FORM 10-QSB


                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


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

               For the quarterly period ended: September 30, 1998

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

                For the transition period from _______ to _______

                         Commission File Number 1-11860


                            FOCUS Enhancements, Inc.
        (Exact name of small business issuer as specified in its charter)


               Delaware                              04-3186320
(State or other jurisdiction of                   (IRS Employer
incorporation or organization)                    identification No.)


                                 142 North Road
                                Sudbury, MA 01776
                    (Address of principal executive offices)


                                (978) 371 - 2000
                           (Issuer's telephone number)


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

As of September 30, 1998,  there were  outstanding  17,187,820  shares of Common
Stock, $.01 par value per share.



<PAGE>

                            FOCUS ENHANCEMENTS, INC.
                                   FORM 10-QSB

                                QUARTERLY REPORT
                               September 30, 1998

                                TABLE OF CONTENTS

                                                                         Page

Facing Page                                                                1
Table of Contents                                                          2

PART I. FINANCIAL INFORMATION

    Item 1. Consolidated Financial Statements:

            Consolidated Balance Sheets at September 30, 1998
            and December 31, 1997                                          3

            Consolidated Statements of Operations
            for the Three Months Ended September 30, 1998 and 1997         4

            Consolidated Statements of Operations
            for the Nine Months Ended September 30, 1998 and 1997          5

            Consolidated Statements of Cash Flows
            for the Nine Months Ended September 30, 1998 and 1997         6-7

            Statement of Changes in Equity for the Nine
            Months Ended September 30, 1998                                8

            Statement of Changes in Equity for the Nine
            Months Ended September 30, 1997                                9

            Notes to Consolidated Financial Statements                   10-12

    Item 2. Management's Discussion and Analysis of Financial
            Condition and Results of Operations                          13-21

PART II. OTHER INFORMATION

1. Legal Proceedings                                                       22
    Item 2. Changes in Securities                                          22
    Item 3.  Default upon Senior Securities                                22
    Item 4. Submissions of Matters to a Vote of Security Holders           22
    Item 5. Other Information                                              22
    Item 6. Exhibits and Reports on Form 8-K                               22


SIGNATURES                                                                 23

                                       2

<PAGE>

<TABLE>
<CAPTION>
                                                FOCUS ENHANCEMENTS, INC.
                                               CONSOLIDATED BALANCE SHEETS
                                                       (UNAUDITED)


                                                         ASSETS

                                                                                 September 30,            December 31,
                                                                                     1998                    1997
                                                                                 ------------             ------------
<S>                                                                             <C>                      <C>
Current Assets:
     Cash and cash equivalents                                                   $  3,009,532             $    719,851 
     Securities available for sale                                                    438,684                  595,000
     Accounts receivable, net of allowances of $430,251 and $820,998                                    
        at September 30, 1998 and December 31, 1997, respectively                   9,742,460                5,538,132
     Inventories                                                                    3,264,443                3,989,604
     Prepaid expenses and other current assets                                        525,802                  470,907
                                                                                 ------------             ------------
        Total current assets                                                       16,980,921               11,313,494
                                                                                                        
Property and equipment, net                                                         1,322,501                1,068,918
Other assets, net                                                                     280,689                  288,482
Goodwill, net                                                                       4,099,514                1,249,750
                                                                                 ------------             ------------
        Total assets                                                             $ 22,683,625             $ 13,920,644
                                                                                 ============             ============
                                                                                                        
                                                                                                        
                                          LIABILITIES AND STOCKHOLDERS' EQUITY
                                                                                                        
Current liabilities:                                                                                    
     Notes payable                                                               $    909,475             $  2,220,000
     Obligations under capital leases                                                  26,837                  102,320
     Accounts payable                                                               3,569,290                5,515,913
     Accrued liabilities                                                              272,696                  855,961
                                                                                 ------------             ------------
        Total current liabilities                                                   4,778,298                8,694,194
                                                                                                        
Notes payable                                                                                           
Deferred Income                                                                        84,212                   84,212
Obligations under capital leases                                                       44,260                   73,855
Notes Payable                                                                         914,668                     --
                                                                                 ------------             ------------
        Total liabilities                                                           5,821,438                8,852,261
                                                                                 ------------             ------------
                                                                                                        
                                                                                                        
Stockholders' equity                                                                                    
     Preferred stock, $.01 par value; 3,000,000 shares authorized; none issued           --                       --
     Common stock, $.01 par value; 25,000,000 shares authorized,                                        
         17,637,820 and 14,010,186 shares issued and outstanding at                                     
        September 30, 1998 and December 31, 1997, respectively                        176,378                  140,102
     Additional paid-in capital                                                    38,505,745               27,339,892
     Accumulated deficit                                                          (20,963,490)             (22,411,611)
                                                                                 ------------             ------------
                                                                                   17,718,633                5,068,383

     Accumulated other comprehensive income (loss)                                   (156,316)                    --
     Treasury Stock                                                                  (700,130)                    --
                                                                                 ------------             ------------
        Total stockholders' equity                                                 16,862,187                5,068,383
                                                                                                        
        Total liabilities and stockholders' equity                               $ 22,683,625             $ 13,920,644
                                                                                 ============             ============
                                                                                               

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

                                                           3
<PAGE>
                            FOCUS ENHANCEMENTS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

                                                       Three Months Ended
                                                September 30,      September 30,
                                                     1998              1997
                                                -------------      ------------

Net sales                                        $  7,266,180      $  6,913,013
Cost of goods sold                                  4,207,259         4,764,299
                                                 ------------      ------------

      Gross profit                                  3,058,921         2,148,714
                                                 ------------      ------------

Operating expenses:

      Sales, marketing and support                  1,473,426         1,147,392
      General and administrative                      571,280           415,775
      Research and development                        323,073           331,318
      Depreciation & amortization expense             218,091           109,586
                                                 ------------      ------------
          Total operating expenses                  2,585,870         2,004,071
                                                 ------------      ------------

Income from operations                                473,051           144,643

Interest expense, net                                 (16,819)          (72,466)
Other income, net                                      11,493           351,279
                                                 ------------      ------------

Income before income taxes                            467,725           423,456

Income tax expense                                       --               9,550
                                                 ------------      ------------

Net income                                       $    467,725      $    413,906
                                                 ============      ============

Net income per common share
          Basic                                  $       0.03      $       0.03
                                                 ============      ============
          Diluted                                $       0.03      $       0.03
                                                 ============      ============

Weighted average common shares outstanding
          Basic                                    17,427,999        14,582,324
                                                 ============      ============
          Diluted                                  18,118,926        15,172,554
                                                 ============      ============


               The accompanying notes are an integral part of the
                       consolidated financial statements.

