5454U.S. SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                                   FORM 10-KSB

  X  Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of
     1934 for the fiscal year ended December 31, 1996

     Transition Report Pursuant to Section 13 or 15(d) of the
     Securities Exchange Act of 1934

                      Commission File Number: 34-0-23-858
                                 VIDEOLABS, INC.
                 (Name of Small Business Issuer in its charter)

               DELAWARE  `                               41-1726281
(State or other jurisdiction of                        (IRS Employer
incorporation or organization)                         Identification No.)


      10925 BREN ROAD EAST, MINNEAPOLIS, MN             55343
     (Address of principal executive offices)         (Zip code)

       Registrants telephone number, including area code: (612) 988-0055

         SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:

                                                   Name of each exchange
     Title of each class                            on which registered
     -------------------                            -------------------
           None                                             None

SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:

                          COMMON STOCK, $.01 PAR VALUE
                                (title of class)

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

                         Yes   X    No ___

     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained herein, 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
amendments to this form 10-KSB. [X]

     State Issuer's revenues for most recent Fiscal Year.  $7,405,548.

     The aggregate market value of the Common Stock held by non-affiliates of
the Issuer, based upon the closing bid price of the Common Stock on January 31,
1997 as reported on the NASDAQ Small Cap Market, was approximately $1,514,259.
Shares of Common Stock held by each officer and director and by each person who
owns 5% or more of the outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.

As of February 28, 1996, Registrant had outstanding 3,134,948 shares of Common
Stock.

                       DOCUMENTS INCORPORATED BY REFERENCE
                PROXY STATEMENT AND ANNUAL REPORT TO SHAREHOLDERS


                                     PART I
               CAUTIONARY STATEMENT IDENTIFYING IMPORTANT FACTORS
                THAT COULD CAUSE THE COMPANY'S ACTUAL RESULTS TO
            DIFFER FROM THOSE PROJECTED IN FORWARD LOOKING STATEMENTS

     In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, readers of this document and any document
incorporated by reference herein, are advised that this document and documents
incorporated by reference into this document contain both statements of
historical facts and forward looking statements. Forward looking statements are
subject to certain risks and uncertainties, which could cause actual results to
differ materially from those indicated by the forward looking statements.
Examples of forward looking statements include, but are not limited to (I)
projections of revenues, income or loss, earning or loss per share, capital
expenditures, dividends, capital structure and other financial items, (ii)
statements of the plans and objectives of the Company or its management of Board
of Directors, including the introduction of new products, or estimates or
predictions of actions by customers, suppliers, competitors or regulatory
authorities, (iii) statements of future economic performance, and (iv)
statements of assumptions underlying other statements and statements about the
Company or its business.

     This document and any documents incorporated by reference herein also
identify important factors which could cause actual results to differ materially
from those indicated by forward looking statements. These risks and
uncertainties include price competition, the decisions of customers, the actions
of competitors, the effects of government regulation, possible delays in the
introduction of new products, customer acceptance of products and services, and
other factors which are described herein and/or in documents incorporated by
reference herein.

     The cautionary statements made pursuant to the Private Litigation
Securities Reform Act of 1995 above and elsewhere by the Company should not be
construed as exhaustive or as any admission regarding the adequacy of
disclosures made by the Company prior to the effective date of such Act. Forward
looking statements are beyond the ability of the company to control and in many
cases the Company cannot predict what factors would cause results to differ
materially from those indicated by the forward looking statements.

ITEM 1.  DESCRIPTION OF BUSINESS


GENERAL

      VideoLabs, Inc. (the "Company") is a Delaware corporation which was
incorporated in 1992. The Company designs and manufactures image capture,
transmission and manipulation devices for use as components of systems for
security, medical, desktop computer video applications, video-teleconferencing
and computer-based and non-computer based audio-visual presentations. The
Company does not produce complete video systems but only certain components
thereof which are specifically described below. The Company sells its products
to individual and organizational customers who assemble complete solutions.

      The Company believes that there are significant opportunities for growth
in the application of the core technologies of the Company in several market
segments. The potential for increases in use of image capture devices in audio
visual, education and computer markets is increasing rapidly as computer
processing power, speed and cost factors have all improved as has higher
capacity transmission utilities. The Company has also observed emerging
applications in the use of video image capture solutions in security, medical
and industrial market segments that are primarily due to new, flexible digital
applications that allow for unique solutions targeted at potential niche
markets.

      The Company's first product was FlexCam, a very small color video camera
and microphone attached to a 3/8ths inch flexible 18- inch shaft which transmits
live video images of persons, objects or documents to a monitor or through a
separate video-capture board to the monitor of a computer. This product was
introduced in March 1993 with first shipments in April of 1993.

     The Company's second product, the FlexCam/Document, introduced in July,
1993, was a specially designed electronic camera for use in transmitting video
information under difficult lighting conditions. The Company believes that
FlexCam and FlexCam/Document are very desirable electronic cameras for use in
video- teleconferencing because they are very small, requiring little space on
the desktop, they can be positioned to focus on either the people participating
in a conference or documents or objects referenced in such conference, and they
produce images of high quality.

      The Company's third product, FlexCam/Teaching, introduced in July, 1994,
is specifically designed for the medical and education markets. It includes a
standard C-mount lens for classroom viewing and magnification of objects and
technical documents. With its microscope adapter, FlexCam/Teaching connects to
most microscopes for displaying slides, X-rays or scientific objects on monitors
for groups and classroom viewing.

      During 1994 the Company introduced the concept of FlexCap, a Universal
Digital Camera Module (UDCM) which includes its own video- capture computer
board. This product was abandoned in November of 1996 due to rapid changes in
technology.

      Additional products, the VideoShot and the T230Pro Video capture board,
were introduced in 1995 and the Stinger video capture card in 1996. All of these
products are designed for Windows-based computer capture. These products gave
the Company the ability to provide complete video solutions to the Windows-
based computer marketplace.

      The Company's long term strategy is to build image capture transmission
and manipulation solutions for individual and organizational customers that can
earn appropriate returns for shareholders.

      The Company's short term strategy is to develop or acquire image capture
solutions for specific niche markets in education, audio visual, security and
medical applications where it already has distribution resources and can provide
value-added solutions.

The Company Strategy

      The Company's business strategy is to utilize its core competencies in
analog and digital image capture development and distribution to provide
solutions for individual and organizational customers and to earn an acceptable
return on equity for the Company's shareholders.

Focus on Profitable Growth

     The Company is focused on internal growth in profitable niches in
professional image capture solutions for audio visual, education, security and
medical markets where it currently has distribution system capabilities. The
Company intends to become a multiple product supplier in these markets through
internal product development and through product acquisitions. The Company is
positioned to respond to growth opportunities in the desktop video and computer
videoconferencing markets as profitable niches and internal resources become
available.

      The company has instituted an ISO 9001 quality program and is working with
its suppliers to reduce cost of goods sold and inventory levels while improving
quality and customer response times. During 1996 the Company reduced its
staffing levels and 1997 budgets to reduce overhead costs.

      Furthermore the Company is working on partnerships with its suppliers and
distributors to reduce cost of goods sold and selling expenses while shortening
cycle times and putting the Company closer to our customers in the selling
channel.

PRINCIPAL PRODUCTS, SERVICES AND THEIR MARKETS

The Company's Current Products

     The Company offers a unique line of video products ranging from image
capture devices, image transmission and image manipulation. The Company's
product offering enables our customers to sell stand alone products or as part
of a system integration.

     The Company has four channels of focus in 1997: Videomicroscopy, Photo
Identification/Security, Audio Visual and PC/Videoconferencing. As new markets
emerge for the FlexCam family of products we will be evaluating and determining
our focus for the next year. Our customers also use our image capture devices in
medical, inspection and industrial applications.

VIDEOMICROSCOPY APPLICATIONS
*    FLEXCAM TEACHING
*    FLEXCAM STUDENT
*    FLEXCAM MICROSCOPE

     When the FlexCam Teaching camera was introduced to the microscope market
late August of 1994, the Company did not anticipate the extent of what impact
the FlexCam Teaching would have. It was a simple concept of reshaping a more
effective and easy to use camera for use with microscopes. The flexible
gooseneck wand allows users of the microscopes to easily attach the camera to a
microscope for previewing on a monitor or with the ability not to use a camera
tripod for presentations outside the microscope. Many schools are discovering
our image capture products have additional applications outside of the science
laboratories, including use in sharing video images with other schools around
the world through the Internet.

