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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997, OR

[ ] 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: 0-20933

RASTER GRAPHICS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 94-3046090
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)

3025 ORCHARD PARKWAY
SAN JOSE, CA 95134
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 232-4000

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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

COMMON STOCK, $0.001 PAR VALUE

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Indicate by check mark whether the registrant (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 shorter period than the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES [ ] NO [X]*

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $2,507,664.38 as of September 1, 1998, based upon
the closing sale price on the over-the-counter "Pink Sheets" of the National
Quotation Bureau, LLC reported for such date. Shares of Common Stock held by
each officer and director and by each person who owns 5% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.

9,599,525 shares of the registrant's Common Stock were issued and
outstanding as of September 1, 1998.
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* Registrant has not filed its Quarterly Report on Form 10Q for the quarters
ended March 31, 1998 and June 30, 1998

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INTRODUCTORY STATEMENT

Except for the historical information contained in this Annual Report on
Form 10-K, certain of the matters discussed herein are forward-looking
statements that are subject to certain risks and uncertainties. Actual results
could differ materially from those projected. Factors that could cause actual
results to differ materially include, but are not limited to, (i) fluctuations
in quarterly results, (ii) competitive products and technologies, (iii)
ability of the Company to upgrade its technologies and commercialize its
products, and (iv) other risks detailed below under the heading "Risk Factors"
and included from time to time in the Company's other SEC reports and press
releases, copies of which are available from the Company upon request. The
Company assumes no obligation to update any forward-looking statements
contained herein.

"PiezoPrint" and "PosterShop" are trademarks of the Company, and all of the
Company's other product names are trademarks of the Company. This Report also
includes trademarks of companies other than Raster Graphics. Unless the
context indicates otherwise, reference in this Report to the "Company" refers
to Raster Graphics, Inc. and its consolidated subsidiaries.

On February 26, 1998 the Company announced its financial results for the
year ended December 31, 1997. The Company reported revenue of $54.7 million,
gross profit of $19.5 million, operating expenses of $20.6 million and a net
loss of $1.2 million for fiscal 1997. On April 1, 1998 the Company announced
that it would revise its 1997 financial results.

In March 1998, after consultation with its independent accountants, the
Board of Directors of the Company performed a review of the Company's
accounting and business practices. By mid-April the Board of Directors became
aware of pervasive errors and irregularities that ultimately affect the dollar
amount and timing of reported revenues in 1997. The Board of Directors
instructed that an analysis be conducted on these matters.

The irregularities took numerous forms and were primarily the result of a
lack of compliance with the Company's procedures and controls. The Company has
concluded that the earnings process for a significant number of printer sales
were not complete at the time of shipment. Further, the Company has determined
that arrangements with a number of resellers resulted in significant
concessions or allowances that were not accounted for when the revenue was
originally reported as earned.

In addition, the Company has determined that its allowances for doubtful
accounts receivable balances and excess and obsolete inventory, and the
realizable value of inventory and the goodwill recorded on the acquisition of
Datagraph have been incorrectly estimated.

As a result, for the year ended December 31, 1997, the Company reversed
recorded revenues of $5.8 million, recorded additional cost of revenue of $7.6
million, and additional operating expenses of $4.6 million. In addition, the
Company has restated its previously reported results for each interim period
in the nine months ended September 30, 1997.

The Company has also restated the net assets purchased on the acquisition of
Datagraph, a distributor of large format digital printer (LFDP) systems in
France. The original figures were based on an estimate, which has since been
revised to reflect actual values. In particular, an intangible asset of
$1,420,000 was initially recorded and was revised to $1,211,000. This
intangible asset was written off in the fourth quarter of 1997 following a
revision to the Company's sales forecasts. In addition, based on recent
developments, it is likely that Datagraph will commence bankruptcy proceedings
in the near term and cease operations.

The Company's policy for recognizing revenue is as follows:

Revenue from product sales is recognized upon the later of shipment,
acceptance of the product by the customer, or when payment from the
customer is assured. In particular, where the Company has made arrangements
with customers, such as resellers, that have resulted in contingencies or
allowances after the product has shipped, revenue is recognized once the
contingency has been removed and cash collection is assured.

Further, where a customer has obtained financing through a third party
broker, revenue is not recognized until the finance agreement is in place
and the product has been accepted by the customer.

Revenue under maintenance contracts is recognized ratably over the term
of the related contract, generally twelve months.

The Company has entered into an Agreement and Plan of Merger with Gretag
Imaging Group, Inc. ("Gretag") for the acquisition of the Company for
approximately $1.30 per share (the "Merger"). The Company has also entered
into a Loan and Pledge Agreement and Asset and Subsidiary Stock Option
Agreement and certain of its stockholders have entered into a Stockholders
Agreement with Gretag. Pursuant to the Loan and Pledge Agreement, Gretag is
providing the Company a loan facility secured by 100% of the issued stock of
Onyx, a wholly owned subsidiary of the Company. The Company may draw down
amounts together with accrued interest of up to $5,000,000. The first
installment of $500,000 was received by the Company on September 23, 1998. In
addition, Gretag has the option to purchase up to $5,000,000 of the Company's
Common Stock in exchange for forgiving the loan and paying the balance in
cash. Pursuant to the Asset and Subsidiary Stock Option Agreement, (i) if the
Agreement and Plan of Merger is terminated, Gretag has the option to acquire
Onyx for $5,000,000 less the amount drawn down under the loan facility, or
(ii) if the Company's stockholders do not vote in favor of the Merger, if the
Company accepts a superior offer to sell the Company or upon certain other
events, Gretag has the option to acquire the Company's inkjet technology for
$6,000,000 less the amount drawn down under the loan facility. Pursuant to the
terms of the Stockholders Agreement, stockholders of the Company holding
approximately 20% of the Company's outstanding Common Stock have agreed to
vote in favor of the Merger and against any other proposal to acquire the
Company. The Merger and the Agreement and Plan of Merger requires stockholder
approval and consummation of the Merger is conditioned upon settlement of the
class action lawsuits against the Company. (See Notes to the Consolidated
Financial Statements for a description of amounts payable on a change in
control.)

PENDING LITIGATION

Commencing in March 1998 several class action lawsuits have been filed in
both state and federal courts purported by on behalf of stockholders who
purchased the Company's stock during various periods in 1997 through early
1998. The complaints name as defendants the Company and its Chairman, Chief
Executive Officer and President, and certain other officers and directors. The
complaints allege, among other things, violation of federal securities laws
and that defendants made false and misleading statements in press releases,
SEC filings and/or other public statements and seek unspecified damages. The
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect on the
Company's business, financial condition and results of operations.

The Company is a party to a number of legal claims arising in the ordinary
course of business. The Company believes the ultimate resolution of the claims
will not have a material adverse effect on its financial position, results of
operation, or cash flow.