                                       4
<PAGE>
                            FOCUS ENHANCEMENTS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

                                                        Nine Months Ended
                                                 September 30,     September 30,
                                                     1998              1997
                                                 ------------      -------------

Net sales                                        $ 19,390,215      $ 17,839,430
Cost of goods sold                                 11,054,551        12,089,949
                                                 ------------      ------------

      Gross profit                                  8,335,664         5,749,481
                                                 ------------      ------------

Operating expenses:

      Sales, marketing and support                  3,920,763         3,112,609
      General and administrative                    1,346,764         1,083,661
      Research and development                        878,797           763,156
      Depreciation & amortization expense             574,590           301,267
                                                 ------------      ------------
          Total operating expenses                  6,720,914         5,260,693
                                                 ------------      ------------

Income from operations                              1,614,750           488,788

Interest expense, net                                (154,229)         (209,109)
Other income, net                                      17,261           395,110
                                                 ------------      ------------

Income before income taxes                          1,477,782           674,789

Income tax expense                                     29,661            12,700
                                                 ------------      ------------

Net income                                       $  1,448,121      $    662,089
                                                 ============      ============

Net income per common share
          Basic                                  $       0.09      $       0.05
                                                 ============      ============
          Diluted                                $       0.09      $       0.05
                                                 ============      ============

Weighted average common shares outstanding
          Basic                                    16,054,513        12,787,591
                                                 ============      ============
          Diluted                                  16,702,305        13,031,965
                                                 ============      ============

               The accompanying notes are an integral part of the
                       consolidated financial statements.

                                       5
<PAGE>
<TABLE>
<CAPTION>
                                              FOCUS ENHANCEMENTS, INC.
                                       CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                    (UNAUDITED)

                                                                                        Nine Months Ended
                                                                                September 30,       September 30,
                                                                                     1998                1997
                                                                               --------------       --------------
<S>                                                                           <C>                  <C>
Cash flows from operating activities:
     Net income                                                                $ 1,448,121           $   662,089 
     Adjustments to reconcile net income to net cash used in                                         
        operating activities:                                                                        
         Depreciation and amortization                                             574,590               301,267
         Amortization of discount on note payable                                    4,583                     0
         Gain on the forgiveness of accounts payable                                  --                (125,427)
         Deferred Income                                                              --                  84,212
         Changes in operating assets and liabilities, net of the                                     
            effects of acquisition;                                                                  
               (Increase) decrease in accounts receivable                       (3,864,571)           (4,514,833)
               (Increase) decrease in marketable securities                              0              (595,000)
               Decrease (increase) in inventories                                1,096,996              (607,373)
               Decrease (increase) in prepaid expenses and other assets            (54,895)             (217,546)
               Decrease (increase) in other assets                                   7,793                  --
               (Decrease) increase in accounts payable                          (2,043,512)            1,766,971
               (Decrease) increase in accrued liabilities                         (621,285)              413,788
                                                                                                     
                                                                               -----------           -----------
         Net cash used in operating activities                                  (3,452,180)           (2,831,852)
                                                                               -----------           -----------
                                                                                                     
Cash flows from investing activities:                                                                
     Purchase of property and equipment                                           (618,394)             (534,932)
     Net proceeds from sale of fixed assets                                                                  800           
     Cash paid in acquisitions, net of cash received                              (930,563)                 --
                                                                                                     
                                                                               -----------           -----------
         Net cash used in investing activities                                  (1,548,957)             (534,132)
                                                                               -----------           -----------
                                                                                                     
Cash flows from financing activities:                                                                
     Payments on notes payable                                                  (1,740,478)             (268,336)
     Payments under capital lease obligations                                     (105,078)              (70,043)
     Payments for purchase of treasury stock                                      (700,130)          
     Net proceeds from private offerings of common stock                         2,827,355             5,650,099
     Net proceeds from exercise of common stock options and warrants             7,009,149               133,075
                                                                               -----------           -----------
                                                                                                     
         Net cash provided by financing activities                               7,290,818             5,444,795
                                                                               -----------           -----------
                                                                                                     
Net increase in cash and cash equivalents                                        2,289,681             2,078,811
                                                                                                     
Cash and cash equivalents at beginning of period                                   719,851               413,894
                                                                               -----------           -----------
                                                                                                     
Cash and cash equivalents at end of period                                     $ 3,009,532           $ 2,492,705
                                                                               ===========           ===========
                                                                                                   
Supplemental Cash Flow Information:                                                                
                                                                                                   
      Interest paid                                                            $   154,229          $   134,943
      Income taxes paid                                                        $    29,661          $     3,150
      Issuance of Common Stock Warrants                                        $      --            $    42,000 
                                                                                             
                 The accompanying notes are an integral part of the consolidated financial statements.

                                                           6
<PAGE>
<CAPTION>

<S>                                                                           <C>                 
Supplemental  schedule of noncash investing and financing  activities:
On March 31, 1998, the Company purchased  certain assets and assumed certain
liabilities of Digital Vision, Inc. as follows:

Fair value of tangible assets acquired                                             224,957
Fair value of liabilities assumed                                                 (384,495)
                                                                               -----------
Fair value of net assets acquired                                                 (159,538)

Common stock issued                                                             (1,115,625)
Cash paid                                                                          (46,980)

                                                                               ===========
Excess of cost over fair value of net assets acquired                          $(1,322,143)
                                                                               ===========


Supplemental schedule of noncash investing and financing activities:
On July 29, 1998, the Company purchased certain assets and assumed certain
liabilities of PC Video Conversion as follows:

Fair value of tangible assets acquired                                             613,336
Fair value of liabilities assumed                                                  (80,367)
                                                                               -----------
Fair value of net assets acquired                                                  532,969

Common stock issued                                                               (350,000)
Cash paid                                                                         (700,000)
Note Payable                                                                      (910,085)
Acquisition Costs                                                                 (229,781)

                                                                               ===========
Excess of cost over fair value of net assets acquired                          $(1,656,897)
                                                                               ===========
                The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>

                                                           7

<PAGE>
<TABLE>
<CAPTION>
                                                      FOCUS ENHANCEMENTS, INC.
                                                   STATEMENT OF CHANGES IN EQUITY
                                            FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998


                                                                                                Accumulated             
                                                                      Additional                   Other                
                                            Comprehensive   Common     Paid-in    Accumulated  Comprehensive  Treasury  
                                            Income (loss)   Stock      Capital      Deficit        (loss)      Stock       Total
                                            ------------- ---------  ----------- ------------- ------------- ---------   --------
<S>                                        <C>           <C>        <C>         <C>             <C>         <C>        <C>        
Balance, December 31, 1997                  $        --   $ 140,102  $27,339,892 $(22,411,611)   $     --    $      --  $ 5,068,383
                                                                                                                        