PHOTO IDENTIFICATION / SECURITY SOLUTIONS
*    FLEXCAM ID
*    T230 CAPTURE CARD
*    FLEXCAM ID BADGING SYSTEM
     *    FLEXCAM ID
     *    T230 CAPTURE CARD
     *    IDTEL 2000 SOFTWARE
     *    PRIVILEGE CARD PRINTER

     The original FlexCam was used in many security applications, one of which
is a basic head to shoulder image of an individual to provide greater security
within an institution. The FlexCam ID was developed solely for use with images
of individuals. The FlexCam ID was selected as the camera of choice for many
schools, health clubs, corporations and membership organizations. The FlexCam ID
system was developed late in 1996 to provide a complete turnkey system for use
with identification badging applications.

AUDIO VISUAL / PRESENTATION SOLUTIONS
*    FLEXCAM DOCUMENT
*    FLEXCAM

     With the presentation market doubling over the last several years,
VideoLabs customers have seen significant growth for video and image capture
applications for this market. The FlexCam Document camera was developed in 1993
specifically for document presentations, as well as any other three dimensional
objects. The FlexCam Document camera is typically sold as an add on to a part of
a customers solution. The camera can be easily integrated with liquid crystal
displays, video projectors, as well as television monitors and VCRs.

PC & MACINTOSH GLOBAL VIDEOCONFERENCING
* FLEXCAM PLANETVIEW
* FLEXCAM
* STINGER PCI CAPTURE CARD
* ENHANCED CU-SEEME SOFTWARE

     In 1992 the Company introduced FlexCam to the personal computer and
videoconferencing markets. The FlexCam is the Company's standard camera which
can be used with any videoconferencing product for integration. With the unique
gooseneck and audio integrated into one camera, which can be positioned in any
direction, System Integrators started to offer the FlexCam as part of their
solution.

     The FlexCam PlaNETVIEW along with the Stinger PCI card and Enhanced
CU-SeeMe software is the Company's first turnkey solution for
videoconferencing. The FlexCam PlaNETVIEW allows consumers to videoconference
over the Internet and/or Intranet throughout the world.

The Company's Proposed Products
     The Company's engineering is committed to the development of a minimum of
three new video capture devices for 1997. This commitment is part of
engineering's eighteen month plan which in turn is part of the Company's 1997
business plan.

STUDENTCAM

     The first product which has been developed is the StudentCam camera. This
is a standard resolution color camera which does not share some of the enhanced
features of the new TeachCam and is priced accordingly. The StudentCam began
shipments in the first quarter of 1997.

TEACHCAM 6.0

     The second product developed is the 6.0 TeachCam to replace the 3.0
TeachCam. This module was co-developed with a key supplier and is a product
improved version of the older 3.0 version. The 6.0 TeachCam began shipping on
schedule the first quarter of 1997 to the US markets and will start shipping
internationally late in the second quarter of 1997. The TeachCam will be
modified in late 1997 to add additional features not yet available from
competition.

PROFESSIONALCAM

     The third product VLI engineering is committed to develop is a high
resolution enhanced feature camera which will be called the 7.0 ProfessionalCam.
This camera will provide the customer with full functional control of the
cameras settings as well as provide a high quality, high resolution video
signal. This camera will replace the existing 3.0 Document Camera as well. The
7.0 camera is scheduled for release during the third quarter of 1997.

STINGER NT

     The Company is currently creating NT drivers and a developers kit for the
Stinger video capture card. This is in response to customers requests for this
driver for use on their NT platform systems. The Stinger is currently compatible
with Windows95 platforms. We believe that these additional drivers will enhance
the product as well as extending its sales life for the Company. The new drivers
are scheduled for release the second quarter of 1997.

Marketing and Distribution

     The Company currently sells through Business Partners, Resellers and the
Internet. All of these distribution levels are maintained and sold with factory
direct sales and marketing employees from the Company.

     The Company's Business Partners are Dealers and Distributors which have
worked with the Company to give a quarterly and annual commitments in sales.
This is a new initiative in 1997 for the Company. The Company supports this
channel through training, product demonstrations and joint marketing efforts.
All of the Company's Business Partners are required to sign annual contracts
and are considered partners versus traditional distributors, due to the change
from transactional to relationship.

     The Company's Resellers consist of Value Added Resellers, Mail Order,
System Integrators and Resellers of products. Our current Reseller base is well
over 1,500 customers, which buy and resell our family of products direct to the
consumer. This channel is supported through training, product demonstrations and
vertical advertising.

      In the international markets the Company sells its products through the
same Business Partner model as above. As of December 31, 1996, the Company's
products were being offered for sale by distributors in over thirty (30)
countries, including the United Kingdom, Germany, France, Italy, The
Netherlands, Switzerland, Scandinavia, Singapore, Korea, Hong Kong and
Australia. Arrangements with these distributors provide for significant
incentives for them to purchase the Company's products in large volumes. Through
exposure of the products at international trade shows, additional international
distributors are being actively solicited. In 1996, approximately forty percent
(40%) of the Company's gross revenue was from international markets.

      All of the Company's international sales are invoiced in United States
dollars. International sales are made on the basis of cash in advance by wire
transfer, credit card, or irrevocable letters of credit. Credit limits have been
established for several of the international distributors and all open accounts
of over $3,000.00 are credit insured. The Company's international sales are
subject to certain risks common to many export activities, such as government
regulations, export license requirements and the risk of imposition of tariffs
and other trade barriers.

      The Company also is actively developing OEM customers for its products.
OEM customers purchase cameras from the Company and incorporate these cameras as
part of their own product offerings. As of December 31, 1996, the Company had
fifteen (15) active OEM customers.

Major Customers

     During 1996 the Company did not have any significant sales to any one
customer. The Company did however in 1995 have significant sales of 13% to a
single customer that did not repeat that volume in 1996.

Backlog

     The Company typically ships product within one to two weeks after receipt
of an order, which is common in this industry. Accordingly, backlog as of any
particular date is not representative of actual sales for any succeeding period.

Customer Service

      The Company believes that customer service is a critical element in
maintaining strong customer relationships. Customer service includes
installation support, product training, technical support, applications support,
timely maintenance and effective operations manuals. Repair of the Company's
products is performed at the Company's manufacturing facility by trained
technicians.

      The Company warrants its camera products against defects in materials and
workmanship for a period of one year from the date of manufacture. For OEM
customers, product line warranty is generally negotiated with each customer.

Research and Development

     The year 1996 brought the development of new products for the education
market as well as video capture devices for PC video and videoconferencing
market. The Stinger video capture card was released early in the year as a low
cost, high quality video capture solution for PC users. Engineering continues to
develop new supporting software for this product with the aid of an experienced
contract software developer.

     During fourth quarter of 1996, VLI engineering has developed an eighteen
month new product development plan. This plan will assist engineering with
utilization of existing resources in development of new products as forecast by
sales and marketing.

     In 1996, the Company's expenses relating to research and development were
$384,804. During 1995, the Company's expenses relating to research and
development were $412,860. The current VLI engineering staff consists five (5)
full-time equivalent employees. The Company also contracts services from both
mechanical engineers and software engineers as required.

Manufacturing and Supplies

      The Company assembles its products at its facility in Minnetonka,
Minnesota. The Company's manufacturing operation consists of procurement and
inspection of components and sub-assemblies, final assembly and testing of
finished products. After components have been procured, they are sent in kits to
sub- assembler companies, mostly located near the Company's facilities, which
then build the sub-assemblies. The sub-assemblies are then returned to the
Company's Minnetonka facility for final assembly. All finished products are
subjected to a minimum twelve hour reliability test before they are packaged and
shipped to customers. Beginning in 1996 some assembly operations were moved
offshore, particularly the assembly of analog camera technology. However,
because of inconsistent quality the Company has returned that operation to our
Minnesota facility.

     Components and sub-assemblies are inspected for mechanical and electrical
compliance with the Company's specifications. All finished products are tested
against Company and customer specifications. The Company's products are shipped
in protective packaging to minimize potential damage during shipment.

     Certain components and camera modules continue to be available only from a
single source, or a limited number of sources. The Company has several principal
suppliers. The Company attempts to keep an adequate supply of critical
components in its inventory to minimize the impact caused by the loss of a
significant supplier. There can be no assurance, however, that loss of a
supplier would not result in a material adverse effect on the ability of the
Company to meet its product shipment requirements.

