** **

**U. S. SECURITIES ANDEXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**
| **x** | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------|

** **

**Forthe quarterly period ended June 30, 2007, or**
| **o** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

** **

**Forthe transition period from                     to                     .**

**CommissionFile Number 1-11860**

**Focus Enhancements, Inc.**

(Name of Issuer in itsCharter)

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

** **

**1370 Dell Ave**

**Campbell, CA 95008**

(Address of PrincipalExecutive Offices)

**(408) 866-8300**

(Issuer’s TelephoneNumber, Including Area Code)

Check whether theIssuer (1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities 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.  Yes: x   No: o

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

| Large accelerated filer: o | Accelerated filer: o | Non-accelerated filer: x |
|---------------------------------|---------------------------|-------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b02 of theExchange Act).

Yes: o   No: x

As of August 6,2007, there were 78,454,178 shares of common stock outstanding.

 

 

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**FOCUSENHANCEMENTS, INC.**

**INDEX**
|                                     | ** ** | ** **                                                                                   | ** ** | **Page  Number** |
|-------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|------------------|
| **PART  I - FINANCIAL INFORMATION** | ** ** | ** **                                                                                   |
| **Item  1.**                        |       | Financial  Statements (unaudited):                                                           |       |             |
|                                |       | Condensed Consolidated Balance Sheets                                                        |       | 3                |
|                                |       | Condensed Consolidated Statements of Operations                                              |       | 4                |
|                                |       | Condensed Consolidated Statements of Cash Flows                                              |       | 5                |
|                                |       | Notes to Condensed Consolidated Financial Statements                                         |       | 6                |
| **Item 2.**                         |       | Management’s Discussion and Analysis of Financial  Condition  and Results of Operations |       | 18               |
| **Item 3.**                         |       | Quantitative and Qualitative Disclosures about Market  Risk                                  |       | 25               |
| **Item 4T.**                        |       | Controls and Procedures                                                                      |       | 25               |
| **PART  II - OTHER INFORMATION**    | ** ** | ** **                                                                                   |
| **Item  1.**                        |       | Legal  Proceedings                                                                           |       | 26               |
| **Item  1A.**                       |       | Risk  Factors                                                                                |       | 26               |
| **Item 2.**                         |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                 |       | 27               |
| **Item 3.**                         |       | Defaults Upon Senior Securities                                                              |       | 27               |
| **Item 4.**                         |       | Submission of Matters to a Vote of Security Holders                                          |       | 27               |
| **Item  5.**                        |       | Other  Information                                                                           |       | 27               |
| **Item 6.**                         |       | Exhibits                                                                                     |       | 27               |
| **SIGNATURES**                      |       | 28                                                                                           |
| **CERTIFICATIONS**                  |       |                                                                                         |

 

2

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**PART I -FINANCIAL INFORMATION**

**Item1.    Financial Statements**

**Focus Enhancements, Inc.**

**CondensedConsolidated Balance Sheets**

(In thousands, exceptshare and per share amounts)

(Unaudited)
| ** **                                                                                                                                                                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                           | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| **Assets**                                                                                                                                                                                           |       |              |       |                  |       |
|                                                                                                                                                                                                 |       |              |       |                  |       |
| Current assets:                                                                                                                                                                                      |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                           |       | $                 | 3,986      |                  | $          | 5,969 |   |
| Accounts  receivable, net of allowances of $274 and $304, respectively                                                                                                                               |       | 4,840             |       | 4,188                 |       |
| Inventories                                                                                                                                                                                          |       | 4,296             |       | 4,072                 |       |
| Prepaid expenses  and other current assets                                                                                                                                                           |       | 1,389             |       | 1,207                 |       |
| Total current  assets                                                                                                                                                                                |       | 14,511            |       | 15,436                |       |
|                                                                                                                                                                                                 |       |              |       |                  |       |
| Property and  equipment, net                                                                                                                                                                         |       | 1,311             |       | 980                   |       |
| Other assets                                                                                                                                                                                         |       | 173               |       | 187                   |       |
| Intangible  assets, net                                                                                                                                                                              |       | —            |       | 186                   |       |
| Goodwill                                                                                                                                                                                             |       | 13,191            |       | 13,191                |       |
|                                                                                                                                                                                                 |       | $                 | 29,186     |                  | $          | 29,980 |   |
|                                                                                                                                                                                                 |       |              |       |                  |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                       |       |              |       |                  |       |
|                                                                                                                                                                                                 |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                                 |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                                     |       | $                 | 3,538      |                  | $          | 3,424 |   |
| Accrued  liabilities                                                                                                                                                                                 |       | 3,532             |       | 3,702                 |       |
| Current portion  of capital lease obligations                                                                                                                                                        |       | 116               |       | 10                    |       |
| Borrowings under  line of credit                                                                                                                                                                     |       | 3,450             |       | 3,390                 |       |
| Term loan                                                                                                                                                                                            |       | 2,500             |       | 2,500                 |       |
| Total current  liabilities                                                                                                                                                                           |       | 13,136            |       | 13,026                |       |
|                                                                                                                                                                                                 |       |              |       |                  |       |
| Convertible  notes                                                                                                                                                                                   |       | 11,493            |       | 10,946                |       |
| Capital lease  obligations, net of current portion                                                                                                                                                   |       | 63                |       | —                |       |
| Total  liabilities                                                                                                                                                                                   |       | 24,692            |       | 23,972                |       |
|                                                                                                                                                                                                 |       |              |       |                  |       |
| Commitments and  contingencies (note 9)                                                                                                                                                              |       |              |       |                  |       |
|                                                                                                                                                                                                 |       |              |       |                  |       |
| Stockholders’  equity:                                                                                                                                                                          |       |              |       |                  |       |
| Preferred stock,  $0.01 par value; authorized 3,000,000 shares; 3,161 shares issued and  outstanding at June 30, 2007 and December 31, 2006, respectively (aggregate  liquidation preference $3,917) |       | —            |       | —                |       |
| Common stock,  $0.01 par value; 150,000,000 shares authorized, 78,970,845 and 73,210,870 shares  issued at June 30, 2007 and December 31, 2006, respectively                                         |       | 780               |       | 722                   |       |
| Treasury stock  at cost, 516,667 and 497,055 shares at June 30, 2007 and December 31, 2006,  respectively                                                                                            |       | (775              | )          | (750                  | )          |
| Additional  paid-in capital                                                                                                                                                                          |       | 118,052           |       | 111,203               |       |
| Accumulated  other comprehensive income                                                                                                                                                              |       | 91                |       | 130                   |       |
| Accumulated  deficit                                                                                                                                                                                 |       | (113,654          | )          | (105,297              | )          |
|                                                                                                                                                                                                 |       |              |       |                  |       |
| Total  stockholders’ equity                                                                                                                                                                     |       | 4,494             |       | 6,008                 |       |
|                                                                                                                                                                                                 |       |              |       |                  |       |
|                                                                                                                                                                                                 |       | $                 | 29,186     |                  | $          | 29,980 |   |

 

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

 

3

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**Focus Enhancements, Inc.**

**CondensedConsolidated Statements of Operations**

(In thousands, except pershare amounts)

(Unaudited)
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                         | ** ** | **June 30,  2007**          | ** ** | **June 30,  2006**        | ** ** | **June 30,  2007** | ** ** | **June 30,  2006** | ** ** |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Net revenue                                                        |       | $                                | 8,354      |                           | $          | 8,457 |   | $ | 15,441 |   | $ | 15,590 |   |
| Cost of revenue                                                    |       | 4,444                            |       | 4,670                          |       | 8,365 |   | 9,138 |   |
| Gross margin                                                       |       | 3,910                            |       | 3,787                          |       | 7,076 |   | 6,452 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Operating expenses:                                                |       |                             |       |                           |       |   |   |   |   |
| Sales, marketing  and support                                      |       | 2,479                            |       | 2,548                          |       | 4,604 |   | 4,622 |   |
| General and  administrative                                        |       | 1,048                            |       | 1,065                          |       | 2,145 |   | 1,980 |   |
| Research and  development                                          |       | 3,979                            |       | 2,866                          |       | 7,917 |   | 5,847 |   |
| Amortization of  intangible assets                                 |       | 51                               |       | 127                            |       | 156 |   | 254 |   |
|                                                               |       | 7,557                            |       | 6,606                          |       | 14,822 |   | 12,703 |   |
| Loss from  operations                                              |       | (3,647                           | )          | (2,819                         | )          | (7,746 | ) | (6,251 | ) |
| Interest  expense, net                                             |       | (299                             | )          | (292                           | )          | (589 | ) | (491 | ) |
| Value of  derivative liability                                     |       | —                           |       | —                         |       | — |   | (4,000 | ) |
| Change in value  of derivative liability                           |       | —                           |       | (1,761                         | )          | — |   | (1,361 | ) |
| Other income  (expense), net                                       |       | (2                               | )          | (2                             | )          | 1 |   | 68 |   |
| Loss before  income tax expense                                    |       | (3,948                           | )          | (4,874                         | )          | (8,334 | ) | (12,035 | ) |
| Income tax  expense                                                |       | 19                               |       | —                         |       | 23 |   | 9 |   |
| Net loss                                                           |       | $                                | (3,967     | )                              | $          | (4,874 | ) | $ | (8,357 | ) | $ | (12,044 | ) |
|                                                               |       |                             |       |                           |       |   |   |   |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Net loss per share                                                 |       |                             |       |                           |       |   |   |   |   |
| Basic and  diluted                                                 |       | $                                | (0.05      | )                              | $          | (0.07 | ) | $ | (0.11 | ) | $ | (0.18 | ) |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Weighted average number  of shares used in per share calculations: |       |                             |       |                           |       |   |   |   |   |
| Basic and diluted                                                  |       | 77,277                           |       | 68,755                         |       | 75,738 |   | 68,455 |   |