Comprehensive Income                                                                                                    
  Net income                                  1,448,121                             1,448,121                             1,448,121
  Other comprehensive income, net of tax                                                                                
    Unrealized (loss) on securities            (156,316)                                         (156,316)                 (156,316)
                                            -----------                                                                 
Comprehensive income                        $ 1,291,805                                                                 
                                            ===========                                                                 
                                                                                                                        
Common stock issued                                          36,276   11,265,853                                         11,302,129
                                                                                                                        
Treasury stock purchased                                                                                      (700,130)    (700,130)
                                                          ---------  ----------- ------------   ---------    ---------  -----------
Balance, September 30, 1998                               $ 176,378  $38,605,745 $(20,963,490)  $(156,316)   $(700,130) $16,962,187
                                                          =========  =========== ============   =========    =========  ===========
                                                                                                                         
                                                                                                              
                        The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>

                                                                 8

<PAGE>
<TABLE>
<CAPTION>
                                                      FOCUS ENHANCEMENTS, INC.
                                                   STATEMENT OF CHANGES IN EQUITY
                                            FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997


                                                                                        Additional
                                                      Comprehensive        Common         Paid-in       Accumulated     
                                                      Income (loss)        Stock          Capital         Deficit           Total
                                                      -------------       --------      -----------     ------------     -----------
                                                                                                                        
<S>                                                   <C>                <C>           <C>             <C>              <C>       
Balance, December 31, 1996                             $     --           $113,018      $21,285,037     $(20,425,532)    $  972,523
                                                                                                                        
Comprehensive Income                                                                                                    
  Net income                                            662,089                                              662,089        662,089
  Other comprehensive income, net of tax                                                                                
    Unrealized (loss) on securities                                                                                               --
                                                       --------                                                         
Comprehensive income                                   $662,089                                                         
                                                       ========                                                         
                                                                                                                        
Common stock issued                                                         25,147        5,758,027                       5,783,174
                                                                          --------      -----------     ------------     ----------
Balance, September 30, 1997                                               $138,165      $27,043,064     $(19,763,443)    $7,417,786
                                                                          ========      ===========     ============     ==========
                                                                                                                        
                                                                                                                        
                        The accompanying notes are an integral part of the consolidated financial statements.        
</TABLE>
                                                                 9


<PAGE>
                            FOCUS ENHANCEMENTS, INC.
              NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.       BASIS OF PRESENTATION

         The consolidated financial statements of FOCUS Enhancements, Inc. ("the
Company") as of  September  30, 1998 and for the three- and  nine-month  periods
ended  September  30,  1998  and  1997  are  unaudited  and  should  be  read in
conjunction with the consolidated financial statements and notes thereto for the
year ended  December 31, 1997  included in the  Company's  Annual Report on Form
10-KSB  for the  year  ended  December  31,  1997.  The  consolidated  financial
statements include the accounts of the Company and its wholly-owned subsidiaries
PC Video  Conversion  Inc.,  Lapis  Technologies,  Inc.,  TView,  Inc. and FOCUS
Enhancements  B.V. On March 31, 1998,  the Company  acquired  certain assets and
assumed certain liabilities of Digital Vision,  Inc. in a transaction  accounted
for under the  purchase  method of  accounting.  On July 29,  1998,  the Company
acquired  certain assets and assumed certain  liabilities of PC Video Conversion
Inc. in a transaction accounted for under the purchase method of accounting.

The results of  operations  of Digital  Vision,  Inc.  have been included in the
accompanying  consolidated financial statements since April 1, 1998. The results
of  operations  of  PC  Video   Conversion  Corp.  have  been  included  in  the
accompanying   consolidated  financial  statements  since  July  29,  1998.  The
following unaudited pro forma information presents a summary of the consolidated
results of operations of the Company as if the  acquisitions had occurred at the
beginning of the nine-month period presented.

                                            Pro forma Results
                                            Nine Months Ended
                                              September 30,

                                        1998               1997
                                    -----------------------------
Net sales                           21,391,000         20,839,000
Income from operations               1,718,000            654,000
Net income                           1,526,333            777,000
Net income per common share                           
     Basic                          $      .09         $      .05
     Diluted                               .09                .05
                                                
In the opinion of management,  the consolidated financial statements include all
adjustments  (consisting only of normal recurring  adjustments)  necessary for a
fair  presentation  of the  results  of the  interim  periods.  The  results  of
operations  for the three- and nine-month  periods ended  September 30, 1998 are
not  necessarily  indicative  of the results that may be expected for any future
period.

2.       NET INCOME PER SHARE

         In February 1997,  the Financial  Accounting  Standards  Board ("FASB")
issued Statement of Financial  Accounting Standards ("SFAS") No. 128 - "Earnings
Per Share" which  requires  earnings per share to be  calculated  on a basic and
dilutive basis.  Basic earnings per share represents  income available to common
stock divided by the weighted-average number of common shares outstanding during
the period.  Diluted earnings per share reflects  additional  common shares that
would have been outstanding if dilutive potential common shares had been issued,
as well  as any  adjustment  to  income  that  would  result  from  the  assumed
conversion.  Potential  common  shares that may be issued by the Company  relate
solely to outstanding  stock options and warrants,  and are determined using the
treasury  stock method.  The assumed  conversion of  outstanding  dilutive stock
options and warrants would increase the shares outstanding but would not require
an adjustment to income as a result of the conversion. For the nine-

                                       10
<PAGE>
months ended  September  30, 1998 and 1997,  options and warrants  applicable to
1,940,040 shares and 4,665,937  shares,  respectively,  were  anti-dilutive  and
excluded  from the diluted  earnings  per share  computation.  The  statement is
effective for interim and annual  periods  ending after  December 15, 1997,  and
requires the  restatement of all prior period earnings per share data presented.
Accordingly,  the Company has  restated  all  earnings  per share data for prior
periods presented herein.

3.       COMPREHENSIVE INCOME

         In June  1997,  FASB  issued  SFAS No.  130,  "Reporting  Comprehensive
Income",   effective  for  fiscal  years  beginning  after  December  15,  1997.
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Certain FASB statements,  however, require
entities  to  report  specific  changes  in  assets  and  liabilities,  such  as
unrealized  gains and  losses on  available-for-sale  securities,  as a separate
component of the equity section of the balance sheet. Such items, along with net
income, are components of comprehensive  income.  SFAS No. 130 requires that all
items of  comprehensive  income be  reported in a  financial  statement  that is
displayed with the same prominence as other financial statements.  Additionally,
SFAS No. 130 requires that the accumulated balance of other comprehensive income
be displayed separately from retained earnings and additional paid-in-capital in
the equity section of the balance sheet.  The Company  adopted these  disclosure
requirements  in the  first  quarter  of  1998  and  has  presented  comparative
disclosure for the nine months ended  September 30, 1998 and September 30, 1997,
respectively.  In 1997,  the Company had no other  components  of  comprehensive
income other than net income.