Competition

      The electronic camera market is highly competitive. The Company competes
with a number of companies ranging from very small businesses to large
companies, some of which have substantially greater financial, manufacturing,
marketing and product development resources than the Company. Some of these
other companies manufacture and sell electronic cameras as well as video-capture
equipment, and some are distributors for these products. The Company believes
that it competes most directly with Sony, Toshiba, Panasonic, Ken A Vision,
Sharp Electronics and Elmo.

     Because the Company manufactures its product lines through the assembly of
component parts which are readily available in the world marketplace, there are
few barriers which would prevent others from designing and assembling products
similar to those sold by the Company.

      The Company competes for electronic camera sales primarily on the basis of
image quality, focus, costs, flexibility, delivery time, reputation,
reliability, the effectiveness of its sales and distribution channels and its
customer service. The Company believes that its products compete favorably on
these factors, although there can be no assurance that this will continue to be
true in the future.

Intellectual Property Rights

      The Company attempts to protect the proprietary rights to its products by
use of patents, copyrights, trade secret law and internal non-disclosure
safeguards. The source code for the software contained in the Company's products
is considered proprietary and is not furnished to customers. The Company has
also entered into confidentiality and non-compete agreements with certain key
engineering and technical employees as well as outside consultants. See
"Management." Despite these restrictions, it may be possible for competitors or
users to copy aspects of the Company's products or to obtain information that
the Company regards as proprietary.

      The Company has received a patent for the FlexCam and intends to
vigorously defend that patent in the marketplace.

      FlexCam was engineered by Suick Bay Technologies of Maple Grove, Minnesota
and Worrell Design of Minneapolis at the direction of the Company. The Company
has a royalty agreement with Worrell Design and pays two percent (2%) of
revenues resulting from the first 36,000 electronic camera sales and one percent
(1%) of the revenues from the subsequent 20,000 unit sales and one-half percent
(0.5%) of the next 20,000 unit sales. The Company has currently shipped
approximately 54,000 units under this agreement. The royalty agreement with
David Krekelberg of Suick Bay Technologies has been terminated.

      The Company uses the name "FlexCam" under an indefinite license from Video
Dynamics, Inc. for a yearly payment of $5,000.

      Because of the rapid pace of technological changes in the computer
industry, the Company believes that patent, trade secret and copyright
protection are less significant to its competitive position than are factors
such as the knowledge, ability and experience of the Company's personnel, the
Company's success at new product development and frequent product enhancements,
and the Company's name recognition and ongoing reliable product maintenance and
support.

Employees

     As of December 31, 1996, the Company had twenty one (21) full-time
employees, including six (6) in manufacturing, five (5) in engineering, product
development and warranty repair, six (6) in sales and marketing, and four (4) in
general administration and finance. None of the Company's employees are
represented by a labor union or are subject to any collective bargaining
agreement. The Company has never experienced a work stoppage and believes that
its employee relations are satisfactory. The Company does not expect to add
employees during 1997.

      During 1996, three significant employees named in the 10KSB for year ended
December 31, 1995, left the employ of the Company. Mr. Gary Campbell, Vice
president of Sales resigned and was not replaced. Frank Broghammer, CFO,
resigned and entered into a consultant agreement and was not replaced. Ward C.
Johnson, President and CEO, retired from the Company as an employee, but remains
on the Board of Directors for the Company and was replaced by James W. Hansen as
Acting President, Treasurer and CEO. There is no assurance that the persons who
replaced others who left the Company will be equal in performance to the
individuals previously holding these positions.

Environmental Compliance

      Compliance with federal, state and local laws regarding the discharge of
materials into the environment has no material effect upon capital expenditures,
earnings, competitive position or finances of the Company.

Government Regulation

     Products sold by the Company are subject to regulations of the US
Government Federal Communication Commission and European product compliance
requirements. All products sold by the Company have met mandatory requirements
of both FCC and CE regulations. The Company does not know of any pending
regulations which would affect its
operations or products.

ITEM 2.  DESCRIPTION OF PROPERTY

     The Company's operations are located in Minnetonka, Minnesota, where the
Company has leased approximately 4,920 square feet of office and 3,153 square
feet of manufacturing and development space since September 1994 under a lease
that expires in September 1997. The Company believes the facility is in
excellent condition. The annual rental is approximately $61,000. The Company
will be evaluating its space requirements prior to the lease expiring in
September 1997.

      In 1994 the Company purchased a condominium in Rotterdam, The Netherlands
for $137,579, for use by Company sales representatives. From September 1994
through November 15, 1996 this condominium was occupied by Greg Craven, a sales
representative of the Company who is also the adult son of Richard F. Craven, a
Director of the Company. The apartment is vacant and is listed for sale with a
Netherlands Real Estate Company.


ITEM 3.  LEGAL PROCEEDINGS

      There are no pending material legal proceedings against the Company or its
property.


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

      No matters were submitted to vote of the security holders during the
quarter ended December 31, 1996.

                                     PART II


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

a)  Market Information.

      The Company's Common Stock is traded on the NASDAQ Small Cap market. The
following table sets forth, for the periods indicated, the high and low bid
prices per share for the Company's Common Stock as reported to the Company by
NASDAQ. The Company's Common Stock began trading on May 10, 1994.

FISCAL YEAR ENDED DECEMBER 31, 1994        Low Bid       High Bid
-----------------------------------        -------       --------
May 10, 1994 through June 30, 1994           $3.25         $3.75
Quarter ended September 30, 1994             $3            $3.375
Quarter ended December 31, 1994              $2.25         $3.25

FISCAL YEAR ENDED DECEMBER 31, 1995
-----------------------------------
Quarter ended March 31, 1995                 $2.5          $3.375
Quarter ended June 30, 1995                  $2            $2.25
Quarter ended September 30, 1995             $2            $2.25
Quarter ended December 31, 1995              $1.938        $2.25

FISCAL YEAR ENDED DECEMBER 31, 1996
-----------------------------------
Quarter ended March 31, 1996                 $2.5          $2.75
Quarter ended June 30, 1996                  $3.375        $3.75
Quarter ended September 30, 1996             $1.875        $2
Quarter ended December 31, 1996              $.5625        $.75

b)  Holders.

As of March 15, 1996 there were approximately 151 record holders of the
Company's Common Stock.

c)  Dividends.

The Company has not declared any cash dividends on any class of common equity
for the last three fiscal years. The Company currently intends to retain
earnings for its use in operations and does not anticipate paying cash dividends
in the foreseeable future.


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

General

      The Company was incorporated in July of 1992 to design and develop a
hardware and software videoconferencing system. Shortly after formation, the
Company sold its software development project due to capital constraints and
concentrated on the design, manufacture and sales of desktop cameras for the
integration into systems for computer video applications, video teleconferencing
and computer based audio-visual presentations.

      The Company's first product was the FlexCam, a small color video camera
with a microphone attached to an 18-inch flexible shaft which transmits live
video images of persons, objects or documents through a video capture board to
the monitor of a computer. Subsequent products have been specifically designed
for specific market niches that have a need for high quality, flexible image
capture.

      The Company completed several rounds of private financing during 1992 and
1993 and completed its IPO on May 10, 1994 at a price of $3.50 per share,
raising approximately $5 million in an underwriting transaction through R.J.
Steichen and Company.

     The Company experienced steady growth through 1995 and reached
profitability due to the sale of the remaining investment in the original
software project the Company had spun out earlier. In 1994, the Company began
the development of the Universal Digital Camera Module (UDCM) and ordered
inventory to support sales expectations. The product was not subsequently
completed and a reserve for inventory value adjustments were taken at year end
1996. At the same time, the Company's founder and President retired and a
reserve was created for severance costs resulting from a layoff of 20% of the
current staff, along with a reserve for the settlement of a lawsuit relating to
the discontinued product development of the UDCM with a former officer and
director of the Company.

       1997 will be a transition year for the Company. The Company is committed
to fulfilling the vision of its founders as it transitions to a revised purpose
statement with renewed focus on providing customer solutions involving our core
competency, image capture, achieving profitability on an annualized basis and
challenging all associates to meet plan and grow professionally.

Results of Operations

      Net Sales for the period ending December 31, 1996 decreased nine (9%) from
the prior year end from $8,097,316 in 1995 to $7,405,548 in 1996. This sales
decrease was primarily due to a price reduction of the Company's product called
the FlexCam. The Company reduced the FlexCam's price from $595 to $395 due to
competitive pressures in the computer industry. Another significant reason was
the loss of sales to a significant 1995 customer that did not meet the same
volumes in 1996. The Company's unit volume sales remained constant to the prior
year. The Company anticipated that a price reduction of its FlexCam would
increase unit volumes, however this did not happen. Unit volumes did however
increase in the Company's Videomicroscopy industry which focuses on the
education market. Sales volumes in this market increased by 60% over the prior
year.