PART I

ITEM 1. BUSINESS.

Overview

Raster Graphics develops, manufactures and markets high-performance, large
format, digital color printing systems, and sells related consumables and
software for the on-demand large format digital printer ("LFDP") market. The
Company's products are designed to meet the short-run, on-demand production
market requirements of quality, speed, flexibility, reliability and low per
copy cost.

The LFDP market consists of color print jobs with run lengths typically
ranging from one to 200 copies, and output sizes of 20-inches by 30-inches or
larger. Applications include Point of Purchase (POP) signs, trade

show exhibit graphics, displays, transit advertising, fleet graphics, banners,
billboards, courtroom graphics, backlit signage, posters and sports and
corporate events. The primary users of Raster Graphics' printing systems are
color photo labs, reprographic houses, graphic arts service bureaus, exhibit
builders, digital color printers, screen printers and in-house print shops.

INDUSTRY BACKGROUND

Graphics Market Size and Trends

The overall graphics market, consisting of offset, screen, photographic and
digital printing, is a large and mature market. According to U.S. Commerce
Daily, in 1995, the graphics market in the United States had sales of $160
billion with an estimated growth rate of 8% per year. However, according to
the May 1997 Wide Format Digital Color Printing report by IT Strategies, a
printing industry market research firm (IT Strategies), the production segment
of the LFDP market is projected to grow more rapidly from estimated annual
sales of approximately $1.4 billion in 1997 to approximately $3.7 billion in
2000.

The anticipated growth of the LFDP market is being driven by a variety of
factors, including:

. Customization. The ability to vary content electronically on a print-by-
print basis enables companies to create highly-focused marketing campaigns
customized to market segment characteristics, such as nuances in language,
culture and geographic location.

. Demand for Color. The use of color in graphics design has become
pervasive as digital technology has made full color printing as accessible
as black and white printing. End users strongly prefer to use full color
in all forms of communications and advertising because of its positive
impact on awareness and retention.

. Available Technology. Advances in high speed, large format digital
printing technology enable cost effective, high quality, on-demand color
print jobs in run-lengths from one to 200 copies.

. Desktop Publishing. Innovations in desktop publishing have provided
graphics design capabilities to thousands of users through the use of
widely available software packages such as Adobe Illustrator, Aldus
PageMaker and QuarkXPress which have revolutionized desktop graphics
design. This digital desktop publishing technology enables users to create
new designs easily and quickly and print them directly using LFDP systems.

. Market Expansion. The installed base of thousands of low-cost, color
inkjet printers is helping to fuel the growth of many new applications
such as corporate presentations, Point of Purchase ("POP") displays and
exhibit graphics. As end users become accustomed to color graphics and
demand higher performance capabilities including speed, graphics size and
outdoor applications, the demand for LFDP should expand.

. Efficiency of Large Format Print Advertising. The Traffic Audit Bureau
for Media Measurement, Inc., estimates in its Planning for Out of Home
Media Report that large format print advertising is six-to-nine times more
cost effective than newspaper and television advertising. As a result,
Outdoor Services, Inc., a marketing research company, estimates that large
format print advertising is one of the fastest growing advertising media,
rising from sales of $260 million in 1970 to $3.5 billion in 1995. LFDP
technology enables adoption of this cost-effective medium by a new class
of regional users desiring a smaller number of prints.

TRADITIONAL PRINTING METHODS

Prior to the availability of LFDP technology, graphic printing methods were
limited to the following three categories:

. Photographic Enlargement. The photographic enlargement process involves
imaging a digital file on a film recorder and using an enlarger to expose
large photographic paper or backlit film. While this method

provides a cost-effective solution for a small number of prints, it
requires extensive chemical-based processing, which requires special
handling. Furthermore, the image quality for line art, such as text, can
lose its sharpness as the image is enlarged. Also, the photographic
process is primarily suited for indoor applications.

. Screen Printing. In the screen print process, an image is first created
on four sets of film-one for each of the four process colors, representing
Cyan, Magenta, Yellow and Key (black) ("CMYK"). These films are then
exposed onto four screens to produce masks for each color. Ink pigments
are applied through these masks by a squeegee to produce the final
graphics. While screen print quality is acceptable for most distance-
viewed applications, this multi-step process is expensive and time-
consuming, making it uneconomical for runs shorter than 50 to 100 copies.

. Offset Printing. Offset printing requires the creation of four films
which are then used to make printing plates. The plates are physically
mounted on a press, ink is applied to the plates, and the image is then
transferred by an intermediary blanket onto the final paper. In addition
to film and plate-making, offset printing also requires extensive press
setup. Offset printing is an expensive, time-consuming process and is
uneconomical for runs shorter than 1,000 copies. However, offset printing
offers the highest quality graphics and lowest cost per copy for runs over
1,000 copies.

Because of the multi-step process and high set-up costs, each of these
traditional printing technologies is only cost-effective within certain ranges
of run lengths.

PRINTING METHODS' CAPABILITIES

Digital Printing

Digital printing fulfills the unmet demand of short-run users, as it does
not require expensive chemicals, films, screens, masks or set-up processes.
Furthermore, this technology allows graphics to be printed directly from a
variety of desktop publishing programs.

Currently, there are two primary methods of digital printing, electrostatic
and inkjet. Electrostatic printheads form images by depositing small dots of
electrical charge across the full width of the paper. The image is developed
by the attraction of the ink to the charged dots. Inkjet printers form images
by spraying very small dots of inks as the printhead moves horizontally in a
scanning-type process.

HIGH IMAGE ON- SHORT OUTDOOR
METHOD QUALITY* DEMAND RUNS APPLICATIONS
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LFDP................................. X X X X
Photograph........................... X X X
Screen............................... X X
Offset............................... X X

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* Determination of image quality is subjective, involving individual taste and
perception. The above chart indicates the Company's estimates of generally-
accepted industry perceptions of image quality.

RASTER GRAPHICS' SYSTEM SOLUTION

Raster Graphics offers complete printing system solutions to meet the
demands of the on-demand production LFDP market. RGI's printing systems allow
users to print short runs of high quality color graphics on-demand at
substantial time and cost savings relative to traditional printing methods.
Raster Graphics' product offerings consist of its electrostatic Digital
ColorStation ("DCS") printers and its PiezoPrint inkjet printers, integrated
image processing software and related consumables and services. Key benefits
of RGI's printing systems include:

High Performance. With a production printing speed of 600 to 1,000 square
feet per hour, the DCS printing systems can produce 50 to 60 full-color, 36-
by 48-inch posters in one hour, which the Company

believes is significantly faster than printers in a comparable price class.
Runs of up to 200 prints can be easily produced in a single shift. The
PiezoPrint 5000, one of the fastest large-format continuous-feed inkjet
printer available, can print 340 square feet per hour in draft mode, 180
square feet per hour in standard mode and 90 square feet per hour in enhanced
mode. Its printing technology employs three printheads per color for a total
of 384 nozzles per color, which gives it the ability to print at production
speeds. In standard mode, using the PiezoPrint 5000, a user can print 120 (3-
foot by 4-foot) posters in one 8-hour shift. The PiezoPrint 1000 prints at up
to 17 square feet per hour.