4.       INCOME TAXES

         The  Company has  utilized  its net  operating  loss  carryforwards  in
estimating its provision for income taxes in the three- and  nine-month  periods
ended September 30,1998.

5.       INVENTORIES

         Inventories consist of the following:

                                     September 30,     December 31,
                                         1998              1997
                                     -------------     ------------

         Finished goods               $2,876,155       $3,304,444
         Raw materials                   388,288          685,160
                                      ----------       ----------
                                      $3,264,443       $3,989,604
                                      ==========       ==========
                                   
6.       NOTES PAYABLE

         Lines of Credit,  Banks.  The Company  maintains  a  revolving  line of
credit with a bank,  which is fully drawn as of September  30, 1998.  Borrowings
under the line are  payable  upon  demand and are  collateralized  by all of the
assets of the Company, except as noted below.  Borrowings,  aggregating $660,000
at  September  30, 1998,  bear  interest at the bank's prime rate plus 1% (9% at
September  30,  1998).  In November of 1998,  the line of credit was extended to
December 15, 1998.

         Term Line of Credit.  The Company owed $1,500,000 to an unrelated party
under a term line of credit.  The Company  repaid this  obligation,  in full, on
July 10, 1998.

         Term Loan, Bank. On March 31, 1998, the Company assumed a $329,953 bank
loan resulting from the purchase of certain assets and the assumption of certain
liabilities of Digital  Vision,  Inc. The  borrowings  bear interest at the Wall
Street Journal prime rate plus 2% (10% at September 30, 1998).  The terms of the
note  require  payment  of  interest  only  through   September  30,  1998.  The
outstanding  balance at  September  30,  1998 is payable  thereafter  in monthly
installments, with interest, until the loan expiration date of June 30, 1999. At
September 30, 1998, the outstanding amount owed on this loan was $249,475.

         Notes payable,  Related  Party.  On July 29, 1998, the Company issued a
$1,000,000  note payable to a related party in conjunction with the acquisition
of PC Video.  The  Company  paid PC Video  $700,000 in cash and  delivered  this
promissory  note in the  principal  amount of  $1,000,000  providing  payment of
principal and interest at 3.5% over a period of 36 months.  The Company computed
a discount of $89,915 on this note based on its  incremental  borrowing rate. In
addition,  the Company  issued 122,796 shares of common stock as a result of the
acquisition,  which  were  valued at  $350,000  and the  Company  has  agreed to
register under the Securities Act of 1933, as amended, by no later than November
30, 1998.  The Company  also assumed  approximately  $79,650 of  liabilities  in
connection  with this  acquisition.  The acquisition is being accounted for as a
purchase and resulted in goodwill of approximately $1,657,000.

                                       11
<PAGE>
7.       COMMON STOCK TRANSACTIONS

         On March 3, 1998,  the Company  completed a financing of  approximately
$3,000,000 in gross  proceeds from the sale of 1,092,150  shares of common stock
and warrants to purchase  327,645 shares of common stock in a private  placement
to an unaffiliated accredited investor. The warrants are exercisable until March
3, 2005. The shares issued in connection with this transaction and issuable upon
exercise of the warrants were  registered  under the  Securities  Act of 1933 on
April 22, 1998.  Fees and expenses  associated  with this  offering  amounted to
approximately  $172,600 yielding net proceeds of $2,827,400.  In connection with
this transaction, the Board of Directors authorized the grant of warrants to the
placement  agent to purchase  21,429 shares of the  Company's  common stock at a
price of $4.2118 per share exercisable for a period of five years.

         On March 31, 1998, the Company issued  approximately  350,000 shares of
common  stock  valued  at  approximately  $1,115,600  in  conjunction  with  the
acquisition of certain assets of Digital  Vision,  Inc. Shares issued as part of
this  transaction  have been  registered  under the  Securities  Act of 1933. In
addition,  the Company agreed to pay  approximately  $47,000 in cash for the net
assets with a  preliminary  estimated  fair value of  approximately  ($160,000),
consisting of accounts receivable ($164,400),  inventory ($60,600) offset by the
assumption of notes  payable  ($330,000)  and accounts  payable  ($55,000).  The
resulting  goodwill  of  approximately  $1,322,000  will be  amortized  over its
estimated benefit period of ten years.

         The Company  received  gross  proceeds of $6,146,887 as a result of the
conversion of 910,650 of the Company's Redeemable Common Stock Purchase Warrants
(the "Warrants") issued in connection with the Company's initial public offering
in May 1993. The Company issued  1,649,202 shares of common stock as a result of
the exercise of the warrants. In accordance with the anti-dilution provisions of
the  Warrants,  the holder was entitled to receive  1.811 shares of common stock
for each Warrant  exercised.  The Warrants were  exercisable at a price of $6.75
per Warrant until May 26, 1998.

         On July 29,  1998,  the  Company  acquired  certain  assets and assumed
certain  liabilities of PC Video Conversion,  Inc. ("PC Video"). At the closing,
the Company paid PC Video  $700,000 in cash and  delivered a promissory  note in
the principal amount of $1,000,000  providing  payment of principal and interest
at 3.5% over a period of 36 months.  The Company  computed a discount of $89,915
on the note based on its incremental  borrowing  rate. In addition,  the Company
issued 122,796 shares of common stock as a result of the acquisition, which were
valued at $350,000 and the Company has agreed to register  under the  Securities
Act of 1933, as amended,  by no later than  November 30, 1998.  The Company also
assumed   approximately   $79,650  of  liabilities   in  connection   with  this
acquisition.  The  acquisition is being accounted for as a purchase and resulted
in goodwill of approximately $1,657,000.

8.       TREASURY STOCK TRANSACTIONS

         Through September 30, 1998, the Company has repurchased  450,000 shares
of its  common  stock at an  average  price of $1.56 per share for an  aggregate
amount of $700,130.

                                       12
<PAGE>
           
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
         CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

         The  following  information  should  be read in  conjunction  with  the
consolidated  financial  statements  and notes thereto in Part I, Item 1 of this
Quarterly  Report and with  Management's  Discussion  and  Analysis of Financial
Condition and Results of Operations  contained in the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1997.

         The  Company  does  not  provide  forecasts  of  the  future  financial
performance of the Company.  However, from time to time, information provided by
the Company or statements  made by its employees may contain  "forward  looking"
information  that involves risks and  uncertainties.  In particular,  statements
contained in this Form 10-QSB which are not historical facts constitute  forward
looking  statements and are made under the safe harbor provisions of the Private
Securities  Litigation Reform Act of 1995. Each forward looking statement should
be read in  conjunction  with the  consolidated  financial  statements and notes
thereto in Part I, Item 1, of this  Quarterly  Report  and with the  information
contained in Item 2, including,  but not limited to,  "Certain  Factors That May
Affect  Future  Results"  contained  herein,   together  with  the  Management's
Discussion  and  Analysis  of  Financial  Condition  and  Results of  Operations
contained  in the  Company's  Annual  Report on Form  10-KSB  for the year ended
December 31, 1997,  including,  but not limited to, the section therein entitled
"Certain Factors That May Affect Future Results."


