**U. S. SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**
| **x**                                                                                                                                                                                                                                                                                                                                      | **QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**        |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                                                                                 |
| **For the  quarterly period ended September 30, 2006, or**                                                                                                                                                                                                                                                                                 |
| ** **                                                                                                                                                                                                                                                                                                                                 |
| **o**                                                                                                                                                                                                                                                                                                                                      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                                                                                                 |
| **For the  transition period from                       to                             .** |

 

**CommissionFile Number 1-11860**

**Focus Enhancements, Inc.**

(Name of Issuer inits Charter)

| **Delaware**                     |   | **04-3144936**       |
|----------------------------------|--------|----------------------|
| (State or Other  Jurisdiction of |   | (I.R.S. Employer     |
| Incorporation or  Organization)  |   | Identification  No.) |

**1370 DellAve**

**Campbell, CA 95008**

(Address ofPrincipal Executive Offices)

**(408) 866-8300**

(Issuer’s TelephoneNumber, Including Area Code)

Check whether the Issuer(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchother 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.  xYes  No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

Large acceleratedfiler: o Accelerated filer:  o Non-acceleratedfiler: x

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes oNo x

As of the close ofbusiness on November 7, 2006, there were 70,764,700 million shares of FocusEnhancement’s common stock issued and outstanding.

Documents Incorporated byReference: None

 

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**FOCUSENHANCEMENTS, INC.**

**INDEX**
| ** **                          | ** **                                                                                  | Page       |
|-------------------------------------|---------------------------------------------------------------------------------------------|------------|
| ** **                          | ** **                                                                                  | **Number** |
| **PART  I - FINANCIAL INFORMATION** |                                                                                        |
|                                |                                                                                        |
| **Item 1.**                         | Financial Statements  (unaudited):                                                          |       |
| ** **                          | Condensed Consolidated Statements of Operations                                             | 2          |
| ** **                          | Condensed Consolidated Balance Sheets                                                       | 3          |
| ** **                          | Condensed Consolidated Statements of Cash Flows                                             | 4          |
| ** **                          | Notes to Condensed Consolidated Financial Statements                                        | 5          |
| ** **                          |                                                                                        |       |
| **Item 2.**                         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 20         |
| ** **                          |                                                                                        |       |
| **Item 3.**                         | Quantitative  and Qualitative Disclosures about Market Risk                                 | 29         |
| ** **                          |                                                                                        |       |
| **Item 4.**                         | Controls and  Procedures                                                                    | 29         |
| ** **                          |                                                                                        |       |
| **PART  II - OTHER INFORMATION**    |                                                                                        |
| ** **                          |                                                                                        |
| **Item 1.**                         | Legal Proceedings                                                                           | 30         |
| ** **                          |                                                                                        |       |
| **Item 1A.**                        | Risk  Factors                                                                               | 30         |
| ** **                          |                                                                                        |       |
| **Item 2.**                         | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 31         |
| ** **                          |                                                                                        |       |
| **Item 3.**                         | Defaults Upon  Senior Securities                                                            | 31         |
| ** **                          |                                                                                        |       |
| **Item 4.**                         | Submission of  Matters to a Vote of Security Holders                                        | 31         |
| ** **                          |                                                                                        |       |
| **Item 5.**                         | Other Information                                                                           | 31         |
| ** **                          |                                                                                        |       |
| **Item  6.**                        | Exhibits                                                                                    | 31         |
|                                |                                                                                        |       |
| **SIGNATURES**                      | 32                                                                                          |
| ** **                          |                                                                                        |
| **CERTIFICATIONS**                  | 33                                                                                          |

 

1

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**PART I - FINANCIAL INFORMATION**

**Item 1.**                          Financial Statements

**FocusEnhancements, Inc.**

**CondensedConsolidated Statements of Operations**

(In thousands,except per share amounts)

(Unaudited)
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                         | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|                                                               |       |                             |       |                             |       |   |   |   |   |
| Net revenue                                                        |       | $                                | 11,605     |                             | $          | 6,880 |   | $ | 27,195 |   | $ | 18,468 |   |
| Cost of revenue                                                    |       | 5,819                            |       | 4,360                            |       | 14,957 |   | 11,804 |   |
| Gross margin                                                       |       | 5,786                            |       | 2,520                            |       | 12,238 |   | 6,664 |   |
|                                                               |       |                             |       |                             |       |   |   |   |   |
| Operating expenses:                                                |       |                             |       |                             |       |   |   |   |   |
| Sales, marketing  and support                                      |       | 2,131                            |       | 1,783                            |       | 6,753 |   | 4,958 |   |
| General and  administrative                                        |       | 1,025                            |       | 925                              |       | 3,005 |   | 2,920 |   |
| Research and  development                                          |       | 3,114                            |       | 2,977                            |       | 8,961 |   | 10,260 |   |
| Amortization of  intangible assets                                 |       | 127                              |       | 127                              |       | 381 |   | 403 |   |
|                                                               |       | 6,397                            |       | 5,812                            |       | 19,100 |   | 18,541 |   |
| Loss from  operations                                              |       | (611                             | )          | (3,292                           | )          | (6,862 | ) | (11,877 | ) |
| Interest  expense, net                                             |       | (337                             | )          | (93                              | )          | (828 | ) | (174 | ) |
| Value of  derivative security                                      |       | —                           |       | —                           |       | (4,000 | ) | — |   |
| Change in value  of derivative security                            |       | —                           |       | —                           |       | (1,361 | ) | — |   |
| Other income  (expense), net                                       |       | 82                               |       | (10                              | )          | 150 |   | (50 | ) |
| Loss before  income tax expense (benefit)                          |       | (866                             | )          | (3,395                           | )          | (12,901 | ) | (12,101 | ) |
| Income tax  expense (benefit)                                      |       | —                           |       | (1                               | )          | 9 |   | 10 |   |
| Net loss                                                           |       | $                                | (866       | )                                | $          | (3,394 | ) | $ | (12,910 | ) | $ | (12,111 | ) |
|                                                               |       |                             |       |                             |       |   |   |   |   |
| Net loss per share                                                 |       |                             |       |                             |       |   |   |   |   |
| Basic and  diluted                                                 |       | $                                | (0.01      | )                                | $          | (0.05 | ) | $ | (0.19 | ) | $ | (0.20 | ) |
|                                                               |       |                             |       |                             |       |   |   |   |   |
| Weighted average number  of shares used in per share calculations: |       |                             |       |                             |       |   |   |   |   |
| Basic and diluted                                                  |       | 69,233                           |       | 62,268                           |       | 68,611 |   | 60,414 |   |

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

2

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**Focus Enhancements, Inc.**

**Condensed Consolidated Balance Sheets**

**(In thousands, except share and per share amounts)**

**(Unaudited)**
| ** **                                                                                                                                                                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| **Assets**                                                                                                                                                                                    | ** ** | ** **             | ** ** | ** **            | ** ** |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                               |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                     |       | $                      | 1,133      |                  | $          | 637 |   |
| Accounts receivable, net of allowances of $367 and  $418, respectively                                                                                                                        |       | 3,707                  |       | 3,197                 |       |
| Inventories                                                                                                                                                                                   |       | 4,551                  |       | 3,743                 |       |
| Prepaid expenses and other current assets                                                                                                                                                     |       | 1,183                  |       | 759                   |       |
| Total current assets                                                                                                                                                                          |       | 10,574                 |       | 8,336                 |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Long-term  assets:                                                                                                                                                                            |       |                   |       |                  |       |
| Property and equipment, net                                                                                                                                                                   |       | 1,023                  |       | 1,212                 |       |
| Other assets                                                                                                                                                                                  |       | 177                    |       | 54                    |       |
| Intangible assets, net                                                                                                                                                                        |       | 349                    |       | 866                   |       |
| Goodwill                                                                                                                                                                                      |       | 13,191                 |       | 13,191                |       |
|                                                                                                                                                                                          |       | $                      | 25,314     |                  | $          | 23,659 |   |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                 | ** ** | ** **             | ** ** | ** **            | ** ** |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Current  liabilities:                                                                                                                                                                         |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                              |       | $                      | 3,730      |                  | $          | 3,001 |   |
| Accrued liabilities                                                                                                                                                                           |       | 4,031                  |       | 3,292                 |       |
| Current portion of capital lease obligations                                                                                                                                                  |       | 24                     |       | 107                   |       |
| Borrowings under line of credit                                                                                                                                                               |       | 500                    |       | 2,966                 |       |
| Current portion of notes payable to bank                                                                                                                                                      |       | —                 |       | 3                     |       |
| Term loan                                                                                                                                                                                     |       | 700                    |       | 2,500                 |       |
| Total current liabilities                                                                                                                                                                     |       | 8,985                  |       | 11,869                |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Long-term  liabilities:                                                                                                                                                                       |       |                   |       |                  |       |
| Convertible notes                                                                                                                                                                             |       | 10,425                 |       | —                |       |
| Other liabilities                                                                                                                                                                             |       | —                 |       | 100                   |       |
| Capital lease obligations, net of current portion                                                                                                                                             |       | —                 |       | 10                    |       |
| Total liabilities                                                                                                                                                                             |       | 19,410                 |       | 11,979                |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Commitments and  contingencies (Note 10)                                                                                                                                                      |       |                   |       |                  |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Stockholders’  equity:                                                                                                                                                                   |       |                   |       |                  |       |
| Preferred stock, $0.01 par value; authorized  3,000,000 shares; 3,161 shares issued and outstanding at September 30, 2006  and December 31, 2005 (aggregate liquidation preference of $3,917) |       | —                 |       | —                |       |
| Common stock, $0.01 par value; 100,000,000 shares  authorized, 70,724,461 and 68,382,113 shares issued and outstanding at  September 30, 2006 and December 31, 2005, respectively             |       | 698                    |       | 674                   |       |
| Treasury stock at cost, 497,055 shares at September  30, 2006 and December 31, 2005                                                                                                           |       | (750                   | )          | (750                  | )          |
| Additional paid-in capital                                                                                                                                                                    |       | 108,322                |       | 101,297               |       |
| Deferred stock-based compensation                                                                                                                                                             |       | —                 |       | (214                  | )          |
| Accumulated other comprehensive income                                                                                                                                                        |       | (82                    | )          | 47                    |       |
| Accumulated deficit                                                                                                                                                                           |       | (102,284               | )          | (89,374               | )          |
| Total stockholders’ equity                                                                                                                                                               |       | 5,904                  |       | 11,680                |       |
|                                                                                                                                                                                          |       | $                      | 25,314     |                  | $          | 23,659 |   |

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

3

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**Focus Enhancements, Inc.**

**CondensedConsolidated Statements of Cash Flows**

(In thousands)

