U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005, or

o 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.

(Name of Issuer in its Charter)

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 Principal Executive Offices)

(408) 866-8300

(Issuer’s Telephone Number, Including Area Code)

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

Title of Each Class

Common Stock, $0.01 par value

Name of Exchange on which Registered

NASDAQ

Securities registered pursuant to Section 12(g) of the Act: None

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). o Yes No ý

As of the close of business May 12, 2005, there were 60.0 million shares of Focus Enhancement’s common stock issued and outstanding.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Focus Enhancements, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended
	March 31, 2005			March 31, 2004

Net revenue	$	5,455		$	4,094
Cost of revenue	3,700			2,780
Gross margin	1,755			1,314

Operating expenses:
Sales, marketing and support	1,424			1,054
General and administrative	1,001			557
Research and development	3,942			1,106
Amortization of intangible assets	149			146
	6,516			2,863
Loss from operations	(4,761		)	(1,549		)
Interest expense, net	(13		)	(46		)
Other income	—			6
Loss before income taxes	(4,774		)	(1,589		)
Income tax expense	4			—
Net loss	$	(4,778	)	$	(1,589	)

Net loss per share
Basic and diluted	$	(0.08	)	$	(0.04	)

Weighted average common and common equivalent shares
Basic and diluted	59,081			42,905

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

Focus Enhancements, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

(Unaudited)

	March 31,			December 31,
	2005			2004
Assets

Current assets:
Cash and cash equivalents	$	3,515		$	3,380
Accounts receivable, net of allowances of $446 and $443	2,972			3,273
Inventories	4,099			3,941
Prepaid expenses and other current assets	521			473
Restricted cash	20			312
Total current assets	11,127			11,379

Long-term assets:
Property and equipment, net	1,396			1,116
Other assets	52			62
Intangible assets, net	1,383			1,577
Goodwill	13,191			13,191

	$	27,149		$	27,325

Liabilities and Stockholders’ Equity

Current liabilities:
Accounts payable	$	4,092		$	2,555
Borrowings under lines of credit	2,723			567
Current portion of long-term debt	52			55
Current portion of capital lease obligations	70			22
Accrued liabilities	2,938			2,634
Total current liabilities	9,875			5,833

Long-term liabilities:
Long-term debt, net of current portion	153			174
Capital lease obligations, net of current portion	58			—
Other liabilities	73			—
Total long-term liabilities	284			174

Stockholders’ equity:
Preferred stock, $0.01 par value; authorized 3,000,000 shares; 3,161 shares issued at March 31, 2005 and December 31, 2004, respectively (aggregate liquidation preference $3,917)	—			—
Common stock, $0.01 par value; 100,000,000 shares authorized, 60,454,525 and 60,412,591 shares issued at March 31, 2005 and December 31, 2004, respectively	597			597
Additional paid-in capital	96,198			95,463
Accumulated deficit	(78,784		)	(74,006		)
Deferred stock-based compensation	(265		)	—
Accumulated other comprehensive income (loss)	(6		)	14
Treasury stock at cost, 497,500 shares at March 31, 2005 and December 31, 2004, respectively	(750		)	(750		)
Total stockholders’ equity	16,990			21,318

	$	27,149		$	27,325

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

Focus Enhancements, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Three Months Ended,
	March 31, 2005			March 31, 2004
Cash flows from operating activities:
Net loss	$	(4,778	)	$	(1,589	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	329			189
Stock-based compensation	30			—
Changes in assets and liabilities:
Decrease in accounts receivable	262			903
Decrease (increase) in inventories	(184		)	555
Increase in prepaid expenses and other assets	(49		)	(124		)
Increase (decrease) in accounts payable	1,567			(695		)
Increase (decrease) in accrued liabilities	531			(136		)
Net cash used in operating activities	(2,292		)	(897		)

Cash flows from investing activities:
Decrease in restricted cash	279			—
Acquisition costs related to Visual Circuits Corporation	—			(194		)
Purchases of property and equipment	(420		)	(15		)
Acquisition of COMO Computer and Motion GmbH net of cash acquired	—			(3		)
Net cash used in investing activities	(141		)	(212		)

Cash flows from financing activities:
Borrowings under lines of credit	2,493			—
Repayments of lines of credit	(311		)	—
Payments of short-term debt	(11		)	—
Repayment of transaction costs related to acquisition of Visual Circuits Corporation	225			—
Proceeds from issuance of escrow stock related to acquisition of COMO Computer and Motion GmbH	191			—
Proceeds from exercise of common stock options, net of issuance costs	(14		)	79
Net cash provided by financing activities	2,573			79

Effect of exchange rate changes on cash and cash equivalents	12			—

Increase (decrease) in cash and cash equivalents	152			(1,030		)
Cash and cash equivalents at beginning of period	3,363			3,731
Cash and cash equivalents at end of period	$	3,515		$	2,701

Non-Cash Activity

Conversion of notes payable and accrued interest to related party into common and preferred stock	$	—		$	4,454

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

Notes to Condensed Consolidated Financial Statements

1. Basis of Presentation – Interim Financial Information

The condensed consolidated financial statements of Focus Enhancements, Inc. (“Focus” or “the Company”) as of March 31, 2005 and for the three-month periods ended March 31, 2005 and March 31, 2004 are unaudited and should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2004, included in Focus’ Annual Report on Form 10-K/A for the year ended December 31, 2004.

In the opinion of management, the condensed consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of Focus’ financial position, operating results and cash flows for the periods presented. The results of operations and cash flows for the three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for any future period. Certain items previously reported in specific financial statement captions have been reclassified. Such reclassifications have not impacted previously reported net loss amounts.

During the first quarter of 2005, Focus converted from a 13-week quarter that ended on the last Sunday of the period to a calendar quarter. For convenience, the comparative results in the accompanying condensed consolidated statements of operations and condensed consolidated statements of cash flows are shown as ending on March 31, 2004, although the first quarter of fiscal year 2004 ended on April 4, 2004. The change in the quarter end did not have a material impact on the reported operating results or financial position of Focus.

2. Consolidation and Foreign Currency Translation

The interim unaudited condensed consolidated financial statements include Focus’ accounts and those of its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated upon consolidation.

The functional currency of Focus’ foreign subsidiary, COMO Computer & Motion GmbH (“COMO” – see Note 6, “Business Combinations”), is the Euro. Gains and losses resulting from the translation of COMO’s financial statements are reported as a separate component of stockholders’ equity. Gains and losses resulting from foreign currency transactions are included in net loss.

3. Pro Forma Stock Compensation Expense

Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date over the amount an employee must pay to acquire the stock. Stock options issued under Focus’ stock option plans have no intrinsic value at grant date. Accordingly, under APB Opinion No. 25, no compensation cost is recognized.

Focus has elected to continue with the accounting prescribed in APB Opinion No. 25 and, as a result, must make pro forma disclosures of net income (loss) and net income (loss) per share and other disclosures as if the fair value based method of accounting had been applied. The estimated fair value of the options is amortized to expense over the vesting period of the option. The following table presents the effect on reported net loss and net loss per share of accounting for employee stock options under the fair value method:

	Three Months Ended
(In thousands, except per share data)	March 31, 2005			March 31, 2004

Reported net loss	$	(4,778	)	$	(1,589	)
Stock-based compensation determined under fair value method for all awards, net of related tax effects	(369		)	(273		)

Pro forma net loss	$	(5,147	)	$	(1,862	)

Reported net loss per share	$	(0.08	)	$	(0.04	)
Stock-based compensation determined under fair value method for all awards, net of related tax effects	(0.01		)	(0.00		)

Basic and diluted pro forma net loss per share	$	(0.09	)	$	(0.04	)

Common stock equivalents have been excluded from all calculations of net loss per share and pro forma net loss per share for the periods presented because the effect of including them would be anti-dilutive.

4. Significant Customers

Sales to one customer accounted for 15% of Focus’ total revenue in the three months ended March 31, 2005. Three customers had sales in excess in of 10% of Focus’ revenue in the three months ended March 31, 2004. The aggregate sales to these three customers accounted for 47% of our total revenue in 2004.