      During 1996, sales in the U.S., Europe and Asia/Pacific were respectively
60%, 32% and 8% of total sales. During 1995 the percentage of sales in these
same regions were respectively 49%, 26% and 25% of total sales. The decrease in
sales volume in the Asia Pacific Region is primarily due to the lack of sales
from a significant customer that purchased 13% of total sales in 1995 and only
3% of total sales in 1996. The Company's largest customer in 1996 purchased
8.5% of the total sales volume in 1996 and is anticipated to keep the same
volumes for 1997, however, the loss of any significant order could adversely
affect the Company.

     Gross profits for the period ending December 31, 1996 were $1,077,677
which was 15% of total sales compared to $3,040,094 which was 38% of total sales
for year ending December 31, 1995. This decrease in gross profit for 1996 is
primarily due to the yearend write down of $1,575,000 to reflect the valuation
of inventory which became technologically obsolete. This inventory valuation
write down was 21% of total sales. The Company started purchasing inventory in
late 1994 for the Universal Digital Camera Module (UDCM) product. The product
was never completed and the technology became obsolete. The Company is
aggressively pursuing different sources to either purchase the components from
the Company at a discount or engineer the components into a future product for
the Company.

      Cost of sales includes all materials, labor, packaging, manuals and
related overhead costs which are directly attributable to the cost of
manufacture and shipment of the Company's products. Cost of sales does not
include royalty costs or commission costs related to the sales of products. The
Company has set goals for 1997 to reduce the cost of materials used in
manufacture and costs associated to manufacturing overhead. The Company has
already realized some of these reductions in the first quarter of 1997.

     In 1996 the Company changed to an off shore supplier to reduce costs and
realized quality problems. This resulted in higher manufacturing overhead cost
for quality repair and warranty repair work. The Company is phasing out of the
off shore components in the first quarter of 1997 and into a higher quality
solution. The Company is committed to restoring the quality of its products in
1997 and thus hired a quality technician early in 1997 to develop an ISO 9001
quality program.

     Selling, general and administrative expenses include all costs of the
Company except those related directly to the manufacture of products described
above and other income and expense items below. Selling, general and
administrative expenses increased 16% from $3,164,461 in 1995 to $3,675,060 in
1996. Selling expenses and research and development expenses remained constant
over the two years. General and administrative expenses increased by
approximately $500,000. The Company attributes this increase to the reserves
that the Company established at year end for retirement and severance charges of
approximately 20% of the current employment base of the Company, for a charge to
cover future warranty costs, and a charge to litigation reserves for settlement
costs associated with the lawsuit with a former officer and director of the
Company.

      After restructuring in late 1996, the Company reduced its employment base
by 20% in addition to cutting over $600,000 of other operating expenses out of
its 1997 operating plan.

     The Company's operating loss for the year ending December 31 , 1996 was
$2,597,383 compared to an operating loss of $124, 367 for the year ending
December 31, 1995. The Company attributes the increase in operating losses to
the fourth quarter adjustments in 1996 as mentioned above, which decreased
income by approximately $1.9 million. The Company anticipates that operating
margins in 1997 will improve with the objectives the Company has set for 1997
including raw material cost reductions, manufacturing overhead cost reductions
and SG&A cost reductions. However, even if these efficiencies are achieved, if
the sales volumes do meet projections, overall income from operations will be
adversely affected.

      Other income for 1996 consisted of interest income of $54,007 compared to
interest income for 1995 of $98,456 and an interest expense for 1996 of $2,117.
In 1995 the Company converted its $100,000 note receivable from RSI, Inc. into
88,888 shares of RSI, Inc. common stock. The Company sold 25,000 shares of RSI,
Inc. commons stock at the time of RSI, Inc.'s initial public offering which
resulted in a non-operating gain on sale of assets of $198,606 for 1995. The
Company sold the remaining 63,888 shares at a discount in May 1996 after
receiving consent from the underwriter for a book profit of $230,354.

      At December 31, 1996 the Company had a net operating loss carry forward of
approximately $819,000 and a general business credit carry forward of $58,000
available to be carried to future periods. The loss carry forward and general
business credit carryforwards expire in 2008 through 2011 if not used.

      The net loss for the year ending December 31, 1996 was $2,362,115 compared
to a net income for the year ending December 31, 1995 of $202,694. The loss per
share for 1996 was $0.75 per share compared to earnings per share for 1995 of
$0.06 per share. The items that negatively impacted this loss were discussed
above.

      Earnings and loss per common share amounts were computed using the
weighted average number of shares outstanding during each period. The weighted
average number of shares outstanding for the years ended December 31, 1996 and
1995 was 3,134,498 and 3,133,948, respectively. During 1996, stock options and
warrants for the purchase of common stock were anti-dilutive and have not been
included in these computations. The fully diluted weighted average number of
shares outstanding for 1995 was 3,183,948, however, this had no effect on
earnings per share.

Liquidity and Capital Resources

      Working Capital, consisting principally of cash, certificates of deposit,
receivables and inventories, was $2,124,418 at December 31, 1996 and $4,526,387
at December 31, 1995. The ratio of current assets to current liabilities was 2:1
at December 31, 1996 and 6:1 at December 31, 1995. A large portion of this
decrease in working capital and current ratio was due to the year end
adjustments of inventory valuation, retirement and severance costs, litigation
reserves and product warranty reserves totaling approximately $1.9 million.

      Inventories at December 31, 1996 were higher than required due to sales
volumes in the fourth quarter of 1996 not meeting projections. The Company has
to purchase long lead time components four months in advance, so if the
Company's projections are not accurate, inventories are higher than required.
The Company anticipates that excess inventory will be liquidated in the first
two quarters of 1997. However, in the event that such inventory becomes
obsolete, the Company's cash would be substantially diminished and the Company
could be put into a position of needing funds.

      Currently the Company has a discretionary working capital line of credit
with its bank of the lesser of $1,500,000 or 80% of eligible accounts receivable
(as defined) plus $500,000 in cash collateral, with outstanding borrowings due
April 10, 1997. The available line of credit is reduced by outstanding
irrevocable letters of credit which totaled $1,201,909 at December 31, 1996. The
letters of credit may be drawn upon by major suppliers of the Company. The
letters of credit expire from March 1997 through April 1997. There are no
borrowing outstanding under this line of credit at December 31, 1996. Advances
under the note are secured by substantially all corporate assets, including
assignment of a certificate of deposit with a minimum amount of $500,000.
Interest is charged at 1% over the bank's index rate. The interest rate at
December 31, 1996 was 9.25%. The terms of the note agreement with the bank
require the Company to maintain certain financial ratios that the Company has
not attained. The Company is presently negotiating with the same bank for a
$500,000 line of credit that would be supported by the Company's accounts
receivable and cash collateral of a $200,000 certificate of deposit thus making
available the $300,000 of the preceding certificate of deposit. The requirement
for the $200,000 certificate of deposit would be reviewed in 90 days and could
be withdrawn subject to the Company meeting its planned objectives for that 90
day period. This line of credit would be used to support letters of credit with
the Company's suppliers.

 The Company believes that it has sufficient liquidity to support its
anticipated growth during the next twelve months. However, this belief is
predicated upon meeting the anticipated sales forecast. If the projections are
not met, the inventory reductions anticipated by the Company will not occur.
This would materially adversely affect the Company's cash position.

ITEM 7.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





                         REPORT OF INDEPENDENT AUDITORS


To the Stockholders
    and Board of Directors
VideoLabs, Inc.
Minnetonka, Minnesota

We have audited the accompanying balance sheet of VideoLabs, Inc. as of December
31, 1996 and 1995, and the related statements of operations, stockholders'
equity, and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VideoLabs, Inc. as of December
31, 1996 and 1995, and the results of its operations and its cash flows for the
years then ended in conformity with generally accepted accounting principles.




                                        Certified Public Accountants

Minneapolis, Minnesota                  Boulay, Heutmaker, Zibell & Co. P.L.L.P
February 11, 1997




<TABLE>
<CAPTION>
                                 VIDEOLABS, INC.