(Unaudited) 
| ** **                                                                                      | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                      | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
| Cash flows from  operating activities:                                                          |       |                             |       |   |   |
| Net loss                                                                                        |       | $                                | (12,910    | ) | $ | (12,111 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities:                    |       |                             |       |   |   |
| Depreciation and amortization                                                                   |       | 1,124                            |       | 1,015 |   |
| Stock-based compensation                                                                        |       | 494                              |       | 105 |   |
| Amortization of debt issuance costs                                                             |       | —                           |       | 40 |   |
| Interest on convertible notes payable                                                           |       | 689                              |       | — |   |
| Value of derivative security                                                                    |       | 4,000                            |       | — |   |
| Change in value of derivative security                                                          |       | 1,361                            |       | — |   |
| Changes in assets and liabilities:                                                              |       |                             |       |   |   |
| Accounts receivable                                                                             |       | (467                             | )          | (304 | ) |
| Inventories                                                                                     |       | (749                             | )          | 124 |   |
| Prepaid expenses and other assets                                                               |       | (638                             | )          | (277 | ) |
| Other assets                                                                                    |       | (123                             | )          |   |   |
| Accounts payable                                                                                |       | 714                              |       | 1,116 |   |
| Accrued liabilities                                                                             |       | 418                              |       | 935 |   |
| Net cash used in  operating activities                                                          |       | (6,087                           | )          | (9,357 | ) |
|                                                                                            |       |                             |       |   |   |
| Cash flows from  investing activities:                                                          |       |                             |       |   |   |
| Decrease in restricted cash                                                                     |       | —                           |       | 289 |   |
| Purchases of property and equipment                                                             |       | (412                             | )          | (496 | ) |
| Net cash used in  investing activities                                                          |       | (412                             | )          | (207 | ) |
|                                                                                            |       |                             |       |   |   |
| Cash flows from  financing activities:                                                          |       |                             |       |   |   |
| Proceeds from issuance of convertible debt                                                      |       | 10,000                           |       | — |   |
| Net proceeds from private offerings of common stock                                             |       | —                           |       | 1,564 |   |
| Repayment of lines of credit                                                                    |       | (2,966                           | )          | (375 | ) |
| Repayments of term loan                                                                         |       | (2,500                           | )          | (1,500 | ) |
| Repayments of short-term debt                                                                   |       | (3                               | )          | (33 | ) |
| Repayment of transaction costs related to  acquisition of Visual Circuits Corporation           |       | —                           |       | 225 |   |
| Proceeds from exercise of warrants                                                              |       | 499                              |       | — |   |
| Proceeds from exercise of common stock options, net                                             |       | 845                              |       | 57 |   |
| Payments under capital lease obligations                                                        |       | (93                              | )          | (62 | ) |
| Proceeds from issuance of escrow stock related to  acquisition of COMO Computer and Motion GmbH |       | —                           |       | 488 |   |
| Borrowings under term loan                                                                      |       | 700                              |       | 4,000 |   |
| Borrowings under lines of credit                                                                |       | 500                              |       | 2,585 |   |
| Net cash  provided by financing activities                                                      |       | 6,982                            |       | 6,949 |   |
|                                                                                            |       |                             |       |   |   |
| Effect of  exchange rate changes on cash                                                        |       | 13                               |       | (7 | ) |
|                                                                                            |       |                             |       |   |   |
| Increase(decrease)  in cash and cash equivalents                                                |       | 496                              |       | (2,622 | ) |
| Cash and cash  equivalents at beginning of period                                               |       | 637                              |       | 3,380 |   |
| Cash and cash  equivalents at end of period                                                     |       | $                                | 1,133      |   | $ | 758 |   |

 

The accompanying notesare an integral part of the condensed consolidated financial statements.

4

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**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

**1.**                                      **Description of Business**

FocusEnhancements, Inc. (“Focus” or “the Company”), headquartered in Campbell, California,is a leading designer of solutions in advanced, proprietary video and wirelessvideo technologies. Focus’ Semiconductor group develops integrated circuits (“ICs”)for high-performance applications in the video convergence market, includingintegrated internet protocol television (“IPTV”) set-top boxes and portablemedia players. Focus is currently developing a wireless IC chip set based onthe WiMedia Ultra Wideband (“UWB”) standard, designed to be compatible withwireless universal serial bus (“USB”) and used in personal computer (“PC”),consumer electronics and mobile electronics applications. Focus’ Systems groupdevelops video products for the digital media markets, with customers in thebroadcast, video production, digital signage and digital asset managementmarkets.

**2.****                                      Basisof Presentation – Interim Financial Information**

Theaccompanying unaudited condensed consolidated financial statements of Focushave been prepared in conformity with accounting principles generally acceptedin the United States of America and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not contain all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements. The year-endcondensed consolidated balance sheet data was derived from audited consolidatedfinancial statements, but does not include all disclosures required byaccounting principles generally accepted in the United States of America.

In the opinion ofmanagement, the condensed consolidated financial statements include alladjustments (consisting only of normal recurring adjustments) necessary for afair presentation of Focus’ financial position, operating results and cashflows for the periods presented. The results of operations for the three andnine months ended September 30, 2006 and cash flows for the nine months endedSeptember 30, 2006 are not necessarily indicative of the results that may beexpected for any future period.

The condensedconsolidated financial statements of Focus as of September 30, 2006 and for thethree and nine month periods ended September 30, 2006 and 2005 are unauditedand should be read in conjunction with the audited consolidated financialstatements for the year ended December 31, 2005, included in Focus’ AnnualReport on Form 10-K for the year ended December 31, 2005.

**3.**                                      Management’s Plans

The accompanying condensed consolidated financial statements have beenprepared on a going concern basis, which contemplates the realization of assetsand the satisfaction of liabilities in the normal course of business. For thenine months ended September 30, 2006 and the year ended December 31, 2005,Focus incurred net losses of $12.9 million and $15.4 million, respectively, andused net cash in operating activities of $6.1 million and $12.5 million,respectively. These results indicate that Focus may potentially be unable tocontinue as a going concern.

The condensedconsolidated financial statements do not include any adjustments relating tothe recoverability and classification of recorded asset amounts or the amountsand classification of liabilities that might be necessary should Focus beunable to continue as a going concern. Focus’ continuation as a going concernis dependent upon its ability to generate sufficient cash flows to meet itsobligations on a timely basis, to obtain additional financing as may berequired, and ultimately to return to profitability and significant positivecash flows.

Focushas historically met cash needs from the proceeds of debt, the sale of commonstock in private placements and the exercise of employee stock options andwarrants. Management continues to assess its product lines in light oftechnology trends and economic conditions, to identify how to enhance existingproduct lines or create new distribution channels.

5

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Focusreceived gross proceeds of $10.0 million from the issuance of securedconvertible notes to a group of private investors in January 2006. Whilemanagement believes that these funds, along with the cash flow generated byFocus’ expanding Systems business, should be adequate to enable Focus tocomplete its UWB engineering development and launch commercialization of itsUWB products, depending upon the results and timing of its UWB initiative andthe profitability of its Systems business, Focus may need to raise furthercapital in 2007. There can be no assurance that sufficient funds will beraised. Moreover, any equity financing or convertible debt financing would resultin dilution to Focus’ existing stockholders and could have a negative effect onthe market price of its common stock. Furthermore, any additional debtfinancing will result in higher interest expense.

Thereis no assurance that management’s plans will be successful, or if successful,that they will result in Focus continuing as a going concern.

**4.****                                     ****Equity-Based Compensation**

Prior to January1, 2006, Focus accounted for employee stock-based compensation using theintrinsic value method supplemented by pro forma disclosures in accordance withAccounting Principles Board (“APB”) Opinion No. 25 and Statement of FinancialAccounting Standards (“SFAS”) No. 123, “*Accounting for Stock-BasedCompensation*” (“SFAS 123”), as amended by SFAS No.148 “*Accounting for Stock-Based Compensation—Transition and Disclosures*”.Employee stock options granted by Focus with an exercise price equal to thegrant date fair value of the Company’s stock had no intrinsic value andtherefore no expense was recorded for these options under APB Opinion No. 25.Grants of restricted stock awards were measured at fair value on the date ofgrant based on the number of shares granted and the quoted price of the Company’scommon stock with such value recognized as an expense over the correspondingvesting period of the award.

On January 1,2006, Focus adopted SFAS No. 123 (revised 2004), “*Share-BasedPayment” (*“SFAS 123R”). SFAS 123R eliminates the alternative ofapplying the intrinsic value measurement provisions of APB Opinion No. 25 tostock compensation awards issued to employees. SFAS 123R requires companies to measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award. That cost will be recognized over the period duringwhich an employee is required to provide services in exchange for the award.Focus adopted SFAS 123R using the modified prospective transition approach andtherefore prior periods have not been restated to reflect the impact of SFAS123R. Under SFAS 123R, stock-based awards granted prior to its adoption will beexpensed over the remaining portion of their requisite service period. Theseawards will be expensed under the accelerated amortization method using thesame fair value measurements that were used in calculating pro formastock-based compensation expense under SFAS 123. For stock-based awards grantedon or after January 1, 2006, Focus will amortize stock-based compensationexpense on a straight-line basis over the requisite service period, which isgenerally a four year vesting period. SFAS 123R requires that the deferredstock-based compensation on the balance sheet on the date of adoption be nettedagainst additional paid-in capital. As of December 31, 2005, there was abalance of $214,000 of deferred stock-based compensation, which was nettedagainst additional paid-in capital on January 1, 2006.

6

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The effect ofrecording stock-based compensation for the three and nine months endedSeptember 30, 2006 was as follows:
| (In thousands, except per share data) | ** ** | **Three Months  Ended September  30, 2006** | ** ** | **Nine Months  Ended September  30, 2006** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
|                                                           |       |                                                       |       |                                                      |       |
| Stock-based  compensation expense by type of award:            |       |                                                       |       |                                                      |       |
| Employee stock options                                         |       | $                                                          | 134        |                                                      | $          | 408 |   |
| Restricted stock awards                                        |       | 37                                                         |       | 86                                                        |       |
|                                                           |       |                                                       |       |                                                      |       |
| Total stock-based compensation                                 |       | 171                                                        |       | 494                                                       |       |
|                                                           |       |                                                       |       |                                                      |       |
| Tax effect on  stock-based compensation                        |       | —                                                     |       | —                                                    |       |
|                                                           |       |                                                       |       |                                                      |       |
| Effect on net  loss                                            |       | $                                                          | 171        |                                                      | $          | 494 |   |
|                                                           |       |                                                       |       |                                                      |       |
| Effect on net loss per  share basic and diluted                |       | $                                                          | 0.00       |                                                      | $          | 0.01 |   |

 

The implementation ofSFAS 123R did not affect basic and diluted net loss per share nor cashflows from operations for the three months ended September 30, 2006 anddid not effect cash flow from operations for the nine months endedSeptember 30, 2006. For the three and nine months ended September 30,2005, Focus recognized $17,000 and $41,000, respectively, of employeestock-based compensation expense under the intrinsic value method.

At September 30,2006, Focus had the ability to issue an additional 479,628 shares of commonstock under its current stock option and incentive option plans, which includerestricted stock.

Stock Options

The exercise priceof each stock option equals the market price of Focus’ common stock on the dateof grant. Option grants generally vest over four years and expire 5 to 10 yearsfrom the grant date. The fair value of each option grant is estimated on thedate of grant using the Black-Scholes option pricing model. The weightedaverage assumptions used in the model are outlined in the following table:
|                                   | ** ** | **Three Months  Ended September  30, 2006** | ** ** | **Nine Months  Ended September  30, 2006** | ** ** |
|-----------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
|                              |       |                                                       |       |                                                      |       |
| Average expected  term of options |       | 4  years                                                   |       | 4  years                                                  |       |
| Risk-free rate  of interest       |       | 4.71%  - 5.11%                                             |       | 4.56%  - 5.11%                                            |       |
| Volatility of  common stock       |       | 81%                                                        |       | 81%                                                       |       |
| Dividend yield                    |       | 0%                                                         |       | 0%                                                        |       |

 

7

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A summary ofactivity related to Focus’ stock option incentive plans for the nine monthsended September 30, 2006 is presented below:
|                                                                                      | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Aggregate  Intrinsic  Value (000s)** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------|------------|
|                                                                                 |       |       |       |                                   |       |                                                |       |                                        |       |
| Options  outstanding at beginning of year                                            |       | 7,253,787  |       | $                                      | 1.10       |                                                |       |                                        |       |   |
| Options granted                                                                      |       | 892,199    |       | $                                      | 0.82       |                                                |       |                                        |       |   |
| Options  exercised                                                                   |       | (1,178,555 | )          | $                                      | 0.73       |                                                |       |                                        |       |   |
| Options canceled                                                                     |       | (459,574   | )          | $                                      | 1.11       |                                                |       |                                        |       |   |
|                                                                                 |       |       |       |                                   |       |                                                |       |                                        |       |
| Options  outstanding at September 30, 2006                                           |       | 6,507,857  |       | $                                      | 1.13       |                                                | 5.8        |                                        | $          | 2,168 |   |
|                                                                                 |       |       |       |                                   |       |                                                |       |                                        |       |
| Options vested  and exercisable and expected to be exercisable at September 30, 2006 |       | 6,167,155  |       | $                                      | 1.14       |                                                | 5.7        |                                        | $          | 2,006 |   |
|                                                                                 |       |       |       |                                   |       |                                                |       |                                        |       |
| Options vested and  exercisable at September 30, 2006                                |       | 4,419,455  |       | $                                      | 1.20       |                                                | 4.6        |                                        | $          | 1,220 |   |

 

The weighted average grant date fair value of optionsgranted in the three and nine months ended September 30, 2006 was $0.72 and$0.51 per share, respectively. The total intrinsic value of options exercisedduring the three and nine months ended September 30, 2006 was $145,000 and$194,000, respectively. At September 30, 2006, Focus had $690,000 ofunrecognized stock compensation expense, net of estimated forfeitures, relatedto stock option plans, which will be recognized over the weighted averageremaining service period of 2.0 years. Cash received from stock optionexercises was $399,000 and $856,000 for the three and nine months endedSeptember 30, 2006, respectively. Focus settles employee stock option exerciseswith newly issued shares of common stock.