 

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

 

4

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**Focus Enhancements, Inc.**

**CondensedConsolidated Statements of Cash Flows**

(In thousands)

(Unaudited)
| ** **                                                                          | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                          | ** ** | **June 30, 2007**    | ** ** | **June 30, 2006** | ** ** |
| Cash flows from  operating activities:                                              |       |                           |       |   |   |
| Net loss                                                                            |       | $                              | (8,357     | ) | $ | (12,044 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:        | ** ** |                           |       |   |   |
| Depreciation and  amortization                                                      |       | 580                            |       | 749 |   |
| Stock-based  compensation                                                           |       | 470                            |       | 323 |   |
| Value of  derivative liability                                                      |       | —                         |       | 4,000 |   |
| Change in value  of derivative liability                                            |       | —                         |       | 1,361 |   |
| Accrued interest  on convertible notes                                              |       | 550                            |       | — |   |
| Amortization of  debt issuance costs                                                |       | 9                              |       | — |   |
| Changes in  assets and liabilities:                                                 |       |                           |       |   |   |
| Accounts  receivable                                                                |       | (630                           | )          | (1,567 | ) |
| Inventories                                                                         |       | (197                           | )          | (925 | ) |
| Prepaid expenses  and other assets                                                  |       | (234                           | )          | (277 | ) |
| Other assets                                                                        |       | 14                             |       | (98 | ) |
| Accounts payable                                                                    |       | 109                            |       | 368 |   |
| Accrued  liabilities                                                                |       | (195                           | )          | 225 |   |
| Net cash used in  operating activities                                              |       | (7,881                         | )          | (7,885 | ) |
|                                                                                |       |                           |       |   |   |
| Cash flows from  investing activities:                                              |       |                           |       |   |   |
| Purchases of  property and equipment                                                |       | (490                           | )          | (296 | ) |
| Net cash used in  investing activities                                              |       | (490                           | )          | (296 | ) |
|                                                                                |       |                           |       |   |   |
| Cash flows from  financing activities:                                              |       |                           |       |   |   |
| Proceeds from  issuance of convertible notes                                        |       | —                         |       | 10,000 |   |
| Net proceeds  from private offerings of common stock                                |       | 6,205                          |       | — |   |
| Repayment of  lines of credit                                                       |       | (3,390                         | )          | (2,966 | ) |
| Repayment of term  loan                                                             |       | (2,500                         | )          | (2,500 | ) |
| Repayment of  short-term debt                                                       |       | —                         |       | (3 | ) |
| Proceeds from  exercise of common stock options and warrants, net at issuance costs |       | 207                            |       | 945 |   |
| Payments under  capital lease obligations                                           |       | (64                            | )          | (72 | ) |
| Repurchase of  common stock                                                         |       | (25                            | )          | — |   |
| Borrowings under  term loan                                                         |       | 3,450                          |       | — |   |
| Borrowings under  lines of credit                                                   |       | 2,500                          |       | 3,000 |   |
| Net cash provided by  financing activities                                          |       | 6,383                          |       | 8,404 |   |
|                                                                                |       |                           |       |   |   |
| Effect of exchange rate  changes on cash and cash equivalents                       |       | 5                              |       | 6 |   |
|                                                                                |       |                           |       |   |   |
| Increase (decrease) in  cash and cash equivalents                                   |       | (1,983                         | )          | 229 |   |
| Cash and cash  equivalents at beginning of period                                   |       | 5,969                          |       | 637 |   |
| Cash and cash equivalents at end of period                                          |       | $                              | 3,986      |   | $ | 866 |   |

 

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

 

5

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

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

FocusEnhancements, Inc. and its subsidiaries (the “Company” or “Focus”) wasincorporated in 1992 and develops and markets proprietary video technology intwo areas: semiconductor and systems. Semiconductor products include severalseries of Application Specific Integrated Circuits (“ASICs”), which address thewireless video and data market using Ultra Wideband (“UWB”) technology and thevideo convergence market. The UWB ASICs are targeted for the wireless USB(Universal Serial Bus) market while the video convergence chips are deployedinto portable media players, GPS navigation devices, video conferencingsystems, media center and interactive TV applications. Focus’ systems productsare designed to provide solutions for the professional video production marketparticularly for the video acquisition, media asset management and digitalsignage markets. Focus markets its systems products primarily through theprofessional channel. Focus production products include video scan converters,video mixers, standard and high definition digital video disk recorders, MPEG(Moving Picture Experts Group) recorders and file format conversion tools.Focus media asset management systems products include network-based videoservers, long-duration program monitors and capture/playout components. Focusdigital signage and retail media solutions products include standard and highdefinition MPEG players and servers. Focus markets its products globally tooriginal equipment manufacturers (“OEMs”), and dealers and distributors in theconsumer and professional channels.

**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 and cash flows forthe six months ended June 30, 2007 are not necessarily indicative of theresults that may be expected for any future period. Certain items previouslyreported in specific financial statement captions have been reclassified. Suchreclassifications have not impacted previously reported total assets, totalstockholders’ equity or net loss amounts.

The condensedconsolidated financial statements of Focus as of June 30, 2007 and for thethree and six-month periods ended June 30, 2007 and 2006 are unaudited andshould be read in conjunction with the audited consolidated financialstatements for the year ended December 31, 2006, included in Focus’ AnnualReport on Form 10-K for the year ended December 31, 2006.

6

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**3.****                                     ****Equity-Based Compensation**

Focus accounts forequity-based compensation in accordance with Statement of Financial AccountingStandards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”),which the Company adopted as of January 1, 2006 using the modified prospectivemethod.

The share-based compensation recognized for the threeand six months ended June, 2007 and 2006, respectively, was:
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(In thousands, except per share data)** | ** ** | **June 30,  2007**          | ** ** | **June 30,  2006**        | ** ** | **June 30,  2007** | ** ** | **June 30,  2006** | ** ** |
|                                                               |       |                             |       |                           |       |   |   |   |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Stock-based  compensation expense by type of award:                |       |                             |       |                           |       |   |   |   |   |
| Employee stock options                                             |       | $                                | 162        |                           | $          | 123 |   | $ | 294 |   | $ | 274 |   |
| Restricted stock awards                                            |       | 81                               |       | 27                             |       | 150 |   | 49 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Total stock-based compensation                                     |       | 243                              |       | 150                            |       | 444 |   | 323 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Tax effect on  stock-based compensation                            |       | —                           |       | —                         |       | — |   | — |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Effect on net  loss                                                |       | $                                | 243        |                           | $          | 150 |   | $ | 444 |   | $ | 323 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Effect on net loss per  share - basic and diluted                  |       | $                                | 0.00       |                           | $          | 0.00 |   | $ | 0.01 |   | $ | 0.00 |   |

 

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 10 years fromthe grant date. The fair value of each option grant is estimated on the date ofgrant using the Black-Scholes option pricing model. The weighted averageassumptions used in the model are outlined in the following table:

|                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **June 30,  2007**          | ** ** | **June 30,  2006**        | ** ** | **June 30,  2007** | ** ** | **June 30,  2006** | ** ** |
|                              |       |                             |       |                           |       |   |   |   |   |
| Average expected  term of options |       | 4 years                          |       | 4 years                        |       | 4 years |   | 4 years |   |
| Risk-free rate  of interest       |       | 4.82                             | %          | 5.03                           | %          | 4.59 | % | 4.68 | % |
| Volatility of  common stock       |       | 77                               | %          | 81                             | %          | 81 | % | 81 | % |
| Dividend yield                    |       | 0                                | %          | 0                              | %          | 0 | % | 0 | % |

 

Thedividend yield of zero is based on the fact that the Company has never paidcash dividends and has no present intention to pay cash dividends. Expectedvolatility is based on the combination of historical volatility of the Company’scommon stock and the expected moderation in future volatility over the periodcommensurate with the expected life of the options and other factors. Therisk-free interest rates are taken from the Daily Federal Yield Curve Rates asof the grant dates as published by the Federal Reserve and represent the yieldson actively traded Treasury securities for terms equal to the expected term ofthe options. The expected term calculation is based on the Company’s observedhistorical option exercise behavior and post-vesting forfeitures of options byemployees.

7

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A summary ofactivity related to Focus’ stock option incentive plans for the six monthsended June 30, 2007 is presented below:
| ** **                                                           | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Aggregate  Intrinsic  Value (000s)** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------|------------|
|                                                                 |       |       |       |                                   |       |                                                |       |                                        |       |
| Options  outstanding at January 1, 2007                              |       | 5,479,537  |       | $                                      | 1.15       |                                                |       |                                        |       |   |
| Options granted                                                      |       | 1,109,691  |       | $                                      | 1.30       |                                                |       |                                        |       |   |
| Options  exercised                                                   |       | (70,706    | )          | $                                      | 1.13       |                                                |       |                                        |       |   |
| Options canceled                                                     |       | (363,742   | )          | $                                      | 1.17       |                                                |       |                                        |       |   |
|                                                                 |       |       |       |                                   |       |                                                |       |                                        |       |
| Options  outstanding at June 30, 2007                                |       | 6,154,780  |       | $                                      | 1.17       |                                                | 5.9        |                                        | $          | 393 |   |
|                                                                 |       |       |       |                                   |       |                                                |       |                                        |       |
| Options  exercisable and expected to be exercisable at June 30, 2007 |       | 5,862,098  |       | $                                      | 1.18       |                                                | 5.9        |                                        | $          | 370 |   |
|                                                                 |       |       |       |                                   |       |                                                |       |                                        |       |
| Options exercisable at  June 30, 2007                                |       | 3,707,119  |       | $                                      | 1.23       |                                                | 5.1        |                                        | $          | 222 |   |

 

The weighted average grant date fair value of optionsgranted during the three and six months ended June 30, 2007 was $0.75 and $0.80per share, respectively. The intrinsic value of options exercised during thethree and six months ended June 30, 2007 was $10,000 and $17,000, respectively.At June 30, 2007, Focus had $1,195,000 of unrecognized compensation expense,net of estimated forfeitures, related to unvested stock options, which will berecognized over the weighted average period of 2.2 years. Cash received fromstock option exercises was $55,000 and $80,000 for the three and six monthsended June 30, 2007, respectively.