RESULTS OF OPERATIONS

             Three-Month Period Ended September 30, 1998 As Compared
              With The Three-Month Period Ended September 30, 1997

Net Sales

         Net sales for the three-month period ended September 30, 1998 ("Q3 98")
were  approximately  $7,266,000 as compared with  $6,913,000 for the three-month
period ended  September  30, 1997 ("Q3 97"),  an increase of $353,000 or 5%. The
increase in sales was due primarily to the  acceptance of the Company's PC to TV
product  line in the  consumer  retail,  VAR,  and mail order  channels in North
America  and in Europe.  Specifically,  net sales in Q3 98 to the  Company's  US
resellers  increased 128% to approximately  $6,161,000 from $2,702,000 in Q3 97.
Net sales to  international  resellers  declined  63% in Q3 98 to  approximately
$275,000  from  $752,000  in Q3 97.  This  decrease  was  due to  poor  economic
conditions  in the  Asian  market  combined  with  the  sale  of  the  Company's
networking  product line that contributed  approximately  $300,000 in Q3 97. Net
sales  to  OEM/Licensing  customers  decreased  76% to  $830,000  in Q3 98  from
$3,459,000  in Q3 97.  This  decrease  reflects  the Company  not  shipping  its
PC-to-TV  products  to a large  television  manufacturer  that  is  experiencing
financial  difficulty (in Q3 97 sales to this customer amounted to approximately
$1,700,000). In addition, a significant OEM customer utilizing the FS300 Digital
Video  Co-processor  for  the  Asian  marketplace  pushed  its  Q3 98  and Q4 98
requirements out until the first half of 1999. During Q3 98, the company shipped
$0 in  networking  products  compared to  approximately  $426,000 in Q3 97. This
decline was due to the Company  selling  its Network  product  line in the third
quarter of 1997.

         As of  September  30,  1998,  the Company had a sales order  backlog of
approximately $ 825,000.

 Cost of Goods Sold

         Cost of goods sold were  approximately  $4,207,000 or 58% of net sales,
for Q3 98,  as  compared  with  $4,764,000  or 69% of net  sales,  for Q3 97,  a
decrease of  approximately  $557,000 or 12%. The Company's  gross profit margins
for Q3 98 and Q3 97 were 42% and 31%,  respectively.  As a percentage  

                                       13
<PAGE>
of sales,  cost of goods sold was lower in Q3 98 principally  due to the cost of
goods reduction in the Company's  PC-to-TV products  utilizing the FS300 digital
Video  Co-Processor.  

Sales, Marketing and Support Expenses

         Sales, marketing and support expenses were approximately  $1,473,000 or
20% of net  sales,  for the Q3 98, as  compared  with  $1,147,000  or 17% of net
sales, for Q3 97, an increase of approximately  $326,000 or 28%. The increase is
due  primarily  to  additional  staffing,  advertising  and  marketing  expenses
resulting from domestic channel expansion efforts.

General and Administrative Expenses

         General  and  administrative  expenses  for  Q3 98  were  approximately
$571,000 or 8% of net sales,  as compared with $416,000,  or 6% of net sales for
Q3 97, an  increase  of  approximately  $155,000  or 37%.  The  increase  is due
primarily to increases in staffing and professional services.

Research and Development Expenses

         Research  and  development   expenses  for  Q3  98  were  approximately
$323,000,  or 4% of net sales, as compared to $331,000,  or 5% of net sales, for
Q3 97, a decrease of approximately $8,000 or 2%. The decrease is due principally
to a decrease in consulting fees of approximately  $56,000 offset by an increase
in staffing of approximately $49,000.

Depreciation & Amortization Expense

         Depreciation  &  amortization  expense  for  Q3  98  was  approximately
$218,000 or 3% of net sales, as compared to $110,000, or 2% of net sales, for Q3
97, an increase of $108,000,  or 98%. The increase is primarily  attributable to
increased  depreciation  associated with purchases of property and equipment and
amortization  associated with the  acquisitions  of Digital Vision,  Inc. and PC
Video Conversion.

Interest Expense, Net

         Net interest expense for Q3 98 was approximately  $17,000 or .2% of net
sales,  as compared to $72,000,  or 1.0% of net sales,  for Q3 97, a decrease of
$55,000,  or 76%.  The  decrease is  primarily  attributable  to a reduction  in
outstanding  debt  balances and the  reduction of certain fees incurred with the
extension of the Company's revolving line of credit.

Other Income (Expense)

         Other Income (Expense) for Q3 98 was approximately  $12,000 as compared
to $ 351,000,  for Q3 97. Other income in Q3 97 was $348,727  resulting from the
sale of the Company's networking product line.

Net Income

         For the quarter  ended  September  30, 1998,  the Company  reported net
income  of  approximately  $468,000,  or $0.03  per  share,  on both a basic and
diluted basis,  as compared to $414,000 or $0.03 per share,  on both a basic and
diluted basis, for the quarter ended September 30, 1997.


                                       14
<PAGE>

             Nine-Month Period Ended September 30, 1998 As Compared
               With The Nine-Month Period Ended September 30, 1997

Net Sales

         Net sales for the nine-month  period ended  September 30, 1998 (the "98
Period") were  approximately  $19,390,000 as compared with  $17,839,000  for the
nine-month  period ended  September 30, 1997 (the "97  Period"),  an increase of
$1,551,000  or 9%.  The  growth  in net  sales is due to the  acceptance  of the
Company's  PC-to-TV  product  line in the  consumer  retail,  VAR and mail order
channels.  Specifically,  net  sales  in the 98  Period,  to  the  Company's  US
resellers  increased 68% to approximately  $15,427,000 from $9,138,000 in the 97
Period.  Net sales to  international  resellers  declined  66% to  approximately
$744,000 from $2,170,000 for the same  nine-month  period in 1997. This decrease
was due to poor economic  conditions in the Asian market  combined with the sale
of the Company's networking product line that contributed sales of approximately
$1,021,000.  Net sales to OEM/Licensing customers decreased 57% to approximately
$2,813,000 in the 98 Period from  $6,531,000 for the nine-month  period in 1997.
This  decrease  was  primarily  due to the Company  not  shipping  its  PC-to-TV
products  to a  large  television  manufacturer  who is  experiencing  financial
difficulties  (sales to this customer amounted to approximately  $300,000 in the
97 period).