Two customers had accounts receivable balances in excess of 10% of Focus’ total accounts receivable at March 31, 2005. These customers accounted for 25% of Focus’ total accounts receivable at that date.

5. Management’s Plans

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. For the three months ended March 31, 2005 and the year ended December 31, 2004, Focus incurred net losses of $4.8 million and $11.0 million, respectively, and used net cash in operating activities of $2.3 million and $9.4 million, respectively. These results indicate that Focus may potentially be unable to continue as a going concern.

The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should Focus be unable to continue as a going concern. Focus’ continuation as a going concern is dependent upon its ability to generate sufficient cash flows to meet its obligations on a timely basis, to obtain additional financing as may be required, and ultimately to return to profitability and significant positive cash flows.

Focus has historically met cash needs from the proceeds of debt, the sale of common stock in private placements and the exercise of employee stock options and warrants. Management continues to assess its product lines in light of technology trends and economic conditions, to identify how to enhance existing product lines or create new distribution channels.

Focus’ management anticipates that Focus will need to obtain additional financing and/or find a partner to fund operations before the end of the second quarter of 2005 in order to meet all currently planned expenditures and cash requirements through the first customer sampling of its Ultra Wideband (“UWB”) chips. Depending upon the results of this sampling program, the profitability of the Systems business, and Focus’ efforts to partner with another entity to market the chips commercially, Focus may need to raise further capital for the widespread commercial deployment of UWB.

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

6 Business Combinations

COMO Computer & Motion GmbH

On February 27, 2004, Focus completed the acquisition of COMO, located in Kiel, Germany, pursuant to which COMO became a wholly-owned subsidiary of Focus. The acquisition was accounted for as a purchase business combination at a total cost of approximately $1.0 million. Under the terms of the agreement, Focus acquired COMO through the issuance of 185,066 shares of its common stock and approximately $359,000 in cash to COMO’s shareholders. Focus was also required to issue up to an additional 46,266 shares of its common stock to COMO’s shareholders, in the event certain conditions were met at the end of 2004 and 2005. These relevant conditions were met at the end of 2004, and accordingly, 23,234 shares were issued to COMO’s former shareholders in March 2005. Additionally, Focus issued 610,096 common shares, held in escrow, to COMO’s two former shareholders who became employees of Focus – see Note 11, “Stockholders’ Equity”. In connection with this transaction, Focus paid vFinance Investments, Inc. (a related party), a success fee of $100,000 and 30,000 shares of Focus’ common stock.

Founded in 1990, COMO develops, manufactures and distributes digital video solutions. COMO’s results of operations are included in Focus’ financial statements from the date of acquisition, and the assets and liabilities were recorded based on their fair values as of the date of acquisition. There were no employee stock options or warrants assumed as a result of the acquisition. Pro forma results of operations have not been presented because the effect of the acquisition was not material to Focus’ financial position or results of operations.

The purchase price of approximately $1.0 million, consisting of 185,066 shares of Focus common stock issued to the COMO shareholders, the fair value of the 46,266 earn-out shares, 30,000 shares of Focus common stock issued to vFinance, cash paid to the COMO shareholders of $359,000, and acquisition costs of approximately $220,000, has been allocated based on the estimated fair value of net tangible and intangible assets acquired, and liabilities assumed. The earn-out shares are included in the purchase price because Focus management believes it is probable that the conditions under which such shares would become payable will be met. The value of the 610,096 common shares issued to COMO’s two shareholders and held in escrow are not included in the purchase price - see Note 11, “Stockholders’ Equity”. A summary of the allocation of the purchase price to the assets acquired and liabilities assumed is as follows:

(In thousands)	Purchase Price Allocation

Assets acquired	$	782
Intangible asset: Existing technology	890
Goodwill	1,104
Liabilities assumed	(1,766		)

	$	1,010

Existing technology is being amortized on a straight-line basis over an estimated useful life of three years.

Visual Circuits Corporation

On May 28, 2004, Focus acquired substantially all the assets and assumed certain liabilities of Visual Circuits Corporation (“Visual Circuits”) pursuant to an Agreement and Plan of Reorganization (“Reorganization Agreement”). The transaction was accounted for as a purchase business combination at a total cost of approximately $8.9 million. Founded in 1991, Visual Circuits is a manufacturer and developer of integrated hardware, software and network products that manage, schedule, distribute, store and present digital video in a wide range of commercial media applications.

Under the terms of the Reorganization Agreement, Visual Circuits, located in Minneapolis, Minnesota, received 3,805,453 shares of voting common stock of Focus, including approximately 380,000 shares placed in escrow for the recovery by Focus of any losses resulting from the breach of covenants by Visual Circuits. In connection with this transaction, Focus paid vFinance Investments, Inc., (a related party) a success fee of $168,000 and 80,000 shares of Focus’ common stock.

Visual Circuits’ results of operations are included in Focus’ financial statements from the date of acquisition, and the assets and liabilities were recorded based on their fair values as of the date of acquisition. There were no employee stock options or warrants assumed as a result of the acquisition.

The purchase price of approximately $8.9 million consisted of the fair value of the shares of Focus common stock issued to Visual Circuits, excluding a portion of the escrow shares associated with amounts owed by Visual Circuits to Focus (see Note 11, “Stockholders’ Equity”), 80,000 shares distributed to vFinance Investments, Inc., and acquisition costs of approximately $440,000. The acquisition costs consisted of financial advisory, legal and accounting fees and other direct transaction costs.

The purchase price allocation is as follows:

(In thousands)	Purchase Price Allocation

Assets acquired	$	1,180
Intangible asset: Existing technology	1,060
Goodwill	6,896
Liabilities assumed	(508		)
In-process research and development	300

	$	8,928

The tangible net assets acquired represent the historical net assets of Visual Circuits’ business as of May 28, 2004. As required under purchase accounting, the assets and liabilities of Visual Circuits have been adjusted to fair value.

Focus performed an allocation of the total purchase price of Visual Circuits to its individual assets acquired and liabilities assumed. Developed technology and in- process research and development (“IPRD”) were identified and valued through interviews, analysis of data provided by the Visual Circuits business concerning development projects, their stage of development, the time and resources needed to complete them, if applicable, their expected income generating ability and associated risks. The income approach, which includes an analysis of the cash flows, and risks associated with achieving such cash flows, was the primary technique utilized in valuing the developed technology and IPRD.

Where development projects had reached technological feasibility, they were classified as developed technology and the value assigned to developed technology was capitalized. The developed technology is being amortized on a straight-line basis over its estimated useful life of three years.

Where the development projects had not reached technological feasibility and had no future alternative uses, they were classified as IPRD. Of the total purchase price, $300,000 was allocated to IPRD, which was expensed upon the consummation of the Reorganization Agreement in the second quarter of 2004. The value was determined by estimating the expected cash flows from the projects once commercially viable, discounting the net cash flows back to their present value and then applying a percentage of completion to the calculated value. If the projects are not successfully developed, the sales and profitability of Focus may be adversely affected in future periods. Goodwill represents the excess of the purchase price over the fair value of the underlying net identifiable assets.

7. Goodwill and Intangible Assets

Goodwill as of March 31, 2005 and December 31, 2004 included the following:

(In thousands)	Goodwill

Videonics	$	5,070
Tview	121
COMO	1,104
Visual Circuits	6,896

	$	13,191

The following tables provide a summary of the carrying amounts of intangible assets:

	March 31, 2005
			Accumulated			Net
(In thousands)	Gross Amount		Amortization			Amount

Existing technology	$	3,945	$	(2,562	)	$	1,383

	December 31, 2004
			Accumulated			Net
	Gross Amount		Amortization			Amount

Existing technology	$	3,945	$	(2,370	)	$	1,575
Tradename	176		(174		)	2

	$	4,121	$	(2,544	)	$	1,577

The total expected future amortization related to intangible assets is provided in the table below:

(In thousands)	Amortization

Nine months ending December 31, 2005	$	517
Fiscal year 2006	681
Fiscal year 2007	185

	$	1,383

8. Inventories

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

(In thousands)	March 31, 2005		December 31, 2004

Raw materials	$	2,154	$	2,308
Work in process	373		51
Finished goods	1,572		1,582

	$	4,099	$	3,941

9. Borrowings

(In thousands)	March 31, 2005		December 31, 2004

Short-term debt:
Current portion of notes payable to bank	$	52	$	55
COMO line of credit	230		567
Accounts receivable-based line of credit	2,493		—
	2,775		622
Long-term debt:
Notes payable to bank (long-term portion)	153		174

	$	2,928	$	796

Short- and long-term bank debt and the COMO line of credit were assumed by Focus as a result of the acquisition of COMO in February 2004 – see Note 6, “Business Combinations”. The notes payable and line of credit are with a local German bank.