The weighted average grant date fair value of optionsgranted in the three and six months ended June 30, 2006 was $0.61 and $0.47 pershare, respectively. The intrinsic value of options exercised during the threeand six months ended June 30, 2006 was $1,000 and $49,000, respectively. Cashreceived from stock option exercises was $89,000 and $456,000 for the three andsix months ended June 30, 2006, respectively.

The options outstanding and exercisable at June 30,2007 were in the following exercise price ranges:
| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                      | ** ** |
|---------------------------------------------|------------|------------------------------|------------|---------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Outstanding**              | ** ** | **Weighted  Average  Remaining Life  (Yrs)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| ** **                                  |       |                         | ** ** | ** **                                        | ** ** | ** ** |   |   | ** ** | ** ** | ** ** |
| $0.43-$0.97                                 |       | 1,186,490                    |       | 6.2                                               |       | $ | 0.71 |   | 660,198 |   | $ | 0.70 |   |
| $0.97-$1.43                                 |       | 4,086,999                    |       | 6.2                                               |       | $ | 1.19 |   | 2,212,785 |   | $ | 1.20 |   |
| $1.43-$1.97                                 |       | 792,427                      |       | 4.4                                               |       | $ | 1.62 |   | 745,272 |   | $ | 1.63 |   |
| $1.97-$5.75                                 |       | 88,864                       |       | 5.0                                               |       | $ | 2.47 |   | 88,864 |   | $ | 2.47 |   |
|                                        |       |                         |       |                                              |       |   |   |   |   |   |   |
| Outstanding at June 30,  2007               |       | 6,154,780                    |       | 5.9                                               |       | $ | 1.17 |   | 3,707,119 |   | $ | 1.23 |   |

 

At June 30, 2007, Focushad the ability to issue an additional 1,460,392 shares of common stock underits current stock option and incentive plans, which include restricted stock.

8

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Restricted Stock Awards

A summary ofactivity related to Focus’ restricted stock awards for the six months endedJune 30, 2007 is presented below:

|                                                                      | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|
|                                                                 |       |       |       |                                                    |       |
| Non-vested  restricted stock shares outstanding at beginning of year |       | 730,307    |       | $                                                       | 0.79       |   |
| Restricted stock  shares granted                                     |       | 551,218    |       | $                                                       | 1.40       |   |
| Restricted stock  shares vested                                      |       | (197,266   | )          | $                                                       | 0.82       |   |
|                                                                 |       |       |       |                                                    |       |
| Non-vested restricted  stock shares outstanding at June 30, 2007     |       | 1,084,259  |       | $                                                       | 1.10       |   |

 

At June 30, 2007,Focus had $880,000 of unrecognized compensation expense, net of forfeitures,related to restricted stock awards, which will be recognized over the weightedaverage period of 3.0 years. During the three and six months ended June 30,2007, 8,750 and 197,266 shares of restricted stock vested with a fair marketvalue of $12,000 and $258,000 respectively. During the six months ended June30, 2006, 61,250 shares of restricted stock vested with a fair market value of$41,000. No restricted stock vested during the three months ended June 30,2006.

**4.**                                      **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 6,154,780 and 7,000,067 shares of common stock, unvested shares ofrestricted stock of 1,084,259 and 730,307, warrants to purchase 4,218,355 and5,442,761 shares of common stock and 3,161 shares of preferred stockconvertible into 3,161,000 shares of common stock were outstanding at June 30,2007 and 2006, respectively, but were not included in the computation ofdiluted net loss per share as the effect would have been anti-dilutive. Inaddition, convertible notes that are convertible into 11,943,000 and 10,425,000shares of common stock were outstanding at June 30, 2007 and 2006,respectively, but were not included in the computation of diluted net loss pershare as the effect would have been anti-dilutive.

**5.**                                      Significant Customers

Sales to twocustomers accounted for 29% of Focus’ revenue in the three months ended June30, 2007.  Sales to one customeraccounted for 15% of Focus’ revenue in the six months ended June 30, 2007.Sales to two customers accounted for 36% of Focus’ revenue in the three monthsended June 30, 2006.  Sales to twocustomers accounted for 25% of Focus’ revenue in the six months ended June 30,2006.

Two customers had accounts receivable balances in excess of 10% of Focus’total accounts receivable at June 30, 2007. These customers accounted for 32%of Focus’ total accounts receivable at that date. Three customers had accountsreceivable balances in excess of 10% of Focus’ total accounts receivable atJune 30, 2006. These customers accounted for 43% of Focus’ total accountsreceivable at that date.

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**6.****                                      Goodwilland Intangible Assets**

Goodwillas of June 30, 2007 and December 31, 2006 included the following:

| (In thousands) | ** ** | **Goodwill** | ** ** |
|---------------------|------------|--------------|------------|
|                |       |         |       |
| Videonics           |       | $            | 5,070      |   |
| Tview               |       | 121          |       |
| COMO                |       | 1,104        |       |
| Visual Circuits     |       | 6,896        |       |
|                |       |         |       |
|                |       | $            | 13,191     |   |

 

Thefollowing tables provide a summary of the carrying amounts of intangibleassets:

|                         | ** ** | **June 30, 2007** | ** ** |
|-------------------------|------------|-----------------------------|------------|
| ** **              | ** ** | ** **                  | ** ** | **Accumulated** | ** ** | **Net** | ** ** |
| **(In thousands)** | ** ** | **Gross Amount**       | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                    |       |                        |       |   |   |   |   |
| Existing  technology    |       | $                           | 3,945      |   | $ | (3,945 | ) | $ | — |   |
| Tradename               |       | 176                         |       | (176 | ) | — |   |
|                    |       |                        |       |   |   |   |   |
|                    |       | $                           | 4,121      |   | $ | (4,121 | ) | $ | — |   |

 

|                         | ** ** | **December 31, 2006** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | ** **                      | ** ** | **Accumulated** | ** ** | **Net** | ** ** |
| **(In thousands)** | ** ** | **Gross Amount**           | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                    |       |                            |       |   |   |   |   |
| Existing  technology    |       | $                               | 3,945      |   | $ | (3,759 | ) | $ | 186 |   |
| Tradename               |       | 176                             |       | (176 | ) | — |   |
|                    |       |                            |       |   |   |   |   |
|                    |       | $                               | 4,121      |   | $ | (3,935 | ) | $ | 186 |   |

 

**7.****                                      Inventories**

Inventories are stated atlower of cost (first-in, first-out) or market:

| (In thousands) | ** ** | **June 30, 2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                |       |                        |       |                        |       |
| Raw materials       |       | $                           | 920        |                        | $          | 1,286 |   |
| Work in process     |       | 1,471                       |       | 1,055                       |       |
| Finished goods      |       | 1,905                       |       | 1,731                       |       |
|                | ** ** | ** **                  |       | ** **                  |       |
|                |       | $                           | 4,296      |                        | $          | 4,072 |   |

 

10

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**8.**                                      Borrowings

| (In thousands)                       | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
|                                      |       |                        |       |                            |       |
| Short-term debt:                          |       |                        |       |                            |       |
| Accounts  receivable-based line of credit |       | $                           | 3,450      |                            | $          | 3,390 |   |
| Term loan                                 |       | 2,500                       |       | 2,500                           |       |
|                                      |       | 5,950                       |       | 5,890                           |       |
| Long-term debt:                           |       |                        |       |                            |       |
| Convertible  notes                        |       | 11,493                      |       | 10,946                          |       |
|                                      | ** ** | ** **                  |       | ** **                      |       |
|                                      |       | $                           | 17,443     |                            | $          | 16,836 |   |

 

AccountsReceivable-Based Line of Credit

InNovember 2004, Focus obtained a $4.0 million line of credit from Greater Bay Bank (“the Bank”) under which itcan borrow up to 90% of its eligible outstanding accounts receivable. Thecredit line expires on February 23, 2008 as a result of an extension granted inFebruary 2007 and is collateralized by a personal guarantee from Carl Berg, aCompany director and shareholder. In connection with this credit line, the Bankhas obtained a first priority security interest in Focus’ accounts receivablethrough an agreement with Mr. Berg, which enables Mr. Berg to retain hisexisting security interest in all of Focus’ assets while subordinating hisinterest in Focus’ accounts receivable. In connection with the February 2007extension, Focus agreed to pay loan commitment fees of $22,500 and agreed toissue a warrant to the Bank to purchase 48,148 shares of common stock at anexercise price of $1.35 per share. In addition, Mr. Berg agreed to continue to personally guaranteeboth the $4.0 million accounts receivable-based line of credit and the$2.5 million term loan to the Bank. In connection with Mr. Berg’s continuedextension of his personal guarantee, Focus agreed to issue to Mr. Berg awarrant to purchase 48,148 shares of common stock at an exercise priceof $1.35 per share. The warrants were each valued at $26,000 using theBlack-Scholes option pricing model. The warrant issued to the Bank will beamortized to interest expense over the term of the line of credit and thewarrant issued to Mr. Berg was charged to general and administrative expense atthe time of issuance.

The credit line issubject to ongoing covenants including a covenant based on operating results.Borrowings under the credit line bear interest at a rate of prime plus 1%,which was 9.25% at June 30, 2007. At June 30, 2007, there was an outstandingbalance on this credit line of $3.45 million and Focus had the ability toborrow an additional $550,000 to the maximum available amount of $4.0 million.