The optionsoutstanding and exercisable at September 30, 2006 were in the followingexercise price ranges:
| **Options Outstanding at September 30, 2006** | ** ** | **Options Vested and Exercisable  at September 30, 2006** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                                                             | ** ** | ** **                                                                              | ** ** | ** ** | ** ** | **Weighted Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                             | ** ** | ** **                                                                              | ** ** | **Weighted Average** | ** ** | **Remaining** | ** ** | ** ** | ** ** | **Weighted Average** | ** ** |
| **Range of Exercise Price**                             | ** ** | **Shares**                                                                              | ** ** | **Exercise Price** | ** ** | **Contractual Life** | ** ** | **Shares** | ** ** | **Exercise Price** | ** ** |
| $0.430 — $0.970                                                   |       | 1,434,938                                                                               |       | $ | 0.71 |   | 6.6 yrs |   | 703,861 |   | $ | 0.69 |   |
| $0.971 — $1.430                                                   |       | 4,211,644                                                                               |       | $ | 1.15 |   | 5.7 yrs |   | 2,867,481 |   | $ | 1.17 |   |
| $1.431 — $1.970                                                   |       | 772,411                                                                                 |       | $ | 1.62 |   | 4.8 yrs |   | 763,124 |   | $ | 1.62 |   |
| $1.971 — $10.210                                                  |       | 88,864                                                                                  |       | $ | 2.47 |   | 5.8 yrs |   | 84,989 |   | $ | 2.49 |   |
|                                                                   |       |                                                                                    |       |   |   |   |   |   |   |   |   |
|                                                                   |       | 6,507,857                                                                               |       | $ | 1.13 |   | 5.8 yrs |   | 4,419,455 |   | $ | 1.20 |   |

 

8

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Restricted Stock Awards

A summary ofactivity related to Focus’ restricted stock awards for the nine months endedSeptember 30, 2006 is presented below:
|                                                                       | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|
|                                                                  |       |       |       |                                                    |       |
| Non-vested  restricted stock shares outstanding at beginning of year  |       | 245,000    |       | $                                                       | 1.11       |   |
| Restricted stock  shares granted                                      |       | 570,176    |       | $                                                       | 0.69       |   |
| Restricted stock  shares vested                                       |       | (61,250    | )          | $                                                       | 1.11       |   |
| Restricted stock  shares cancelled                                    |       | (23,619    | )          | $                                                       | 0.82       |   |
|                                                                  |       |       |       |                                                    |       |
| Non-vested restricted  stock shares outstanding at September 30, 2006 |       | 730,307    |       | $                                                       | 0.79       |   |

 

At September 30, 2006,Focus had $383,000 of unrecognized compensation expense, net of estimatedforfeitures, related to restricted stock awards, which will be recognized overthe weighted average period of 3.1 years. During the nine months ended September 30, 2006, 61,250 shares ofrestricted stock vested with a fair market value of $41,000. No restrictedstock vested during the three months ended September 30, 2006.

Pro Forma Information under SFAS 123 for the Three andNine Months Ended September 30, 2005

Prior to 2006, Focus followed the disclosure-onlyprovisions of SFAS 123. The following table illustrates the effect on net lossand net loss per share for the three and nine months ended September 30, 2005 hadthe fair value recognition provisions of SFAS 123 been applied to optionsgranted under Focus’ equity-based employee compensation plans. For purposes ofthis pro forma disclosure, the estimated value of the options is recognizedover the options’ vesting periods. If Focus had recognized the expense ofequity programs in the condensed consolidated statements of operations,additional paid-in capital would have increased by a corresponding amount.
| **(In thousands, except per share data)**                                               | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
|                                                                                                             |       |                                                           |       |                                                          |       |
| Reported net  loss                                                                                               |       | $                                                              | (3,394     | )                                                             | $          | (12,111 | ) |
| Add: Stock-based  compensation expense included in net loss                                                      |       | 17                                                             |       | 41                                                            |       |
| Deduct:  Stock-based compensation determined under fair value method for all awards,  net of related tax effects |       | (226                                                           | )          | (937                                                          | )          |
|                                                                                                             |       |                                                           |       |                                                          |       |
| Pro forma net  loss                                                                                              |       | $                                                              | (3,603     | )                                                             | $          | (13,007 | ) |
|                                                                                                             |       |                                                           |       |                                                          |       |
| Reported net  loss per share                                                                                     |       | $                                                              | (0.05      | )                                                             | $          | (0.20 | ) |
|                                                                                                             |       |                                                           |       |                                                          |       |
| Basic and diluted pro  forma net loss per share                                                                  |       | $                                                              | (0.06      | )                                                             | $          | (0.22 | ) |

 

9

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For purposes of the weighted average estimated fairvalue calculations, the fair value of each stock option grant is estimated onthe date of grant using the Black-Scholes option pricing model and thefollowing assumptions:
|                                   | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
|                              |       |                                                           |       |                                                          |       |
| Average computed  life of options |       | 3.45  years                                                    |       | 3.28  years                                                   |       |
| Risk-free rate  of interest       |       | 3.9%  - 4.2%                                                   |       | 3.0%  - 4.2%                                                  |       |
| Volatility of  common stock       |       | 86%                                                            |       | 86%  - 88%                                                    |       |
| Dividend yield                    |       | 0%                                                             |       | 0%                                                            |       |

 

Based on the Black-Scholes option pricing model, theweighted average grant date fair value of employee stock option grants was$0.52 and $0.54 per share for the three and nine months ended September 30,2005

**5.**                                      **Net Loss per Share**

Basic net loss per share was computed by dividing thenet loss by the weighted average number of shares of common stock outstandingduring the period. Diluted net loss per share is computed by dividing the netloss by the weighted average number of shares of common stock and potentialcommon stock equivalents outstanding during the period, if dilutive. Options topurchase 6,507,857 and 7,488,758 shares of common stock, unvested shares ofrestricted stock of 730,307 and 245,000, warrants to purchase 5,195,261 and4,160,621 shares of common stock and 3,161 shares of preferred stockconvertible into 3,161,000 shares of common stock were outstanding at September30, 2006 and 2005, respectively, but were not included in the computation ofdiluted net loss per share for the three and nine month periods as the effectwould have been anti-dilutive. In addition, convertible notes that areconvertible into 10,425,000 shares of common stock were outstanding atSeptember 30, 2006, but were not included in the computation of diluted netloss per share for the three and nine month periods as the effect would havebeen anti-dilutive.

**6.**                                      Significant Customers

Sales to onecustomer accounted for 48% of Focus’ revenue in the three months endedSeptember 30, 2006.  Sales to onecustomer accounted for 26% of Focus’ revenue in the nine months ended September30, 2006.  No customer accounted for more than 10% of Focus’ revenue in the threeand nine months ended September 30, 2005.

One customer had accounts receivable balances in excess of 10% of Focus’total accounts receivable at September 30, 2006. This customer accounted for24% of Focus’ total accounts receivable at that date. As of December 31,2005, two distributors each represented approximately 12% of Focus’ accountsreceivable.

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**7.****                                      Goodwilland Intangible Assets**

Goodwill as of September30, 2006 and December 31, 2005 included the following:
| (In thousands) | ** ** | **Goodwill** | ** ** |
|---------------------|------------|--------------|------------|
|                |       |         |       |
| Videonics           |       | $            | 5,070      |   |
| Tview               |       | 121          |       |
| COMO                |       | 1,104        |       |
| Visual Circuits     |       | 6,896        |       |
|                |       |         |       |
|                |       | $            | 13,191     |   |

 

The following tablesprovide a summary of the carrying amounts of intangible assets:
|                         | ** ** | **September 30, 2006** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | ** **                       | ** ** | **Accumulated** | ** ** | **Net** | ** ** |
| **(In thousands)** | ** ** | **Gross Amount**            | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                    |       |                             |       |   |   |   |   |
| Existing  technology    |       | $                                | 3,945      |   | $ | (3,596 | ) | $ | 349 |   |
| Tradename               |       | 176                              |       | (176 | ) | — |   |
|                    |       |                             |       |   |   |   |   |
|                    |       | $                                | 4,121      |   | $ | (3,772 | ) | $ | 349 |   |

 
|                      | ** ** | **December 31, 2005** | ** ** |
|----------------------|------------|-----------------------|------------|
| ** **           | ** ** | ** **            | ** ** | **Accumulated** | ** ** | **Net** | ** ** |
| ** **           | ** ** | **Gross Amount**      | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                 |       |                  |       |   |   |   |   |
| Existing  technology |       | $                     | 3,945      |   | $ | (3,079 | ) | $ | 866 |   |
| Tradename            |       | 176                   |       | (176 | ) | — |   |
|                 |       |                  |       |   |   |   |   |
|                 |       | $                     | 4,121      |   | $ | (3,255 | ) | $ | 866 |   |

 

The total expected futureamortization related to intangible assets is provided in the table below:
| (In thousands)                    | ** ** | **Amortization** | ** ** |
|----------------------------------------|------------|------------------|------------|
|                                   |       |             |       |
| Three months  ending December 31, 2006 |       | $                | 292        |   |
| Fiscal year 2007                       |       | 57               |       |
|                                   |       |             |       |
|                                   |       | $                | 349        |   |

 

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**8.****                                      Inventories**

Inventories are stated atlower of cost (first-in, first-out) or market:
| (In thousands) | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------|------------|----------------------------------|------------|---------------------------------|------------|
|                |       |                             |       |                            |       |
| Raw materials       |       | $                                | 2,240      |                            | $          | 2,427 |   |
| Work in process     |       | 349                              |       | 146                             |       |
| Finished goods      |       | 1,962                            |       | 1,170                           |       |
|                |       |                             |       |                            |       |
|                |       | $                                | 4,551      |                            | $          | 3,743 |   |

 

**9.**                                      Borrowings
| (In thousands)                      | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
|                                     |       |                             |       |                            |       |
| Short-term debt:                         |       |                             |       |                            |       |
| Current portion of notes payable to bank |       | $                                | —     |                            | $          | 3 |   |
| Term loan                                |       | 700                              |       | 2,500                           |       |
| Accounts receivable-based line of credit |       | 500                              |       | 2,966                           |       |
|                                     |       | 1,200                            |       | 5,469                           |       |
| Long-term debt:                          |       |                             |       |                            |       |
| Convertible notes                        |       | 10,425                           |       | —                          |       |
|                                     |       |                             |       |                            |       |
|                                     |       | $                                | 11,625     |                            | $          | 5,469 |   |

 

AccountsReceivable-Based Line of Credit

InNovember 2004, Focus obtained a $4.0 million line of credit from Greater Bay Bank under which it can borrow upto 90% of its eligible outstanding accounts receivable. The credit line expireson December 24, 2006 as a result of an extension granted in November 2005 andis collateralized by a personal guarantee from Carl Berg, a Company directorand shareholder. In connection with this credit line, the bank has obtained afirst priority security interest in Focus’ accounts receivable through anagreement with Mr. Berg, which enables Mr. Berg to retain his existing securityinterest in all of Focus’ assets while subordinating his interest in Focus’accounts receivable.