                                  Balance Sheet

                                                                      December 31
ASSETS                                                             1996          1995
                                                                ----------    ----------
<S>                                                             <C>           <C>
Current Assets
    Cash and cash equivalents                                   $  631,456    $  687,508
    Certificates of deposit- restricted                            513,788       576,900
    Marketable securities                                                        353,963
    Accounts receivable
        Trade accounts, less allowance for doubtful accounts
            of $25,400 in 1996 and 1995                            799,799     1,259,517
        Other receivables                                            6,157        15,843
    Inventories                                                  1,830,300     2,399,947
    Deferred income taxes                                                         30,000
    Prepaid expenses                                               154,749       106,802
                                                                ----------    ----------
            Total current assets                                 3,936,249     5,430,480

Property Held for Sale, net of $37,805 accumulated
    depreciation                                                    99,774

Property and Equipment
    Office and computer equipment                                  356,126       324,068
    Machinery and equipment                                        280,262       312,723
    European real estate                                                         137,579
    Leasehold improvements                                          21,249        21,249
    Vehicles                                                                      31,623
                                                                ----------    ----------
                                                                   657,637       827,242
    Less accumulated depreciation                                  355,877       265,107
                                                                ----------    ----------
            Net property and equipment                             301,760       562,135
                                                                ----------    ----------

            Total assets                                        $4,337,783    $5,992,615
                                                                ==========    ==========

Notes to Financial Statements are an integral part of this Statement
</TABLE>

                                 VIDEOLABS, INC.

                                  Balance Sheet


                                                         December 31
LIABILITIES AND STOCKHOLDERS' EQUITY                 1996            1995
                                                 -----------     -----------

Current Liabilities
    Accounts payable                             $ 1,057,869     $   770,356
    Current maturities of long-term debt              10,285
    Customer deposits                                 15,070          21,125
    Accrued compensation                             153,607          64,612
    Purchase commitments, reserves and other         575,000          48,000
                                                 -----------     -----------
            Total current liabilities              1,811,831         904,093


Long-Term Debt, net of current maturities             16,110

Commitments and Contingencies


Stockholders' Equity
    Common stock, $.01 par value;
        Authorized, 20,000,000 shares
        Issued and outstanding, 3,134,948
         shares in 1996 and 3,133,948 in 1995         31,349          31,339
    Preferred stock, $.01 par value;
        Authorized, 5,000,000 shares
        No shares issued and outstanding
    Additional paid-in capital                     5,514,293       5,511,653
    Unrealized gain on marketable securities                         219,215
    Accumulated deficit                           (3,035,800)       (673,685)
                                                 -----------     -----------
            Total stockholders' equity             2,509,842       5,088,522
                                                 -----------     -----------

            Total liabilities and
             stockholders' equity                $ 4,337,783     $ 5,992,615
                                                 ===========     ===========


Notes to Financial Statements are an integral part of this Statement.


                                 VIDEOLABS, INC.

                             Statement of Operations


                                                     Years Ended December 31
                                                       1996            1995
                                                   -----------     -----------
Sales                                              $ 7,405,548     $ 8,097,316
Cost of Sales
    Cost of goods sold                               4,752,871       5,057,222
    Adjustment for write down of
     inventories including purchase commitments      1,575,000
                                                   -----------     -----------
      Total cost of sales                            6,327,871       5,057,222
                                                   ===========     ===========

Gross Profit                                         1,077,677       3,040,094

Operating Expenses
    Selling expenses                                 1,677,189       1,647,029
    General and administrative expenses              1,613,067       1,104,572
    Research and development                           384,804         412,860
                                                   -----------     -----------
      Total operating expenses                       3,675,060       3,164,461
                                                   -----------     -----------

Operating Loss                                      (2,597,383)       (124,367)

Other Income (Expense)
    Interest income                                     54,007          98,456
    Interest expense                                    (2,117)
    Gain on sale of assets                             213,378         198,605
                                                   -----------     -----------
      Total other income, net                          265,268         297,061
                                                   -----------     -----------

Income (Loss) Before Provision for
 (Recovery of)Income Taxes                          (2,332,115)        172,694

Provision for (Recovery of) Income Taxes                30,000         (30,000)
                                                   -----------     -----------

Net Income (Loss)                                  ($2,362,115)    $   202,694
                                                   ===========     ===========

Earnings (Loss) per Share                          ($      .75)    $       .06
                                                   ===========     ===========

Notes to Financial Statements are an integral part of this Statement.


                                VIDEOLABS, INC.

                        Statement of Stockholders' Equity

                     Years Ended December 31, 1996 and 1995

                                                           Net
                                                       Unrealized
                          Common Stock     Additional    Gain On
                        ----------------    Paid-In     Marketable   Accumulated
                        Shares    Amount    Capital     Securities     Deficit
                        ------    ------    -------     ----------     -------

Balances -
   December 31, 1994   3,133,948  $31,339  $5,511,403                 ($876,379)

   Net income                                                           202,694

   Issuance of warrant                            250

   Net unrealized gain
     on marketable
     securities                                         $219,215
                       ---------   ------   ----------   --------     ---------

Balances -
   December 31, 1995   3,133,948   31,339   5,511,653    219,215       (673,685)

   Net loss                                                           (2,362,15)

   Exercise of warrant     1,000       10       2,640

   Change in unrealized
     gain on marketable
     securities                                         (219,215)
                       ---------   ------   ----------   --------     ---------

Balances -
   December 31, 1996    3,134,948  $31,349  $5,514,293  $    --    $($3,035,800)
                        =========  =======  ==========  ========   ============


Notes to Financial Statements are an integral part of this Statement.


<TABLE>
<CAPTION>
                                 VIDEOLABS, INC.

                             Statement of Cash Flows

                                                         Years Ended December 31
                                                           1996           1995
                                                       -----------     -----------
<S>                                                   <C>             <C>
Cash Flows from Operating Activities
    Net income (loss)                                  ($2,362,115)    $   202,694
    Adjustments to reconcile net income
     (loss) to net cash used
        for operations:
        Depreciation and amortization                      221,867         194,362
        Provision for losses on accounts receivable                          5,383
        Amortized premium on investments                       861
        Gain on sale of assets                            (213,378)       (170,943)
        Deferred income taxes                               30,000         (30,000)
        Change in assets and liabilities
            Interest receivable                              3,094           7,744
            Accounts receivable                            466,310        (265,716)
            Inventories                                    569,647      (1,088,210)
            Prepaid expenses                               (47,947)        (73,582)
            Accounts payable                               287,513        (272,978)
            Customer deposits                               (6,055)        (31,735)
            Accrued compensation                            88,995          27,266
            Purchase commitments, reserve and other        527,000          48,000
                                                       -----------     -----------
            Net cash used for operating activities        (434,208)     (1,447,715)

Cash Flows from Investing Activities
    Capital expenditures                                   (70,177)       (208,349)
    Proceeds from sale of equipment                         25,144             800
    Purchase of certificates of deposit                 (1,034,960)       (810,650)
    Proceeds from maturities of
       certificates of deposit                           1,098,072         333,750
    Purchase of marketable securities                      (63,713)
    Proceeds from sales and maturities of
       marketable securities                               365,468       2,645,743
                                                       -----------     -----------
            Net cash from investing activities             383,547       1,897,581

                                  - Continued -

Notes to Financial Statements are an integral part of this Statement.
</TABLE>


                                 VIDEOLABS, INC.

                       Statement of Cash Flows - Continued

                                                       Years Ended December 31

                                                           1996          1995
                                                        ---------     ---------
Cash Flows from Financing Activities
    Issuance of common stock and warrants               $   2,650     $     250
    Payments of long-term debt                             (8,041)         --
                                                        ---------     ---------
       Net cash (used for) from financing activities       (5,391)          250
                                                        ---------     ---------

Net (Decrease) Increase in Cash and Cash                  (56,052)      450,116
  Equivalents

Cash and Cash Equivalents - Beginning of Year             687,508       237,392
                                                        ---------     ---------

Cash and Cash Equivalents - End of Year                 $ 631,456     $ 687,508
                                                        =========     =========

Supplemental Cash Flow Information
    Cash paid during the year for interest              $   2,117     $    --
                                                        =========     =========
    Cash paid during the year for taxes                 $    --       $    --
                                                        =========     =========

Supplemental Schedule of Noncash Investing
  and Financing Activities
    Unrealized gain on marketable securities
      classified as available-for-sale,
      net of tax effect                                 ($219,215)    $ 219,215
                                                        =========     =========

    Capital lease obligations incurred                  $  34,436
                                                        =========

    During 1996, the Company retired $64,552 of fully depreciated fixed assets.