The notes payable to a bank, consisting of two notes of $181,000 and $24,000 are denominated in Euros and are scheduled to be repaid through December 2011 and December 2005, respectively, at an average interest rate of 6% per annum. However, the bank reviews COMO’s financial results in connection with these notes and reserves the right to call these notes due at its discretion.

In connection with the COMO line of credit, Focus’ German subsidiary - COMO, maintains a cash balance with the lending institution, which is reported as restricted cash on Focus’ balance sheet. Interest is payable on this line of credit at a rate of 10% per annum. There are no financial covenants applicable to this credit facility, nor is there an applicable maturity date. However, the bank reviews COMO’s financial results in assessing future extensions of credit. At March 31, 2005, there were no further borrowings available under this facility.

The notes payable and COMO line of credit are secured by personal guarantees of approximately $500,000 and life insurance pledges from the two shareholders from whom Focus purchased the shares of COMO common stock, as well as COMO’s inventory, accounts receivable and fixed assets.

Accounts Receivable-Based Line of Credit

In November 2004, Focus obtained a $4.0 million line of credit under which it can borrow up to 90% of its eligible outstanding accounts receivable. The credit line expires in November 2005 and is secured by a personal guarantee from Carl Berg, a Company director and shareholder. In connection with this credit line, the bank has obtained a first priority security interest in Focus’ accounts receivable through an agreement with Mr. Berg, which enables Mr. Berg to retain his existing security interest in all of Focus’ assets while subordinating his interest in Focus’ accounts receivable.

The credit line is subject to certain ongoing covenants based on liquidity ratios and operating results. Borrowings under the credit line bear interest at a rate of prime plus 1%, which equated to 6.75% at March 31, 2005. In connection with this line of credit, Focus issued warrants to the bank to purchase 77,186 shares of Focus’ common stock at an exercise price of approximately $1.17 per share. The warrants were valued at $76,000 using the Black-Scholes option-pricing

model and are being amortized to interest expense over the term of the credit line. At March 31, 2005, there was an outstanding balance of $2.5 million on this credit line and Focus had the ability to borrow an additional $95,000.

10. Commitments and Contingencies

Research and Development Agreements

In June 2004, Focus entered into a development and license agreement under which Focus agreed to pay $664,000 to a third party for engineering services and the rights to certain intellectual property that will be used in the research and development of UWB technology. Such amount was expensed to research and development ratably over the development period from June 2004 to January 2005 based on the level of effort incurred by the third party. A total of $16,000 was expensed in the three months ended March 31, 2005. Payments were made upon the achievement of specific development milestones by the third party, which were completed in January 2005.

On October 1, 2004, Focus entered into a design services contract under which Focus agreed to pay $2.9 million to a third party for the design and development of high performance UWB integrated circuits. Payments are made upon the completion of specific milestones by the third party, which are expected to be completed by December 2005. For the three months ended March 31, 2005, $850,000 was charged to research and development expense based on the level of effort incurred by the third party and $175,000 was included within other accrued liabilities at March 31, 2005.

Leases

Focus leases office facilities and certain equipment under operating leases. Under the lease agreements, Focus is obligated to pay for utilities, taxes, insurance and maintenance.

Minimum lease commitments at March 31, 2005 were as follows:

(In thousands)	Lease Commitments

Nine months ending December 31, 2005	$	369
2006	540
2007	523
2008	183
2009	192

	$	1,807

Employment Agreements

Focus has employment agreements with certain corporate officers. The agreements are generally one to two years in length and provide for minimum salary levels. These agreements include severance payments of approximately half to one times each officer’s annual compensation.

Indemnification agreements

Focus enters into standard indemnification agreements with its customers and certain other business partners in the ordinary course of business. These agreements include provisions for indemnifying the customer against any claim brought by a third party to the extent any such claim alleges that Focus’ products infringe a patent, copyright or trademark, or misappropriate a trade secret, of that third party. The agreements generally limit the scope of the available remedies in a variety of industry-standard methods, including but not limited to product usage and geography-based limitations, a right to control the defense or settlement of any claim, and a right to replace or modify the infringing products to make them noninfringing. Such indemnification provisions are accounted for in accordance with SFAS No. 5, Accounting for Contingencies, and are generally limited to the amount paid by the customer. Focus has not incurred significant expenses related to these indemnification agreements and no material claims for such indemnifications are outstanding as of March 31, 2005. As a result, no liability has been recorded with respect to such indemnifications as of March 31, 2005.

Inventory Purchase Commitments

Under contract manufacturing arrangements, contract manufacturers procure inventory to manufacture products based upon a forecast of customer demand provided by Focus. Focus is responsible for the financial impact on the contract manufacturer of any reduction or product mix shift in the forecast relative to materials that the contract manufacturer had already purchased, and is unable to return, under a prior forecast. Such a variance in forecasted demand could require a cash payment for finished goods in excess of current customer demand or for costs of excess or obsolete inventory.

At March 31, 2005, Focus had issued non-cancelable purchase orders for approximately $1.9 million to purchase finished goods from its contract manufacturers, and had not incurred any significant liability for finished goods in excess of current customer demand or for the costs of excess or obsolete inventory.

General

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

11. Stockholders’ Equity

The acquisition of COMO on February 27, 2004 resulted in the issuance of 215,066 shares of Focus’ common stock, consisting of 185,066 shares issued to COMO’s shareholders, and 30,000 shares issued to vFinance Investments, Inc., for investment banking services related to the acquisition. Additionally, Focus issued 610,096 common shares, held in escrow, (“the Escrow shares”) to COMO’s two former shareholders (“the Sellers”) who became employees of Focus. The Escrow shares were issued in exchange for the Sellers non-interest bearing, non-recourse, demand notes payable to Focus and COMO in the aggregate amount of $1.1 million. For accounting purposes, the Escrow shares are reported in the accompanying financial statements as outstanding, subscribed shares. The two former shareholders of COMO can sell the Escrow shares at no less than the then current fair market value, with all proceeds to be remitted to Focus and COMO in exchange for cancellation of the outstanding note obligations, regardless of whether such proceeds are greater than or less than the balance of the notes. In March 2005, 200,000 of the escrow shares were sold for net proceeds of $191,000. The proceeds from the sale of such shares were remitted to Focus by the Sellers and recorded as an increase in paid-in capital. The note receivable from the Sellers is not recorded in the accompanying condensed consolidated financial statements, as it will be cancelled upon receipt of the proceeds from the sale of the remaining Escrow shares.