TermLoan

On June28, 2005, Focus signed a term loan agreement with the Bank under which Focus can borrow up to$2.5 million. The term loan expires on February 23, 2008 as a result ofextensions granted in February and March 2007. Mr. Berg has personally guaranteed the loan, which is interest onlyuntil maturity and is in addition to Focus’ existing $4.0 million accountsreceivable-based secured line of credit that Focus has with this Bank. Interestis payable under this term loan at prime plus 1%, which was 9.25% atJune 30, 2007. At June 30, 2007,there was an outstanding balance under this term loan of $2.5 million.

Convertible Notes 

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:

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

·                  Interestdue on the first three semi-annual payments may, at the issuers option, be paidin the form of a note with the same terms and conditions of the original notes,including conversion rights.

·                  Thenotes are convertible, at the option of the holder, into shares of Focus commonstock at a conversion price of $1.00 per share. The conversion price is subjectto adjustment for stock splits, reverse stock splits, recapitalizations andsimilar corporate actions.

·                  Thenotes are collateralized by all of the assets of Focus in accordance with theterms and subject to the conditions contained in a security agreement enteredinto concurrent with the issuance of the notes.

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·                  Thenotes are redeemable, at the option of Focus, at any time at a redemption priceequal to 102% times the face rate 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 or anotherestablished automated over-the-counter trading marking in the United States,each holder of the notes may require Focus to repurchase all of its debt at apurchase price equal to 101% of the principal amount of the notes plus accruedand 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 June 30, 2007,December 30, 2006 and June 30, 2006, Focus issued additional notes in the amountsof $547,167, $521,250 and $425,000, in lieu of the cash interest payments dueon June 30, 2007, December 30, 2006 and June 30, 2006, respectively. Thesenotes retain the same terms and conditions as the $10.0 million convertiblenotes issued on January 27, 2006.

**9.**                                      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 $3.2 million. Payments were madeupon the completion of specific milestones by the third party. The contract wascompleted in April 2007.

For the three months ended June 30, 2007, research anddevelopment expenses were reduced by $175,000 upon a final reconciliation oftime and materials related to this design services contract. For the threemonths ended June 30, 2006, $117,000 was charged to research and developmentbased on the level of effort incurred by the third party. For the six monthsended June 30, 2007, research and development expenses were reduced by $117,000upon a final reconciliation of time and materials related to the contract. Forthe six months ended June 30, 2006, $409,000 was charged to research anddevelopment based on the level of effort incurred by the third party.

No amounts related to this contract were includedwithin the condensed consolidated balance sheet at June 30, 2007. At December31, 2006, $141,000 was included within other accrued liabilities on thecondensed consolidated balance sheet.

Leases

Focus leases officefacilities and certain equipment under operating and capital leases. Under thelease agreements, Focus is obligated to pay for utilities, taxes, insurance andmaintenance.

Minimum lease commitments at June 30, 2007 wereas follows:

| (In thousands)                 | ** ** | **Operating Lease  Commitments** | ** ** | **Capital Lease  Commitments** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
|                                |       |                                  |       |                                |       |
| 2007                                |       | $                                     | 342        |                                | $          | 65 |   |
| 2008                                |       | 262                                   |       | 129                                 |       |
| 2009                                |       | 190                                   |       | —                              |       |
| 2010                                |       | 114                                   |       | —                              |       |
|                                |       |                                  |       |                                |       |
|                                |       | $                                     | 908        |                                | 194        |   |
| Less: amount  representing interest |       |                                  |       | (15                                 | )          |
|                                |       |                                  |       | 179                                 |       |
| Less: current portion               |       |                                  |       | (116                                | )          |
|                                |       |                                  |       |                                |       |
| Long-term portion                   |       |                                  |       | $                                   | 63         |   |

 

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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 June 30, 2007, Focus had issuednon-cancelable purchase orders for approximately $2.4 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.

Product Warranty Costs. 

Focus’ warrantyperiod for its products is generally 90 days to two years. Focus accrues forwarranty costs, based on estimated warranty return rates and costs to repair,at the time revenue is recognized. At June 30, 2007 and December 31, 2006,Focus’ reserves for warranty costs were $162,000 and $191,000, respectively.

Changes in Focus’product warranty liability during the six months ended June 30, 2007 and 2006were as follows:

|                         | ** ** | **Six Months Ended** | ** ** |
|-------------------------|------------|--------------------------------|------------|
| **(in thousands)** | ** ** | **June 30, 2007**    | ** ** | **June 30, 2006** | ** ** |
|                    |       |                           |       |   |   |
| Balance at January 1    |       | $                              | 191        |   | $ | 220 |   |
| Charged to operations   |       | $                              | 71         |   | $ | 111 |   |
| Reductions              |       | (100                           | )          | (131 | ) |
|                    |       |                           |       |   |   |
| Ending balance          |       | $                              | 162        |   | $ | 200 |   |

 

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.

**10.****                            Stockholders’Equity**

As of June 30,2007, Focus was obligated under certain circumstances, to issue the followingadditional shares of common stock pursuant to derivative securities,instruments or agreements:

| (In thousands)                            | ** ** | **Shares of  Common Stock** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|
| Options to purchase  common stock              |       | 6,155                                 |       |
| Warrants to purchase  common stock             |       | 4,218                                 |       |
| Preferred stock  convertible into common stock |       | 3,161                                 |       |
| Convertible notes                              |       | 11,943                                |       |
|                                           |       |                                  |       |
|                                           |       | 25,477                                |       |

 

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On February 20,2007, Focus entered into two separate transactions with certain investors,relating to the issuance and sale of (i) 4,500,000 shares of Focus common stockat a purchase price of $1.26 per share and warrants to purchase 450,000 sharesof common stock at an exercise price of $2.00 per share and (ii) 500,000 sharesof common stock at a purchase price of $1.26 per share and warrants to purchase50,000 shares of Focus common stock at an exercise price of $2.00 per share. Inaggregate, Focus sold 5,000,000 shares of common stock and issued warrants topurchase an additional 500,000 shares of common stock. In connection with thistransaction Focus received net proceeds of approximately $6.2 million.

During the six monthsended June 30, 2007, Focus repurchased 19,612 shares of common stock for$25,000 and included the repurchased shares in treasury stock at June 30, 2007.Such shares had originally been issued in connection with the Company’s stockcompensation plans as restricted stock.

**11.****                               RelatedParty Transactions**

CarlBerg

In December 2002,Mr. Berg provided Samsung Semiconductor Inc., one of Focus’ contracted ASICmanufacturers, with a personal guarantee to secure Focus’ working capitalrequirements for ASIC purchase order fulfillment. Mr. Berg agreed to providethe personal guarantee on Focus’ behalf without additional cost or collateral,as Mr. Berg maintains a secured priority interest in substantially all of Focus’assets. At June 30, 2007, Focus owed Samsung $129,000 under net 30 terms.

In November 2004,Focus secured a line of credit of up to $4.0 million under which Focus canborrow up to 90% of its eligible outstanding accounts receivable. This line ofcredit is secured by a personal guarantee from Mr. Berg. In connection withthis line of credit, the Bank will obtain a priority security interest in Focus’accounts receivable. Mr. Berg will maintain his security interest in all Focus’assets, subject to the Bank’s lien on accounts receivable.

OnMarch 19, 2007, Mr. Berg was awarded a warrant to purchase 48,148 shares ofcommon stock in connection with Mr. Berg maintaining his personal guarantee ofthe term loan and accounts receivable-based line of credit, which were bothextended to February 23, 2008. The warrant was issued at $1.35 per share andexpires on March 19, 2012. The warrant was valued at $26,000 using theBlack-Scholes option pricing model and was charged to general andadministrative expense at the time of issuance.

In connection withthe $10.0 million convertible note financing completed in January 2006, Focusentered into an amendment to the Intercreditor Agreement by and among the Bank,Mr. Berg and Focus, pursuant to which the Bank, Mr. Berg and the holders of the notes have defined their relativerights and priorities with respect to the shared collateral, with the Bankhaving a first priority security interest in certain specified collateral ofFocus and an Intercreditor Agreement specifying the shared interests of thenote holders and Mr. Berg in the collateral securing both the notes (all ofFocus’ assets) and Mr. Berg’s guaranty of Focus’ obligations to the  Bank, subject to the priority securityinterest of the 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 June30, 2007 and 2006, Focus paid Dolby $9,000 and $4,000 respectively inroyalties, which were recorded in cost of revenue. For the six months endedJune 30, 2007 and 2006, Focus paid Dolby $21,000 and $9,000 respectively inroyalties, which were recorded in cost of revenue.

Norman Schlomka

Norman Schlomka, GeneralManager of COMO and an executive officer of Focus since February 2006, owns onethird of the building that COMO occupies. For the three months periods endedJune 30, 2007 and 2006, Focus paid rent related to this building ofapproximately $24,000 and $15,000, respectively. For the six months ended June30, 2007 and 2006, Focus paid rent related to this building of approximately$46,000 and $30,000, respectively.