The credit line is subject to ongoing covenantsincluding a covenant based on operating results. Borrowings under the creditline bear interest at a rate of prime plus 1%, which was 9.25% at September 30,2006. At September 30, 2006, there was $500,000 outstanding on this credit lineand Focus had the ability to borrow up to $2.9 million.  At September 30, 2006, Focus was not incompliance with the maximum net loss covenant. On November 8, 2006, Focus received a waiver from Greater Bay Bank.

TermLoan

On June28, 2005, Focus signed a term loan agreement with Greater Bay Bank under which Focus can borrow up to$2.5 million. The term loan has a maturity date of December 24, 2006. Mr. Berghas personally guaranteed the loan, which is interest only until maturity andis in addition to Focus’ existing $4.0 million accounts receivable-basedsecured line of credit that Focus has with this bank. Interest is payable underthis term loan at prime plus 1%, which was 9.25% at September 30, 2006. At September 30, 2006, there was $700,000outstanding balance under this term loan.

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Convertible Notes and Derivative Liability

On January 27,2006, Focus issued $10.0 million in aggregate principal amount of 10% securedconvertible notes due January 1, 2011 to certain purchasers. The following arethe key features of the notes: 

·                  Interest accrueson the principal amount of the notes at a rate of 10% per annum, payablesemi-annually on June 30 and December 30 of each year. 

·                  Interest due onthe first three semi-annual payments may, at the issuers option, be paid in theform of a note with the same terms and conditions of the original notes,including conversion rights. 

·                  The notes are convertible,at the option of the holder, into shares of Focus common stock at a conversionprice of $1.00 per share. The conversion price is subject to adjustment forstock splits, reverse stock splits, recapitalizations and similar corporateactions.

·                  The notes aresecured by all of the assets of Focus in accordance with the terms and subjectto the conditions contained in a security agreement entered into concurrentwith the issuance of the notes.

·                  The notes are redeemable, at theoption of Focus, at any time at a redemption price equal to 102% times the facerate of the notes, plus any accrued interest.

·                  Upona fundamental change, which includes a change in control of Focus or failure ofFocus’ common stock to be listed for quotation on the Nasdaq Stock Market oranother established automated over-the-counter trading marking in the UnitedStates, each holder of the notes may require Focus to repurchase all of itsdebt at a purchase price equal to 101% of the principal amount of the notesplus accrued and unpaid interest.

Pursuant to theRegistration Rights Agreement with the Purchasers dated January 24, 2006 (the “RegistrationRights Agreement”), Focus agreed to file a resale registration statementcovering the resale of the shares issuable to the investors upon the conversionof the notes. The due date may accelerate in the event Focus commences any caserelating to bankruptcy or insolvency, or related events of default. 

On May 10, 2006,the registration statement filed by Focus to register the shares underlying thenotes was declared effective by the Securities and Exchange Commission asrequired by the Registration Rights Agreement. Focus must maintain an effectiveregistration statement until the earlier to occur of (i) the date after whichall the shares registered there under have been sold or (ii) the date allshares underlying the notes may be sold without volume restrictions pursuant toRule 144(k). Subject to certain conditions, the holders of the convertiblenotes may, at their election, exchange the notes for interests in an entity orentities to which Focus’ semiconductor business is spun off, if such an eventoccurs prior to July 24, 2007, at a conversion rate equal to 1% of votinginterests in such other entity for every $400,000 of note principal, up to acollective maximum of 25% of the voting power of such other entity. As ofSeptember 30, 2006, no date has been set for the potential spin-off nor havethe exact assets and liabilities to be included in such a spin-off beendetermined.  

Pursuant toEmerging Issues Task Force (“EITF”) 00-19, “*Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock*” (“EITF 00-19”), Focus evaluated the registration rightsagreement and concluded that it triggers the “settlement in cash” assumptionthat underlies the separate evaluation of the derivative elements of thecontract. There is no alternative settlement option in the registration rightsagreement, even though the agreement is quiet as to penalties. The agreementrepresents a contingent liability that must be considered if registration isnot successfully maintained. In accordance with SFAS No. 133, “*Accounting for Derivative Instruments and Hedging Activities*”,(“SFAS 133”), Focus determined that the conversion feature of the notes met thecriteria of an embedded derivative and therefore the conversion feature of thedebt needed to be bifurcated and accounted for as a derivative. 

The conversion featurefails to qualify for equity classification under EITF 00-19, and must beaccounted for as a derivative liability. Focus accounts for derivativefinancial instruments in accordance with SFAS 133. Derivative financialinstruments are recorded as liabilities in the condensed consolidated balancesheets and measured at fair value. When available, quoted market prices areused in determining fair value. However, if quoted market prices are notavailable, Focus estimates fair value using either quoted market prices offinancial instruments with similar characteristics or other valuationtechniques. 

Using a binomialoptions valuation model, the fair value of the conversion option within theconvertible notes was initially computed at $4.0 million. The model usedseveral assumptions to determine the estimated fair value of the derivativeliability including: historical stock price volatility (utilizing a five-yearperiod), risk-free interest rate 

13

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(4.50%), remainingtime to maturity and the closing price of Focus’ common stock.  The value of this embedded derivativeinstrument was bifurcated from the debt host contract and recorded as aderivative liability, which resulted in a discount to the initial carryingamount of the convertible notes. The $4.0 million discount was immediatelyexpensed in the condensed consolidated statements of operations as value ofderivative security as the notes may be converted to common stock at any timeafter issuance.

At March 31, 2006, Focusrevalued the derivative liability based on the closing price of Focus’ commonstock of $0.66, the remaining term coinciding with the contract and utilizing avolatility of 87%. For the three months ended March 31, 2006, due in part to adecrease in the market value of Focus’ common stock, Focus recorded a $400,000gain for the change in the fair value of the derivative liability.  

Effective June 28, 2006,Focus amended certain agreements associated with the convertible notes,eliminating the requirements that Focus: (i) register the common stockunderlying the convertible notes issuable pursuant to the Note PurchaseAgreement and (ii) once such underlying stock is registered, keep suchregistration continuously effective. Such amendments effectively removed thederivative liability component of the convertible notes. However, in accordancewith SFAS 133, Focus was required to revalue the derivative liability based onthe closing price of Focus’ common stock on June 28, 2006 ($0.85), utilizingthe remaining original contract term and a volatility of 83%. In accordancewith such revaluation, Focus recorded a $1.8 million expense for the change inthe fair value of the derivative liability between March 31, 2006 and June 28,2006. With the elimination of the derivative component, Focus reclassified thetotal derivative liability of approximately $5.4 million to additional paid-incapital. 

**10.**                               Commitments and Contingencies

Research and DevelopmentAgreements

In October 2004, Focus entered into a design servicescontract under which Focus agreed to pay $2.9 million to a third party for thedesign and development of high performance UWB integrated circuits. Thecontract amount was subsequently increased to $3.3 million. Payments are madeupon the completion of specific milestones by the third party, which areexpected to be completed by January 2007. For the three months ended September30, 2006 and 2005, $58,000 and $218,000, respectively, was charged to researchand development expense based on the level of effort incurred by the thirdparty. For the nine months ended September 30, 2006 and 2005, $467,000 and $1.7million was charged to research and development expense based on the level ofeffort incurred by the third party.  AtSeptember 30, 2006, Focus had $229,000 recorded as payable, of which $88,000was included within accounts payable and $141,000 was included in other accruedliabilities. 

In July 2005, Focus entered into a development agreement with acustomer under which the customer agreed to pay Focus for the joint developmentby Focus and the customer of a custom product. The customer agreed to pay Focus$600,000 in four installments of $150,000 at the completion of specificmilestones. For the nine months ended September 30, 2006, $263,000 wasrecognized as revenue based on the level of effort incurred by Focus and$319,000 of development expense was recorded in cost of revenue.  The project was completed in April 2006 andall amounts due under the development agreement were billed and collected byJune 30, 2006. 

Leases

Focus leases officefacilities under operating leases. Under the lease agreements, Focus isobligated to pay for utilities, taxes, insurance and maintenance. 

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Minimum lease commitments at September 30, 2006were as follows: 
| (In thousands)                                    | ** ** | **Operating Lease  Commitments** | ** ** | **Capital Lease  Commitments** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
|                                                   |       |                                  |       |                                |       |
| 2006                                                   |       | $                                     | 170        |                                | $          | 10 |   |
| 2007                                                   |       | 668                                   |       | 15                                  |       |
| 2008                                                   |       | 266                                   |       | —                              |       |
| 2009                                                   |       | 192                                   |       | —                              |       |
| 2010                                                   |       | 114                                   |       | —                              |       |
|                                                   |       |                                  |       |                                |       |
|                                                   |       | $                                     | 1,410      |                                | 25         |   |
|                                                   |       |                                  |       |                                |       |
| Less: amount  representing interest                    |       |                                  |       | (1                                  | )          |
|                                                   |       |                                  |       |                                |       |
| Present value of future  minimum future lease payments |       |                                  |       | $                                   | 24         |   |

 

Inventory PurchaseCommitments

Under contractmanufacturing arrangements, contract manufacturers procure inventory tomanufacture products based upon a forecast of customer demand provided byFocus. Focus is responsible for the financial impact on the contractmanufacturer of any reduction or product mix shift in the forecast relative tomaterials that the contract manufacturer had already purchased, and is unableto return, under a prior forecast. Such a variance in forecasted demand couldrequire a cash payment for finished goods in excess of current customer demandor for costs of excess or obsolete inventory.

At September 30, 2006, Focus had issuednon-cancelable purchase orders for approximately $4.9 million to purchasefinished goods from its contract manufacturers, and had not incurred anysignificant liability for finished goods in excess of current customer demandor for the costs of excess or obsolete inventory.

General

From time-to-time, Focusis party to certain other claims and legal proceedings that arise in theordinary course of business which, in the opinion of management, will not havea material adverse effect on Focus’ financial position or results of operation.

**11.****                               Stockholders’Equity**

As of September30, 2006, Focus was obligated under certain circumstances, to issue thefollowing additional shares of common stock pursuant to derivative securities,instruments or agreements:
| (In thousands)                            | ** ** | **Shares of  Common Stock** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|
|                                           |       |                                  |       |
| Options to  purchase common stock              |       | 6,508                                 |       |
| Warrants to  purchase common stock             |       | 5,195                                 |       |
| Preferred stock  convertible into common stock |       | 3,161                                 |       |
| Convertible  notes                             |       | 10,425                                |       |
|                                           |       |                                  |       |
|                                           |       | 25,289                                |       |

 

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During the threeand nine months ended September 30, 2006, 594,104 shares of common stock wereissued upon the exercise of warrants, for gross proceeds of approximately$499,000.

**12.****                               RelatedParty Transactions**

CarlBerg

In December 2002,Mr. Berg provided Samsung Semiconductor Inc., Focus’ contracted ApplicationSpecific Integrated Circuit (“ASIC”) manufacturer, with a personal guarantee tosecure Focus’ working capital requirements for ASIC purchase order fulfillment.Mr. Berg agreed to provide the personal guarantee on Focus’ behalf withoutadditional cost or collateral, as Mr. Berg maintains a secured priorityinterest in substantially all of Focus’ assets. At September 30, 2006, Focusowed Samsung $624,000 under net 30 day payment terms. 