Low Cost for Short Runs. Primary job costs of RGI's printing systems are
variable and are principally composed of relatively low cost consumables. In
contrast, conventional printing methods involve relatively high fixed
overhead, set-up and labor costs for each printing job. Furthermore, the on-
demand capability of digital printing reduces the waste of surplus or outdated
copies. As a result, the Company believes that its printing systems provide a
cost-effective solution for color printing runs of up to 200 copies.

Targeting and Customizing or "Narrowcasting." RGI's printing systems allow
content to be varied on a print-by-print basis. Fixed and variable data are
printed in one process at the same quality level. This permits narrowcasting
marketing campaigns that are customized to a specific market segment.

High Print Quality and Flexibility. RGI's printing systems offer adjustable
printing modes allowing utilization of the same system for different levels of
image quality to meet the needs of both close-up graphics and distance-viewed
graphics.

Raster Graphics has received eight highly acclaimed industry awards for its
contribution to digital printing technology. Most recently, the Company's
PiezoPrint 5000 received the Digital Printing and Imaging Association's "1997
Product of the Year" award, a Seybold Seminars 1997 "Hot Pick" award, and
Digital Graphics Magazine 1997 "Trailblazer" award. In addition, the Company's
DCS 5400 product received the Digital Printing and Imaging Association's 1994
Product of the Year award; was named among the Top 10 New Repro Products for
1994 by Modern Reprographics; was designated a Hot Product for 1994 by
Electronic Publishing; received a 1994 Editor's Choice Award from Computer
Graphics World; and was honored with the 1994 Industry Excellence Award by
IEEE Computer Graphics and Applications.

STRATEGY

Raster Graphics' objective is to become a market leader in providing digital
printing systems and related consumables and services for the on-demand
production LFDP market. The Company's strategy for growth includes the
following:

Provide System Solutions. In 1995, the Company acquired Onyx, a leader in
image processing software, enabling the Company to develop highly integrated
systems solutions for its customers. Raster Graphics plans to continue
developing additional products and services to provide complete integrated
solutions to its customers. The Company believes that customers prefer an
integrated solution since most customers lack the expertise or time to source
and integrate individual and potentially incompatible components from multiple
suppliers.

Focus on Large Format Digital Segment. Raster Graphics plans to continue to
focus its efforts on producing LFDP systems with capabilities that target and
address specific needs of the production customer, such as paper graphics,
backlit graphics, vinyl graphics and textile graphics. The Company believes
that the rapid growth in small format on-demand color printing will also
stimulate demand for comparable large format solutions by raising the level of
awareness of the benefits of short-run printing.

Increase Recurring Revenues Base. Raster Graphics plans to continue
expanding its services and specialized consumables businesses which provide
recurring revenues to the Company. The Company currently sells various inks,
varnish, specially-coated papers, vinyls and maintenance and training
services.

Core Technologies. Raster Graphics plans to utilize its technological
expertise to expand its product offerings. The Company has expertise in a
number of core technologies, including knowledge of complex printhead design
and manufacturing; high speed paper transport; high speed data transfer; and
image processing software.

Pursue Acquisitions, Joint Ventures and Alliances. Raster Graphics will seek
to acquire strategic businesses and technologies and establish joint ventures
with companies offering complementary products or synergistic distribution.
For example, by utilizing Onyx's leadership position in image processing
software, Raster Graphics plans to build alliances with manufacturers and
distributors of entry level low-speed graphics printers. The Company believes
that this large base of low-speed graphics printing systems will become
upgrade prospects for the Company's high performance production systems.

PRODUCTS

Raster Graphics DCS Printer. RGI's DCS 5442 utilizes electrostatic
technology to print on roll stock and is capable of producing 54-inch wide
graphics, in lengths of up to 100 feet. A paper transport system advances the
paper through the printer and the Silicon Imaging Bar printhead deposits small
dots of electrical charge on the paper. The inking system then applies the
inks to develop the image. This process is repeated for each color. Throughout
the entire process, the printer control system is responsible for all
operations of the printer.

Raster Graphics, in its DCS 5442 printer, offers the following innovative
features to satisfy the requirements of the LFDP market:

. High Performance Using Non-Multiplexed Writing. Raster Graphics'
patented, non-multiplexed printhead, the Silicon Imaging Bar,
simultaneously images across the full 54-inch width of paper allowing DCS
printers to operate at much higher speeds than traditional multiplexed
printers. In multiplexed electrostatic printing, a segmented printhead
images across the width of the paper one segment at a time.

. Five Color Capability. The DCS 5442 printer utilizes a unique five color
process that allows printing spot colors or applying varnish. Spot colors
enable the printing of precise corporate identity colors (e.g. Coca-Cola
red or Kodak yellow), accent metallic colors or neon colors. Varnish
enables the application of a protective finish coat. Traditional four-
color printing processes using only CMYK cannot offer these capabilities.

. Dual Resolution Printing Mode. The DCS 5442 is capable of printing images
in 200 x 200 dpi mode or 200 x 400 dpi mode without any special printer
setup. Images are processed faster in 200 x 200 dpi mode, while 200 x 400
dpi mode provides better image definition. A user can select the
appropriate mode to match the application needs. Currently, comparable
electrostatic printers do not offer this dual resolution printing mode.

. Seamless Integration with System Software. The DCS 5442 permits real time
interaction between the printers and the image processing server to manage
job attributes (e.g. type of media on which to print, type of ink, rush
vs. normal priority, number of inking passes per color, etc.), and keep
the operator informed of the job and print engine status. Traditionally,
printers and image processing software have been developed independently
with limited communication capabilities. As a result, operators have been
forced to manually track job attributes, requiring additional time and
causing workflow inefficiencies.

It is the Company's intent to continue actively marketing and selling the
DCS 5442 printer.

Raster Graphics PiezoPrint Product Family. Raster Graphics markets a line of
digital color inkjet printers, supplies and accessories which are targeted at
the production-oriented digital printing environment. Both the PiezoPrint 1000
and PiezoPrint 5000 printers offer several significant features:

. Piezo Printhead Technology. The Piezo printhead technology differs from
conventional thermal inkjet technology in that heat is not used to produce
the bubble which propels the drop of ink needed for

printing. PiezoPrint printheads utilize piezoelectric crystal technology
which produces ink droplets by force. The piezoelectric crystal changes
shape when electrically stimulated, squeezing a droplet out of the nozzle
to form a pixel.