     During 1995, the Company converted  a note  receivable for $100,000 into
       88,888 shares of the debtor's common stock.


Notes to Financial Statements are an integral part of this Statement.


VIDEOLABS, INC.

                          Notes to Financial Statements

                           December 31, 1996 and 1995



1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF BUSINESS

VideoLabs, Inc. designs, manufactures and markets products for computer based
video systems and video communications. The products are sold throughout the
world. The Company extends credit in the normal course of business to its
customers who are generally companies in the computer industry. The Company
performs credit evaluations of its customers' financial condition and generally
requires no collateral.

ACCOUNTING ESTIMATES

Management uses estimates and assumptions in preparing these financial
statements in accordance with generally accepted accounting principles. Those
estimates and assumptions affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities, and the reported revenues
and expenses. Actual results could differ from those estimates.

The Company has recognized a write down of inventories including future purchase
commitments for a product that is not expected to be marketable. In addition,
the Company has recognized a reserve for future inventory obsolescence of
$60,000 in 1996 and $30,000 in 1995 due to the risk of continuing technological
changes in the industry. Management believes this will reduce inventory to the
lower of cost or market. While it is possible that the estimate will change
materially in the near term, no estimate can be made of the range of additional
loss, if any.

The Company has recorded a reserve for product warranties in the amount of
$35,000. This warranty accrual pertains primarily to new products shipped in the
last half of the year. It is reasonably possible that actual warranty costs
could differ from amounts estimated. It is not possible to estimate any
additional product warranty costs, if any, at this time.

Fourth quarter adjustments in 1996, which decreased income by approximately
$1,975,000, were made to reflect changes in the valuation of inventory,
retirement and severance charges, and for costs associated with litigation
involving the Company. The Company had fourth quarter adjustments in 1995, which
increased income by approximately $100,000, to adjust estimated realization of
deferred tax assets and gain on sale of assets.

In 1995, the Company recorded a net deferred tax asset of $30,000, reflecting
the benefit of approximately $591,000 of net operating loss carryforward,
reduced by a deferred tax allowance valuation. The amount of the deferred tax
asset considered to be realizable was reduced to $0 during 1996 due to the
uncertainty that the Company will be able to use the net operating loss
carryforwards in the future.

                                 VIDEOLABS, INC.

                          Notes to Financial Statements

                           December 31, 1996 and 1995



1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

CASH AND CASH EQUIVALENTS

For purposes of the statements of cash flows, the Company considers all highly
liquid debt instruments purchased with an original maturity of three months or
less to be cash. At times throughout the year, the Company's cash deposited in
financial institutions may exceed FDIC insurance limits.

MARKETABLE SECURITIES

The Company classifies its marketable debt securities as "held-to- maturity" if
it has the intent and ability to hold the securities to maturity. All other
marketable securities are classified as "available-for-sale". Securities
classified as held-to-maturity are carried at amortized cost. Securities
classified as available- for-sale are carried at their estimated fair value.
Realized gains and losses, determined using the average cost method, are
included in earnings; unrealized holding gains and losses on available-for- sale
securities are reported as a separate component of stockholders' equity, net of
any tax effect.

PROPERTY AND EQUIPMENT

Property and equipment is recorded at the lower of cost or fair value.
Depreciation is provided over estimated useful lives by the use of straight-line
and accelerated methods. The present values of capital lease obligations are
classified as long-term debt and the related assets are included in machinery
and equipment. Amortization of machinery and equipment under capital leases is
included in depreciation expense.

RESEARCH AND DEVELOPMENT COSTS

Research and development costs are charged to operations when incurred.

INCOME TAXES

Income taxes are provided for the tax effects of transactions reported in the
financial statements and consist of taxes currently due plus deferred taxes
related primarily to differences between the bases of accounts receivable,
inventory, property and equip ment, and certain accrued liabilities for
financial and income tax reporting. Deferred taxes are also recognized for
operating losses that are available to offset future taxable income and tax
credits that are available to offset future income taxes payable. Deferred tax
assets are subject to a valuation allowance based on the esti mated realization
of those assets.

INVENTORIES

Materials and work-in-process are stated at the lower of average cost or market.
Finished goods are stated at the lower of moving average cost or market.

ADVERTISING

The Company expenses the costs of advertising as incurred. Advertising expense
was $351,008 and $315,132 in 1996 and 1995, respectively.

EARNINGS (LOSS) PER COMMON SHARE

Earnings (loss) per common share amounts were computed using the weighted
average number of shares outstanding during each period. The weighted average
number of shares outstanding for the years ended December 31, 1996 and 1995 was
3,134,498 and 3,133,948, respectively. During 1996, stock options and warrants
for the purchase of common stock were anti-dilutive and have not been included
in these computations. The fully diluted weighted average number of shares
outstanding for 1995 was 3,183,948, however, this had no effect on earnings per
share.

NEWLY ISSUED ACCOUNTING STANDARDS

In February 1997, Statement of Financial Accounting Standards No. 128, "Earnings
Per Share" was approved for issuance. The Company will adopt this Statement in
fiscal 1997. The effect of this Statement has not been determined, however, the
impact on the Company's financial position and results of operations is not
expected to be material.

2.  MAJOR CUSTOMERS AND SUPPLIERS

In 1996, the Company has two customers who accounted for approximately $144,000
of the outstanding trade accounts receivable balance at December 31, 1996.

In 1995, the Company derived approximately $1,025,000 of its revenue from sales
to a single customer. This customer also accounted for approximately $256,000 of
the outstanding trade accounts receivable balance at December 31, 1995, which
amount was secured by a letter of credit.

During 1996 and 1995, the Company had total sales outside the United States of
approximately $2,907,000 and $4,110,000, respectively. Of these amounts
approximately $2,244,000 and $2,071,000, respectively, were sales to customers
in Europe, and $539,000 and $2,039,000, respectively, were sales to customers in
the Asia/Pacific region.

In 1996 and 1995, the Company had a supplier from which it made purchases of
$1,600,000 and $1,900,000, respectively. Although no long-term supply contract
exists, the Company believes there are alternative suppliers of this raw
material.

At December 31, 1996 the Company had purchase commitments with four suppliers in
the amount of $1,626,000 (See Note 14).

3.  MARKETABLE SECURITIES

At December 31, 1996 the Company held no investments. The cost and fair value of
the Company's investments in marketable debt and equity securities at December
31, 1995 was as follows:


                                                                         Gross
                                   Amortized        Unrealized           Fair
                                     Cost             Gains              Value
                                     ----             -----              -----
December 31, 1995
    Available-for-Sale
        Equity securities          $ 71,875          $219,215          $291,090
    Held-to-Maturity
        U.S. Treasury Securities     62,873                              62,873
                                   --------          ---------         --------

           Totals                  $134,748          $219,215          $353,963
                                   ========          ========          ========

The U.S. Treasury Securities matured in 1996. The amortized cost basis was
$62,000 and there was no realized gain or loss. Proceeds from sales of
securities held as available-for-sale were $303,456 and $131,743 in 1996 and
1995, respectively. During 1996 and 1995 the Company realized gains of $231,582
and $103,618, respectively, from sales of available-for-sale marketable
securities.

4.  NOTE RECEIVABLE

On December 30, 1993, the Company sold the rights to a teleconferencing codec (a
data compression and decompression hardware and software product) which it had
been developing since the Company's inception. The sale, to a start-up company
owned by a VideoLabs, Inc. director and stockholder, also included certain
equipment. The Company received a $100,000 note in this transaction which was
converted into common stock of the debtor in 1995 (Note 3). Deferred profit of
$95,000 was recognized in 1995 when the note was converted to common stock.

5.  INVENTORIES

Inventories consisted of the following at December 31:

                                                  1996                    1995
                                                  ----                    ----

      Materials                              $2,137,687              $1,822,647
      Work-in-process                           335,486                 243,895
      Finished goods                            747,127                 363,405
                                             ----------              ----------
                                              3,220,300               2,429,947

      Reserves for inventory write down and
        obsolescence                         (1,390,000)                (30,000)
                                             ----------              ----------
                                             $1,830,300              $2,399,947
                                             ==========              ==========



6.  EUROPEAN REAL ESTATE

During fiscal 1994, the Company purchased real estate in the Netherlands for use
as an office and residence by its European salesperson who is a related party.
The residence was provided to the salesperson as part of his compensation. The
Company no longer employs a salesperson in Europe and the residence is listed
for sale.

