license agreement with General Electric
Company ("GE") granting to the Company a non-exclusive license for use of
certain of GE's intellectual property. This agreement expired in July 1996 and
in November 1997 the Company negotiated a new agreement with GE. This 
agreement, which is retroactive to July 1996, has a five-year term.

Under the terms of the license agreement, the Company would pay royalties to GE
based upon the Company's gross revenues. All royalties accrue as earned and are
payable semi-annually. As of July 30, 1998, the amount accrued under this
agreement was not material.

SARNOFF AGREEMENT
The Company entered into an agreement with David Sarnoff Research Center, Inc.
("Sarnoff") in November 1990, which was amended in August 1991 and June 1995,
granting the Company an exclusive, worldwide license for use of the proprietary
Pyramid Image Processing technology developed by Sarnoff in the fields of
television advertising and for any purpose for television programming involving
sports. The Company may terminate this agreement at any time after the earlier
of the date on which the Company's cumulative gross revenues reach $20,000,000
or January 1, 1999.



                                      F-32
<PAGE>   69

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

Under terms of this agreement, the Company will pay royalties of between 3% and
5% to Sarnoff, based upon the Company's gross revenues. All royalties shall
accrue as earned, but no payments are required to be made until the earlier of
the date on which cumulative gross revenues reach twenty million dollars or
January 1, 1999. Commencing on January 1, 1999, minimum quarterly royalties of
$100,000 shall be paid by the Company to Sarnoff. At June 30, 1998 and 1997,
respectively, the amounts accrued under this agreement were not material.


THESEUS AGREEMENT
In December 1995, the Company entered into a license agreement with Theseus
Research, Inc. ("Theseus") whereby the Company was granted a non-exclusive
worldwide license, without the right of sublicense, to use Theseus technology in
its system. During the term of the license, the Company will pay royalties of
between .05% and .20% of net sales on a quarterly basis. The agreement
terminates with the expiration of the last of the patents included in the
licensed technology. At June 30, 1998 the amount accrued under this agreement
was not material.


GDM AGREEMENT
In December 1995, the Company entered into a license and association agreement
with Gerencia de Medios, S.A., ("GDM"), a subsidiary of Prisa, a Spanish media
company. The purpose of this association was to allow GDM to market and use the
Company's system in sports broadcasts in Spain and Portugal throughout a trial
period, which expired in December 1996.

Under the terms of the association, GDM paid the Company $500,000 in license and
royalty fees, $200,000 of which was refundable if GDM was unable to use the
Company's system during the trial period because of patent infringement on third
parties. The remaining $300,000 was a deposit paid by GDM for use of the
Company's system which must be refunded to GDM. GDM sought a refund of the
license and royalty fee it previously paid to the Company asserting, as one
reason, its receipt of a letter from an affiliate of Symah Vision-SA ("Syman"),
a competitor of the Company, asserting that use of the L-VIS System in Spain
would infringe one of Symah's patents. Both GDM and the Company were advised by
European patent counsel that use of the L-VIS System would not infringe Symah's
patent.

In November 1997 the Company settled its dispute with GDM concerning amounts
owed by the Company to GDM under the terms of their association agreement. GDM
returned the L-VIS system equipment to the Company in January 1998 in exchange
for a $365,000 payment to GDM from the Company. The remaining $135,000 of the
original $500,000 received from GDM was recorded as license revenue by the
Company in the second quarter 1998.



                                      F-33
<PAGE>   70

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)


D&D ENTERTAINMENT

In May 1997, the Company signed a non-binding letter of intent with D&D
Entertainment Group N.V. of Belgium ("D&D") for purposes of marketing the
Company's technology in the Benelux region of Europe. Under the terms of this
letter of intent, the Company received $250,000 of advanced licensing fees which
were held as customer deposits pending the decision of D&D and the Company to
enter into a definitive agreement. Between May 1997 and May 1998, D&D used the
L-VIS System on a trial marketing basis in connection with a subsidiary company
of D&D called Mobilis.

In May 1998 the Company entered into a definitive agreement with D&D under the
terms of which the Company paid D&D $250,000 held on deposit, in exchange for
the return of the L-VIS System. The Company agreed to pay an additional $50,000
as consideration for the purchase of certain assets of D&D pending a
determination of their fair market value, use of office space for a period of
six months, and the rights to hire two D&D technicians trained in the operation
of the L-VIS System.

LEASES

The Company leases its primary office space under operating leases. In July
1997, the Company entered into a three-year operating lease for office space in
New York City. In October 1997, the Company entered into a five-year operating
lease agreement for its new office headquarters in Lawrenceville, New Jersey.
Rent and equipment lease expense for the years ended July 30, 1998 and 1997 was
$395,979 and $141,415, respectively.

Future minimum rent and lease payments are as follows:

<TABLE>
<S>                                         <C>
                              1999          $  342,632
                              2000             342,632
                              2001             218,714
                              2002             205,032
                              2003              51,258
                        Thereafter                  --
                                            ==========
      Total minimum lease payments          $1,160,268
                                            ==========
</TABLE>

Under the terms of the three year lease signed in 1997 for the New York
facility, the Company is required to maintain an irrevocable, unconditional
$70,000 letter of credit throughout the term of the lease. Under the terms of
the five year lease signed in October 1997 for the Lawrenceville, New Jersey
headquarters, the Company is required to maintain an irrevocable, unconditional
$51,258 letter of credit throughout the term of the lease.