. UV-Stable Pigmented Ink. The Piezo family of printers can utilize UV-
stable pigmented ink to produce prints which are sufficiently durable and
light resistant to be used outdoors.

. PosterShop Color Production Software. PosterShop color production
software is integrated in all PiezoPrint printers and provides users a
flexible and easy-to-use interface.

Raster Graphics PiezoPrint 1000 Inkjet Printing System. In December 1996, the
Company introduced the PiezoPrint 1000, a more affordable inkjet printer
targeted at the entry level market. In addition to its lower price point, the
PiezoPrint 1000 also offers significant performance features:

. Easy Setup and Initial Operation. The PiezoPrint 1000 and the
accompanying PosterShop Pro software are designed so that a typical user
can install the complete system and begin production printing in less than
one hour.

. Media Versatility. Users can select from a variety of media including
bond paper, photo-gloss, opaque and backlit film, banner tyvik, canvas and
adhesive-backed vinyl, for both indoor and outdoor applications. Such
media can be up to 52 inches in width, thereby providing a full 50 inches
of printable area. When using the optional take-up feeder, the available
print length of the PiezoPrint 1000 is limited only by the length of the
media.

. High Resolution. The PiezoPrint 1000 is capable of printing at
resolutions of up to 720 dpi.

It is the Company's intent to discontinue actively marketing and selling the
PiezoPrint 1000 in 1998 when existing inventory has been exhausted. The
Company has no current plans to replace the PiezoPrint 1000 with another entry
level printer. The Company intends to provide service and consumables to
existing PiezoPrint 1000 customers through a third party service provider.

Raster Graphics PiezoPrint 5000 Inkjet Printing System. In March, 1997, the
PiezoPrint 5000 joined the Raster Graphics family of production-oriented
large-format digital printing systems. Fitting comfortably in the mid-range of
price/performance between the affordable PiezoPrint 1000 inkjet printer and
the high-volume Digital ColorStation 5442 electrostatic digital press, the
PiezoPrint 5000 is a complete production system for the professional print
provider. The PiezoPrint 5000 offers the following features:

. Inking System. Ink reservoirs hold 32 ounces of UV-resistant pigment-
based colors.

. Diagnostics. Productive workflow is ensured by the printer's built-in
PiezoRx technology, which, after a misfiring nozzle is identified by the
operator, automatically allows the user to compensate for it by directing
other nozzles to fire.

. Media. Several media are available for the PiezoPrint 5000, including
high-quality bond paper for indoor applications, moisture-resistant bond
for outdoor applications, adhesive and banner vinyls, and backlit film.
Additional media will be added as they are qualified.

. Color Consistency. Piezo printing technology generally provides greater
reliability of color consistency because it is not susceptible to the heat
buildup common in thermal inkjet technology which can cause perceptible
color shifts. In addition, Piezo printheads are designed to last longer
than thermal heads and to provide increased printer reliability, which
translates into greater uptime.

. Six Color Capability. In addition to the standard four-color cyan,
magenta, yellow and black (CMYK), the PiezoPrint 5000 is capable of an
expanded color gamut by using fifth and sixth ink stations.

The Company and its customers have experienced operational issues with the
PiezoPrint 5000. The Company received printheads from its sole-source supplier
which displayed quality problems after shipment of the printer to customer
sites. During 1997, it was necessary for the Company to correct the problems
by

replacement of faulty printheads as a field upgrade as well as returning
printers to Raster Graphics for a factory upgrade. The Company believes that
the upgrade of faulty printheads will continue into 1998.

In addition, during the development of consumables for the PiezoPrint 5000,
the Company found that oil-based inks used in this printer had certain
limitations which did not allow the Company to develop a photogloss media
which was compatible with the printer. This lack of a photogloss media limited
the market acceptance of the printer.

Print System Software. The Company's PosterShop printer system software,
based on client/server architecture, is designed to facilitate the workflow in
a graphics production shop. A typical environment consists of multiple
PosterShop clients connected to a PC server. The PosterShop software allows
clients to prepare printing jobs and send them to the server. The server
manages the job queues, performs the raster image processing ("RIP") function
and communicates with the printer(s) and clients. Clients can also remotely
access job and printer status from the server. In addition, the DCS system
software can concurrently process and print, thereby maximizing throughput.

PosterShop software, developed by the Company's wholly-owned subsidiary
Onyx, provides a complete set of tools for producing large-format color
graphics in a wide variety of printers. PosterShop, which is Onyx's second
generation image processing software, includes the following tools:

. Preview and Size. Preview and sizing module displays the image on the
screen, rendered with the same software that is used to create the final
print. This "What You See is What You Get" ("WYSIWYG") display also
provides an easy drag-and-drop cropping box to select the size and area to
be printed. The image can be enlarged to any size up to 50 feet by 50
feet.

. Tiling. Tiling enables PosterShop to automatically create panels or tiles
when an image will not fit on a single page. These tiles are displayed on
the screen with easy drag-and-drop lines so the user can easily edit them.
The user can also specify an overlap so that the image is duplicated along
the adjoining edges.

. Color Correction. Using several sliders, the color correction tool is
used to control the image appearance. These sliders are highlights,
midtones, shadows, contrast, brightness and saturation. These adjustments
are displayed both on screen and on the printout. This color tool also has
more advanced features for sophisticated users, such as set white, set
black, histograms, CMYK curves, sample point and others. Up to four views
of the image can be displayed at the same time.

. Color Calibration. Color calibration is used to provide device-
independent color when changing media, ink or dot pattern. Calibration
reads a color swatch using a densitometer to create color tables
associated with each media resolution and dot pattern.

. PostScript RIP and Font Manager. PosterShop features a full PostScript
level 2 RIP. This RIP converts the PostScript graphics files to binary
data formats specific to each printer. The RIP function utilizes a number
of specialized dot patterns including Fixed Dot Random Placement (FDRP), a
patented Onyx dot pattern. A font manager is included to add special fonts
to the RIP.

Inkjet Image Processing Software. In addition to the PosterShop software
sold with RGI's printing systems, the Company offers specialized versions of
PosterShop to other inkjet printer manufacturers and distributors under the
Onyx brand name.

Consumables

Color printing requires the consumption of significant quantities of inks
and papers. Raster Graphics' product offerings include a range of consumables,
such as specialized process color inks, spot color inks and varnish, vinyls,
films, indoor and outdoor papers and laminates.

The specialized toners and inks, concentrates and varnish are created
specifically for the DCS and PiezoPrint products to optimize image quality and
printer performance. The Company currently offers over 200 different

configurations of toner and ink, concentrate and varnish products. Toner, ink
and concentrate consumption varies depending upon both the content and number
of rolls printed. A graphic with a primarily white background will require
much less ink than a graphic with high image content.