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**12.          Business Segment Information**

Focus’ reportablesegments are Systems and Semiconductor. These reportable segments have distinctproducts — Systems consists of products designed to provide solutions in videoacquisition, media asset management and digital signage and Semiconductorconsists of ASICs. Focus’ chief operating 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.

|                                    | ** ** | **Three Months Ended June, 2007** | ** ** | ** **        |
|------------------------------------|------------|-------------------------------------------------------|------------|-------------------|
| ** **                         | ** ** | **Systems**                                           | ** ** | **Semiconductor** | ** ** | **Total** | ** ** | ** ** |
| ** **                         | ** ** | ** **                                            | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** |
| Net revenue                        |       | $                                                     | 7,020      |              | $ | 1,334 |   | $ | 8,354 |   |   |
| Cost of revenue                    |       | 3,891                                                 |       | 553               |   | 4,444 |   |   |
| Gross margin                       |       | 3,129                                                 |       | 781               |   | 3,910 |   |   |
|                               |       |                                                  |       |              |   |   |   |   |
| Operating expenses:                |       |                                                  |       |              |   |   |   |   |
| Sales, marketing  and support      |       | 1,732                                                 |       | 747               |   | 2,479 |   |   |
| General and  administrative        |       | 662                                                   |       | 386               |   | 1,048 |   |   |
| Research and  development          |       | 1,037                                                 |       | 2,942             |   | 3,979 |   |   |
| Amortization of  intangible assets |       | 30                                                    |       | 21                |   | 51 |   |   |
|                               |       | 3,461                                                 |       | 4,096             |   | 7,557 |   |   |
| Loss from operations               |       | $                                                     | (332       | )                 | $ | (3,315 | ) | $ | (3,647 | ) |   |

 

|                                    | ** ** | **Six Months Ended June 30, 2007** | ** ** | ** **        |
|------------------------------------|------------|-------------------------------------------------------------|------------|-------------------|
| ** **                         | ** ** | **Systems**                                                 | ** ** | **Semiconductor** | ** ** | **Total** | ** ** | ** ** |
| ** **                         | ** ** | ** **                                                  | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** |
| Net revenue                        |       | $                                                           | 12,873     |              | $ | 2,568 |   | $ | 15,441 |   |   |
| Cost of revenue                    |       | 7,252                                                       |       | 1,113             |   | 8,365 |   |   |
| Gross margin                       |       | 5,621                                                       |       | 1,455             |   | 7,076 |   |   |
|                               |       |                                                        |       |              |   |   |   |   |
| Operating expenses:                |       |                                                        |       |              |   |   |   |   |
| Sales, marketing  and support      |       | 3,045                                                       |       | 1,559             |   | 4,604 |   |   |
| General and  administrative        |       | 1,369                                                       |       | 776               |   | 2,145 |   |   |
| Research and  development          |       | 2,137                                                       |       | 5,780             |   | 7,917 |   |   |
| Amortization of  intangible assets |       | 94                                                          |       | 62                |   | 156 |   |   |
|                               |       | 6,645                                                       |       | 8,177             |   | 14,822 |   |   |
| Loss from operations               |       | $                                                           | (1,024     | )                 | $ | (6,722 | ) | $ | (7,746 | ) |   |

 

15

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|                                    | ** ** | **Three Months Ended June, 2006** | ** ** | ** **        |
|------------------------------------|------------|-------------------------------------------------------|------------|-------------------|
| ** **                         | ** ** | **Systems**                                           | ** ** | **Semiconductor** | ** ** | **Total** | ** ** | ** ** |
|                               |       |                                                  |       |              |   |   |   |   |
| Net revenue                        |       | $                                                     | 6,663      |              | $ | 1,794 |   | $ | 8,457 |   |   |
| Cost of revenue                    |       | 3,730                                                 |       | 940               |   | 4,670 |   |   |
| Gross margin                       |       | 2,933                                                 |       | 854               |   | 3,787 |   |   |
|                               |       |                                                  |       |              |   |   |   |   |
| Operating expenses:                |       |                                                  |       |              |   |   |   |   |
| Sales, marketing  and support      |       | 2,076                                                 |       | 472               |   | 2,548 |   |   |
| General and  administrative        |       | 545                                                   |       | 520               |   | 1,065 |   |   |
| Research and  development          |       | 678                                                   |       | 2,188             |   | 2,866 |   |   |
| Amortization of  intangible assets |       | 75                                                    |       | 52                |   | 127 |   |   |
|                               |       | 3,374                                                 |       | 3,232             |   | 6,606 |   |   |
| Loss from operations               |       | $                                                     | (441       | )                 | $ | (2,378 | ) | $ | (2,819 | ) |   |

 

|                                    | ** ** | **Six Months Ended June, 2006** | ** ** | ** **        |
|------------------------------------|------------|-----------------------------------------------------|------------|-------------------|
| ** **                         | ** ** | **Systems**                                         | ** ** | **Semiconductor** | ** ** | **Total** | ** ** | ** ** |
| ** **                         | ** ** | ** **                                          | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** |
|                               |       |                                                |       |              |   |   |   |   |
| Net revenue                        |       | $                                                   | 12,415     |              | $ | 3,175 |   | $ | 15,590 |   |   |
| Cost of revenue                    |       | 7,403                                               |       | 1,735             |   | 9,138 |   |   |
| Gross margin                       |       | 5,012                                               |       | 1,440             |   | 6,452 |   |   |
|                               |       |                                                |       |              |   |   |   |   |
| Operating expenses:                |       |                                                |       |              |   |   |   |   |
| Sales, marketing  and support      |       | 3,659                                               |       | 963               |   | 4,622 |   |   |
| General and  administrative        |       | 1,150                                               |       | 830               |   | 1,980 |   |   |
| Research and  development          |       | 1,334                                               |       | 4,513             |   | 5,847 |   |   |
| Amortization of  intangible assets |       | 157                                                 |       | 97                |   | 254 |   |   |
|                               |       | 6,300                                               |       | 6,403             |   | 12,703 |   |   |
| Loss from operations               |       | $                                                   | (1,288     | )                 | $ | (4,963 | ) | $ | (6,251 | ) |   |

 

**13.          Comprehensive Loss**

Comprehensiveloss includes net loss and foreign currency translation adjustments. Thecomponents of comprehensive loss are as follows:

 
|                                      |       | **Three Months Ended** | ** ** | **Six Months Ended** |       |                        |
|-------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|-----------------------------|
| **(in thousands)**                        | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |   |
|                                      |       |                             |       |                           |       |                        |   |   |   |   |
| Net loss                                  |       | $                                | (3,967     | )                              | $          | (4,874                      | ) | $ | (8,357 | ) | $ | (12,044 | ) |   |
| Other comprehensive  loss:                |       |                             |       |                           |       |                        |   |   |   |   |
| Foreign currency  translation adjustments |       | (60                              | )          | (66                            | )          | (39                         | ) | (107 | ) |   |
|                                      |       |                             |       |                           |       |                        |   |   |   |   |
| Comprehensive loss                        |       | $                                | (4,027     | )                              | $          | (4,940                      | ) | $ | (8,396 | ) | $ | (12,151 | ) |   |

 

16

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**14.          Income Taxes**

On January 1,2007, the Company adopted the provisions of Financial Accounting StandardsBoard (“FASB”) Interpretation No. 48, “Accounting for Uncertain Income Taxes —An Interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 clarifiesthe accounting for uncertainty in income taxes recognized in an entity’sfinancial statements in accordance with FASB Statement No. 109, “Accounting forIncome Taxes” (“FAS 109”) and prescribes a recognition threshold andmeasurement attributes for financial statement disclosure of tax positionstaken or expected to be taken on a tax return.  Under FIN 48, the impactof an uncertain income tax position on the income tax return must be recognizedat the largest amount that is more-likely-than-not to be sustained upon auditby the relevant taxing authority.  An uncertain income tax position willnot be recognized if it has less than a 50% likelihood of beingsustained.  Additionally, FIN 48 provides guidance on de-recognition,classification, interest and penalties, accounting in interim periods, disclosureand transition.

As a result of theadoption of FIN 48, there was no impact to the Company’s consolidated financialposition, results of operations or cash flows for the six month period endedJune 30, 2007. In accordance with FIN 48, the Company recognizes interest andpenalties related to unrecognized tax benefits as a component of incometaxes. At June 30, 2007 no interest or penalties related to unrecognizedtax benefits had been recorded.  There was no change to the Company’sunrecognized tax benefits for the six month period ended June 30, 2007.

The Company and certain of its subsidiaries are subject totaxation in the U.S. and various states and foreign jurisdictions.  Allthe Company’s tax years will be open to examination by the U.S. federal andcertain state tax authorities due to the Company’s net operating loss andoverall credit carry forward position.  With few exceptions, the Companyis not subject to examination by foreign tax authorities for years before 2004.

17

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**Item  2.**                       Management’s Discussion andAnalysis 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, 2006 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 Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities and ExchangeAct of 1934, as amended (the “Exchange Act”), and as such, may involve risksand 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 thatmay cause such differences include, without limitation, the availability of capitalto fund our future cash needs, reliance on major customers, history ofoperating losses, market acceptance of our products, technologicalobsolescence, competition, successful integration of acquisitions, componentsupply problems and protection of proprietary information, the unpredictabilityof costs to develop new technologies, as well as the accuracy of our internalestimates of revenue and operating expense levels.  For a discussion of these factors and some ofthe factors that might cause such a difference see also Item 1A of our Form10-K under the heading “Risk Factors” and those described from time to time inour other reports filed with the Securities and Exchange Commission.  These factors should be considered inevaluating the forward-looking statements, and undue reliance should not beplaced on such statements. We do not undertake, and specifically disclaim anyobligation, to update any forward-looking statements to reflect occurrences orunanticipated events or circumstances after the date of such statements exceptas required by law.