On May 28, 2004, Focus acquired substantially all the assets and assumed certain liabilities of Visual Circuits pursuant to an Agreement and Plan of Reorganization. The agreement required VCC Liquidating Corporation (“VCC”), formerly Visual Circuits Corporation, to reimburse Focus for all transaction costs paid by Visual Circuits prior to the acquisition. Such transaction costs, originally estimated to be $400,000 and later reduced to approximately $337,000 upon final determination of the transaction costs, were to have been reimbursed to Focus on or before October 8, 2004. Focus was entitled to recover the amount owed, in the event such amount was not reimbursed to Focus, by the return to Focus of Focus common stock held in escrow, with such number of shares to be determined by dividing the amount owed by an agreed-upon exchange rate of $2.33 per share. VCC subsequently sought to reduce this obligation, citing certain potential offsetting claims against Focus. Consequently, on November 2, 2004, the parties entered into a settlement agreement, whereby the obligation to Focus was initially reduced to approximately $225,000, to be repaid on or before February 15, 2005. If VCC did not remit this settlement amount by February 15, 2005, then the settlement amount owed was to have been increased in $20,000 increments on a monthly basis if not paid on the fifteenth of each subsequent month to a maximum of $305,000, if the then existing settlement amount was not repaid by May 15, 2005. If any amount owed remained unpaid after May 15, 2005, Focus had the right to recover such amounts in exchange for Focus common stock held in escrow, based on a reduced exchange rate of $1.15 per share. The receivable from VCC was not recorded in the accompanying consolidated balance sheet at December 31, 2004, as the recourse available to Focus in the event of default was limited to the shares held in escrow. On February 15, 2005, Focus collected the amount owed of $225,000 and recorded the proceeds as an increase in capital at that date.

As of March 31, 2005, Focus was obligated under certain circumstances, to issue the following additional shares of common stock pursuant to derivative securities, instruments or agreements:

(In thousands)		Shares of Common Stock

Warrants to purchase common stock		3,312
Options to purchase common stock		7,707
Preferred Stock convertible into common stock		3,161

		14,180

12. Related Party Transactions

Carl Berg

In December 2002, Mr. Berg, a Company director and shareholder, provided Samsung Semiconductor Inc., Focus’ contracted ASIC manufacturer, with a personal guarantee to secure Focus’ working capital requirements for ASIC purchase order fulfillment. Mr. Berg agreed to provide the 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 March 31, 2005, Focus owed Samsung $11,000 under net 30 terms.

In November 2004, Focus secured a line of credit of up to $4.0 million under which Focus can borrow up to 90% of its eligible outstanding accounts receivable. This line of credit is secured by a personal guarantee from Mr. Berg. In connection with this line of credit, the bank obtained 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.

Dolby Laboratories Inc.

N. William Jasper Jr., who is the Chairman of Focus’ Board of Directors, is also the President and Chief Executive Officer of Dolby Laboratories, Inc. (“Dolby”), a signal processing technology company located in San Francisco, California. Focus is required to submit quarterly royalty payments to Dolby based on Dolby technology incorporated into certain products assumed in the acquisition of Visual Circuits in May 2004. For the three months ended March 31, 2005, Focus paid Dolby $3,000 in royalties, which were recorded in cost of revenue.

13. Business Segment Information

Focus’ reportable segments are Systems and Semiconductor. These reportable segments have distinct products – Systems consists of products designed to provide solutions in PC-to-TV scan conversion, video presentation, digital-video conversion, video production and home theater markets and Semiconductor consists of Application Specific Integrated Circuits (ASICs). Focus’ chief operating decision maker is the CEO.

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

	Three Months Ended March 31, 2005
	Systems			Semiconductor			Total

Net revenue	$	4,964		$	491		$	5,455
Cost of revenue	3,441			259			3,700
Gross margin	1,523			232			1,755

Operating expenses:
Sales, marketing and support	1,093			331			1,424
General and administrative	662			339			1,001
Research and development	1,082			2,860			3,942
Amortization of intangible assets	86			63			149
	2,923			3,593			6,516
Loss from operations	$	(1,400	)	$	(3,361	)	$	(4,761	)

	Three Months Ended March 31, 2004
	Systems			Semiconductor			Total

Net revenue	$	2,847		$	1,247		$	4,094
Cost of revenue	1,904			876			2,780
Gross margin	943			371			1,314

Operating expenses:
Sales, marketing and support	844			210			1,054
General and administrative	387			170			557
Research and development	571			535			1,106
Amortization of intangible assets	109			37			146
	1,911			952			2,863
Loss from operations	$	(968	)	$	(581	)	$	(1,549	)

14. Recent Accounting Pronouncements

Focus accounts for stock-based compensation awards issued to employees using the intrinsic value measurement provisions of APB No. 25. Accordingly, no compensation expense has been recorded for stock options granted with exercise prices greater than or equal to the fair value of the underlying common stock at the option grant date. On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”). SFAS 123R eliminates the alternative of applying the intrinsic value measurement provisions of Opinion 25 to stock compensation awards issued to employees. Rather, the new standard requires enterprises to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period).

Focus has not yet quantified the effects of the adoption of SFAS 123R, but it is expected that the new standard may result in significant stock-based compensation expense. The pro forma effects on net loss and loss per share if Focus had applied the fair value recognition provisions of original SFAS No. 123 on stock compensation awards (rather than applying the intrinsic value measurement provisions of Opinion 25) are disclosed in Note 3, “Pro Forma Stock Compensation Expense”. Although such pro forma effects of applying the original SFAS 123 may be indicative of the effects of adopting SFAS 123R, the provisions of these two statements differ in some important respects. The actual effects of adopting SFAS 123R will be dependent on numerous factors including, but not limited to, the valuation model chosen by Focus to value stock-based awards; the assumed award forfeiture rate; the accounting policies adopted concerning the method of recognizing the fair value of awards over the requisite service period; and the transition method (as described below) chosen for adopting SFAS 123R.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following information should be read in conjunction with the condensed 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 Focus’ Annual Report on Form 10-K/A for the year ended December 31, 2004.

Certain Factors That May Affect Future Results

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

In particular, statements contained in this document that are not historical facts (including, but not limited to, statements concerning anticipated revenues, anticipated operating expense levels, potential new products and orders, and such expense levels relative to our total revenues) constitute forward-looking statements and are made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Our 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 our future cash needs, reliance on major customers, history of operating losses, market acceptance of our products, technological obsolescence, competition, successful integration of acquisitions, component supply problems and protection of proprietary information, the unpredictability of costs to develop new technologies, as well as the accuracy of our internal estimates of revenue and operating expense levels. For a discussion of these factors and some of the factors that might cause such a difference see also “ - Risks Factors.” These factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. We do not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

RESULTS OF OPERATIONS

Net revenue

	Three Months Ended
(Dollars in thousands)	March 31, 2005		March 31, 2004		Increase / (decrease)			% increase / (decrease)

System products	$	4,964	$	2,847	$	2,117		74.4	%
Semiconductor products	491		1,247		(756		)	-60.6	%

	$	5,455	$	4,094	$	1,361		33.2	%

Revenue for the three months ended March 31, 2005 was $5.5 million, an increase of $1.4 million, or 33 percent, compared with the three months ended March 31, 2004. The increase in revenue from sales of systems products was partially offset by a decrease in revenue from sales of our semiconductor products.

For the three months ended March 31, 2005, net sales of system products to distributors, retailers and Value Added Resellers, were approximately $5.0 million compared to $2.8 million for the same period in 2004, an increase of $2.2 million. This increase in sales of our systems products mainly reflects sales of products of approximately $2.5 million resulting from the acquisitions of COMO Computer & Motion GmbH (“COMO”) in February 2004 and Visual Circuits

Corporation (“Visual Circuits”) in May 2004, as well as the introduction of a new variation of FireStore – the FS-4, partially offset by a decrease in sales of our consumer scan conversion and home theater products. Our consumer scan conversion product sales have decreased as an increasing number of personal computers and televisions now incorporate scan conversion technology.

Sales of semiconductor products to distributors and OEM customers were approximately $491,000 in the three months ended March 31, 2005, compared to $1.2 million for the same period in 2004, a decrease of $756,000. This decrease mainly reflects reduced sales of our FS454 chip, which was included in Microsoft’s Xbox, in the three months ended March 31, 2004. In January 2004, Microsoft ceased placing orders for our FS454 product. Shipments of the FS454, which were primarily to this significant customer, represented $1.0 million, or 25%, of our total revenues for the three months ended March 31, 2004.

As of March 31, 2005, we had a sales order backlog of approximately $1.9 million, an increase of $441,000 when compared to the fourth quarter of 2004.

Sales to one customer accounted for 15% of our total revenue in the three months ended March 31, 2005. Three customers had sales in excess in of 10% of our revenue in the three months ended March 31, 2004. The aggregate sales to these three customers accounted for 47% of our total revenue in 2004.