Raster Graphics markets 30 different types of specially coated medias for
use in its electrostatic and inkjet printer products, some of which are
offered in various widths to meet market applications requirements. The
Company also continues to supply paper and ink products for its discontinued
printer products.

Services

The Company devotes significant resources in striving for excellence in
customer service. Service response and repair data is recorded and tracked via
an on-line customer dispatch system Raster Graphics has also developed a
state-of-the-art maintenance manual for its printers that resides on a laptop
computer and is interactive with the printer. Using the laptop computer, the
field engineer or trained distributor can diagnose and test the various
components of the printer.

In the United States, Raster Graphics provides installation and 90-day on-
site warranty support for the DCS 5442 and PiezoPrint 5000, and a one year
parts warranty for the PiezoPrint 1000. After the initial warranty period, the
Company offers service maintenance contracts to its installed base of
customers. The Company's service organization consists of technical support
personnel, technical trainers, field service technicians, a customer call
dispatch center and inventory and logistics support. The field service
technicians are located in 13 key locations across the United States.
Internationally, Raster Graphics provides 90-day (12 months for printhead)
return-to-factory parts warranty. Maintenance service is provided by
authorized dealers and distributors.

Raster Graphics provides classroom and on-site training for all products
sold domestically. All of the Company's training programs are listed in the
Company product/price book. The Company also trains its international dealers
and distributors at the Raster Graphics training center in San Jose,
California.

MARKETS

The Company's current printing systems are targeted for the high performance
production electrostatic and inkjet segment of the on-demand large format
digital printing market. According to IT Strategies, in June, 1998, the
potential professional channels which produce and supply wide format digital
printing to business customers on a print-for-pay basis are:

ESTIMATED
NUMBER OF
MARKET SEGMENT SITES
-------------- -------------

Quick Printers.............................................. 3,000-7,000
Sign Shops.................................................. 2,000-4,000
Screen Printers............................................. 6,640-10,240
Color Photo Labs............................................ 975-1,040
Exhibit Builders............................................ 1,600
Digital Color Print Shops................................... 2,500
Graphic Arts Service Bureaus................................ 2,160-2,880
-------------
Total..................................................... 14,775-29,260

IT Strategies estimates the worldwide annual sales of professional large
format color printers (professional inkjet and electrostatic) were 21,140
units or $308 million in 1997 and are projected to grow to 48,079 units or

$290 million in 2002. In addition, sales of consumables (inks, varnish,
papers, vinyls, and other substrates) were $287 million in 1997 and are
projected to grow to $5.3 billion in 2002. IT Strategies estimates the retail
valuation of print output in 1997 was $11.4 billion, and is projected to grow
to $18.5 billion in 2002.

The major markets and applications for LFDP are as follows:

--POP Displays --Museums/Galleries
--Vinyl and Cloth Banners --Presentations/Seminars
--Corporate Identity Graphics --Backlit and Reflective Posters
--Mall Graphics --Courtroom Graphics
--Exhibit/Trade Show Graphics --Seasonal/Travel Promotions
--Billboards --Advertising/Merchandising Tie-
--Sports/Concert/Event Graphics ins
--Custom Commercial Wallpaper

CUSTOMERS, SALES AND MARKETING

Raster Graphics sells complete printing systems, printers and PosterShop
image processing software to customers both internationally and domestically.
To address these customers, the Company has adopted a dual distribution
strategy that encompasses both a direct sales organization and third-party
distributors, including original equipment manufacturers ("OEMs") and value
added resellers ("VARs").

In the United States, Raster Graphics has traditionally employed a direct
sales force. These individuals sold DCS and PiezoPrint printing systems to end
user customers such as commercial photo labs, reprographics service bureaus,
exhibit builders, screen printers, digital printing centers, pre-press trade
shops and in-plant printers. This sales force also assisted OEMs and VARs,
such as 3M and Cactus, in reselling printers when the image processing
software system is supplied by such OEMs or VARs. 3M markets the Company's
printers under the 3M ScotchPrint system brand name and differentiates its
offerings by providing specialized, premium-priced long-durability
consumables.

More recently, the Company has changed its sales strategy to increased focus
on the indirect sales channel and has begun to recruit a select number of
dealers and distributors to market its inkjet products in the United States.

Internationally, the Company sells and supports its products through the
direct sales efforts of its European subsidiaries and through non-exclusive
agreements with a number of distributors. In 1995, the Company formed a
wholly-owned subsidiary in Germany to support the existing German
distributors. As of August 1996, this subsidiary began to directly sell DCS
printing systems, DCS printers and consumables to the Company's German
customers. In March 1997, the Company merged with ColourPass Technologies, a
leading distributor of printing systems for the LFDP market in the United
Kingdom. In September 1997, the Company acquired Datagraph, a distributor in
France of LFDP systems. In addition, based on recent developments, it is
likely that Datagraph will commence bankruptcy proceedings in the near term
and cease operations.

In addition to marketing its products in the United States and Europe,
Raster Graphics also sells its products in a number of other countries through
distributors and VARs. Raster Graphics also sells stand-alone printer products
to international OEMs and systems integrators/VARs. These customers integrate
these printers with an image processing system.

In addition, the Company distributes specialized versions of the PosterShop
image processing software to inkjet printer manufacturers and distributors
under the Onyx brand name. Some of the key distributors of these versions of
PosterShop include Ahearn & Soper and Casey Johnson. The Company employs a
dedicated sales force located in Salt Lake City, Utah to work with these
inkjet customers.

The Company promotes its products through public relations, direct mail,
advertising, trade shows and on-going customer communication programs. The
Company utilizes telemarketing programs to market consumables

to its installed customer base. Additionally, the PosterShop product is also
promoted through the inkjet printer dealer channel by offering free, time-
limited copies of PosterShop image processing software with the printer sales.

Uncertainty Regarding Asian and Latin American Markets

A significant number of the Company's customers and suppliers are based in
Asia and Latin America. The financial instability in these regions has and may
have an adverse impact on the financial position of customers and suppliers in
the region, which could impact the Company's future revenues and operations,
including the ability of customers to pay the Company. As a result of
experiencing collection problems from its Asian and Latin American customers
in 1997 as the Company did not require letters of credit, the Company is
planning to require sales to these regions to be secured by letters of credit
or transacted on a prepaid wire transfer basis. Should the current volatility
in Asia and Latin America continue, either the Company or the Company's
customers may be unable to sell its products in the region. The inability to
generate revenue in this region, or the inability to collect amounts due,
could have a material adverse impact on the Company's business, financial
condition and results of operations.