Cost of Goods Sold

         Cost of goods sold were approximately  $11,055,000 or 57% of net sales,
for the 98 Period,  as compared with $12,090,000 or 68% of net sales, for the 97
Period,  a decrease in absolute dollars of $1,035,000 or 9%. The Company's gross
profit  margins  for  the 98  Period  and  the  97  Period  were  43%  and  32%,
respectively.  As a percentage of sales,  cost of goods sold was lower in the 98
Period  principally due to reduced  manufacturing  costs achieved as a result of
the use of the  Company's  FS300  integrated  circuit  in  manufacturing  of the
Company's  products,  combined with a decrease in OEM sales on which margins are
typically  lower. 

Sales, Marketing and Support Expenses

         Sales, marketing and support expenses were approximately  $3,921,000 or
20% of net sales,  for the 98 Period,  as compared with $3,113,000 or 17% of net
sales,  for the 97 Period,  an  increase of  $808,000  or 26%.  The  increase in
absolute  dollars is due  primarily  to  additional  staffing,  advertising  and
marketing expenses resulting from domestic channel expansion efforts.

General and Administrative Expenses

         General   and   administrative   expenses   for  the  98  Period   were
approximately  $1,3478,000 or 8% of net sales, as compared with $1,084,000 or 6%
of net sales for the 97 Period,  an increase of $263,000 or 24%. The increase in
absolute  dollars  is  due  primarily  to  increases  in  staffing  of  $50,000,
professional services of $40,000 and acquisition related expenses of $118,000

Research and Development Expenses

         Research and development  expenses for the 98 Period were approximately
$879,000 or 5% of net sales,  as compared with $763,000 or 4% of net sales,  for
the 97 Period,  an increase of $116,000 or 15%. The increase is due  principally
to increases in staffing of $75,000 and recruiting expenses of $15,000.

Depreciation & Amortization Expense

         Depreciation & amortization expense for the 98 Period was approximately
$575,000 or 3% of net sales, as compared to $301,000 or 2% of net sales, for the
97  Period,  an  increase  of  $274,000,  or  91%.  The 

                                       15
<PAGE>

increase is primarily  attributable  to increased  depreciation  associated with
purchases  of  property  and  equipment  and  amortization  associated  with the
acquisitions of Digital Vision, Inc. and PC Video Conversion.

Interest Expense, Net

         Net interest  expense for the 98 Period was  approximately  $154,000 or
 .8% of net sales,  as  compared  to  $209,000  or 1.2% of net sales,  for the 97
Period, a decrease of $55,000, or 26%. The decrease is primarily attributable to
a reduction  in  outstanding  debt  balances  and the  reduction of certain fees
incurred with the extension of the Company's revolving line of credit.

Other Income

         Other Income for the 98 Period was approximately $17,000 as compared to
$395,000, for the 97 Period, primarily due to the recognition of a $348,727 gain
on the sale of the Company's networking product line in the 97 Period.

Net Income

         For the  nine-months  period  ended  September  30,  1998,  the Company
reported net income of approximately  $1,448,000,  or $0.09 per share, on both a
basic and diluted basis as compared to $662,000,  or $0.05 per share,  on both a
basic and diluted basis for the nine-months period ended September 30, 1997.


LIQUIDITY AND CAPITAL RESOURCES

         Net cash used in operating  activities for the nine-month periods ended
September 30, 1998 and 1997 was  approximately  ($3,452,180)  and  ($2,831,852),
respectively.  In the 98 Period, net cash used in operating activities consisted
primarily of an increase in accounts  receivable of $3,864,571  and decreases in
inventory of $1,096,996,  accounts payable of $2,403,512 and accrued liabilities
of  $621,285.   This  was  offset  by  non-cash  charges  for  depreciation  and
amortization  of $574,590,  and net income of  $1,448,121.  As of September  30,
1998,  accounts  receivable  from a major  distributor and from a major national
retailer represented approximately 53% and 10%,  respectively, of total accounts
receivable.  In the 98 Period, the Company wrote-off  approximately  $400,000 of
uncollectable  accounts receivable against a reserve established at December 31,
1997. In the 98 Period, the Company continued to record provisions for potential
future uncollectable accounts. The Company continually monitors inventory levels
at its resellers, and during the 98 Period experienced improved sell-through and
lower inventory levels of its products in its distribution  channels.  In the 97
period,  net  cash  used in  operations  activities  consisted  primarily  of an
increase in accounts  receivable  and  inventory  of  $4,514,833  and  $607,373,
respectively.  This was offset by an increase in accounts payable of $1,766,971,
depreciation and amortization  (non-cash charge) of $301,267,  and net income of
$662,089.

         Net cash used in investing  activities for the nine-month periods ended
September 30, 1998 and 1997 was  ($1,548,957) and ($534,132),  respectively.  In
the 98 Period,  the  Company  acquired  the assets and  liabilities  of PC Video
Conversion Corp. for  approximately  $929,000 which included the actual cost and
related expenses  incurred in connection with the completion of the acquisition.
In addition to that activity in the 98 Period the Company also paid  acquisition
costs of approximately $47,000 for the purchase of Digital Vision, Inc. The only
other  activities  in the 98  Period  and the 97 Period  where  cash was used in
investing  activities was principally for the purchase of property and equipment
in amounts of $618,394 and $534,932, respectively.

         Net cash provided from financing  activities for the nine-month periods
ended September 30, 1998 and 1997 was $7,290,818 and  $5,444,795,  respectively.
In the 98 Period,  the Company received  $2,827,355 in net proceeds from private
offerings  of common  stock and  $7,009,149  from the  exercise of 

                                       16
<PAGE>

common stock options and warrants.  The Company's financing proceeds were offset
by payments on notes payable,  treasury stock and capital lease obligations.  In
the same  nine-month  period in 1997,  the Company  received  $5,650,099  in net
proceeds  from private  offerings of Common Stock and $133,075 from the exercise
of common stock  options and  warrants.  The 97 Period  financing  proceeds were
offset by payments on notes payable and capital lease obligations.

         As  of  September  30,  1998,  the  Company  had  working   capital  of
$12,202,623,  as compared to  $2,619,300  at December 31,  1997,  an increase of
$9,583,323. The Company's cash position increased to $3,009,532 at September 30,
1998, an increase of $2,289,681, or 318%, over amounts at December 31, 1997.

         On March 3, 1998, the Company sold 1,092,150 shares of common stock and
warrants  to  purchase  327,645  shares of common  stock for gross  proceeds  of
approximately  $3,000,000 in a private  placement to an unaffiliated  accredited
investor.  The warrants are exercisable until March 3, 2005 if during the period
ending  August 25, 1999,  the average of the closing bid prices of the Company's
common  stock  during any  consecutive  20 trading days is equal to or less than
$2.7469. The shares issued in connection with this transaction and issuable upon
exercise of the warrants were  registered  under the  Securities  Act of 1933 on
April 22, 1998.  Fees and expenses  associated  with this  offering  amounted to
approximately  $172,600 yielding net proceeds of $2,827,400.  In connection with
this transaction, the Board of Directors authorized the grant of warrants to the
placement  agent to purchase  21,429 shares of the  Company's  common stock at a
price of $4.2118 per share exercisable for a period of five years.