Gross margin

	Three Months Ended
(Dollars in thousands)	March 31, 2005			March 31, 2004			Increase

Gross margin	$	1,755		$	1,314		$	441

Gross margin rate	32.2		%	32.1		%	0.1		%

Our gross margin rate for the three months ended March 31, 2005 increased slightly to 32.2% from 32.1% for the three months ended March 31, 2004, an increase of 0.1 of a percentage point. This increase in the gross margin rate reflects the below average gross margin business that we conducted with Microsoft in the three months ended March 31, 2004, which did not occur in the three months ended March 31, 2005, partially offset by inventory obsolescence charges of approximately $134,000 in the three months ended March 31, 2005. Sales to Microsoft were made at a gross profit margin percentage of less than 30%, primarily as a result of volume discounts provided.

Operating expenses

	Three Months Ended
	March 31, 2005				March 31, 2004				Increase / (decrease)
			% of				% of				% of
(Dollars in thousands)			revenue				revenue				revenue

Sales, marketing and support	$	1,424	26.1	%	$	1,054	25.7	%	$	370	0.4	%
General and administrative	1,001		18.4	%	557		13.6	%	444		4.8	%
Research and development	3,942		72.3	%	1,106		27.0	%	2,836		45.3	%
Amortization of intangible assets	149		2.7	%	146		3.6	%	3		-0.9	%

	$	6,516	119.5	%	$	2,863	69.9	%	$	3,653	49.6	%

Sales, marketing and support

Sales, marketing and support expenses for the three months ended March 31, 2005 were $1.4 million, an increase of $370,000 from $1.1 million in the three months ended March 31, 2004.

This increase in sales and marketing expense mainly reflects the inclusion of COMO sales and marketing expenses for the entire period and an increase in sales and marketing costs associated with the expansion of our business development group. COMO’s expenses were only partially included in the prior year’s three-month period as the COMO acquisition occurred on February 28, 2004. An increase in commission expense of $109,000 and advertising expense of $72,000 also contributed to the increase in sales and marketing expense. The increase in commission expense reflects an increase in revenue in the three months ended March 31, 2005 compared to the same quarter in 2004 and the increase in advertising expense reflects recent introductions of our new mixer products and the FS-4.

General and administrative

General and administrative expenses for the three months ended March 31, 2005 were $1.0 million, an increase of $444,000 from $557,000 for the three months ended March 31, 2004.

The increase in general and administrative expenses was mainly due to the addition of four employees, and to a lesser extent, an increase in auditing fees of $67,000 and legal fees of $35,000.

Research and development

Research and development expenses for the three months ended March 31, 2005 were $3.9 million, an increase of $2.8 million from $1.1 million for the three months ended March 31, 2004.

The increase in research and development expenses mainly reflects our investment in UWB and the acquisition of Visual Circuits in May of 2004. Our investment in UWB technology resulted in an increase in research and development expense of $2.3 million, reflecting an increase in semiconductor design service fees of $1.7 million in the three months ended March 31, 2005 compared to the same quarter in 2004 and the hiring of an additional 29 employees. We will need significant additional capital to continue to fund the development of this technology - see Note 5, “Management’s Plans”. The acquisition of Visual Circuits in May 2004 resulted in a headcount increase of 13 employees and contributed to a $423,000 increase in research and development expense.

Amortization

Amortization expense for the three months ended March 31, 2005 was $149,000, an increase of $3,000 from $146,000 for the three months ended March 31, 2004. The increase reflects an increase in amortization expense associated with the intangible assets that resulted from the acquisitions of COMO in February 2004 and Visual Circuits in May 2004, partially offset by the completion of amortization on certain intangible assets.

Interest expense, net and Other income, net

	Three Months Ended
(Dollars in thousands)	March 31, 2005			March 31, 2004			Decrease			% Decrease

Interest expense, net	$	(13	)	$	(46	)	$	(33	)	-71.7	%

Other income, net	—			6			(6		)	n/a

Net interest expense for the three months ended March 31, 2005 was $13,000, compared to $46,000 in the three months ended March 31, 2004. The decrease in net interest expense reflects the conversion of the convertible promissory notes that were outstanding until March 2004 into common and preferred stock, partially offset by interest expense associated with our accounts receivable-based line of credit and with the short- and long-term debt assumed with the acquisition of COMO in February 2004.

LIQUIDITY AND CAPITAL RESOURCES

The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. For the three months ended March 31, 2005 and the year ended December 31, 2004, we incurred net losses of $4.8 million and $11.0 million, respectively, and used cash in operating activities of $2.3 million, and $9.4 million, respectively. These factors indicate that we may potentially be unable to continue as a going concern.

The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern. Our continuation as a going concern is dependent upon our ability to generate sufficient cash flows to meet our obligations on a timely basis, to obtain additional financing as may be required, and ultimately to return to profitability and significant positive cash flows.

Since inception, we have financed our operations primarily through the public and private sale of common stock, proceeds from the exercise of options and warrants, short-term borrowings from private lenders, and favorable credit arrangements with vendors and suppliers.

First Quarter of Fiscal Year 2005 compared to the First Quarter of Fiscal Year 2004

	As of or for Three Months Ended
(Dollars in thousands)	March 31, 2005		December 31, 2004

Cash and cash equivalents	$	3,515	$	3,380

Working capital	$	1,252	$	5,546

	March 31, 2005			March 31, 2004

Days sales outstanding (DSO)	49.0			36.5

Inventory turns - annualized	3.6			3.5

Net cash used in operating activities	$	(2,292	)	$	(897	)
Net cash used in investing activities	$	(141	)	$	(212	)
Net cash provided by financing activities	$	2,573		$	79

Net cash used in operating activities

	Three Months Ended,
	March 31, 2005			March 31, 2004			Change in
	cash (used),			cash (used),			cash (used),
(In thousands)	provided			provided			provided

Net loss	$	(4,778	)	$	(1,589	)	$	(3,189	)
Non-cash income statement items	359			189			170
Decrease in accounts receivable	262			903			(641		)
Decrease (increase) in inventories	(184		)	555			(739		)
Increase in prepaid expenses and other assets	(49		)	(124		)	75
Increase (decrease) in accounts payable	1,567			(695		)	2,262
Increase (decrease) in accrued liabilities	531			(136		)	667

	$	(2,292	)	$	(897	)	$	(1,395	)

Net cash used in operating activities for the three months ended March 31, 2005 and 2004 was $2.3 million and $897,000, respectively. The increase in net cash used in operating activities mainly reflects an increase in the net loss, partially offset by an increase in cash provided from accounts payable and accrued liabilities. The increase in cash provided by accounts payable and accrued liabilities reflects timing of payments and research and development expenses related to our investment in UWB technology.

Two customers had accounts receivable balances in excess of 10% of our total accounts receivable at March 31, 2005 and those customers accounted for 25% of our total accounts receivable at that date.

We expect that our operating cash flows may fluctuate in future periods as a result of fluctuations in our operating results, shipment timetable and accounts receivable collections, inventory management, and the timing of payments among other factors.

Net cash used in investing activities

Net cash used in investing activities was $141,000 for the three months ended March 31, 2005, compared to $212,000 used in the three months ended March 31, 2004. The decrease in cash used in investing activities mainly reflects a decrease in our restricted cash balance at COMO (see Note 9, “Borrowings”) and fees paid in the three months ended March 31, 2004 related to the acquisition of Visual Circuits in May 2004, partially offset by an increase in purchases of equipment and design tools related to our investment in UWB technology.

Net cash provided by financing activities

Net cash provided by financing activities was $2.6 million for the three months ended March 31, 2005, compared to $79,000 for the three months ended March 31, 2004. The increase mainly reflected borrowings of $2.5 million under our accounts receivable-based line of credit, proceeds of $191,000 from the sale of escrow shares (see Note 11, “Stockholders’ Equity”) and the reimbursement of acquisition fees by Visual Circuits Corporation Liquidating Trust related to the acquisition of Visual Circuits, partially offset by repayments of $311,000 related to our German subsidiary’s line of credit balance.