INTELLECTUAL PROPERTY

As of December 31, 1997, the Company has seven pending patent applications
and has been awarded nine United States patents covering technical features
and fabrication methods used in Raster Graphics' printers and color rendering
techniques used by its image processing software. The expiration dates of
these patents range from 2006 to 2010. Topics covered in these patents include
methods for fabricating electrostatic writing heads, paper positioning and
stabilizing systems, and devices for applying digital ink on paper. The
Company currently holds no foreign patents. The Company expects to continue to
seek patents on innovations related to its products under development. There
can be no assurance that the Company will be successful in obtaining necessary
patents, that the Company's patent applications will result in the issuance of
patents, that the Company will develop additional proprietary technology that
is patentable, that any issued patents will provide the Company with any
competitive advantages or will withstand challenges by third parties or that
patents of others will not have an adverse effect on the Company. In addition
to patents, the Company believes its competitive position is dependent on its
unpatented industrial know-how, its copyrighted software, and the timing of
the introduction of product innovations in advance of potential future
competitors.

There can be no assurance that others will not independently develop similar
products, duplicate the Company's products or design products that circumvent
any patents used by the Company. No assurance can be given that the Company's
processes or products will not infringe patents or proprietary rights of
others or that any licenses required under any such patents or proprietary
rights would be made available on terms acceptable to the Company, if at all.
If the Company does not obtain such licenses, it could encounter delays in
product introductions while it attempts to change the design of the product,
or it could find that the development, manufacture or sale of products
requiring such licenses could be enjoined. In addition, the Company could
incur substantial costs in defending itself in suits brought against the
Company on such patents or in bringing suits to protect the Company's patents
against infringement. The Company's business could be adversely affected by
these actions.

MANUFACTURING

Raster Graphics' in-house manufacturing is performed in San Jose,
California. This operation consists primarily of writing head manufacturing,
electro-mechanical assembly and printer and system testing. The Company's
printhead assembly process for the PiezoPrint 5000 inkjet printer and the
patented electrostatic writing head manufacturing process are extremely
complex. All other electronic components and assemblies are subcontracted to
qualified suppliers. All products are tested prior to shipment to customers.
The PosterShop image processing software manufacturing is performed by Onyx in
Salt Lake City, Utah. Raster Graphics also contracts with a warehouse and
distribution center in Rotterdam, Netherlands to store and distribute
consumables

for the European markets. Consumables for the United States and the rest of
the world are supplied from the Company's San Jose headquarters, a warehouse
and distribution facility in Newark, California and a contracted warehouse
distribution center in New Jersey.

Raster Graphics' inventory delivery and control systems include MRP, Just-
In-Time and KANBAN systems. The Company focuses on continuous critical process
improvement. These programs include early supplier involvement on new
products, product qualification testing on new products, a qualified supplier
base, in-line statistical defect tracking systems and an outgoing and incoming
inspection capability.

Raster Graphics obtains safety certification for its products with the
assistance of Underwriters Laboratories ("UL") and TUV Product Services. This
allows Raster Graphics to affix UL and CE mark labels to its equipment. A
self-certification process is employed to confirm that Raster Graphics
printers conform to the required standards for electromagnetic emissions.
Testing is typically carried out under the supervision of CKC Laboratories,
who document the results. Raster Graphics then affixes the appropriate FCC,
CSA and CE mark labels to the products. The Company also maintains a complete
CE mark technical file for each product as required by the European Economic
Community.

SUPPLIERS

The Company maintains strong business relationships with its key suppliers,
several of whom have been with the Company since its inception. With the
exception of the PiezoPrint 1000, the printhead for the PiezoPrint 5000 and
three key components of the Company's line of printers, as well as paper
transport belts for its discontinued CAD products, all components have
multiple sources. To date, the Company has experienced only minor material
problems or delays in dealing with its sole source suppliers, with the
exception of the supplier of the printhead for the PiezoPrint 5000. During
1997, the Company received PiezoPrint 5000 printheads from its supplier which
displayed quality problems after shipment of the printer to customer sites.
The supplier is reviewing its manufacturing process and intends to supply
printheads in numbers that will not adversely affect the Company's ability to
produce printers. However, in case of loss of any of the suppliers of sole
sourced parts, or if additional quality problems are encountered with sole-
sourced parts, the Company's ability to deliver its products on a timely basis
would be materially adversely affected, and would have a material adverse
effect on the Company's business, financial condition and results of
operations.

The inks, concentrates and varnish currently used in RGI's electrostatic
printers are specially developed by two suppliers. There is no assurance that
these two suppliers will continue to sell to the Company. Also, there is no
assurance that a new supplier will not enter the market and provide
consumables that compete with the Company's offerings. Papers used in RGI's
electrostatic products are developed by additional suppliers. A number of
other companies also acquire papers from these suppliers and compete with the
Company in the sale of paper to end users.

The inks used by the Company's PiezoPrint 1000 and PiezoPrint 5000 products
are currently sole sourced. The printing media for the PiezoPrint 1000 and the
PiezoPrint 5000 are supplied by three suppliers. The Company will continue to
develop additional sources for these products. There is no assurance that the
suppliers will continue to sell to the Company, nor is there any assurance
that a new supplier will not enter the market to provide consumables to
compete with the Company's offering.

COMPETITION

The market for LFDP equipment in general is extremely competitive. The
Company believes that the key competitive factors in the LFDP market are
speed, print quality, price and the ability to provide complete system
solutions, including service. Many of the Company's competitors, including
Xerox ColorgrafX Systems, a subsidiary of Xerox Corporation, ("ColorgrafX"),
Encad, Inc. ("Encad"), ColorSpan Corporation, the primary operating subsidiary
of VirtualFund.com ("ColorSpan") and CalComp Technology, Inc. ("CalComp") are
well established, have substantially greater resources than Raster Graphics
and offer similar, and in some instances superior, products and services.
ColorgrafX, for example, markets several color electrostatic printers priced

below the Company's DCS 5442. In addition, ColorSpan offers attractively
priced lower performance inkjet printing systems. Encad markets inkjet
printers for the LFDP market which offer high image quality at a relatively
low price. Calcomp recently introduced their CrystalJet printer, which
utilizes piezoelectric-based inkjet technology similar to that of the
PiezoPrint 5000. At the high end of the market, 3M Commercial Graphics, a
division of Minnesota Mining and Manufacturing Company ("3M"), markets the
ScotchPrint 2000 which offers high performance at a premium price. Raster
Graphics believes, however, that its complete solutions and services compare
favorably against these and other competitors in terms of price and
performance.

In the image processing software market, there are a large number of
companies that compete with the Company's PosterShop product, such as Cactus,
a division of 3M, Star Technology and VisualEdge. However, with the exception
of ColorSpan, Raster Graphics is the only other manufacturer of both the
printer and the software. This allows the Company to offer a highly integrated
printer and software solution resulting in increased productivity.