                                      F-34
<PAGE>   71

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)


RELATED PARTY TRANSACTIONS:

A member of the Board of Directors of the Company is also the President of J.J.
Pomerance & Co., Inc., a corporation that has furnished consulting services to
the Company from time to time.

A member of the Board of Directors of the Company is also a principal
shareholder and the President of the Board of Directors of Presencia, which has
made several equity investments in the Company and is the Company's joint
venture partner in Publicidad.

A member of the Board of Directors of the Company is also the sole shareholder
and President of Princeton Venture Research, Inc. ("PVR"), a shareholder of the
Company. PVR entered into an arrangement with the Company regarding the services
of a consultant that PVR provided to the Company for several months in 1995. In
connection with such arrangement, in September 1997, the Company granted PVR a
warrant to purchase 20,000 shares of common stock at an exercise price of $4.50
per share. Additionally, of the $124,000 of Notes received in consideration for
amounts owed under a stock subscription agreement (see Note 9), $80,000 relates
to the member of the Board of Directors, $20,000 relates to the wife of the
member of the Board of Directors and $24,000 relates to PVR. Commencing in July
1997, PVR furnished the Company with extensive consulting services in connection
with financial structuring, negotiations with various major shareholders and
preparation of the Bridge Financing. In connection with such services, the
Company has paid PVR a fee of $100,000. In consideration for financial advisory
services rendered to the Company in connection with the Bridge Financing, the
Company paid PVR Securities, Inc., an affiliate of PVR, a fee of $70,000, or
five percent of the gross proceeds of the Bridge Financing obtained from
investors introduced to the Company by PVR Securities, Inc. In connection with
the purchase of Common Stock under the Company's 1997 rights offering, the wife
of the member of the Board of Directors and PVR executed promissory notes in
favor of the Company in the amounts of $9,720 and $50,543, respectively. Such
notes and the related accrued interest, were repaid in full in December 1997.
The member of the Board of Directors of the Company is also the Manager and a
member of Acorn Technology Partners, L.L.C., the general partner of Acorn
Technology Fund, L.P., which purchased 1.5 units in the Bridge Financing in
October 1997. Each unit consisted of one Bridge Note in the principal amount of
$100,000 and Bridge Warrants to purchase 10,000 shares of Common Stock at an
exercise price of $0.01 per share. The purchase price of each unit was $100,000.

A member of the Board of Directors of the Company is also a Managing Director
and Executive Vice President of Allen & Company Incorporated, which is a
principal shareholder of the Company and furnishes financial advisory services
to the Company from time to time. In connection with the February 1996 Offering,
Allen & Co. received a financial advisory fee of $247,000, plus expenses, as
well as a five-year warrant to purchase 28,226 shares of common stock at an
exercise price of $19.25 per share. Allen, as a Representative, received
underwriting discounts and commissions, as well as Representatives' Warrants
initially exercisable for 380,000 shares of Common Stock, with respect to
services rendered on behalf of the Company with respect to the initial 



                                      F-35
<PAGE>   72

PRINCETON VIDEO IMAGE, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

public offering of its Common Stock in December 1997.

A member of the Board of Directors of the Company has been retained as a
consultant to the Company.

The Chief Executive Officer and President of the Company purchased one unit in
the Bridge Financing that closed in October 1997.

In July 1997, two employees of the Company signed notes (the "Employee Notes")
for $655,000 as consideration for the exercise of warrants to purchase 262,000
shares of common stock at an exercise price of $2.50 per share. Accordingly, a
$360,250 charge to general and administrative expense was recorded in July 1997
for the excess of the fair value of the Company's stock in July 1997 over the
exercise price of the underlying warrants. In December 1997, these two employees
signed notes (the "Tax Notes") for $169,498 as consideration for funds received
for the express purpose of paying the tax liabilities incurred by each of them
in connection with the exercise of their warrants. The Employees concurrently
signed Pledge Agreements pursuant to which the 262,000 shares of common stock
purchased were pledged to the Company. Both the Employee Notes and the Tax Notes
bear interest at a rate of 8.5% and contain no recourse provisions by which the
Company can enforce collection. The Employee Notes mature in July 2002 and the
Tax Notes become due and payable upon the earlier of (i) the first anniversary
of the date on which all of the Pledged Shares become freely transferrable, and
(ii) the date on which the employee sells, assigns or otherwise disposes of, for
consideration, any interest in any share of capital stock of Company stock.

CONCENTRATION OF CREDIT RISK:

The Company maintains its cash and cash equivalents with major financial
institutions. Held to maturity securities consist of U.S. government Treasury
securities.

SUBSEQUENT EVENTS:

On September 9, 1997, the Board of Directors of the Company passed a resolution
to amend the Corporation's Amended 1993 Stock Option Plan by increasing the
authorized number of shares which may be issued pursuant to options granted
under the Plan from 1,560,000 to 1,960,000 shares. This amendment is subject to
shareholder approval and ratification within one year of the date of the
resolution.



                                      F-36