         The Company received gross proceeds of $6,146,887.50 as a result of the
conversion of 910,650 of the Company's Redeemable Common Stock Purchase Warrants
(the "Warrants") issued in connection with the Company's initial public offering
in May 1993. The Company issued  1,649,202 shares of common stock as a result of
the conversion. In accordance with the anti-dilution provisions of the Warrants,
the holder was entitled to receive 1.811 shares of common stock for each Warrant
exercised.  The Warrants were  exercisable at a price of $6.75 per Warrant until
May 26, 1998.

         Although  the  Company  has  been  successful  in the  past in  raising
sufficient  capital to fund its  operations,  there can be no assurance that the
Company will achieve sustained  profitability or obtain sufficient  financing in
the  future to provide  the  liquidity  necessary  for the  Company to  continue
operations.

         In  November  1998,  the  Company  received  a waiver of the  covenants
contained in its revolving line of credit,  together with a revision of the loan
covenants and an agreement to extend the line until December 15, 1998.


Effects of Inflation and Seasonality

         The Company believes that inflation has not had a significant impact on
the  Company's  sales or operating  results.  The  Company's  business  does not
experience  substantial  variations  in revenues or operating  income during the
year due to seasonality.

Environmental Liability

         The Company has no known environmental violations or assessments.

Year 2000

General

         The  Company's  Year  2000   compliance   project  (the  "Project")  is
proceeding on schedule. The Project is addressing the issue of computer programs
and embedded computer chips being unable to distinguish

                                       17
<PAGE>

between  the year 1900 and the year  2000.  In early  1998,  in order to improve
access to business  information  and to strengthen  its  infrastructure  through
common,  integrated  computing  systems across the Company,  the Company began a
business systems  replacement  project with systems that use programs  primarily
from Macola,  Inc. The  installation  of the new systems,  which are expected to
make  approximately 90 percent of the Company's  business  computer systems Year
2000 compliant,  is scheduled for completion by mid-1999. The Macola system will
replace a non-compliant  accounting and manufacturing system.  Implementation of
the Macola programs is on schedule and  approximately  20 percent  complete.  To
facilitate  the  Project,  The Company has  retained  outside  consultants  with
expertise   in  wide  area   networking   ("WAN"),   systems   integration   and
business/contact data management.

         The Company has developed a contingency  plan to make the programs that
are  scheduled to be replaced by the Macola  programs Year 2000  compliant.  The
contingency plan includes  contracted  on-site support,  work flow modification,
and  integration  of Year 2000  compliant  systems.  A decision to implement the
contingency  plan is  expected  to be made by the  end of  first  quarter  1999.
Remaining business software programs are expected to be made Year 2000 compliant
through the  Project,  including  those  supplied  by  vendors,  or they will be
retired.  None of the Company's other information  technology (IT) projects have
been delayed due to the implementation of the Project.

Project

         The Project is being  implemented in two phases:  Phase I, installation
of the hardware and business applications, will precede the WAN installation and
the  integration of various  communications  systems.  Phase I is expected to be
completed by December 21, 1998 and Phase II is expected to be completed by April
30, 1999.

         The Project is divided  into two major  sections -  infrastructure  and
applications  software (sometimes  collectively referred to as "IT Systems") and
third-party  suppliers and customers  ("External  Agents").  The general  phases
common to all sections  are: (1)  inventorying  Year 2000 items;  (2)  assigning
priorities to identified  items; (3) assessing the Year 2000 compliance of items
determined to be material to the Company;  (4)  repairing or replacing  material
items that are determined not to be Year 2000  compliant;  (5) testing  material
items; and (6) designing and implementing  contingency and business continuation
plans for each organization and company location.

         At September 30, 1998, the inventory and priority  assessment phases of
each section of the Project had been completed and the Company is in the process
of  assessing  Year 2000  compliance  of its  material  items and  repairing  or
replacing such items. Material items are those believed by the Company to have a
risk involving the safety of  individuals,  or that may cause damage to property
or the  environment,  or that have a material effect on the Company's  revenues.
The testing  phases of the Project  will be performed by the Company and will be
ongoing as hardware or system software is remedied, upgraded or replaced.

         The  infrastructure  portion of the IT section consists of hardware and
systems software other than  applications  software.  The Company estimates that
approximately  50 percent of the activities  required to achieve  infrastructure
Year 2000  compliance  had been  completed  at September  30, 1998.  Contingency
planning for infrastructure is scheduled to commence in fourth quarter 1998. All
infrastructure activities are expected to be completed by March 31, 1999.

         The application  software  portion of the IT section  includes both the
conversion of  applications  software that is not Year 2000 compliant and, where
available  from the supplier,  the  replacement  of such  software.  The Company
estimates that the software  conversion  phase was more than 10 percent complete
at  September  30,  1998,  and the  remaining  conversions  are  expected  to be
completed by mid-1999.

                                       18
<PAGE>
         The testing phase for  application  software is ongoing and is expected
to be completed by mid-1999.  The vendor software  replacements and upgrades are
presently  behind  schedule,  although,  the  Company  currently  believes  that
replacements and upgrades will be completed on schedule by mid-1999. Contingency
planning for  application  software is scheduled to begin in fourth quarter 1998
and be completed by mid-1999.

         The External  Agents section  includes the process of  identifying  and
prioritizing critical suppliers and customers at the direct interface level, and
communicating  with them about their plans and progress in addressing  their own
Year 2000 issues.  Detailed  evaluations of the most critical third parties have
been  initiated.  These  evaluations  will be  followed  by the  development  of
contingency  plans,  which are  scheduled  in the fourth  quarter of 1998,  with
completion by mid-1999.  The Company estimates that this section was on schedule
at September 30, 1998.  Follow-up  reviews of External Agents are expected to be
undertaken through the remainder of 1999.

Costs

         The total cost  associated with required  modifications  to become Year
2000  compliant  is not  expected  to be  material  to the  Company's  financial
position. The estimated total cost of the Project is approximately $300,000. The
total amount expended on the Project  through  September 30, 1998, was $150,000,
of which  approximately  $140,000  related  to the  cost to  repair  or  replace
software and related hardware problems, and approximately $10,000 related to the
cost of identifying and communicating with External Agents. The estimated future
cost of  completing  the Project is  estimated to be  approximately  $150,000 --
$130,000  to repair or replace  software  and related  hardware,  and $20,000 to
identify  and  communicate  with  External  Agents.  Funds for the  Project  are
provided  from a separate  budget of $300,000 for all items other than  External
Agent costs, which are included in existing  operating budgets.  Ancillary costs
of  implementing  the Macola  business  replacement  systems are not included in
these cost estimates.