Many of the companies that currently compete with the Company or that may
compete with the Company in the future have longer operating histories and
significantly greater financial, technical, sales, marketing and other
resources, as well as greater name recognition and a larger customer base,
than the Company. As a result, these competitors may be able to respond more
quickly and/or effectively to new or emerging technologies and changes in
customer requirements or to devote greater resources to the development,
promotion, sale and support of their products than the Company. These
companies may have the ability to offer superior payment terms. Consequently,
the Company expects to continue to experience increased competition, which
could result in significant price reductions, loss of market share and lack of
acceptance of new products, any of which could have a material adverse effect
on the Company's business, financial condition and results of operations.
There can be no assurance that the Company will be able to compete against
current or future competitors successfully or that competitive pressures faced
by the Company will not have a material adverse effect upon its business,
financial condition and results of operations.

In the consumables market, Oce supplies consumables, including inks and
papers, to its customers using the Company's printers. In addition, 3M markets
a set of special premium-priced, long-durability inks. A number of other
companies compete with the Company for the paper business.

EMPLOYEES

As of December 31, 1997, Raster Graphics had 218 regular employees in the
following areas: 52 in manufacturing; 53 in customer support; 30 in research
and development; 45 in sales and marketing; and 38 in general and
administrative functions. The Company's employees are not represented by any
collective bargaining organization, and the Company has never experienced a
work stoppage. The Company believes that its relations with employees are
good.

During the first quarter of 1998, the Company implemented a plan of internal
restructuring of its operations. The plan was initiated to reduce operating
expenses and improve the Company's financial condition. The plan resulted in a
reduction in headcount of approximately 28 and included several officers of
the Company. The costs associated with this restructuring totaled
approximately $300,000.

EXECUTIVE OFFICERS OF THE COMPANY

The executive officers of the Company, and their ages as of July 15, 1998,
are set forth below:

NAME AGE POSITION
---- --- --------

Rakesh Kumar..................... 53 President, Chief Executive Officer and
Chairman of the Board
Kathy J. Bagby................... 35 Acting Chief Financial Officer
Marc Willard..................... 32 Executive Vice President, Sales and Marketing

Mr. Kumar joined the Company in 1991 as President and Chief Executive
Officer. From 1988 to 1991, he was Group Marketing Manager, Engineering
Systems, for Digital Equipment Corporation, where he was responsible for
worldwide marketing to technical customers. From 1985 to 1987, he was Vice
President of Sales and Marketing for Precision Image Corporation, a
manufacturer of electrostatic printers. Prior to 1985, Mr. Kumar held a number
of management positions with Phoenix Data Systems, an electronic design
automation software company, Applicon, Inc., a CAD systems company, and
Digital Equipment Corporation.

Ms. Bagby came to the Company in 1998 through The Brenner Group LLC, an
interim management and financial advisory services firm. From 1992 to 1997,
she held successive financial management positions at Red Brick Systems, most
recently as the Vice President of Finance and Accounting. Prior to Red Brick
Systems, Ms. Bagby held financial positions at Adia Services and Syntex Corp.
The Company's consulting agreement with The Brenner Group LLC expires November
13, 1998.

Mr. Willard joined the Company in 1997 through the acquisition of
ColourPass. In April, 1998 Mr. Willard was appointed to Executive Vice
President, Sales and Marketing. In January, 1998, Mr. Willard was appointed to
the position of Vice President, Applications and Market Development for the
Company. From 1989 to 1997, Mr. Willard served as President of ColourPass.
Prior to that time, Mr. Willard was a Service Manager with Agfa's Digital Film
Service Department.

ITEM 2. PROPERTIES.

Raster Graphics has leased facilities in six locations. Its main
headquarters of approximately 62,000 square feet is located in San Jose,
California, of which approximately 31% is used for administration and sales
and marketing, approximately 6% is used as a storage facility, and
approximately 63% is used for research and development, manufacturing, and
assembly. The Company's other facilities are comprised of 33,000 square feet
in Newark, California used as a storage and distribution facility, 11,000
square feet in Midvale, Utah, used primarily for administration, sales and
marketing and research and development, and 7,600 square feet, 5,700 square
feet, and 6,800 square feet in Germany, France and England respectively, used
primarily for administration and sales and marketing. The Company believes its
facilities are adequate to support its operations through 1998.

ITEM 3. LEGAL PROCEEDINGS.

Commencing in March 1998 several class action lawsuits were filed in both
state and federal courts purportedly on behalf of stockholders who purchased
the Company's stock during various periods in 1997 through early 1998. The
complaints name as defendants the Company and its Chairman, Chief Executive
Officer and President, and certain other officers and directors. The
complaints allege, among other things, violation of federal securities laws
and that defendants made false and misleading statements in press releases,
SEC filings and/or other public statements and seek unspecified damages. The
litigation could result in substantial costs and a diversion of management's
attention and resources, which could have a material adverse effect on the
Company's business, financial condition and results of operations.

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

No matters were submitted to a vote of security holders during the fourth
quarter for the fiscal year ended December 31, 1997.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Market Information

The Company's Common Stock has been traded in the over-the-counter market
under the Nasdaq symbol RGFX since the Company's initial public offering on
August 8, 1996 until April 21, 1998, at which time the Company's Nasdaq symbol
was changed to RGFXE due to delinquent filing of Form 10-K for December 31,
1997. On May 21, 1998, the Company's stock was delisted from the Nasdaq
National Market due to the Company's failure to meet the filing requirements
of the Securities and Exchange Act of 1934. Since May 21, 1998, the Company's
Common Stock has been listed under the symbol RGFX on the over-the-counter
"Pink Sheets" of the National Quotation Bureau. Prior to the initial public
offering, no public market existed for the Company's Common Stock.

The prices per share reflected in the table represent the range of high and
low closing prices in the Nasdaq National Market System for the quarters
indicated.

HIGH LOW
---- ---

1996
Third quarter ended September 30, 1996................... 11 1/4 8 1/8
Fourth quarter ended December 31, 1996................... 12 1/2 7 5/8
1997
First quarter ended March 31, 1997....................... 11 7/8 6 1/8
Second quarter ended June 30, 1997....................... 8 1/2 5 1/8
Third quarter ended September 30, 1997................... 8 3/8 6 5/8
Fourth quarter ended December 31, 1997................... 8 5/16 4
1998
First quarter ended March 31, 1998....................... 5 2 1/4
Second quarter ended June 30, 1998....................... 2 1/16 1/4

Historically, the Company has not paid cash dividends on its common stock
and there is no plan to pay dividends in the near future.

The Company had approximately 2,904 stockholders of record as of September
1, 1998.

ITEM 6. SELECTED FINANCIAL DATA.

