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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2004, 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. Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
 
As of the close of business on November 11, 2004, there were 53.2 million shares of Focus Enhancement’s common stock issued and outstanding.
 
  1   
 
 
        Page Number 
PART I - FINANCIAL INFORMATION   
         
Item 1.    Financial Statements:    
      Condensed Consolidated Statements of Operations  3
      Condensed Consolidated Balance Sheets  4
      Condensed Consolidated Statements of Comprehensive Loss  5
      Condensed Consolidated Statements of Cash Flows   6
      Notes to Condensed Consolidated Financial Statements  7
         
Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations 16
         
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.    Changes in securities 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 and reports on Form 8-K 32
         
SIGNATURES    33
         
CERTIFICATIONS    34
      
 
  2   
 

 
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   
    
Nine Months Ended  
  
     
September 30, 2004 
    
September 30, 2003 
    
September 30, 2004 
    
September 30, 2003 
  
                           
Net revenue
 
$
5,774
  
$
10,762
  
$
14,892
  
$
19,153
  
Cost of revenue
    
3,508
   
7,469
   
9,493
   
12,312
 
  Gross margin
   
2,266
   
3,293
   
5,399
   
6,841
 
 
                          
Operating expenses:
                          
  Sales, marketing and support
   
1,256
   
1,103
   
3,583
   
3,190
 
  General and administrative
   
729
   
417
   
2,194
   
1,230
 
  Research and development
   
2,489
   
1,070
   
5,261
   
3,174
 
  Amortization of intangible assets
   
300
   
132
   
707
   
436
 
  In-process research and development
   
-
   
-
   
300
   
-
 
  Restructuring recovery
   
-
   
-
   
-
   
(29
)
     
4,774
   
2,722
   
12,045
   
8,001
 
  Income (loss) from operations
   
(2,508
)
  
571
   
(6,646
)
  
(1,160
)
Interest expense, net
   
(8
)
  
(46
)
  
(68
)
  
(150
)
Other net income (expense)
   
(10
)
  
7
   
10
   
104
 
  Income (loss) before income tax expense
   
(2,526
)
  
532
   
(6,704
)
  
(1,206
)
Income tax expense
   
-
   
-
   
1
   
2
 
  Net income (loss)
 
$
(2,526
)
$
532
  
$
(6,705
)
$
(1,208
)
                           
Net income (loss) per share
                          
  Basic
 
$
(0.05
)
$
0.01
  
$
(0.14
)
$
(0.03
)
  Diluted
  
$
(0.05
)
$
0.01
  
$
(0.14
)
$
(0.03
)
                           
Weighted average common and common equivalent shares
                          
  Basic
    
52,803
   
40,159
   
48,578
   
38,150
 
  Diluted
    
52,803
   
48,755
   
48,578
   
38,150
 
 

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

 
  3   
 

Focus Enhancements, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except per-share amounts)
(Unaudited)
 
 
              
Assets
    
September 30,  2004
December 31, 2003 
  
Current assets:
              
  Cash and cash equivalents
  
$
2,788
  
$
3,731
  
  Accounts receivable, net of allowances of $358 and $384
    
3,133
   
2,385
 
  Inventories
    
4,000
   
3,493
 
  Prepaid expenses and other current assets
    
634
   
368
 
      Total current assets
    
10,555
   
9,977
 
               
Long-term assets:
              
  Property and equipment, net
    
948
   
146
 
  Other assets
    
54
   
151
 
  Intangible assets, net
    
1,878
   
635
 
  Goodwill
    
12,860
   
5,191
 
      Total long-term assets
    
15,740
   
6,123
 
                   
   
$
26,295
  
$
16,100
  
               
Liabilities and Stockholders' Equity
              
               
Current liabilities:
              
  Accounts payable
  
$
3,298
  
$
2,292
  
  Accrued liabilities
    
2,648
   
1,989
 
  Current portion of long-term debt
    
31
   
-
 
  Borrowings under line-of-credit
    
224
   
-
 
      Total current liabilities
    
6,201
   
4,281
 
               
Long-term liabilities:
              
Convertible promissory notes payable to shareholder
    
-
   
3,867
 
Long-term debt, net of current portion
    
184
   
-
 
Total long-term liabilities
    
184
   
3,867
 
               
Stockholders' equity:
              
  Preferred stock, $0.01 par value; authorized 3,000,000 shares; 3,161 and 1,904 shares issued at
September 30, 2004 and December 31, 2003, respectively (aggregate liquidation preference $3,917)
    
-
   
-
 
  Common stock, $0.01 par value; 100,000,000 shares authorized, 53,733,424 and
42,800,240 shares issued at September 30, 2004 and December 31, 2003, respectively
    
536
   
428
 
  Additional paid-in capital
    
89,846
   
71,295
 
  Accumulated deficit
    
(69,726
)
  
(63,021
)
  Cumulative foreign currency translation adjustments
    
4
   
-
 
  Treasury stock at cost, 497,055 shares at September 30, 2004 and December 31, 2003, respectively
    
(750
)
  
(750
)
      Total stockholders' equity
    
19,910
   
7,952
 
                   
   
$
26,295
  
$
16,100
  
 
The accompanying notes are an integral part of the condensed consolidated financial statements.

 
  4   
 

Focus Enhancements, Inc.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
(Unaudited)

   
Three Months Ended  
Nine Months Ended
 
September 30, 2004 
September 30, 2003
September 30, 2004
September 30, 2003
  
                           
Net income (loss)
 
$
(2,526
)
$
532
  
$
(6,705
)
$
(1,208
)</