Capital Resources and Liquidity Outlook

We have incurred losses and used net cash in operating activities for the three months ended March 31, 2005 and each of the two years in the period ended December 31, 2004, and as such, have been dependent upon raising money for short- and long-term cash needs through debt, proceeds from the exercise of options and warrants, and the sale of our common stock in private placements. For the year ended December 31, 2004, we received approximately $10.7 million in proceeds from the sale of approximately 10.5 million shares our common stock in private placement transactions.

In November 2004 we obtained a $4.0 million credit line under which we can borrow up to 90% of our eligible outstanding accounts receivable, excluding accounts receivable of COMO. Carl Berg, a Company director and shareholder, provided a personal guarantee to secure this credit line. In connection with this credit line, the bank obtained a first priority security interest in our accounts receivable through an agreement with Mr. Berg, which enables Mr. Berg to retain his existing security interest in all of our assets while subordinating his interest in our accounts receivable. The bank credit line is subject to ongoing covenants, including maintenance of certain liquidity ratios and operating results. At March 31, 2005, there was an outstanding balance of $2.5 million on this credit line and we had the ability to borrow an additional $95,000.

At March 31, 2005, our German subsidiary–COMO–had outstanding debt obligations that consisted of notes payable of $205,000 and borrowings under a line of credit of $230,000, both of which are denominated in Euros and were assumed in connection with the acquisition of COMO – see Note 9, “Borrowings”. Although the notes payable are scheduled to be repaid through 2011, the bank reviews COMO’s financial results in connection with these notes and reserves the right to call these notes due at its discretion.

In addition to regularly reviewing our cost structure, we have recently announced new product introductions and are continually reviewing our product lines to identify how to enhance existing, or create new, distribution channels. There can be no assurances as to the amount of revenue these new products will produce.

We anticipate that we will need to obtain additional financing and/or find a partner to fund operations before the end of the second quarter of 2005 in order to meet all currently planned expenditures and cash requirements through the first customer sampling of our UWB chips. Such financing terms could include debt and/or equity instruments. Our first chip is currently expected to be available for sampling by August 31, 2005, and the second of our chips is anticipated for sampling in the fourth quarter of 2005. Depending upon the results of this sampling program, the profitability of our systems business, and our efforts to partner with another entity to market the chips commercially, we may need to raise further capital for the widespread commercial deployment of UWB.

While we have been successful in the past in raising sufficient capital to fund our operations, there can be no assurance that we will obtain sufficient financing in the future on acceptable terms to continue operations, or if we do obtain such funding, that we can do so without unduly diluting the equity interests of our current stockholders.

Summary of Certain Contractual Obligations as of March 31, 2005

(In thousands)	< 1 year		1-3 years		3-5 years		> 5 years		Total

Operating leases	$	503	$	974	$	330	$	—	$	1,807
Inventory purchase commitments	1,879		—		—		—		1,879
Notes payable	52		55		55		43		205
Interest expense on notes payable	8		9		5		2		24
Lines of credit	2,723		—		—		—		2,723

	$	5,165	$	1,038	$	390	$	45	$	6,638

RISK FACTORS

You should carefully consider the following risks relating to our business and our common stock, together with the other information described elsewhere in this prospectus. If any of the following risks actually occur, our business, results of operations and financial condition could be materially affected, the trading price of our common stock could decline, and you might lose all or part of your investment.

Risks Related to Our Business

We have a long history of operating losses.

As of March 31, 2005, we had an accumulated deficit of $78.8 million. We incurred net losses of $4.8 million, $11.0 million and $1.7 million for the three months ended March 31, 2005 and the years ended December 31, 2004 and 2003, respectively. There can be no assurance that we will ever become profitable. Additionally, our auditors have included an explanatory paragraph in their report on our financial statements for the year ended December 31, 2004 with respect to substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of that uncertainty.

We will need to raise additional capital, which, if through equity securities placements, will result in further dilution of existing and future stockholders.

Historically, we have met our short- and long-term extra cash needs through debt and the sale of common stock in private placements, because cash flow from operations has been insufficient to fund our operations.

Future capital requirements will depend on many factors, including cash flow from operations, continued progress in research and development programs, competing technological and market developments, and our ability to market our products successfully. There can be no assurance that sufficient funds will be raised. Moreover, any equity financing or convertible debt would result in dilution to our existing stockholders and could have a negative effect on the market price of our common stock. Furthermore, any additional debt financing will result in higher interest expense.

We completed the acquisitions of COMO and Visual Circuits in the first and second quarters of 2004, respectively. These acquisitions were effected through the issuance of common stock, and the businesses associated with these acquisitions are not currently profitable.

Our common stock currently does not meet the minimum bid price requirement to remain listed on the Nasdaq SmallCap Market. If we were to be delisted, it could make trading in our stock more difficult.

Our voting common stock is traded on the Nasdaq SmallCap Market. There are various quantitative listing requirements for a company to remain listed on the Nasdaq SmallCap Market, including maintaining a minimum bid price of $1.00 per share of common stock and maintaining stockholders’ equity of $2.5 million. On May 4, 2005, the Nasdaq Stock Market notified us that for the previous 30 consecutive business days, the bid price of our common stock had closed below the minimum $1.00 per share price requirement for continued inclusion under Nasdaq Marketplace Rules.

We have until October 31, 2005 to regain compliance with the Nasdaq SmallCap Market $1.00 minimum bid price rule. If at any time before October 31, 2005, the bid price of our common stock closes at $1.00 or more per share for a minimum of 10 consecutive business days, Nasdaq will notify us that we are in compliance with the Rules. If we do not regain compliance within the allotted compliance period, including any extensions that may be granted by Nasdaq, Nasdaq will notify us that our common stock will be delisted from The Nasdaq SmallCap Market, eliminating the only established trading market for our shares. We would then be entitled to appeal this determination to a Nasdaq Listing Qualifications Panel and request a hearing.

In the event we are delisted from the Nasdaq SmallCap Market, we would be forced to list our shares on the OTC Electronic Bulletin Board or some other quotation medium, such as pink sheets, depending on our ability to meet the specific listing requirements of those quotation systems. As a result, an investor might find it more difficult to trade, or to obtain accurate price quotations for, such shares. Delisting might also reduce the visibility, liquidity, and price of our voting common stock.

We are dependent upon a significant shareholder to meet our financing needs and there can be no assurance that this shareholder will continue to provide financing.

We have relied upon the ability of Carl Berg, a director and significant owner of our common stock, for interim financing needs. At December 31, 2003, we had an aggregate of approximately $4.4 million in debt and accrued interest outstanding to Mr. Berg. On March 19, 2004, Mr. Berg converted this debt and accrued interest to common and preferred stock. Additionally, Mr. Berg has provided a personal guarantee to Samsung Semiconductor Inc., our contracted ASIC manufacturer, to secure our working capital requirements for ASIC purchase order fulfillment and a personal guarantee to Greater Bay Bank in connection with our recent $4 million accounts receivable-based line of credit. Mr. Berg maintains a security interest in all the company’s assets, subject to the bank’s lien on our accounts receivable. There can be no assurances that Mr. Berg will continue to provide such interim financing or personal guarantees, should we need additional funds or increased credit facilities with our vendors.

We have a significant amount of convertible securities that will dilute existing stockholders upon conversion.

At March 31, 2005, we had 3,161 shares of preferred shares issued and outstanding, and 3.3 million warrants and 7.7 million options, which are all exercisable into shares of common stock. The 3,161 shares of preferred stock are convertible into approximately 3.2 million shares of our voting common stock. Furthermore, at March 31, 2005, 821,000 additional shares of common stock were available for grant to our employees, officers, directors and consultants under our current stock option and incentive plans. We also may issue additional shares in acquisitions. Any additional grant of options under existing or future plans or issuance of shares in connection with an acquisition will further dilute existing stockholders.

Any acquisitions of companies or technologies by us, including our acquisitions of COMO and Visual Circuits in 2004, may result in distraction of our management and disruptions to our business.