18

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**RESULTS OF OPERATIONS**

#### Net revenue

|                                      | ** ** | **Three Months Ended** | ** ** | ** **                  | ** ** | ** **     | ** ** | ** **          |
|--------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|----------------|------------|---------------------|
| ** **                           | ** ** | ** **                       | ** ** | ** **                  | ** ** | **Increase**   | ** ** | **% increase** | ** ** | ** ** |
| **(Dollars in thousands)** | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006** | ** ** | **(decrease)** | ** ** | **(decrease)**      | ** ** | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | ** **                  | ** ** | ** **     | ** ** | ** **          | ** ** | ** ** |
| Systems products                     |       | $                                | 7,020      |                        | $          | 6,663          |       | $                   | 357 |   | 5.4 | % |   |
| Semiconductor products               |       | 1,334                            |       | 1,794                       |       | (460           | )          | (25.6               | )% |   |
|                                 |       |                             |       |                        |       |           |       |                |   |   |
|                                 |       | $                                | 8,354      |                        | $          | 8,457          |       | $                   | (103 | ) | (1.2 | )% |   |

 

|                                      | ** ** | **Six Months Ended** | ** ** | ** **                  | ** ** | ** **     | ** ** |
|--------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|----------------|------------|
| ** **                           | ** ** | ** **                     | ** ** | ** **                  | ** ** | **Increase**   | ** ** | **% increase** | ** ** |
| **(Dollars in thousands)** | ** ** | **June 30, 2007**    | ** ** | **June 30, 2006** | ** ** | **(decrease)** | ** ** | **(decrease)** | ** ** |
|                                 |       |                           |       |                        |       |           |       |   |   |
| Systems products                     |       | $                              | 12,873     |                        | $          | 12,415         |       | $ | 458 |   | 3.7 | % |
| Semiconductor products               |       | 2,568                          |       | 3,175                       |       | (607           | )          | (19.1 | )% |
|                                 |       |                           |       |                        |       |           |       |   |   |
|                                 |       | $                              | 15,441     |                        | $          | 15,590         |       | $ | (149 | ) | (1.0 | )% |

 

Revenue for the three monthsended June 30, 2007 was $8.4 million, a decrease of $103,000, or 1.2%, comparedwith the three months ended June 30, 2006. Revenue for the six months ended June 30, 2007 was $15.4 million, adecrease of $149,000, or 1.0%, compared with the six months ended June 30,2006.

For the three monthsended June 30, 2007, net sales of systems products to distributors, retailersand Value Added Resellers, were approximately $7.0 million compared to $6.7million for the same period in 2006, an increase of $357,000. For the sixmonths ended June 30, 2007, net sales of our systems products wereapproximately $12.9 million compared to $12.4 million for the same period in2006, an increase of $458,000. This increase in sales of systems productsmainly reflects sales of our Direct to Edit acquisition products and ProxSysproducts, partially offset by a decrease in sales of digital signage systems.

Sales of semiconductorproducts to distributors and OEM customers were approximately $1.3 million inthe three months ended June 30, 2007, compared to $1.8 million for the sameperiod in 2006, a decrease of $460,000. For the six months ended June 30, 2007,sales of our semiconductor products were approximately $2.6 million compared to$3.2 million for the same period in 2006, a decrease of $607,000. This decreasereflects a decrease in the demand by a customer that had incorporated our videoconvergence chips in their portable media player (PMP) player in 2006.Subsequent orders from that customer were not received in 2007.

As of June 30, 2007, wehad a sales order backlog of approximately $1.8 million, a decrease of $500,000when compared to the first quarter of 2007.

Sales to twocustomers accounted for 29% of our revenue in the three months ended June 30,2007. Sales to two customers accounted for 36% of our revenue in the threemonths ended June 30, 2006. Sales toone customer accounted for 15% of our revenue for the six month ended in June 30,2007. Sales to two customers accounted for more than 25% of our revenuein the six months ended June 30, 2006.

19

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#### Gross margin

|                                      | ** ** | **Three Months Ended** | ** ** | ** **                  | ** ** |
|--------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| **(Dollars in thousands)** | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006** | ** ** | **Increase** | ** ** |
|                                 |       |                             |       |                        |       |   |   |
| Gross margin                         |       | $                                | 3,910      |                        | $          | 3,787 |   | $ | 123 |   |
|                                 |       |                             |       |                        |       |   |   |
| Gross margin rate                    |       | 46.8                             | %          | 44.8                        | %          | 2.0 percentage points |   |
|                                      |            |                                  |            |                             |            |  |  |  |  |  |

 

|                                      | ** ** | **Six Months Ended** | ** ** | ** **                  | ** ** |
|--------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| **(Dollars in thousands)** | ** ** | **June 30, 2007**    | ** ** | **June 30, 2007** | ** ** | **Increase** | ** ** |
|                                 |       |                           |       |                        |       |   |   |
| Gross margin                         |       | $                              | 7,076      |                        | $          | 6,452 |   | $ | 624 |   |
|                                 |       |                           |       |                        |       |   |   |
| Gross margin rate                    |       | 45.8                           | %          | 41.4                        | %          | 4.4 percentage points |   |
|                                      |            |                                |            |                             |            |  |  |  |  |  |

 

Our gross marginrate for the three months ended June 30, 2007 increased to 46.8% from 44.8% forthe three months ended June 30, 2006, an increase of 2.0 percentage points. Ourgross margin rate in the six months ended June 30, 2007 increased to 45.8% from41.4% in the six months ended June 30, 2006, an increase of 4.4 percentagepoints. This increase in the gross margin rate mainly reflects an increase insales of our higher margin products and improved margins on our TV-Outsemiconductor chips.

**Operatingexpenses**
| ** **                           | ** ** | **Three Months Ended** | ** ** | ** **                  | ** ** | ** **                          | ** ** |
|--------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|-------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006** | ** ** | **Increase / (Decrease)** | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | **% of**               | ** ** | ** **                          | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | **revenue**                 | ** ** | ** **                          | ** ** | **revenue** | ** ** | ** ** | ** ** | **revenue** | ** ** |
|                                 |       |                             |       |                        |       |                                |       |   |   |   |   |   |   |
| Sales, marketing and  support        |       | $                                | 2,479      |                        | 29.7       | %                                   | $          | 2,548 |   | 30.1 | % | $ | (69 | ) | (0.4 | )% |
| General and  administrative          |       | 1,048                            |       | 12.5                        | %          | 1,065                               |       | 12.6 | % | (17 | ) | (0.1 | )% |
| Research and  development            |       | 3,979                            |       | 47.6                        | %          | 2,866                               |       | 33.9 | % | 1,113 |   | 13.7 | % |
| Amortization of  intangible assets   |       | 51                               |       | 0.6                         | %          | 127                                 |       | 1.5 | % | (76 | ) | (0.9 | )% |
|                                 |       |                             |       |                        |       |                                |       |   |   |   |   |   |   |
|                                 |       | $                                | 7,557      |                        | 90.4       | %                                   | $          | 6,606 |   | 78.1 | % | $ | 951 |   | 12.3 | % |

 
| ** **                           | ** ** | **Six Months Ended** | ** ** | ** **                  | ** ** | ** **                          | ** ** |
|--------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|-------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **June 30, 2007**    | ** ** | **June 30, 2006** | ** ** | **Increase / (Decrease)** | ** ** |
| ** **                           | ** ** | ** % of**            | ** ** | ** **                  | ** ** | ** **                          | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                           | ** ** | **revenue**                    | ** ** | ** **                  | ** ** | ** **                          | ** ** | **revenue** | ** ** | ** ** | ** ** | **revenue** | ** ** |
|                                 |       |                           |       |                        |       |                                |       |   |   |   |   |   |   |
| Sales, marketing and  support        |       | $                              | 4,604      |                        | 29.8       | %                                   | $          | 4,622 |   | 29.6 | % | $ | (18 | ) | 0.2 | % |
| General and  administrative          |       | 2,145                          |       | 13.9                        | %          | 1,980                               |       | 12.7 | % | 165 |   | 1.2 | % |
| Research and  development            |       | 7,917                          |       | 51.3                        | %          | 5,847                               |       | 37.5 | % | 2,070 |   | 13.8 | % |
| Amortization of  intangible assets   |       | 156                            |       | 1.0                         | %          | 254                                 |       | 1.6 | % | (98 | ) | (0.6 | )% |
|                                 |       |                           |       |                        |       |                                |       |   |   |   |   |   |   |
|                                 |       | $                              | 14,822     |                        | 96.0       | %                                   | $          | 12,703 |   | 81.4 | % | $ | 2,119 |   | 14.6 | % |

 

20

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Sales, marketing andsupport 

Sales, marketing andsupport expenses for the three and six months ended June 30, 2007 were $2.5million and $4.6 million, respectively, consistent with amounts for the threeand six month ended June 30, 2006.

General andadministrative 

General andadministrative expenses for the three months ended June 30, 2007 were $1.0million, compared to $1.1 million for the three months ended June 30, 2006.General and administrative expenses for the six months ended June 30, 2007 were$2.1 million, an increase of $165,000 from $2.0 million for the six monthsended June 30, 2006.

The increase in generaland administrative expenses reflects an increase in consulting fees of $53,000mainly related to implementation of the requirements of Section 404 of theSarbanes-Oxley Act, an increase in legal fees of $37,000 and an increase inpayroll and payroll related expenses of $116,000, partially offset by a decreaseof $37,000 in investor relation expenses.

Research and development 

Research and developmentexpenses for the three months ended June 30, 2007 were $4.0 million, anincrease of $1.1 million from $2.9 million for the three months ended June 30,2006. The increase in research and development expenses mainly reflects anincrease in payroll and payroll-related expenses of $145,000 and an increase inmaterial and prototyping charges of $990,000 related to our UWB initiative. Theincrease in payroll and payroll-related expenses is due to a higher averageheadcount during the three months ended June 30, 2007 compared to the threemonths ended June 30, 2006. These increases were partially offset by a decreasein consulting expense due to the completion of a third party design service.