In connection withthe $10.0 million convertible note financing completed in January 2006, Focusentered into an amendment to the Intercreditor Agreement by and among GreaterBay Bank, Mr. Berg and Focus, pursuant to which Greater Bay Bank, Mr. Berg andthe holders of the notes have defined their relative rights and priorities withrespect to the shared collateral, with Greater Bay Bank having a first prioritysecurity interest in certain specified collateral of Focus and an IntercreditorAgreement specifying the shared interests of the note holders and Mr. Berg inthe collateral securing both the notes (all of Focus’ assets) and Mr. Berg’sguaranty of Focus’ obligations to Greater Bay Bank, subject to the prioritysecurity interest of the Greater Bay Bank.

Dolby LaboratoriesInc.

N. William JasperJr., who is the Chairman of Focus’ Board of Directors, is also the Presidentand Chief Executive Officer of Dolby Laboratories, Inc. (“Dolby”), a signalprocessing technology company located in San Francisco, California. Focus isrequired to submit quarterly royalty payments to Dolby based on Dolbytechnology incorporated into certain products. For the three months ended September30, 2006 and 2005, Focus paid Dolby $8,000 and $1,000, respectively, which wererecorded in cost of revenue.  For thenine months ended September 30, 2006 and September 30, 2005, Focus paid Dolby$17,000 and $8,000, respectively, which were recorded in cost of revenue. 

Norman Schlomka

Norman Schlomka, GeneralManager of COMO Computer & Motion GmbH (“COMO”), Focus’ wholly owned Germansubsidiary, and an executive officer of Focus since February 2006, owns onethird of the building that COMO occupies. For both three month periods endedSeptember 30, 2006 and 2005, COMO paid rent of approximately $15,000 related tothis building.  For the nine monthperiods ended September 30, 2006 and 2005, COMO paid rent of approximately$45,000 related to this building. 

**13.          Business Segment Information**

Focus’ reportablesegments are Systems and Semiconductor. These reportable segments have distinctproducts – Systems consists of video products for the digital media markets,with customers in the broadcast, video production, digital signage and digitalasset management markets and Semiconductor develops integrated circuits forhigh-performance applications in the video convergence market. Focus’ chiefoperating decision maker is the CEO. 

Focus evaluates segmentperformance based on operating income (loss) and does not allocate netinterest, other income or taxes to operating segments. Additionally, Focus doesnot allocate assets by operating segment.

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|                                   | ** ** | **Three Months Ended September 30, 2006** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------|------------|
| **(In thousands)**           | ** ** | **Systems**                                                        | ** ** | **Semiconductor** | ** ** | **Total** | ** ** |
|                              |       |                                                               |       |   |   |   |   |
| Net revenue                       |       | $                                                                  | 5,441      |   | $ | 6,164 |   | $ | 11,605 |   |
| Cost of revenue                   |       | 3,332                                                              |       | 2,487 |   | 5,819 |   |
| Gross margin                      |       | 2,109                                                              |       | 3,677 |   | 5,786 |   |
|                              |       |                                                               |       |   |   |   |   |
| Operating  expenses:              |       |                                                               |       |   |   |   |   |
| Sales, marketing and support      |       | 1,488                                                              |       | 643 |   | 2,131 |   |
| General and administrative        |       | 618                                                                |       | 407 |   | 1,025 |   |
| Research and development          |       | 902                                                                |       | 2,212 |   | 3,114 |   |
| Amortization of intangible assets |       | 78                                                                 |       | 49 |   | 127 |   |
|                              |       | 3,086                                                              |       | 3,311 |   | 6,397 |   |
| Income(loss) from operations      |       | $                                                                  | (977       | ) | $ | 366 |   | $ | (611 | ) |

 
|                                   | ** ** | **Three Months Ended September 30, 2005** | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------|
| **(In  thousands)**               | ** ** | **Systems**                               | ** ** | **Semiconductor** | ** ** | **Total** | ** ** |
|                              |       |                                      |       |   |   |   |   |
| Net revenue                       |       | $                                         | 5,934      |   | $ | 946 |   | $ | 6,880 |   |
| Cost of revenue                   |       | 3,733                                     |       | 627 |   | 4,360 |   |
| Gross margin                      |       | 2,201                                     |       | 319 |   | 2,520 |   |
|                              |       |                                      |       |   |   |   |   |
| Operating  expenses:              |       |                                      |       |   |   |   |   |
| Sales, marketing and support      |       | 1,351                                     |       | 432 |   | 1,783 |   |
| General and administrative        |       | 548                                       |       | 377 |   | 925 |   |
| Research and development          |       | 786                                       |       | 2,191 |   | 2,977 |   |
| Amortization of intangible assets |       | 79                                        |       | 48 |   | 127 |   |
|                              |       | 2,764                                     |       | 3,048 |   | 5,812 |   |
| Loss from operations              |       | $                                         | (563       | ) | $ | (2,729 | ) | $ | (3,292 | ) |

 
|                                   | ** ** | **Nine Months Ended September 30, 2006** | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|
| **(In  thousands)**               | ** ** | **Systems**                              | ** ** | **Semiconductor** | ** ** | **Total** | ** ** |
|                              |       |                                     |       |   |   |   |   |
| Net revenue                       |       | $                                        | 17,856     |   | $ | 9,339 |   | $ | 27,195 |   |
| Cost of revenue                   |       | 10,735                                   |       | 4,222 |   | 14,957 |   |
| Gross margin                      |       | 7,121                                    |       | 5,117 |   | 12,238 |   |
|                              |       |                                     |       |   |   |   |   |
| Operating  expenses:              |       |                                     |       |   |   |   |   |
| Sales, marketing and support      |       | 5,147                                    |       | 1,606 |   | 6,753 |   |
| General and administrative        |       | 1,768                                    |       | 1,237 |   | 3,005 |   |
| Research and development          |       | 2,236                                    |       | 6,725 |   | 8,961 |   |
| Amortization of intangible assets |       | 235                                      |       | 146 |   | 381 |   |
|                              |       | 9,386                                    |       | 9,714 |   | 19,100 |   |
| Loss from operations              |       | $                                        | (2,265     | ) | $ | (4,597 | ) | $ | (6,862 | ) |

 

17

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|                                   | ** ** | **Nine Months Ended September 30, 2005** | ** ** |
|-----------------------------------|------------|-------------------------------------------------------------------|------------|
| **(In thousands)**           | ** ** | **Systems**                                                       | ** ** | **Semiconductor** | ** ** | **Total** | ** ** |
|                              |       |                                                              |       |   |   |   |   |
| Net revenue                       |       | $                                                                 | 16,176     |   | $ | 2,292 |   | $ | 18,468 |   |
| Cost of revenue                   |       | 10,401                                                            |       | 1,403 |   | 11,804 |   |
| Gross margin                      |       | 5,775                                                             |       | 889 |   | 6,664 |   |
|                              |       |                                                              |       |   |   |   |   |
| Operating  expenses:              |       |                                                              |       |   |   |   |   |
| Sales, marketing and support      |       | 3,860                                                             |       | 1,098 |   | 4,958 |   |
| General and administrative        |       | 1,841                                                             |       | 1,079 |   | 2,920 |   |
| Research and development          |       | 2,834                                                             |       | 7,426 |   | 10,260 |   |
| Amortization of intangible assets |       | 257                                                               |       | 146 |   | 403 |   |
|                              |       | 8,792                                                             |       | 9,749 |   | 18,541 |   |
| Loss from  operations             |       | $                                                                 | (3,017     | ) | $ | (8,860 | ) | $ | (11,877 | ) |

 

**14.****                               RecentAccounting Pronouncements**

In February 2006,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 155, “*Accounting for CertainHybrid Instruments — an amendment of FASB Statements No. 133 and 140*”(“SFAS 155”). SFAS 155 amends SFAS 133, “*Accounting for DerivativeInstruments and Hedging Activities”*and SFAS No. 140*“Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities”.*SFAS 155 gives entities the optionof applying fair value accounting to certain hybrid financial instruments**in their entirety if they contain certain embeddedderivatives that would otherwise require bifurcation under SFAS 133. SFAS 155will be effective as of January 1, 2007. Focus is currently assessing theimpact that SFAS 155 may have on its consolidated financial statements.

In June 2006,the FASB issued FASB Interpretation No. 48 *“AccountingFor Uncertain Tax Positions — An Interpretation of FASB Statement No. 109”*(“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s financial statements in accordance with FASBStatement No. 109 “Accounting for Income Taxes”*.*It prescribes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return. FIN 48 also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition. FIN 48 is effective for fiscalyears beginning after December 15, 2006. Focus is currently evaluating theimpact of FIN 48 to its consolidated financial position and results ofoperations. 

In June 2006, theFASB ratified the consensus reached by the EITF on Issue No. 06-3 “*How Taxes Collected from Customers and Remitted to GovernmentalAuthorities Should Be Presented in the Income Statement (That Is, Gross versusNet Presentation*)” (“EITF 06-3”*).* EITF 06-3includes any tax assessed by a governmental authority that is directly imposedon a revenue-producing transaction between a seller and a customer and mayinclude, but is not limited to, sales, use, value added, and some excise taxes.EITF 06-3 concludes that the presentation of taxes on either a gross (includedin revenues and costs) or a net (excluded from revenues) basis is an accountingpolicy decision that should be disclosed. In addition, for any such taxes thatare reported on a gross basis, a company should disclose the amounts of thosetaxes in interim and annual financial statements for each period for which anincome statement is presented if those amounts are significant. The provisionsof EITF 06-3 should be applied to financial reports for interim and annualreporting periods beginning after December 15, 2006, with earlier adoptionpermitted. Focus is currently assessing the impact of the adoption that EITF06-3 may have on its consolidated financial position, results of operations orcash flows.

InSeptember 2006, the FASB issued SFAS No. 157, *“Fair ValueMeasurements”* (“SFAS 157”). SFAS 157 defines fair value, establishesa framework for measuring fair value in accordance with generally acceptedaccounting principles, and expands disclosures about fair value measurements.SFAS 157 does not require any new fair value measurements; rather, it appliesunder other accounting pronouncements that require or permit fair valuemeasurements. The provisions of SFAS 157 are to be applied prospectively as ofthe beginning of the fiscal year in which it is initially applied, with anytransition adjustment recognized as a cumulative-effect adjustment to theopening balance of retained 

18

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earnings. Theprovisions of SFAS 157 are effective for fiscal years beginning afterNovember 15, 2007; therefore, Focus anticipates adopting SFAS 157 as ofJanuary 1, 2008. Focus is assessing the impact of the adoption of SFAS157. 

InSeptember 2006, the Securities and Exchange Commission (“SEC”) issuedStaff Accounting Bulletin No. 108 (“SAB 108”), *“Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements.”* SAB 108 is effective for fiscalyears ending on or after November 15, 2006 and addresses how financialstatement errors should be considered from a materiality perspective andcorrected. The literature provides interpretive guidance on how the effects ofthe carryover or reversal of prior year misstatements should be considered inquantifying a current year misstatement. Historically, there have been twoapproaches commonly used to quantify such errors: (i) the “rollover”approach, which quantifies the error as the amount by which the current yearincome statement is misstated, and (ii) the “iron curtain” approach, whichquantifies the error as the cumulative amount by which the current year balancesheet is misstated. The SEC Staff believes that companies should quantifyerrors using both approaches and evaluate whether either of these approachesresults in quantifying a misstatement that, when all relevant quantitative andqualitative factors are considered, is material. Focus is currently evaluatingthe impact, if any, of adopting the provisions of SAB 108 on its consolidatedfinancial position, results of operations and liquidity. 