7.  LINE OF CREDIT

The Company has a discretionary working capital line of credit with its bank of
the lesser of $1,500,000 or 80% of eligible accounts receivable (as defined)
plus $500,000 in cash collateral, with outstanding borrowings due April 10,
1997. The available line of credit is reduced by outstanding irrevocable letters
of credit which totaled $1,201,909 at December 31, 1996. The letters of credit
may be drawn upon by major suppliers of the Company. The letters of credit
expire from March 1997 through April 1997. There were no borrowings outstanding
under this line of credit at December 31, 1996. Advances under the note are
secured by substantially all corporate assets, including assignment of a
certificate of deposit with a minimum amount of $500,000. Interest is charged at
1% over the bank's "index rate". The interest rate at December 31, 1996 was
9.25%. The terms of the note agreement with the bank require the Company to
maintain certain financial ratios. The Company was not in compliance with all
such terms of the agreement at December 31, 1996. Such lack of compliance may
prevent the Company from drawing on the line of credit.

During 1995, the Company had a discretionary working capital line of credit with
its bank of the lesser of $1,000,000 or 75% of eligible accounts receivable (as
defined), with outstanding borrowings due July 26, 1996. The Company was
required to maintain at least a 50% cash collateral with its bank against all
loan advances and/or letter of credit commitments throughout the year. Any
credit available in excess of $1,000,000 was required to be secured by equal
cash deposits. Advances under the note are secured by substantially all
corporate assets. Interest was charged on borrowings at 1% over the bank's
reference rate, which was 8.5% at December 31, 1995. There were no borrowings
under this line of credit at December 31, 1995. The terms of the note agreement
with the bank required the Company to maintain certain financial ratios.

At December 31, 1995, the available balance on the line of credit of $1,216,000
was reduced by outstanding, irrevocable bank letters of credit totaling
$1,153,500 which were secured by certificates of deposit of $576,900.

8.  LONG-TERM DEBT

Long-term debt consists of the following at December 31, 1996:

     Capital lease obligations, at implicit
     rates from 12% to 14%, payable in
     installments to 1999                                        $26,395
        Less amounts due within one year                          10,285
                                                                 -------

        Net long-term debt                                       $16,110
                                                                 =======


Scheduled maturities of long-term debt are as follows at December 31, 1996:

     1997                                         $10,285
     1998                                          11,693
     1999                                           4,417
                                                  -------

               Total long-term debt               $26,395
                                                  =======

9.  LEASE OBLIGATIONS

The Company leases various items of equipment over terms of 3 to 5 years. The
Company also leases office and warehouse space. Equipment leases expire at
varying dates over the next three years. The office and warehouse lease expires
in September 1997. The Company is obligated to pay costs of property taxes and
operating costs under the terms of the office and warehouse lease.

Property and equipment includes the following amounts for capital leases at
December 31, 1996:

       Machinery and equipment                     $34,436
       Accumulated amortization                      4,384
                                                   -------

          Net equipment under capital leases       $30,052
                                                   =======


At December 31, 1996, the Company had the following minimum commitments for
payments of rentals under leases which at inception had a noncancellable term of
more than one year:


                                                  Operating             Capital
                                                    Leases              Leases
                                                    ------              ------
       1997                                        $42,615             $13,101
       1998                                          1,511              13,101
       1999                                                              4,568
                                                   -------             -------


           Total lease commitments                 $44,126              30,770
                                                   =======

           Less amount representing interest                             4,375
                                                                       -------

           Present value of minimum lease payments
              (included in long-term debt)                             $26,395
                                                                       =======

Rental expense for operating leases totaled $67,755 and $56,899 in 1996 and
1995, respectively.

10.  STOCKHOLDERS' EQUITY

The Company has outstanding warrants to purchase common stock at prices ranging
from $1.50 to $3.50. Expiration dates vary from July 1997 to November of 2000.
Following is a summary of transactions:


                                                  Shares Under Warrants
                                                  ---------------------
                                                  1996             1995
                                                  ----             ----

     Outstanding, beginning of year               820,264        818,264
         Exercised during the year                 (1,000)
         Granted during the year                                   2,000
                                                  -------        -------

     Outstanding, end of year                     819,264        820,264
                                                  =======        =======


11.  STOCK BASED COMPENSATION

The Company has a qualified incentive stock option plan, whereby options to
purchase shares of the Company's common stock are granted at a price not less
than the fair market value of the stock at the date of grant. Each option
expires no later than ten years from the date of grant. If options are granted
to persons owning more than ten percent of the voting stock of the Company, the
Plan provides that the exercise price shall not be less than 110% of the fair
market value per share at the date of grant, and will expire no later than five
years from the date of grant. The plan has authorized 300,000 options for the
purchase of Company stock.

The Company has another incentive stock option plan, with 500,000 authorized
options to purchase the Company's stock. The plan is substantially the same as
the plan discussed above. However, the exercise price may be lower than, greater
than, or equal to the stock price at the date of issuance.

The fair value of each option grant is estimated on the date of grant using the
Black-Sholes option-pricing model with the following weighted-average
assumptions used for grants in 1996 and 1995, respectively; dividend yield of 0%
for all years; expected volatility of 71% and 48%; risk-free interest rates of
5.8 and 6.0 percent; and expected lives of four years.

A summary of the Company's stock option plans as of December 31, 1996 and 1995
and changes during the years ending on those dates is listed below:


                                         1996                      1995
                              --------------------------  ----------------------
                                        Weighted-                Weighted-
                                        Average                  Average
                              Shares    Exercise Price   Shares   Exercise Price
                              ------    --------------   ------   --------------

Outstanding at beginning
  of year                    200,000             $2.51  127,528           $2.98
Granted                      255,000               .81  114,000            2.19
Expired                            -                 -        -               -
Forfeited                    (50,000)             2.79  (41,528)           3.04
                             -------                    -------
Outstanding at end of year   405,000              1.82  200,000            2.51
                             =======                    =======


Options exercisable at       226,750                     85,500
  year end
Weighted-average fair
  value of options
  granted during
  the year                      $.47                       $.97



The following table summarizes information about fixed stock options outstanding
at December 31, 1996.

<TABLE>
<CAPTION>

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

             $2.65            12,000                .8 years               12,000        In whole or in part over four years.
              3.13            31,000               1.8 years               15,500        25% each year for four years.
              2.13            97,000               8.8 years               24,250        25% each year for four years.
              2.81            10,000               2.8 years               10,000        In whole or in part over four years.
               .81            90,000               4.0 years                             25% each year for for years.
               .81           165,000               5.0 years              165,000        In whole or in part over ten years.
                             -------                                      -------

                             405,000                                      226,750
                             =======                                      =======
</TABLE>

The Company has chosen to account for stock based compensation in accordance
with APB Opinion 25. If compensation cost would have been recognized in
accordance with Statement of Financial Accounting Standards No. 123,
compensation cost would have been $119,850, which would have increased the net
loss by the same amount and loss per share by $.04 in 1996.


12.  FAIR VALUE OF FINANCIAL INSTRUMENTS

Estimated fair values of the Company's financial instruments are as follows at
December 31, 1996 and 1995:


                                      1996                        1995
                           -------------------------    -----------------------
                             Carrying          Fair      Carrying        Fair
                              Amount          Value       Amount         Value
                              ------          -----       ------         -----

   Cash and equivalents      $631,456       $631,456     $687,508      $687,508
   Certificate of deposit     513,788        513,788      576,900       576,900
   Marketable securities                                  353,963       353,963
                           ----------     ----------   ----------    ----------

                           $1,145,244     $1,145,244   $1,618,371    $1,618,371
                           ==========     ==========   ==========    ==========


The carrying values of cash and equivalents and certificates of deposit
approximate fair values. The fair value of marketable securities were estimated
at 50% of their quoted market price due to restrictions on sale and uncertainty
as to the volatility of the market price of this investment in a start-up
company.