Research and developmentexpenses for the six months ended June 30, 2007 were $7.9 million, compared to$5.8 million for the six months ended June 30, 2006, an increase of $2.1million. The increase in research and development expenses mainly reflects anincrease in payroll and payroll-related expenses of $1,640,000 and an increasein material and prototyping charges of $500,000. The increase in payroll andpayroll-related expenses mainly due to a higher average headcount during thesix months ended June 30, 2007 compared to the six months ended June 30, 2006.

Amortization

Amortization expense wasrecorded as follows:

|                         | ** ** | **Three Months Ended** | ** ** | ** **                  | ** ** |
|-------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| **(In thousands)** | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006** | ** ** | **Decrease** | ** ** |
|                    |       |                             |       |                        |       |   |   |
| Cost of revenue         |       | $                                | 6          |                        | $          | 46 |   | $ | (40 | ) |
| Operating  expenses     |       | 51                               |       | 127                         |       | (76 | ) |
|                    |       |                             |       |                        |       |   |   |
|                    |       | $                                | 57         |                        | $          | 173 |   | $ | (116 | ) |

 

|                         | ** ** | **Six Months Ended** | ** ** | ** **                  | ** ** |
|-------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| **(In thousands)** | ** ** | **June 30, 2007**    | ** ** | **June 30, 2006** | ** ** | **Decrease** | ** ** |
|                    |       |                           |       |                        |       |   |   |
| Cost of revenue         |       | $                              | 30         |                        | $          | 91 |   | $ | (61 | ) |
| Operating  expenses     |       | 156                            |       | 254                         |       | (98 | ) |
|                    |       |                           |       |                        |       |   |   |
|                    |       | $                              | 186        |                        | $          | 345 |   | $ | (159 | ) |

 

Amortization expense forthe three months ended June 30, 2007 and 2006 was $57,000 and $173,000respectively.  Amortization expense forthe six months ended June 30, 2007 was $186,000, which decreased $159,000 fromthe six months ended June 30, 2006. The decrease in amortization expensereflects the completion of amortization for certain intangibles associated withour acquisition of COMO Computer & Motion GmbH in February 2004 and VisualCircuits Corporation in May 2004.

21

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**Interest expense, net, Value ofderivative liability, Change in value of derivative liability and Other income,net**

|                                                   | ** ** | **Three Months Ended** | ** ** | ** **                  | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                                        | ** ** | ** **                       | ** ** | ** **                  | ** ** | **Increase /** | ** ** |
| **(Dollars in thousands)**              | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006** | ** ** | **(Decrease)** | ** ** |
|                                              |       |                             |       |                        |       |   |   |
| Interest  expense, net                            |       | $                                | (299       | )                           | $          | (292 | ) | $ | 7 |   |
|                                              |       |                             |       |                        |       |   |   |
| Change in value of  derivative security liability |       | $                                | —     |                        | $          | (1,761 | ) | $ | (1,761 | ) |
|                                              |       |                             |       |                        |       |   |   |
| Other expense, net                                |       | $                                | (2         | )                           | $          | (2 | ) | $ | — |   |

 

|                                                   | ** ** | **Six Months Ended** | ** ** | ** **        | ** ** |
|---------------------------------------------------|------------|----------------------|------------|-------------------|------------|
| **(Dollars in thousands)**                        | ** ** | **June 30, 2007**    | ** ** | **June 30, 2006** | ** ** | **Increase / (Decrease)** | ** ** |
|                                              |       |                 |       |              |       |   |   |
| Interest expense, net                             |       | $                    | (589       | )                 | $          | (491 | ) | $ | 98 |   |
|                                              |       |                 |       |              |       |   |   |
| Value of derivative  liability                    |       | $                    | —     |              | $          | (4,000 | ) | $ | (4,000 | ) |
|                                              |       |                 |       |              |       |   |   |
| Change in value of  derivative security liability |       | $                    | —     |              | $          | (1,361 | ) | $ | (1,361 | ) |
|                                              |       |                 |       |              |       |   |   |
| Other income, net                                 |       | $                    | 1          |              | $          | 68 |   | $ | (67 | ) |

 

Net interest expense forthe three months ended June 30, 2007 was $299,000, compared to $292,000 in thethree months ended June 30, 2006. Net interest expense for the six months endedJune 30, 2007 was $589,000 compared to $491,000 in the six months ended June30, 2006. The increase in net interest expense reflects interest expense onapproximately $17.4 million of debt at June 30, 2007 compared to debt ofapproximately $13.4 million at June 30, 2006.

The $4.0 millionderivative liability represents the fair value of the conversion optioncalculated in connection with the $10.0 million convertible notes issued inJanuary 2006. The value of the conversion option was bifurcated from the debthost contract and recorded as a derivative liability, which resulted in adiscount to the initial carrying amount of the convertible notes. The $4.0million discount was immediately expensed in the condensed consolidatedstatements of operations as value of derivative security as the notes may beconverted to common stock at any time after 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 Focus’ 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. With theelimination of the derivative component, we reclassified the total derivativeliability of approximately $5.4 million to additional paid-in capital.

The six 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 six months ended June 30, 2006.

Other income (expense)for the three and six months ended June 30, 2007 consists mainly offluctuations associated with exchange rate differences related to transactionsdenominated in Euros.

22

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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 sixmonths ended June 30, 2007 and the year ended December 31, 2006, we incurrednet losses of $8.4 million and $15.9 million, respectively, and used cash inoperating activities of $7.9 million, and $8.3 million, respectively. Absentcontinued access to capital from the sale of securities or other sources, wemay potentially be unable to continue 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 we be unableto continue as a going concern. Continuing as a going concern depends upon ourability to generate sufficient positive cash flows to meet our obligations on atimely basis, to obtain additional financing as may be required, and ultimatelyto return to profitability.

Since inception, we havefinanced our operations primarily through the public and private sale of commonstock and other convertible debt securities, lines of credit and debtborrowings from financial institutions, proceeds from the exercise of optionsand warrants, short-term borrowings or guarantees from private lenders(including individuals) and credit arrangements with vendors and suppliers.

 

| (Dollars in thousands) | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|----------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
|                             |       |                        |       |                            |       |
| Cash and cash  equivalents       |       | $                           | 3,986      |                            | $          | 5,969 |   |
| Working capital                  |       | $                           | 1,375      |                            | $          | 2,410 |   |
| Days sales outstanding  (DSO)    |       | 47.9                        |       | 36.0                            |       |
| Inventory turns - annualized     |       | 4.1                         |       | 5.2                             |       |

 

|                                            | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **June 30, 2007**    | ** ** | **June 30, 2006** | ** ** |
|                                       |       |                           |       |   |   |
| Net cash used in  operating activities     |       | $                              | (7,881     | ) | $ | (7,885 | ) |
| Net cash used in  investing activities     |       | $                              | (490       | ) | $ | (296 | ) |
| Net cash provided by  financing activities |       | $                              | 6,383      |   | $ | 8,404 |   |

 

Net cash used inoperating activities

|                                        | ** ** | **Six Months Ended,** | ** ** | ** **        | ** ** |
|----------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                             | ** ** | **June 30, 2007**     | ** ** | **June 30, 2006** | ** ** | **Change in** | ** ** |
| ** **                             | ** ** | **cash (used)**       | ** ** | **cash (used)**   | ** ** | **cash (used)** | ** ** |
| **(In thousands)**                     | ** ** | **provided**          | ** ** | **provided**      | ** ** | **provided** | ** ** |
|                                   |       |                  |       |              |       |   |   |
| Net loss                               |       | $                     | (8,357     | )                 | $          | (12,044 | ) | $ | 3,687 |   |
| Non-cash income  statement items       |       | 1,609                 |       | 6,433             |       | (4,824 | ) |
| Adjusted net loss                      |       | (6,748                | )          | (5,611            | )          | (1,137 | ) |
|                                   |       |                  |       |              |       |   |   |
| Changes in working capital             |       | (1,133                | )          | (2,274            | )          | 1,141 |   |
|                                   |       |                  |       |              |       |   |   |
| Net cash used in  operating activities |       | $                     | (7,881     | )                 | $          | (7,885 | ) | $ | 4 |   |

 

Net cash used inoperating activities for the six months ended June 30, 2007 and 2006 was $7.9million for both periods presented. Net loss adjusted for non-cash items was$6.7 million at June 30, 2007 increased by changes in working capital of $1.1million. Net loss adjusted for non-cash items was $5.6 million at June 30, 2006increased by changes in working capital of $2.3 million.

23

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Two customers had accounts receivable balances in excess of 10% of ourtotal accounts receivable at June 30, 2007. These customers accounted for 32%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 $490,000 for the six months ended June 30, 2007,compared to $296,000 used in the six months ended June 30, 2006. The increasein cash used in investing activities mainly reflects the timing of purchases ofequipment and design tools related to our investment in UWB technology.

Net cash provided byfinancing activities

Net cash provided byfinancing activities was $6.4 million for the six months ended June 30, 2007,compared to $8.4 million for the six months ended June 30, 2006. The net cashprovided by financing activities in the six months ended June 30, 2007 mainlyconsists of net proceeds of $6.2 million from the issuance of stock in aprivate placement and $207,000 from the exercise of stock options and warrants.The net cash provided by financing activities in the six months ended June 30,2006 mainly consists of proceeds of $10.0 million from the issuance ofconvertible notes, $3.0 million of borrowing under the line of credit andproceeds of $945,000 from the exercise of stock options and warrants, partiallyoffset by the repayment of $5.5 million associated with our term loan and lineof credit.

**CapitalResources and Liquidity Outlook**

We have incurred lossesand used net cash in operating activities for the six months ended June 30,2007 and each of the two years in the period ended December 31, 2006, and assuch, have been dependent upon raising money for short- and long-term cashneeds through the issuance of debt, proceeds from the exercise of options andwarrants, and the sale of our common stock in private placements.