19

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**Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

The following informationshould be read in conjunction with the condensed consolidated financialstatements and notes thereto in Part I, Item 1 of this Quarterly Report andwith Management’s Discussion and Analysis of Financial Condition and Results ofOperations contained in Focus’ Annual Report on Form 10-K for the year endedDecember 31, 2005 and Item 1A—”Risk Factors”—contained therein.

**Certain Factors That May AffectFuture Results**

Discussions of certain matters in this Quarterly Report on Form 10-Q mayconstitute forward-looking statements within the meaning of the Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the Securities andExchange Act of 1934, as amended (the “Exchange Act”), and as such, may involverisks and uncertainties.  Forward-lookingstatements, which are based on certain assumptions and describe future plans,strategies, and expectations, are generally identifiable by the use of words orphrases such as “believe”, “plan”, “expect”, “intend”, “anticipate”, “estimate”,“project”, “forecast”, “may increase”, “may fluctuate”, “may improve” andsimilar expressions or future or conditional verbs such as “will”, “should”, “would”,and “could”.   

In particular, statements contained in this document that are nothistorical facts (including, but not limited to, statements concerninganticipated revenues, anticipated operating expense levels, capital resourcesand needs and liquidity outlook, potential new products and orders, and suchexpense levels relative to our total revenues) constitute forward-lookingstatements and are made under the safe harbor provisions of the PrivateSecurities Litigation Reform Act of 1995. Our actual results of operations andfinancial condition have varied and may in the future vary significantly andmaterially from those stated in any forward-looking statements.  Factors that may cause such differencesinclude, without limitation, the availability of capital to fund our futurecash needs, reliance on major customers, history of operating losses, marketacceptance of our products, technological obsolescence, competition, successfulintegration of acquisitions, component supply problems and protection ofproprietary information, the unpredictability of costs to develop newtechnologies, as well as the accuracy of our internal estimates of revenue andoperating expense levels.  For adiscussion of these factors and some of the factors that might cause such adifference see also Item 1A of our Form 10-K under the heading “Risk Factors”and those described from time to time in our other reports filed with theSecurities and Exchange Commission. These factors should be considered in evaluating the forward-lookingstatements, and undue reliance should not be placed on such statements. We donot undertake, and specifically disclaim any obligation, to update anyforward-looking statements to reflect occurrences or unanticipated events orcircumstances after the date of such statements except as required by law.

**RESULTS OF OPERATIONS**

#### Net revenue

|                                      | ** ** | **Three Months Ended** | ** ** | ** **                   | ** ** | ** **              | ** ** |
|--------------------------------------|------------|----------------------------------|------------|------------------------------|------------|-------------------------|------------|
| **(Dollars in thousands)** | ** ** | **September 30,  2006**     | ** ** | **September 30,  2005** | ** ** | **Increase/(decrease)** | ** ** |
|                                 |       |                             |       |                         |       |                    |       |   |   |
| System products                      |       | $                                | 5,441      |                         | $          | 5,934                   |       | $ | (493 | ) | -8.3 | % |
| Semiconductor  products              |       | 6,164                            |       | 946                          |       | 5,218                   |       | 551.6 | % |
|                                 |       |                             |       |                         |       |                    |       |   |   |
|                                 |       | $                                | 11,605     |                         | $          | 6,880                   |       | $ | 4,725 |   | 68.7 | % |

 

20

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|                                      | ** ** | **Nine Months Ended** | ** ** | ** **                   | ** ** | ** **   | ** ** |
|--------------------------------------|------------|---------------------------------|------------|------------------------------|------------|--------------|------------|
| **(Dollars in thousands)** | ** ** | **September 30,  2006**    | ** ** | **September 30,  2005** | ** ** | **Increase** | ** ** |
|                                 |       |                            |       |                         |       |         |       |   |   |
| System products                      |       | $                               | 17,856     |                         | $          | 16,176       |       | $ | 1,680 |   | 10.4 | % |
| Semiconductor  products              |       | 9,339                           |       | 2,292                        |       | 7,047        |       | 307.5 | % |
|                                 |       |                            |       |                         |       |         |       |   |   |
|                                 |       | $                               | 27,195     |                         | $          | 18,468       |       | $ | 8,727 |   | 47.3 | % |

 

Revenue for the threemonths ended September 30, 2006 was $11.6 million, an increase of $4.7 million,or 69%, compared with the three months ended September 30, 2005. Revenue forthe nine months ended September 30, 2006 was $27.2 million, an increase of $8.7million, or 47%, compared with the nine months ended September 30, 2005.

For the three monthsended September 30, 2006, sales of system products to distributors, retailersand Value Added Resellers were approximately $5.4 million compared to $5.9million for the same period in 2005, a decrease of $493,000. The decrease wasdue to decreased sales of our mature mixer and consumer scan conversionproducts partially offset by increased sales of our recently introducedvariants of our high definition Direct to Edit product line.

For the nine months endedSeptember 30, 2006, sales of our system products were approximately $17.9million compared to $16.2 million for the same period in 2005, an increase of$1.7 million. The increase was due to the strong sales of high definitionDirect to Edit product line and increased sales of ProxSys partially offset bydecreased sales of our mature mixer and scan versions products.

Sales of semiconductorproducts to distributors and OEM customers were $6.2 million in the threemonths ended September 30, 2006, an increase of $5.2 million compared to$946,000 in the comparative period in 2005. For the nine months ended September30, 2006, sales of our semiconductor products were approximately $9.3 millioncompared to $2.3 million for the same period in 2005, an increase of $7.0million. This increase is being driven by customers incorporating our videoconvergence chips in their portable media player (PMP) designs for the 2006holiday season.

As of September 30, 2006,we had a sales order backlog of $4.9 million, a decrease of $3.9 million whencompared to the second quarter of 2006. The decrease in backlog between thethird quarter and second quarter of 2006 is primarily the result of theseasonality of our customer’s ordering. Backlog for the third quarter of 2005 was $893,000.

Sales to onecustomer accounted for 48% our revenue in the three months ended September 30,2006.  Sales to one customer accountedfor 26% of our revenue in the nine months ended September 30, 2006. No customer accounted for more than 10% ofour revenue in the three and nine months ended September 30, 2005.

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#### **Gross margin**

|                                      | ** ** | **Three Months Ended** | ** ** | ** **                       | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **Increase** | ** ** |
|                                 |       |                             |       |                             |       |   |   |
| Gross margin                         |       | $                                | 5,786      |                             | $          | 2,520 |   | $ | 3,266 |   |
|                                 |       |                             |       |                             |       |   |   |
| Gross margin rate                    |       | 49.9                             | %          | 36.6                             | %          | 13.3 percentage points |   |
|                                      |            |                                  |            |                                  |            |  |  |  |  |  |

 
|                                      | ** ** | **Nine Months Ended**  | ** ** | ** **                       | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **Increase** | ** ** |
|                                 |       |                             |       |                             |       |   |   |
| Gross margin                         |       | $                                | 12,238     |                             | $          | 6,664 |   | $ | 5,574 |   |
|                                 |       |                             |       |                             |       |   |   |
| Gross margin rate                    |       | 45.0                             | %          | 36.1                             | %          | 8.9 percentage points |   |
|                                      |            |                                  |            |                                  |            |  |  |  |  |  |

 

Our gross marginrate in the three months ended September 30, 2006 increased to 49.9% from 36.6%in the three months ended September 30, 2005, an increase of 13.3 percentagepoints. Our gross margin rate in the nine months ended September 30, 2006increased to 45.0% from 36.1% in the nine months ended September 30, 2005, anincrease of 8.9 percentage points. This increase in the gross margin ratemainly reflects an increase in sales of our higher margin Direct to Edit HDrecorders, higher margin semiconductor chips and an increase in overall salesvolume. 

**Operatingexpenses**
|                                      | ** ** | **Three Months Ended** | ** ** | ** **                       | ** ** | ** **   | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|--------------|------------|
| **(Dollars in thousands)** | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **Increase** | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | **% of  revenue**           | ** ** | ** **   | ** ** | **% of  revenue** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                 |       |                             |       |                             |       |         |       |   |   |   |   |   |   |
| Sales, marketing  and support        |       | $                                | 2,131      |                             | 18.4       | %            | $          | 1,783 |   | 25.9 | % | $ | 348 |   | 19.5 | % |
| General and  administrative          |       | 1,025                            |       | 8.8                              | %          | 925          |       | 13.4 | % | 100 |   | 10.8 | % |
| Research and  development            |       | 3,114                            |       | 26.8                             | %          | 2,977        |       | 43.3 | % | 137 |   | 4.6 | % |
| Amortization of  intangible assets   |       | 127                              |       | 1.1                              | %          | 127          |       | 1.8 | % | — |   | 0.0 | % |
|                                 |       |                             |       |                             |       |         |       |   |   |   |   |   |   |
|                                 |       | $                                | 6,397      |                             | 55.1       | %            | $          | 5,812 |   | 84.5 | % | $ | 585 |   | 10.1 | % |

 

22

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|                                      | ** ** | **Nine Months Ended**  | ** ** | ** **                       | ** ** | ** **                          | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|-------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **Increase / (decrease)** | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | **% of  revenue**           | ** ** | ** **                          | ** ** | **% of  revenue** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                 |       |                             |       |                             |       |                                |       |   |   |   |   |   |   |
| Sales, marketing  and support        |       | $                                | 6,753      |                             | 24.8       | %                                   | $          | 4,958 |   | 26.8 | % | $ | 1,795 |   | 36.2 | % |
| General and  administrative          |       | 3,005                            |       | 11.0                             | %          | 2,920                               |       | 15.8 | % | 85 |   | 2.9 | % |
| Research and  development            |       | 8,961                            |       | 33.0                             | %          | 10,260                              |       | 55.6 | % | (1,299 | ) | -12.7 | % |
| Amortization of  intangible assets   |       | 381                              |       | 1.4                              | %          | 403                                 |       | 2.2 | % | (22 | ) | -5.5 | % |
|                                 |       |                             |       |                             |       |                                |       |   |   |   |   |   |   |
|                                 |       | $                                | 19,100     |                             | 70.2       | %                                   | $          | 18,541 |   | 100.4 | % | $ | 559 |   | 3.0 | % |

 

Sales, marketing andsupport 

Sales, marketing andsupport expenses for the three months ended September 30, 2006 were $2.1million compared to $1.8 million in the three months ended September 30, 2005,an increase of $348,000. The increase in sales, marketing and support expensesmainly reflects an increase in payroll and payroll-related expenses of $125,000resulting from an increase in headcount and an increase in commission and bonusexpense primarily reflecting the increase in sales revenue, an increase oftrade show expenses of approximately $61,000 and an increase of $89,000 ofconsulting and temporary help to assist with advertising, lead generation andweb marketing. Stock-based compensation increased $48,000 over the priorperiod.

Sales, marketing andsupport expenses for the nine months ended September 30, 2006 were $6.8million, compared to $5.0 million for the nine months ended September 30, 2005,an increase of $1.8 million. The increase in sales, marketing and supportexpenses mainly reflects an increase in payroll and payroll-related expenses ofover $960,000 resulting from an overall increase in headcount of eightemployees in our Systems customer support department and Semiconductor salesdepartment, an increase in commission and bonus expense primarily reflectingthe increase in sales revenue, an increase of $294,000 in consultants andtemporary help, an increase of $218,000 related to trade show expenses and$170,000 in increased advertising and direct marketing expenses associated withlead generation and web marketing during the period. Stock-based compensationincreased $120,000 in the nine months ended September 30, 2006, compared to thenine months ended September 30, 2005.