We may acquire or make investments in complementary businesses, technologies, services or products if appropriate opportunities arise, as was the case in February 2004 when we acquired the stock of COMO and in May 2004 when we acquired substantially all the assets of Visual Circuits. From time-to-time, we may engage in discussions and negotiations with companies regarding the possibility of acquiring or investing in their businesses, products, services or technologies. We may not be able to identify suitable acquisition or investment candidates in the future, or if we do identify suitable candidates, we may not be able to make such acquisitions or investments on commercially acceptable terms, if at all. If we acquire or invest in another company, we could have difficulty assimilating that company’s personnel, operations, technology or products and service offerings. In addition, the key personnel of the acquired company may decide not to work for us. These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect the results of operations. Furthermore, we may incur indebtedness or issue equity securities to pay for any future acquisitions and/or pay for the legal, accounting or finders fees, typically associated with an acquisition. The issuance of equity securities could be dilutive to our existing stockholders. In addition, the accounting treatment for any acquisition transaction may result in significant goodwill and intangible assets, which, if impaired, will negatively affect our consolidated results of operations. The accounting treatment for any potential acquisition may also result in a charge for in-process research and development expense, as was the case with the acquisition of Visual Circuits, which will negatively affect our consolidated results of operations.

We rely on certain vendors for a significant portion of our manufacturing.

Approximately 41% of the components for our products are manufactured on a turnkey basis by three vendors: Furthertech Company Ltd., BTW Inc. and Samsung Semiconductor Inc. In addition, a single vendor in Mexico assembles certain of our products. If these vendors experience production or shipping problems for any reason, we in turn could experience delays in the production and shipping of our products, which would have an adverse effect on our results of operations.

We are dependent on our suppliers.

We purchase all of our parts from outside suppliers and from time-to-time experience delays in obtaining some components or peripheral devices. Additionally, we are dependent on sole source suppliers for certain components. There can be no assurance that labor problems, supply shortages or product discontinuations will not occur in the future, which could significantly increase the cost, or delay shipment, of our products, which in turn could adversely affect our results of operations.

If we fail to meet certain covenants in our credit facility, we may not be able to draw down on such facility and our ability to finance our operations could be adversely affected.

We have a $4.0 million credit line under which we can borrow up to 90% of our eligible outstanding accounts receivable. The various agreements in connection with such credit line require us to maintain certain covenants. For example, we are required to maintain certain financial covenants, including maintenance of certain liquidity ratios and operating results. In the event we are not able to obtain a waiver for any covenant violation, and/or remain out of compliance with a particular covenant, we will not be able to draw down on the line of credit, which could have a material adverse impact on our financial condition and results of operation.

Furthermore, the restrictions contained in the line of credit documents, as well as the terms of other indebtedness we may incur from time-to-time, could limit our ability to plan for or react to market conditions or meet capital needs or otherwise restrict our activities or business plans. These restrictions could also adversely affect our ability to finance our operations or other capital needs, or to engage in other business activities that would be in our interest.

We depend on a few customers for a high percentage of our revenues and the loss or failure to pay of any one of these customers could result in a substantial decline in our revenues and profits.

For the three months ended March 31, 2005, five customers in aggregate provided 33% of our total revenues and as of

March 31, 2005 comprised 40% of our accounts receivable balance. We presently have no reason to believe that these customers lack the financial resources to pay. We do not have long-term contracts requiring any customer to purchase any minimum amount of products. There can be no assurance that we will continue to receive orders of the same magnitude as in the past from existing customers or will be able to market our current or proposed products to new customers. The loss of any major customer, the failure of any such identified customer to pay us, or to discontinue issuance of additional purchase orders, would have a material adverse effect on our revenues, results of operation, and business as a whole, absent the timely replacement of the associated revenues and profit margins associated with such business. Furthermore, many of our products are dependent upon the overall success of our customers’ products, over which we often have no control.

Our quarterly financial results are subject to significant fluctuations.

We have been unable in the past to accurately forecast our operating expenses or revenues. Revenues currently depend heavily on volatile customer purchasing patterns. If actual revenues are less than projected revenues, we may be unable to reduce expenses proportionately, and our operating results, cash flows and liquidity would likely be adversely affected.

Our markets are subject to rapid technological change, and to compete effectively, we must continually introduce new products, requiring significant influx of additional capital.

Many of our markets are characterized by extensive research and development and rapid technological change resulting in short product life cycles. Development by others of new or improved products, processes or technologies may make our products or proposed products obsolete or less competitive. We must devote substantial efforts and financial resources to enhance our existing products and to develop new products, including our significant investment in UWB technology. To fund such ongoing research and development, we will require a significant influx of additional capital. There can be no assurance that we will succeed with these efforts. Failure to effectively develop such products, notably our UWB technology, could have a material adverse effect on our financial condition and results of operations.

We may not be able to protect our proprietary information.

As of March 31, 2005 we held six patents and four pending applications, one of which combined five previous provisional patent applications, in the United States. Certain of these patents have also been filed and issued in countries outside the United States. We treat our technical data as confidential and rely on internal non-disclosure safeguards, including confidentiality agreements with employees, and on laws protecting trade secrets, to protect our proprietary information. There can be no assurance that these measures will adequately protect the confidentiality of our proprietary information or prove valuable in light of future technological developments.

We believe our products and other proprietary rights do not infringe upon the proprietary rights or products of third parties. There can be no assurance, however, that third parties will not assert infringement claims against us or that such assertions will not result in costly litigation or require us to license intellectual proprietary rights from third parties. In addition, there can be no assurance that any such licenses would be available on terms acceptable to us, if at all.

Delays in product development could adversely affect our market position or customer relationships.

We have experienced delays in product development in the past and may experience similar delays in the future. Given the short product life cycles in the markets for our products, any delay or unanticipated difficulty associated with new product introductions or product enhancements could cause us to lose customers and damage our competitive position. Prior delays have resulted from numerous factors, such as:

• changing product specifications;

• the discontinuation of certain third party components;

• difficulties in hiring and retaining necessary personnel;

• difficulties in reallocating engineering resources and other resource limitations;

• difficulties with independent contractors;

• changing market or competitive product requirements;

• unanticipated engineering complexity;

• undetected errors or failures in software and hardware; and

• delays in the acceptance or shipment of products by customers.

The development of new, technologically advanced products, including our significant investment in UWB, is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. In order to compete, we must be able to deliver products to customers that are highly reliable, operate with the customer’s existing equipment, lower the customer’s costs of acquisition, installation and maintenance, and provide an overall cost-effective solution. We may not be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, our new products may not gain market acceptance or we may not be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Our failure to respond effectively to technological changes would significantly harm our business. Finally, there can be no assurances we will be successful in these efforts.

If we are unable to respond to rapid technological change in a timely manner, then we may lose customers to our competitors.

To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our products. Our industry is characterized by rapid technological change, changes in user and customer requirements and preferences and frequent new product and service introductions. If competitors introduce products and services embodying new technologies, or if new industry standards and practices emerge, then our existing proprietary technology and systems may become obsolete. Our future success will depend on our ability to do the following:

• both license and internally develop leading technologies useful in our business;

• enhance our existing technologies;

• develop new services and technology that address the increasingly sophisticated and varied needs of our prospective customers; and

• respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.

To develop our proprietary technology entails significant technical and business risks. We may use new technologies ineffectively, or we may fail to adapt our proprietary technology and transaction processing systems to customer requirements or emerging industry standards. If we face material delays in introducing new services, products and enhancements, then our customers may forego the use of our services and use those of our competitors.

We typically operate without a significant amount of backlog, which could have an adverse impact on our operating results.

We typically operate with a small amount of backlog. Accordingly, we generally do not have a material backlog of unfilled orders, and revenues in any quarter are substantially dependent on orders booked in that quarter. Any significant weakening in current customer demand would therefore have, and has had in the past, an almost immediate adverse impact on our operating results.

Our common stock price is volatile.