13.  INCOME TAXES

The income tax provision consists of the following components:


                                                               1996      1995
                                                               ----      ----

        Current                                                         $69,000
        Deferred                                             $30,000    (30,000)
        Tax benefit of net operating loss carryforward                   69,000
                                                             -------   --------

        Net provision for (recovery of) income taxes         $30,000   ($30,000)
                                                             =======   ========

The provision for (recovery of) income taxes differs from that which would
result from applying Federal statutory rates to the earnings (loss) before
income taxes because a valuation allowance has been provided to reduce the
deferred tax asset to the amount that is estimated to be realized. This
difference is reconciled as follows:

                                                       1996               1995
                                                       ----               ----

        Federal statutory rate                         34.0%              34.0%
        State tax rate - net                            6.5                6.5
        Permanent differences                             0                2.2
        Net operating loss                            (77.1)             (42.7)
        Valuation allowance                            35.3               17.4
                                                       ====               ====

        Effective tax rate                             (1.3%)             17.4%
                                                       ====               ====


The total deferred tax assets and liabilities included in the net deferred tax
balance are as follows:


                                                          1996          1995
                                                          ----          ----

      Deferred tax assets (primarily inventory
        reserve, litigation reserve, net
        operating loss and tax
        credit carryforward)                          $1,061,000       $292,000
      Deferred tax liabilities (property
        and equipment)                                   (11,000)       (28,000)
      Deferred tax asset valuation allowance          (1,050,000)      (234,000)
                                                      ----------       --------

     Net deferred taxes                               $     --         $ 30,000
                                                      ==========       ========

The net increase in the valuation allowance was $816,000 and $102,000 in 1996
and 1995, respectively.

At December 31, 1996, for income tax purposes, the Company had a federal net
operating loss carryforward of approximately $819,000 and a general business
credit carryforward of approximately $58,000 available to be carried to future
periods. The net operating loss carryforward and general business credit
carryforward expire in 2008 through 2011 if not used.

14.  COMMITMENTS AND CONTINGENCIES

The Company has accrued a loss on purchase commitments and established a reserve
for pending litigation. The Company has purchase commitments related to raw
materials for a product the Company will not be able to bring to market. The
Company is a defendant in a lawsuit by a former consultant claiming damages for
payment of royalties on products developed by the claimant. A tentative
settlement has been reached, and the settlement amount is within the amount
accrued.

15.  EMPLOYEE BENEFIT PLAN

The Company sponsors a discretionary 401(k) profit sharing plan and trust
covering employees who are over 18 years of age and have completed 90 days of
service. The Company made no contributions to the Plan in 1996 and 1995.

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

     The Company has not changed public accountants and has not had any
disagreements with such accountants on accounting and disclosure matters.


                                    PART III

      Certain information required by Part III is omitted from this report in
that the Registrant will file a definitive Proxy Statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this report, and certain information included therein
is incorporated herein by reference. Only those sections of the Proxy Statement
which specifically address the items set forth herein are incorporated by
reference.


ITEM 9.   DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS

      The information required by this Item is incorporated by reference to the
Company's Proxy Statement.

ITEM 10.  EXECUTIVE COMPENSATION

      The information required by this item is incorporated by reference to the
Company's Proxy Statement.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

      The information required by this item is incorporated by reference to the
Company's Proxy Statement.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

      The information required by this item is incorporated by reference to the
Company's Proxy Statement.

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

(a)  The following documents are filed as a part of this report.

      1.  Financial Statements:  The following Financial Statements
of  the Company and Report of Independent Auditors are incorporated
as Item 7 of this report.

          Balance Sheet - December 31, 1996 and 1995.

          Statement of Operations - Years Ended December 31, 1996 and 1995.

          Statement of Stockholders' Equity - Years Ended December 31, 1996 and
          1995.

          Statement of Cash Flows - Years ended December  31,  1996
          and 1995.

          Notes to Financial Statements.

          Report of Independent Auditors.

          Financial Data Schedule

      2. Financial Statement Schedules: The following financial statement
schedules of the Company for the fiscal year ended December 31, 1996 are filed
as part of this Report and should be read in conjunction with the Financial
Statements of the Company.

      Schedule
         I     Marketable securities at December 31, 1996 see note 3, to the
Financial Statements.

      3. Exhibits: The exhibits listed in the following Index to Exhibits are
filed as a part of, or incorporated by reference into this Report.

     Exhibit      Form SB-2*
        No.       Exhibit No.      Description
        ---       -----------      -----------
       (3)(i)      3.1             Certificate of Incorporation

       (3)(ii)     3.2             by-laws

       (4)         Pg. 29          Instruments defining the rights of
                                   security holders, including indentures.

       (10)                        Material contracts.
       (10)(i)     1.1             Underwriting Agreement
       (10)(ii)    1.2             Selected Dealer Agreement
       (10)(iii)   4.2             Warrant to Purchase Shares of Common
                                    Stock
       (10)(iv)    4.3             Bridge Note
       (10)(v)     4.4             Bridge Warrant
       (10)(vi)    10.3            Settlement and License Agreement
       (10)(vii)   10.4            Design Royalty Agreement
       (10)(viii)  10.5            Waiver of Contract Rights by Messrs.
                                    Johnson, Craven, Clapp and Collins
       (10)(ix)    10.6            Johnson Employment Agreement
       (10)(x)     10.8            Asset Sale Agreement with RSI (formerly
                                    Rocket Science, Inc.)
       (10)(xi)    10.14           Krekelberg Employment Agreement
       (10)(xii)   10.13            Suick Bay Technologies Royalty
                                    Agreement
       (10)(xiii)  1.1             Underwriting Agreement
       (10)(xiv)   10.10           CLI Purchase Order
       (10)(xv)    10.15           Underwriter lockup Agreements
       (10)(xvi)   10.1            Office Warehouse Lease

       (10)(xvii)  10.7            Letter of Credit Americana Bank-filed
                                   herewith
       (10)(xviii)                 Johnson  Retirement Agreement-filed herewith
       (10)(xix)                   Hansen Consulting Agreement-filed herewith
       (10)(xx)                    Broghammer Consulting Agreement-filed
                                   herewith
       (27)                        Financial Data Schedule-filed herewith

                    Footnote No.
                    ------------
        (11)          1.           Statement regarding computation of per
                                    share earnings

        (13)          2.           Annual report to security holders,
                                    Form 10-Q or quarterly report to security
                                    holders

        (25)                       Power of Attorney-filed herewith

*   Incorporated by reference to the exhibit filed with the Registrants
Registration Statement on Form SB-2 filed March 26, 1994, and amended on April
27, 1994, which became effective on May 10, 1994.

1.  Incorporated by reference to Company Annual Report to Shareholders.

2.  Incorporated by reference to Annual Report to Shareholders.

(b)  Reports on Form 8-K

     On December 4, 1995, the following information was reported on
form 8-K

      David E. Krekelberg, Vice President of Engineering, resigned from the
Board of Directors of the Company effective November 29, 1995, and as an officer
and employee of the Company effective December 31, 1996.

     On January 15, 1996, the following information was reported on
form 8-K

      Alvin J. Porter, resigned from the Board of Directors of the Company
effective December 29, 1995. The Company does not anticipate that the vacancy on
the board of directors left by Mr. Porter will be filled.

     On November 8, 1996, the following information was reported on
form 8-K

      VideoLabs announced the retirement of its CEO and President, Ward C.
Johnson. Johnson was a founder of the Company and has been President since 1992.
Johnson will remain as Chairman of the Board, and a Director of VideoLabs until
the next annual meeting of shareholders. He will also continue to assist in
bringing several new product introductions to completion.

      Mr.  Johnson's successor is James Hansen, a business advisor.
Hansen will serve as CEO and President on an interim basis until  a
permanent selection can be made.  Mr. Hansen will provide strategic
input  and  leadership, and evaluate potential options to  optimize
shareholder value for the Company.


SIGNATURES

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.



                                   VIDEOLABS, INC.




                                   By:  /s/  James W. Hansen
                                         James W. Hansen
                                         President and CEO
Dated: March 26, 1997


POWER OF ATTORNEY

      KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints James W. Hansen and Jill R. Larson,
jointly and severally, attorneys-in-fact, each with the power of substitution,
for any and all capacities, to sign any amendments to this Report on Form
10-KSB, and to file the same, with exhibits thereto and all documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each said attorneys-in-fact, or his substitute
or substitutes, may do or cause to be done by virtue hereof.

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

Signature                               Title                    Date
---------                               -----                    ----

/s/James W. Hansen
James W. Hansen               President, Treasurer          March 26, 1997
                              Chief Executive Officer,

/s/ Ward C. Johnson
Ward C. Johnson               Director,                     March 26, 1997

/s/ Richard F. Craven
Richard  F. Craven            Director.                     March 26, 1997


/s/ John A. Collins
John A. Collins               Director.                     March 26, 1997