General andadministrative 

General andadministrative expenses for the three months ended September 30, 2006 were $1.0million, compared to $925,000 in the three months ended September 30, 2005, anincrease of $100,000. The increase in general and administrative expenses wasdue to an increase in payroll and payroll-related expenses of $150,000resulting from an increase in headcount and bonus expense, increasedstock-based compensation expense of $136,000 and increased accounting fees ofapproximately $45,000 partially offset by a decrease in bad debt expense of$67,000 and decreased legal fees of $88,000.

General andadministrative expenses for the nine months ended September 30, 2006 were $3.0million, compared to $2.9 million for the nine months ended September 30, 2005,an increase of $85,000. The increase in general and administrative expenses wasdue to an increase in payroll and payroll-related expenses of $200,000resulting from an increase in headcount and bonus expense and increasedstock-based compensation expense of $136,000 largely offset by a decrease inlegal fees of $87,000, a decrease in bad debt expense of $75,000 and decreasedconsulting and recruiting expenses of $100,000.

Research and development 

Research and developmentexpenses for the three months ended September 30, 2006 were $3.1 million,compared to $3.0 million in the three months ended September 30, 2005, anincrease of $137,000. The increase in research and development expenses mainlyreflects an increase in payroll and payroll-related expenses of $238,000 andincreased expenses for development tools and tooling charges of $142,000related to our UWB development.  Theincrease was partially offset by a decrease of $124,000 in consulting fees dueto the UWB project nearing completion and decreased development fees.

23

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Research and developmentexpenses for the nine months ended September 30, 2006 were $9.0 million,compared to $10.3 million for the nine months ended September 30, 2005, adecrease of $1.3 million.  The decreasein research and development expenses mainly reflects a decrease in consultingand temporary help expenses of $2.2 million, partially offset by increasedmaterial and prototyping charges of $600,000 related to our UWB initiative,increased license fees of $72,000 for development tools and increasedstock-based compensation of $149,000. The decrease in consulting and temporaryhelp expense is due to the UWB development project nearing completion

Amortizationof intangible assets

Amortizationexpense was recorded as follows:
|                         | ** ** | **Three Months Ended** | ** ** | ** **                   | ** ** |
|-------------------------|------------|----------------------------------|------------|------------------------------|------------|
| **(In thousands)** | ** ** | **September 30,  2006**     | ** ** | **September 30,  2005** | ** ** | **Decrease** | ** ** |
|                    |       |                             |       |                         |       |   |   |
| Cost of revenue         |       | $                                | 45         |                         | $          | 45 |   | $ | — |   |
| Operating  expenses     |       | 127                              |       | 127                          |       | — |   |
|                    |       |                             |       |                         |       |   |   |
|                    |       | $                                | 172        |                         | $          | 172 |   | $ | — |   |

 
|                         | ** ** | **Nine Months Ended** | ** ** | ** **                   | ** ** |
|-------------------------|------------|---------------------------------|------------|------------------------------|------------|
| **(In thousands)** | ** ** | **September 30,  2006**    | ** ** | **September 30,  2005** | ** ** | **Increase/  (Decrease)** | ** ** |
|                    |       |                            |       |                         |       |   |   |
| Cost of revenue         |       | $                               | 136        |                         | $          | 135 |   | $ | 1 |   |
| Operating  expenses     |       | 381                             |       | 403                          |       | (22 | ) |
|                    |       |                            |       |                         |       |   |   |
|                    |       | $                               | 517        |                         | $          | 538 |   | $ | (21 | ) |

 

Amortization expense forthe three months ended September 30, 2006 was $172,000, which was consistentwith the three months ended September 30, 2005. Amortization expense for the nine months ended September 30, 2006 was$517,000, which decreased $21,000 from the nine months ended September 30,2005. The decrease in amortization expense reflects the completion ofamortization for certain intangibles associated with our acquisition ofVideonics in January 2001.

24

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**Interestexpense, net and Other income (expense), net**
|                                      | ** ** | **Three Months Ended** | ** ** | ** **                   | ** ** |
|--------------------------------------|------------|----------------------------------|------------|------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **September 30,  2006**     | ** ** | **September 30,  2005** | ** ** | **Increase** | ** ** |
|                                 |       |                             |       |                         |       |   |   |
| Interest  expense, net               |       | $                                | (337       | )                            | $          | (93 | ) | $ | 244 |   |
|                                 |       |                             |       |                         |       |   |   |
| Other income (expense),  net         |       | $                                | 82         |                         | $          | (10 | ) | $ | 92 |   |

 
|                                         | ** ** | **Nine Months Ended** | ** ** | ** **                   | ** ** |
|-----------------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| **(Dollars in thousands)**    | ** ** | **September 30,  2006**    | ** ** | **September 30,  2005** | ** ** | **Increase** | ** ** |
|                                    |       |                            |       |                         |       |   |   |
| Interest  expense, net                  |       | $                               | (828       | )                            | $          | (174 | ) | $ | 654 |   |
|                                    |       |                            |       |                         |       |   |   |
| Value of  derivative security           |       | $                               | (4,000     | )                            | $          | — |   | $ | 4,000 |   |
|                                    |       |                            |       |                         |       |   |   |
| Change in value  of derivative security |       | $                               | (1,361     | )                            | $          | — |   | $ | 1,361 |   |
|                                    |       |                            |       |                         |       |   |   |
| Other income (expense),  net            |       | $                               | 150        |                         | $          | (50 | ) | $ | 200 |   |

 

Net interest expense forthe three months ended September 30, 2006 was $337,000, compared to $93,000 inthe three months ended September 30, 2005. Net interest expense for the ninemonths ended September 30, 2006 was $828,000 compared to $174,000 in the ninemonths ended September 30, 2005. The increase in net interest expense reflectsinterest expense on approximately $11.6 million of debt at September 30, 2006compared to debt of approximately $5.5 million at September 30, 2005.

The $4.0 millionderivative liability represents the fair value of the conversion option inconnection with the $10.0 million convertible notes issued in January 2006. Thevalue of the conversion option was bifurcated from the debt host contract andrecorded as a derivative liability, which resulted in a discount to the initialcarrying amount of the convertible notes. The $4.0 million discount was immediatelyexpensed in the condensed consolidated statements of operations as value ofderivative security as the notes may be converted to common stock at any timeafter issuance.

Effective June 28, 2006,we amended certain agreements associated with the $10 million convertiblenotes, eliminating the derivative component. However, we were required torevalue the derivative liability as of the amendment date based on the closingprice of our common stock of $0.85, the remaining term coinciding with thecontract and a volatility of 83%. As such, we recorded a $1.8 million expensefor the change in the fair value of the derivative liability in the threemonths ended June 30, 2006. With the elimination of the derivative component,we reclassified the total derivative liability of approximately $5.4 million toadditional paid-in capital during the quarter ended June 30, 2006.

The nine monthchange in value of the derivative security represents the difference betweenthe fair value of the derivative liability when the convertible notes wereissued and the fair value of the derivative liability at June 30, 2006. Therevaluation of the derivative liability resulted in a $1.4 million expense inthe nine months ended September 30, 2006.

Other income (expense)for the three and nine months ended September 30, 2006 consists mainly offluctuations associated with exchange rate differences related to transactionsdenominated in foreign currency.

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**LIQUIDITYAND CAPITAL RESOURCES**

The accompanyingcondensed consolidated financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and thesatisfaction of liabilities in the normal course of business. For the ninemonths ended September 30, 2006 and the year ended December 31, 2005, we incurrednet losses of $12.9 million and $15.4 million, respectively, and used cash inoperating activities of $6.1 million, and $12.5 million, respectively. Thesefactors indicate that we may potentially be unable to continue as a goingconcern.

The condensedconsolidated financial statements do not include any adjustments relating tothe recoverability and classification of recorded asset amounts or the amountsand classification of liabilities that might be necessary should we be unableto continue as a going concern. Our continuation as a going concern isdependent upon our ability to generate sufficient positive cash flows to meetour obligations on a timely basis, to obtain additional financing as may berequired, and ultimately to return to profitability.

Since inception, we havefinanced our operations primarily through the public and private sale of commonstock, lines of credit and debt borrowings from financial institutions,proceeds from the exercise of options and warrants, short-term borrowings fromprivate lenders and credit arrangements with vendors and suppliers. 
| (Dollars in thousands) | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                             |       |                         |       |                        |       |
| Cash and cash  equivalents       |       | $                            | 1,133      |                        | $          | 637 |   |
| Working capital  (deficit)       |       | $                            | 1,589      |                        | $          | (3,533 | ) |
| Days sales  outstanding (DSO)    |       | 33                           |       | 48                          |       |
| Inventory turns -  annualized    |       | 5.1                          |       | 4.1                         |       |

 
|                                            | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|
| ** **                                 | ** ** | **September 30,  2006**    | ** ** | **September 30,  2005** | ** ** |
|                                       |       |                            |       |   |   |
| Net cash used in  operating activities     |       | $                               | (6,087     | ) | $ | (9,357 | ) |
| Net cash used in  investing activities     |       | $                               | (412       | ) | $ | (207 | ) |
| Net cash provided by  financing activities |       | $                               | 6,982      |   | $ | 6,949 |   |

 

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Net cash used inoperating activities
| ** **                         | ** ** | **Nine Months Ended**  | ** ** | ** **                       | ** ** |
|------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                         | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **Change in** | ** ** |
| ** **                         | ** ** | **cash (used)/**            | ** ** | **cash (used)/**            | ** ** | **cash (used)/** | ** ** |
| **(In thousands)**            | ** ** | **provided**                     | ** ** | **provided**                     | ** ** | **provided** | ** ** |
|                               |       |                             |       |                             |       |   |   |
| Net loss                           |       | $                                | (12,910    | )                                | $          | (12,111 | ) | $ | (799 | ) |
| Non-cash income  statement items   |       | 7,668                            |       | 1,160                            |       | 6,098 |   |
|                               |       | (5,242                           | )          | (10,951                          | )          | 5,299 |   |
|                               |       |                             |       |                             |       |   |   |
| Changes in assets and  liabilities |       | (845                             | )          | 1,594                            |       | (2,029 | ) |
|                               |       |                             |       |                             |       |   |   |
|                               |       | $                                | (6,087     | )                                | $          | (9,357 | ) | $ | 3,270 |   |

 

Net cash used inoperating activities for the nine months ended September 30, 2006 and 2005 was$6.1 million and $9.4 million, respectively. The decrease in net cash used inoperating activities mainly reflects a decrease in the net loss adjusted fornon-cash items and an increase in accounts payable and accrued liabilitiespartially offset by an increase in cash used for accounts receivable,inventories and other current assets. The increase in accounts receivablereflects an increase in net revenue in the nine months ended September 30,2006. The increase in inventories reflects our higher sales run rate comparedto prior year. The increase in accounts payable and accrued liabilities mainly reflectstiming of payments related to our UWB investment.

One customer had accounts receivable balances in excess of 10% of ourtotal accounts receivable at September 30, 2006. This customer accounted for24% of our total accounts receivable at that date.

We expect that ouroperating cash flows may fluctuate in future periods as a result offluctuations in our operating results, shipment timetable and accountsreceivable collections, inventory management, and the timing of payments amongother factors.

Net cash used ininvesting activities

Net cash used ininvesting activities was $412,000 for the nine months ended September 30, 2006,compared to $207,000 for the nine months ended September 30, 2005. The increasein cash used in investing activities for the nine months ended September 30,2006 does not include the decrease in restricted cash of $289,000 reflected forthe nine months ended September 30, 2005 partially offset by purchases ofequipment for our semiconductor operations and purchases of design toolsprimarily related to our investment in UWB technology.