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, Greater Bay Bank (“the Bank”) obtained a first priority security intereston our accounts receivable through an agreement with Mr. Berg, which enabledMr. Berg to retain his existing security interest in all of our assets whilesubordinating to the Bank his security interest in our accounts receivable. TheBank credit line is subject to ongoing covenants, including a covenant relatedto operating results. Interestis payable under this loan at prime plus 1%. At June 30, 2007, there wasan outstanding balance on this credit line of $3.45 million, $550,000 less thanthe maximum amount of $4.0 million that was available to borrow. The creditline expires on February 23, 2008.

On June 28, 2005, wesigned a term loan agreement with the Bank under which we can borrow up to $2.5 million. The term loan has amaturity date of February 23, 2008, is interest only until maturity and is inaddition to our existing $4.0 million accounts receivable based secured line ofcredit facility described above with the Bank. Interest is payable under thisloan at prime plus 1%. At June 30, 2007, the outstanding balance under thisterm loan was $2.5 million which is the maximum amount available to borrow.

On January 27, 2006, we raised gross proceeds of$10.0 million from the issuance of secured convertible notes to a group ofprivate investors. Interest accrues on the principal amount of the notes at arate of 10% per annum, payable semi-annually. The notes are convertible intoshares of Focus common stock at a conversion price of $1.00 per share. Thenotes are due January 1, 2011 and are secured by all of the assets of Focus.Under certain circumstances, including a change in control or our failure tocontinue to be listed on the Nasdaq Stock Market, the due date of the notes maybe accelerated. On June 30, 2006 and December 30, 2006, in accordance with theterms of the secured convertible notes, we issued an additional $425,000 and$521,000 of convertible notes in lieu of a cash interest payment due on June30, 2006 and December 30, 2006, respectively. We issued an additional $547,000of convertible notes to satisfy our interest obligations under the securedconvertible notes for the interest payment that was due June 30, 2007.

We received net proceeds of $6.2 million fromthe issuance of common stock to a group of private investors inFebruary 2007.  In addition to thesefunds, we will have to raise additional amounts to complete development andlaunch commercialization of our UWB products. The amount necessary will dependupon the results and timing of ongoing UWB

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development efforts and the anticipated growthof our semiconductor and systems businesses. Our future capital requirements will remain dependent upon  these and other  factors, including cash flow from operations,maintaining our gross margins at current or increased  levels, continued progress in research anddevelopment programs, competing technological and market developments, and ourability to market our new products successfully.

Summary of Certain Contractual Obligations as of June 30, 2007

| (In thousands)                                | ** ** | **< 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|---------------------------|------------|--------------------|------------|--------------------|------------|-----------|------------|
|                                               |       |                      |       |               |       |               |       |      |       |
| Capital and operating  leases (including interest) |       | $                         | 619        |               | $          | 467                |       | $         | 16         |   | $ | 1,102 |   |
| Inventory purchase  commitments                    |       | 2,405                     |       | —             |       | —             |       | 2,405     |       |
| Convertible notes                                  |       | —                    |       | —             |       | 11,493             |       | 11,493    |       |
| Interest on convertible  notes                     |       | 1,149                     |       | 2,877              |       | —             |       | 4,026     |       |
|                                               |       |                      |       |               |       |               |       |      |       |
|                                               |       | $                         | 4,173      |               | $          | 3,344              |       | $         | 11,509     |   | $ | 19,026 |   |

 

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

**Interest Rate Risk**

AtJune 30, 2007, we did not hold any short-term investments that would be exposedto market risk from adverse movements in interest rates.

At June 30, 2007, our outstanding debt obligations consisted of secured convertible notes of $11.5 million — see Note 8, “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 June 30, 2007 and 2006.

**Item 4T. Controlsand 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 are effective.

There was nochange in our internal control over financial reporting that occurred duringour second quarter of 2007 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

We will berequired to evaluate our internal controls over financial reporting and preparea management 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 $650,000through February 2009.

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**PART II - OTHERINFORMATION**

**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, will not have a material adverse effect onFocus’ financial position or results of operations.

**Item 1A.**                 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, 2006. You should carefully consider the risksidentified therein any of which could materially affect our business, financialcondition or future results.**

**We will need to raiseadditional capital, which, if through equity securities placements, will resultin further dilution of existing and future stockholders.**

Historically, we have met our short- and long-term cash needs throughdebt issuances and the sale of common stock in private placements, because cashflow from operations has been insufficient to fund our operations. Set forthbelow is information regarding net proceeds received recently through privateplacements of our convertible debt, common stock and through the exercise ofstock options and warrants:
| (In thousands) | ** ** | **Private Placement of   Convertible Debt** | ** ** | **Private Placements of  Common Stock** | ** ** | **Exercise of Stock  Options and Warrants** | ** ** |
|---------------------|------------|-----------------------------------------------------------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
|                |       |                                                            |       |                                                   |       |                                                            |       |
| 2007                |       | —                                                          |       | $                                                      | 6,205      |                                                            | $          | 207 |   |
| 2006                |       | $                                                               | 10,000     |                                                   | —     |                                                            | $          | 3,843 |   |
| 2005                |       | —                                                          |       | $                                                      | 4,531      |                                                            | $          | 152 |   |
|                     |            |                                                                 |            |                                                        |            |                                                                 |            |  |  |  |

 

We received net proceeds of $6.2 million from the issuance of commonstock to a group of private investors in February 2007.  In addition to these funds, we will have toraise additional amounts to complete development and launch commercializationof our UWB products. The amount necessary will depend upon the results and timingof ongoing UWB development efforts and the anticipated growth of ourSemiconductor and Systems businesses. Our future capital requirements will remain dependent upon  these and other  factors, including cash flow from operations,maintaining our gross margins at current or increased  levels, continued progress in research anddevelopment programs, competing technological and market developments, and ourability to market our new products successfully.  There can be no assurance that additionalequity or debt financing, if required, will be available on acceptable terms orat all. Moreover, any equity financing or convertible debt financing wouldresult in dilution to our existing stockholders and could have a negativeeffect on the market price of our common stock.

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

At August 6, 2007, we had 3,161 shares of preferred stock issued andoutstanding, 4,218,355 warrants and 5,676,499 options outstanding, and $11.5million of convertible notes, which are all exercisable or convertible intoshares of common stock. The 3,161 shares of preferred stock are convertibleinto 3,161,000 shares of our voting common stock and the convertible notes areconvertible into 11,493,000 shares of common stock. Furthermore, at August 6,2007, 1,938,673 additional shares of common stock were available for grant toour employees, officers, directors and consultants under our current stockoption and incentive plans. We also may issue additional shares inacquisitions. Any additional grant of options under existing or future plans orissuance of shares in connection with an acquisition will further diluteexisting stockholders.

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**If our common stock doesnot meet the minimum bid price requirement to remain listed on the NasdaqCapital Market, we will be delisted.  If we were to be delisted, it could,among other things, decrease the liquidity of our common stock and limit ourability to raise additional capital and accelerate the amounts due underour $11.5 million outstanding principal amount of convertible notes  atthe option of the holders.**

Our voting common stock is traded onthe Nasdaq Capital Market. There are various quantitative listing requirementsfor a company to remain listed on the Nasdaq Capital Market, includingmaintaining a minimum bid price of $1.00 per share of common stock andmaintaining stockholders’ equity of $2.5 million.  Our common stock hasnot met the minimum bid price for the period between July 2, 2007 and Aug 9,2007.  We expect to receive a letter from Nasdaq informing usthat because we did not meet the minimum bid price for 30consecutive business days, we will have a period of six months toregain compliance with the minimum bid requirement.

At June 30, 2007, we had totalstockholders’ equity of $4.5 million. To the extent we incur net losses and donot raise additional equity capital, our stockholders’ equity would decline. Ifour stockholders equity fell below the $2.5 million and we did not otherwisehave $35 million market value of our securities, we would likely receivenotification from the Nasdaq Capital Market that we were not in compliance withthe minimum bid price rule. If we do not regain compliance within the allottedcompliance period, including any extensions that may be granted by the NasdaqCapital Market, the Nasdaq Capital Market would notify us that our common stockwould be delisted from the Nasdaq Capital Market, eliminating the onlyestablished trading market for our shares. We would then be entitled to appealthis determination to a Nasdaq Listing Qualifications Panel and request ahearing. If we fail at such hearing in our efforts to retain our listing, wewould be delisted.

In the event we are delisted fromthe Nasdaq Capital Market, we would be forced to list our shares on the OTCElectronic Bulletin Board or some other quotation medium, such as the pinksheets, depending on our ability to meet the specific listing requirements ofthose quotation systems. As a result, an investor might find it more difficultto trade, or to obtain accurate price quotations for, such shares. Delistingmight also reduce our ability to raise capital as well as the visibility,liquidity, and price of our voting common stock. In the event our common stockwas not listed on the Nasdaq Capital Market or another established automatedover-the-counter trading market in the United States, all amounts outstandingunder our $11.5 million senior secured convertible notes would become due andpayable at the option of the holders.

**Item 2.**                          UnregisteredSales of Equity Securities and Use of Proceeds

(a) to (e)                                  None.

**Item 3.**                          DefaultsUpon Senior Securities

None.

**Item 4.**                          Submissionof Matters to a Vote of Security Holders

#### None.

**Item 5.**                          OtherInformation

None.

**Item 6.**                          Exhibits
| 14.  |   | Code of Conduct (Incorporated  by reference to Form 8-K filed on June 13, 2007) |
|------|--------|---------------------------------------------------------------------------------|
| 31.1 |   | Rule 13a-14(a) Certification  of CEO                                            |
| 31.2 |   | Rule 13a-14(a) Certification  of CFO                                            |
| 32.1 |   | CEO 906 Certification                                                           |
| 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.

 
| August 13, 2007 |   | 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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