The market price for our voting common stock is volatile and has fluctuated significantly to date. For example, between January 1, 2004 and March 31, 2005, the per share price has fluctuated between $0.85 and $2.87 per share, closing at $0.77 on May 12, 2005. The trading price of our voting common stock is likely to continue to be highly volatile and subject to wide fluctuations in response to factors including the following:

• actual or anticipated variations in our quarterly operating results;

• announcements of technological innovations or failures, new sales formats or new products or services by us or our competitors;

• cyclical nature of consumer products using our technology;

• changes in financial estimates by us or securities analysts;

• changes in the economic performance and/or market valuations of other multi-media, video scan companies;

• announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments;

• additions or departures of key personnel;

• additions or losses of significant customers; and

• sales of common stock or issuance of other dilutive securities.

In addition, the securities markets have experienced extreme price and volume fluctuations in recent times, and the market prices of the securities of technology companies have been especially volatile. These broad market and industry factors may adversely affect the market price of common stock, regardless of actual operating performance. In the past, following periods of volatility in the market price of stock, many companies have been the object of securities class action litigation, including us. If we are sued in a securities class action, then it could result in additional substantial costs and a diversion of management’s attention and resources.

We are subject to various environmental laws and regulations that could impose substantial costs upon us and may adversely affect our business.

The European Parliament has enacted the Restriction on Use of Hazardous Substances Directive, or RoHS Directive, which restricts the use of certain hazardous substances in electrical and electronic equipment. We may need to redesign products containing hazardous substances regulated under the RoHS Directive to reduce or eliminate those regulated hazardous substances in our products. As an example, certain of our products include lead, which is included in the list of restricted substances.

We are in the process of evaluating the impact of this directive on our business and have not yet estimated the potential costs of compliance.

Risks Related to Our Industry

International sales are subject to significant risk.

Our revenues from outside the United States are subject to inherent risks related thereto, including currency rate fluctuations, the general economic and political conditions in each country. There can be no assurance that an economic or currency crisis experienced in certain parts of the world will not reduce demand for our products and therefore have a

material adverse effect on our revenue or operating results.

Our businesses are very competitive.

The computer peripheral markets are extremely competitive and are characterized by significant price erosion over the life of a product. We currently compete with other developers of video conversion products and with video-graphic integrated circuit developers. Many of our competitors have greater market recognition and greater financial, technical, marketing and human resources. Although we are not currently aware of any announcements by our competitors that would have a material impact on our operations, there can be no assurance that we will be able to compete successfully against existing companies or new entrants to the marketplace.

The video production equipment market is highly competitive and is characterized by rapid technological change, new product development and obsolescence, evolving industry standards and significant price erosion over the life of a product. Competition is fragmented with several hundred manufacturers supplying a variety of products to this market. We anticipate increased competition in the video post-production equipment market from both existing manufacturers and new market entrants. Increased competition could result in price reductions, reduced margins and loss of market share, any of which could materially and adversely affect our business, financial condition and results of operations. There can be no assurance that we will be able to compete successfully against current and future competitors in this market.

Often our competitors have greater financial, technical, marketing, sales and customer support resources, greater name recognition and larger installed customer bases than we possess. In addition, some of our competitors also offer a wide variety of video equipment, including professional video tape recorders, video cameras and other related equipment. In some cases, these competitors may have a competitive advantage based upon their ability to bundle their equipment in certain large system sales.

We are exposed to general economic conditions that have resulted in significantly reduced sales levels. If we experience adverse economic conditions our business, financial condition and operating results could be adversely impacted.

If we experience adverse economic conditions in the United States and throughout the world, we may continue to experience a material adverse impact on our business, operating results, and financial condition. We have taken actions and charges to reduce our cost of sales and operating expenses in order to address adverse economic conditions. A prolonged continuation or worsening of sales trends may require additional actions and charges to reduce cost of sales and operating expenses in subsequent quarters. We may be unable to reduce cost of sales and operating expenses at a rate and to a level consistent with such a future adverse sales environment. If we must undertake further expense reductions, we may incur significant incremental special charges associated with such expense reductions that are disproportionate to sales, thereby adversely affecting our business, financial condition and operating results. Adverse economic conditions could decrease demand for our products, increase delinquencies in payments and otherwise have an adverse impact on our business.

Recent corporate bankruptcies, accounting irregularities, and alleged insider wrong doings have negatively affected general confidence in the stock markets and the economy, causing the United States Congress to enact sweeping legislation, which will increase the costs of compliance.

In an effort to address growing investor concerns, the United States Congress passed, and on July 30, 2002, President Bush signed into law, the Sarbanes-Oxley Act of 2002. This sweeping legislation primarily impacts investors, the public accounting profession, public companies, including corporate duties and responsibilities, and securities analysts. Some highlights include establishment of a new independent oversight board for public accounting firms, enhanced disclosure and internal control requirements for public companies and their insiders, required certification by CEO’s and CFO’s of Securities and Exchange Commission (“SEC”) financial filings, prohibitions on certain loans to offices and directors, efforts to curb potential securities analysts’ conflicts of interest, forfeiture of profits by certain insiders in the event financial statements are restated, enhanced board audit committee requirements, whistleblower protections, and enhanced civil and criminal penalties for violations of securities laws. Such legislation and subsequent regulations will increase the costs of securities law compliance for publicly traded companies such as us.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

At March 31, 2005, we did not hold any short-term investments that would be exposed to market risk from adverse movements in interest rates.

At March 31, 2005, our outstanding debt obligations consisted of notes payable of $205,000 and borrowings under lines of credit of $2.7 million – see Note 9, “Borrowings”. The average interest rate applicable to these debt obligations is 7.0% per annum. If short-term interest rates were to increase 100 basis points (100 basis points equals 1%), the increased interest expense associated with these debt obligations would increase by approximately $7,000 on a quarterly basis.

Foreign Currency Risk

Gains or losses related to foreign exchange currency transactions were not material for the periods ended March 31, 2005 and March 31, 2004.

Item 4. Controls and Procedures

Management of the Company, with the participation of the President and Chief Executive Officer and the Chief Financial Officer (its principal executive officer and principal financial officer, respectively), evaluated Focus’ disclosure controls and procedures as of the end of the period covered by this Report.

Based on that evaluation, the President and Chief Executive Officer and the Chief Financial Officer have concluded that, as of the end of the period covered by this Report, Focus’ disclosure controls and procedures are effective to ensure that information required to be disclosed by Focus in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by Focus in such reports is accumulated and communicated to Focus’ management, including the President and Chief Executive Officer and the Chief Financial Officer of Focus, as appropriate to allow timely decisions regarding required disclosure.

There was no change in Focus’ internal control over financial reporting that occurred during Focus’ first fiscal quarter of 2005 that has materially affected, or is reasonably likely to materially affect, Focus’ internal control over financial reporting.

Focus will be required to evaluate its internal controls over financial reporting in order to comply with the requirements of the Sarbanes-Oxley Act of 2002 and expects to incur significant costs in meeting these requirements. We estimate the external costs involved in meeting these requirements to be approximately $650,000. Focus is required to meet the requirements of the Sarbanes-Oxley Act by December 31, 2005 if it is deemed to be an accelerated filer based on market capitalization on June 30, 2005, otherwise the requirements must be met by December 31, 2006.

		Page
		Number

PART I - FINANCIAL INFORMATION		3

Item 1.	Financial Statements:	3
	Condensed Consolidated Statements of Operations	3
	Condensed Consolidated Balance Sheets	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	17

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	31

Item 4.	Controls and Procedures	31

PART II - OTHER INFORMATION

Item 1.	Legal Proceedings	32

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32

Item 3.	Defaults Upon Senior Securities	32

Item 4.	Submission of Matters to a Vote of Security Holders	32

Item 5.	Other Information	32

Item 6.	Exhibits	32

SIGNATURES		33

CERTIFICATIONS

May 16, 2005	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
		Vice President of Finance,
		Chief Financial Officer
		(Principal Accounting Officer)

For the quarterly period ended March 31, 2005, or

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Net revenue

Gross margin

None.