Net cash provided byfinancing activities

Net cash provided byfinancing activities was $7.0 million for the nine months ended September 30,2006, compared to $6.9 million for the nine months ended September 30, 2005.The net cash provided by financing activities in the nine months endedSeptember 30, 2006 mainly consists of proceeds of $10.0 million from theissuance of convertible notes, $500,000 of borrowing under the line of credit,$700,000 of borrowing under the term loan and proceeds of $1.3 million from theexercise of stock options and warrants, partially offset by total repayment onour term loan and line of credit facilities totaling $5.5 million. Net cashfrom financing activities in the nine months ended September 30, 2005 consistedmainly of borrowings of $2.6 million under our accounts receivable-based lineof credit and $4.0 million under our term loan, net proceeds of $1.6 millionreceived in June 2005 from a private equity placement transaction, proceeds of$488,000 from the sale of escrow shares and the reimbursement of acquisitionfees by Visual Circuits Corporation Liquidating Trust related to theacquisition of Visual Circuits, partially offset by repayments of $375,000related to our German subsidiary’s line of credit balance and $1.5 millionrepayments under our term loan.

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**CapitalResources and Liquidity Outlook**

We have incurred lossesand used net cash in operating activities for the nine months ended September30, 2006 and each of the two years in the period ended December 31, 2005, andas such, have been dependent upon raising money for short- and long-term cashneeds through debt, proceeds from the exercise of options and warrants, and thesale of our securities in private placements.

For the year endedDecember 31, 2005, we received approximately $4.5 million in proceeds from thesale of approximately 7.4 million shares of our common stock in privateplacement transactions.

In November 2004, weobtained a revolving $4.0 million bank credit line under which we can borrow upto 90% of our eligible outstanding accounts receivable, excluding accountsreceivable of COMO. Carl Berg, a Company director and shareholder, provided apersonal guarantee to secure this credit line. In connection with this creditline, the Greater Bay Bank obtained a first priority security interest on ouraccounts receivable through an agreement with Mr. Berg, which enabled Mr. Bergto retain his existing security interest in all of our assets while subordinatingto Greater Bay Bank his security interest in our accounts receivable. The bankcredit line is subject to ongoing covenants, including a covenant related tooperating results. Interestis payable under this loan at prime plus 1%. At September 30, 2006,there was $500,000 outstanding balance on this credit line and $2.4 million wasavailable to borrow. The credit line expires on December 24, 2006. At September30, 2006, Focus was not in compliance with the net loss covenant.  On November 8, 2006, Focus received a waiverfrom Greater Bay Bank

On June 28, 2005, wesigned a term loan agreement with Greater Bay Bank under which we can borrow up to $2.5million. The term loan has a maturity date of December 24, 2006, is interestonly until maturity and is in addition to our existing $4.0 million accountsreceivable-based secured line of credit facility described above with this samebank. Interest is payable under this loan at prime plus 1%. At September 30,2006, there was $700,000 outstanding balance under this term loan and $1.8million was available to borrow.

OnJanuary 27, 2006, we raised gross proceeds of $10.0 million from the issuanceof secured convertible notes to a group of private investors. On June 30, 2006,in accordance with the terms of the secured convertible notes, we issued anadditional $425,000 of convertible notes in lieu of a cash interest payment dueon June 30, 2006. While we believe that these funds, along with the cash flowgenerated by our expanding Systems business, should be adequate to enable us tocomplete our UWB engineering development and launch commercialization of UWBproducts, depending upon the results and timing of our UWB initiative and theprofitability of our Systems business, we may need to raise further capital in 2007.There can be no assurance that sufficient funds will be raised. Moreover, anyequity financing or convertible debt financing would result in dilution to ourexisting stockholders and could have a negative effect on the market price ofour common stock. Furthermore, any additional debt financing will result inhigher interest expense.

Summary of Certain Contractual Obligations as of September 30, 2006
|                                                    | ** ** | **Payment due by Period** | ** ** | ** **         | ** ** |
|----------------------------------------------------|------------|------------------------------------------|------------|--------------------|------------|
| **(In thousands)**                            | ** ** | **< 1 year**                | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Total** | ** ** |
|                                               |       |                                     |       |               |       |   |   |   |   |
| Capital and  operating leases (including interest) |       | $                                        | 696        |               | $          | 576 |   | $ | 163 |   | $ | 1,435 |   |
| Line of credit                                     |       | 500                                      |       | —             |       | — |   | 500 |   |
| Term loan                                          |       | 700                                      |       | —             |       | — |   | 700 |   |
| Inventory  purchase commitments                    |       | 5,000                                    |       | —             |       | — |   | 5,000 |   |
| Convertible  notes                                 |       | —                                   |       | —             |       | 10,425 |   | 10,425 |   |
| Interest on  convertible notes                     |       | 1,068                                    |       | 3,448              |       | 578 |   | 5,094 |   |
|                                               |       |                                     |       |               |       |   |   |   |   |
|                                               |       | $                                        | 7,964      |               | $          | 4,024 |   | $ | 11,166 |   | $ | 23,154 |   |

** **

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** **

**Item 3.Quantitative and Qualitative Disclosures about Market Risk**

**Interest Rate Risk**

AtSeptember 30, 2006, we did not hold any short-term investments that would beexposed to market risk from adverse movements in interest rates.

At September 30, 2006, our outstanding debt obligations consisted of secured convertible notes of $10.4  million – see Note 9, “Borrowings”. A fixed interest rate is applicable to these debt obligations of 10.0% per annum.

**Foreign Currency Risk**

Gains or losses related to foreign exchange currency transactions werenot material for the periods ended September 30, 2006 and 2005.

**Item 4.Controls and Procedures**

Management of theCompany, with the participation of the President and Chief Executive Officerand the Chief Financial Officer (its principal executive officer and principalfinancial officer, respectively), evaluated our disclosure controls andprocedures as of the end of the period covered by this Report.

Based on thatevaluation, the President and Chief Executive Officer and the Chief FinancialOfficer have concluded that, as of the end of the period covered by thisReport, our disclosure controls and procedures, as defined in Rule 13a-15(e) ofthe Securities and Exchange Act of 1934, as amended, are effective.

There was no change inour internal control over financial reporting that occurred during our thirdfiscal quarter of 2006 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

We will be required toevaluate our internal controls over financial reporting and prepare amanagement assessment on our internal controls in order to comply with therequirements of the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002requires that the management assessment of our internal controls be audited. Weestimate the cost of meeting these requirements will be approximately $750,000.We will be required to meet these requirements by December 31, 2007.

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** **

**PART II - OTHER INFORMATION**

**Item 1.****            Legalproceedings**

From time to time, Focus is party to certain otherclaims and legal proceedings that arise in the ordinary course of business ofwhich, in the opinion of management, do not have a material adverse effect onFocus’ financial position or results of operation.

**Item1A.**         Risk Factors

**Except as described below, there have been no materialchanges to our risk factors disclosed in our Annual Report on Form 10-K for theyear ended December 31, 2005. You should carefully consider the risksidentified therein any of which could materially affect our business, financialcondition or future results as well as the following risk factors.**

**From November 2005 to earlyMay 2006 and late May 2006 to mid July 2006, our common stock did not meet theminimum bid price requirement to remain listed on the Nasdaq Capital Market. Ifwe were to be delisted, it could make trading in our stock more difficult andour $10.4 million outstanding principal amount of convertible notes would bedeemed payable at the option of the holders**

Our voting common stock is traded on the Nasdaq Capital Market. Thereare various quantitative listing requirements for a company to remain listed onthe Nasdaq Capital Market, including maintaining a minimum bid price of $1.00per share of common stock and maintaining stockholders’ equity of $2.5 million.On June 27, 2006, the Nasdaq Stock Market notified us that for the previous30 consecutive business days, the bid price of our common stock had closedbelow the minimum $1.00 per share price requirement for continued inclusionunder Nasdaq Marketplace Rules. We were given until December 26, 2006 to regaincompliance with the Nasdaq Capital Market $1.00 minimum bidprice rule. On July 28, 2006, we received notification from theNasdaq Stock Market that we had regained compliance and the matter was closed.

At September 30, 2006, we had total stockholders’ equity of $5.9million. To the extent we incur net losses and do not raise additional capital,our stockholders’ equity will be reduced.

If the minimum bid price of our common stock were to close below $1.00for 30 consecutive days, we would likely again receive notification from theNasdaq Capital Market that we were not in compliance with the $1.00 minimum bidprice rule. If we do not regain compliance within the allotted complianceperiod, including any extensions that may be granted by the Nasdaq CapitalMarket, the Nasdaq Capital Market would notify us that our common stock wouldbe delisted from the Nasdaq Capital Market, eliminating the onlyestablished trading market for our shares. We would then be entitledto appeal this determination to a Nasdaq Listing Qualifications Panel andrequest a hearing.

In the event we are delisted from the Nasdaq CapitalMarket, we would be forced to list our shares on the OTC Electronic BulletinBoard or some other quotation medium, such as the pink sheets, depending on ourability to meet the specific listing requirements of those quotation systems.As a result, an investor might find it more difficult to trade, or to obtainaccurate price quotations for, such shares. Delisting might also reduce thevisibility, liquidity, and price of our voting common stock. In the event ourcommon stock was not listed on the Nasdaq Stock Market or another establishedautomated over-the-counter trading market in the United States, all amountsoutstanding under our $10.4 million convertible notes would become due andpayable at the option of the holders

**We have a significantamount of convertible securities that will dilute existing stockholders uponconversion.**

At November 7, 2006, we had 3,161 shares of preferred shares issued andoutstanding, 4,928,882 warrants and 5,951,571 options outstanding, and $10.4million of convertible notes outstanding, which are 

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convertible into shares of common stock. The 3,161 shares of preferredstock are convertible into 3,161,000 shares of our voting common stock and theconvertible notes are convertible into 10,425,000 shares of common stock.Furthermore, at November 7, 2006, 475,001 additional shares of common stockwere available for grant to our employees, officers, directors and consultantsunder our current stock option and incentive plans. We also may issueadditional shares in acquisitions and additional convertible notes as interestpayments on our outstanding convertible notes. Any additional grant of optionsunder existing or future plans or issuance of shares in connection with anacquisition or issuance of additional convertible notes will further diluteexisting stockholders.

**Asignificant portion of our semiconductor revenue is from products that aredesigned for consumer goods that have seasonal sales.**

A significantportion of our semiconductor revenue is subject to risks associated with thesales of certain end products at retail that are seasonal, with a majority ofretail sales occurring during the period of August through October. As aresult, our annual operating results with respect to sales of our semiconductorchips designed into newly introduced products depend, in large part, on salesduring the relatively brief holiday season.

**Item 2.****            Unregisteredsales of equity securities and use of proceeds**

None.

**Item 3.****            Defaultsupon senior securities**

None.

#### **Item 4.****            Submission of matters to a vote of securityholders**

None.

**Item 5.****            Otherinformation**

None.

**Item 6.****            Exhibits**

Exhibit31.1 - Rule 13a-14(a) Certification of CEO

Exhibit31.2 - Rule 13a-14(a) Certification of CFO

Exhibit 32.1 – CEO 906Certification

Exhibit 32.2 – CFO 906 Certification

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** **

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
| November 14, 2006 |   |   | Focus Enhancements, Inc.               |   |
|-------------------|--------|--------|----------------------------------------|--------|
| Date              |   |   | Registrant                             |   |
|              |   |   |
|              | By:    | /s/    | Brett A. Moyer                         |   |
|              |   |   | Brett A. Moyer                         |
|              |   |   | Chief Executive Officer  and President |
|              |   |   | (Principal Executive  Officer)         |
|              |   |   |                                   |
|              |   |   |                                   |
|              | By:    | /s/    | Gary L. Williams                       |   |
|              |   |   | Gary L. Williams                       |
|              |   |   | Executive Vice  President of Finance,  |
|              |   |   | Chief Financial Officer                |
|              |   |   | (Principal Accounting  Officer)        |
|                   |        |        |                                        |        |  |  |  |

 

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