Risks

         The failure to correct a material  Year 2000 problem could result in an
interruption  in,  or a  failure  of,  certain  normal  business  activities  or
operations.  Such failures could  materially and adversely  affect the Company's
results of  operations,  liquidity and financial  condition.  Due to the general
uncertainty  inherent  in the Year  2000  problem,  resulting  in part  from the
uncertainty of the Year 2000  readiness of third-party  suppliers and customers,
the Company is unable to determine at this time whether the consequences of Year
2000  failures  will  have  a  material  impact  on  the  Company's  results  of
operations,  liquidity  or  financial  condition.  The  Project is  expected  to
significantly  reduce the  Company's  level of  uncertainty  about the Year 2000
problem and, in particular,  about the Year 2000 compliance and readiness of its
material External Agents.  The Company believes that, with the implementation of
new business systems and completion of the Project as scheduled, the possibility
of significant interruptions of normal operations should be reduced.

         Readers are cautioned that forward-looking  statements contained in the
year 2000 Update should be read in  conjunction  with the Company's  disclosures
under the heading: "CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS" beginning on
page 21.

         The Company is including  the  following  cautionary  statement to take
advantage of the "safe harbor" provisions of the PRIVATE  SECURITIES  LITIGATION
REFORM ACT OF 1995 for any  forward-looking  statement made by, or on behalf of,
the Company.  The factors identified in this cautionary  statement are important
factors (but not  necessarily  all  important  factors)  that could cause actual
results  to  differ  materially  from  those  expressed  in any  forward-looking
statement made by, or on behalf of, the Company.

                                       19
<PAGE>
         Where any such  forward-looking  statement  includes a statement of the
assumptions or bases  underlying  such  forward-looking  statement,  the Company
cautions that,  while it believes such assumptions or bases to be reasonable and
makes them in good faith,  assumed facts or bases almost always vary from actual
results,  and the differences  between assumed facts or bases and actual results
can be material,  depending on the circumstances.  Where, in any forward-looking
statement, the Company, or its management, expresses an expectation or belief as
to future  results,  such  expectation  or belief is expressed in good faith and
believed to have a  reasonable  basis,  but there can be no  assurance  that the
statement of expectation or belief will result, or be achieved or accomplished.

         Taking into account the  foregoing,  the  following  are  identified as
important  risk  factors  that could cause  actual  results  with respect to the
Company's Year 2000 compliance to differ  materially from those expressed in any
forward-looking statement made by, or on behalf of, the Company:

o        The dates on which the Company  believes  the Project will be completed
         and the Macola  business  computer system will be implemented are based
         on management's best estimates,  which were derived utilizing  numerous
         assumptions of future events,  including the continued  availability of
         certain  resources,  third-party  modification plans and other factors.
         However,  there  can be no  guarantee  that  these  estimates  will  be
         achieved,  or that  there  will not be a delay in, or  increased  costs
         associated with, the implementation of the Project.

o        A delay in the  implementation  of the Macola  systems could impact the
         Company's  readiness  for the  introduction  of the  Euro  currency  in
         connection with the Company's European sales activities.

o        Other  specific  factors  that  might  cause  differences  between  the
         estimates  and actual  results  include,  but are not  limited  to, the
         availability and cost of personnel  trained in these areas, the ability
         to locate and correct all relevant  computer code,  timely responses to
         and  corrections  by  third-parties  and  suppliers,   the  ability  to
         implement  interfaces between the new systems and the systems not being
         replaced, and similar uncertainties.

o        Due to the  general  uncertainty  inherent  in the Year  2000  problem,
         resulting in part from the  uncertainty  of the Year 2000  readiness of
         third-parties and the interconnection of global businesses, the Company
         cannot  ensure  its  ability  to timely  and  cost-effectively  resolve
         problems  associated  with the Year 2000 issue that may  materially and
         adversely  affect  its  operations  and  business,   or  expose  it  to
         third-party liability.


                                       20
<PAGE>

                 CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

         The  Company  does  not  provide  forecasts  of  the  future  financial
performance of the Company.  However, from time to time, information provided by
the Company or statements  made by its employees may contain  "forward  looking"
information  that involve risks and  uncertainties.  In  particular,  statements
contained in this Form 10-QSB which are not historical facts (including, but not
limited to, statements concerning international revenues,  anticipated operating
expense levels and such expense levels relative to the Company's total revenues)
constitute  forward  looking  statements  and are made  under  the  safe  harbor
provisions  of  the  Private  Securities  Litigation  Reform  Act of  1995.  The
Company's  actual results of operations and financial  condition have varied and
may in the future vary  significantly  from those stated in any forward  looking
statements. Factors that may cause such differences include, without limitation,
the availability of capital to fund the Company's future cash needs, reliance on
major customers,  history of operating losses,  limited  availability of capital
under credit  arrangements  with  lenders,  market  acceptance  of the Company's
products, technological obsolescence, competition, component supply problems and
protection of proprietary information,  as well as the accuracy of the Company's
internal  estimates of revenue and  operating  expense  levels and the Company's
ability  to  achieve  Year  2000  compliance  on a timely  basis  as more  fully
described above.


                                       21
<PAGE>

                           PART II - OTHER INFORMATION


ITEM 1.  LEGAL PROCEEDINGS

         The Company is not party to any pending legal  proceedings,  other than
routine  litigation  that is  incidental  to its business.

ITEM 2.  CHANGES IN SECURITIES

         None

ITEM 3.  DEFAULT UPON SENIOR SECURITIES

         None

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

         None

ITEM 5.  OTHER INFORMATION

         None

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

a.       The following exhibits are filed herewith:

         11       Statement Re: Computation of Per Share Earnings

         27       Financial Data Schedule


b. Reports on Form 8-K


         The  Company  did not file any  reports on Form 8-K during the  quarter
         ended September 30, 1998.


                                       22
<PAGE>


                                   SIGNATURES

In accordance with the  requirements of the Exchange Act, the Registrant  caused
this  report to be  signed on its  behalf  by the  undersigned,  thereunto  duly
authorized.


                                             FOCUS Enhancements, Inc.




         November 16, 1998      By:  \s\  Thomas L. Massie
                                          Thomas L. Massie
                                      Chief Executive Officer and
                                        Chairman of the Board
                                      (Principal Executive Officer)



         November 16, 1998      By:   \s\  Gary M. Cebula 
                                           Gary M. Cebula
                                      Vice President of Finance
                                         and Administration
                                    (Principal Accounting Officer)

                                       23