The following table presents selected consolidated financial data of the
Company. This historical data should be read in conjunction with the attached
consolidated Financial Statements and the related notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing in Item 7 of this Form 10-K. In addition, in order to
take advantage of the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company hereby notifies readers that the
factors set forth above in "Risk Factors" as well as other factors, could in
the future affect, and in the past have affected, the Company's actual results
and could cause the Company's results for future quarters to differ materially
from those expressed in any forward looking statements made by or on behalf of
the Company, including without limitation those made in the following
discussion.

SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 30, DECEMBER 31,
1997 1996 1995(2) 1994 1993
------------ ------------ ------------ ------------ ------------
(RESTATED) (RESTATED)
(5) (5)

STATEMENTS OF OPERATIONS
DATA:
Net revenues............ $ 48,928 $42,629 $28,870 $13,235 $14,719
Cost of revenues........ 42,754 25,343 18,691 9,704 9,942
-------- ------- ------- ------- -------
Gross profit............ 6,174 17,286 10,179 3,531 4,777
Operating expenses:
Research and develop-
ment.................. 5,763 4,516 3,373 2,748 2,179
Sales, general and ad-
ministrative.......... 13,725 9,189 5,389 3,012 2,492
Allowance for doubtful
accounts.............. 4,394 403 509 -- --
Merger related ex-
penses (1)............ 139 -- -- -- --
Write-off of acquired
goodwill (2).......... 1,211 -- -- -- --
Acquired in-process re-
search and develop-
ment (3) -- -- 889 -- --
-------- ------- ------- ------- -------
Total operating ex-
penses................. 25,232 14,108 10,160 5,760 4,671
-------- ------- ------- ------- -------
Operating income
(loss)................. (19,058) 3,178 19 (2,229) 106
Interest income (ex-
pense), net............ 403 309 49 101 (60)
-------- ------- ------- ------- -------
Income (loss) before
provision for income
taxes (18,655) 3,487 68 (2,128) 46
Provision for income
taxes.................. 310 425 82 -- 5
-------- ------- ------- ------- -------
Net income (loss)....... $(18,965) $ 3,062 $ (14) $(2,128) $ 41
======== ======= ======= ======= =======
Net income per share
(diluted) (4).......... $ (2.01) $ 0.35 $ --
======== ======= =======
Shares used in per share
Calculation (diluted).. 9,426 8,642 6,025
======== ======= =======

DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 30, DECEMBER 31,
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
(RESTATED) (RESTATED)
(5) (5)

CONSOLIDATED BALANCE
SHEETS DATA:
Cash and short term in-
vestments............. $ 5,327 $16,063 $ 1,550 $ 1,607 $ 4,148
Total assets........... 25,558 36,578 13,122 7,912 9,010
Long-term debt......... 164 178 605 338 --
Total stockholders' eq-
uity.................. 8,305 26,927 6,794 3,801 5,900

- --------
(1) In March 1997 the Company completed a merger with ColourPass and incurred
$139,000 of merger related expenses. (See Notes to Consolidated Financial
Statements.)
(2) In September 1997 the Company acquired Datagraph and recorded goodwill of
$1,211,000; after subsequent review the intangible asset was written off.
(See Notes to Consolidated Financial Statements.)
(3) In August 1995, the Company acquired Onyx and incurred a charge of
$889,000 for acquired in-process research and development. (See Notes to
Consolidated Financial Statements.)
(4) See Notes to Consolidated Financial Statements and Management's Discussion
and Analysis.
(5) Restated for the pooling of interests with ColourPass. (See Notes to
Consolidated Financial Statements.)

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

The Company has restated previously issued financial results for each of the
quarters in the nine months ending September 30, 1997. The restated financial
results primarily reflect revisions to net revenues and related costs,
unrecorded liabilities, inventory reserves, the allowance for bad debt and the
write-off of the Datagraph Intangible Asset. See Amended Form 10-Q/A.

As a result, for the year ended December 31, 1997 the Company reversed
recorded revenues of $5.8 million, recorded additional cost of revenues of
$7.6 million, and additional operating expenses of $4.6 million. In addition,
the Company has restated its previously reported results for each interim
period in the nine months ended September 30, 1997.

The Company has also restated the net assets purchased on the acquisition of
Datagraph, a distributor of LFDP systems in France. The original figures were
based on an estimate, which has since been revised to reflect actual values.
In particular, an intangible asset of $1,420,000 was initially recorded and
was revised to $1,211,000. This intangible asset was written off in the fourth
quarter of 1997 following a revision to the Company's sales forecasts. In
addition, based on recent developments, it is likely that Datagraph will
commence bankruptcy proceedings in the near term and cease operations.

The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes thereto.

OVERVIEW

Raster Graphics was established in 1987 initially to develop low-cost
electrostatic raster printers for the computer-aided design ("CAD") market.
Raster Graphics commenced shipments of its first printer, a 22-inch printer,
in 1989, followed by a 24-inch printer in 1990 and a 36-inch printer in 1992.

In 1993, the Company identified the on-demand production large format
digital printing ("LFDP") market as a new opportunity to develop a product
based on its proprietary high-speed printhead technology. As a result, in 1993
the Company shifted its product focus and began to develop the DCS 5400
specifically for the LFDP market. The Company began shipping the DCS 5400 in
July 1994. Since the Company began commercial production of the DCS 5442 in
January 1996 as a second generation to the DCS 5400, this line has,
substantially replaced the DCS 5400. In December 1996, the Company introduced
the PiezoPrint 1000, an inkjet printer

manufactured by a third party, that is targeted at the lower priced entry
level production market. In March 1997, the Company introduced the PiezoPrint
5000 as a mid-range, price/performance product. It is the Company's intent to
discontinue actively marketing and selling the PiezoPrint 1000 in 1998 when
existing inventory has been exhausted. The Company has no current plans to
replace the PiezoPrint 1000 with another entry level printer. However, the
future success of the Company will likely depend on its ability to develop and
market new products that offer different levels of performance for the
production segment of the LFDP market and upon its ability to get additional
financing.

In order to provide a complete digital printing solution to its customers,
the Company began shipping Onyx's image processing software with its digital
printers in July 1994. Onyx develops and markets image processing software for
the Company's digital printers as well as printers manufactured by companies
such as CalComp, Encad, Hewlett-Packard and ColorgrafX. In August 1995, the
Company acquired Onyx. Onyx supplies its software to Raster Graphics and also
sells its software products to OEMs, VARs, systems integrators and other
printer manufacturers. Onyx's current image processing software product,
PosterShop, was introduced in April 1996 as a replacement for Onyx's Imagez
image processing software product, which Onyx had been shipping since May
1991. Although the Company has no current plans to replace its PosterShop
product, the Company will likely introduce new versions of its image
processing software in the future.

Raster Graphics also sells related consumables, including specialized inks
and papers which it acquires from third party suppliers and resells under the
Raster Graphics name for use in the Company's digital printers. The sale of
consumables generates recurring revenues which the Company believes will
continue to increase to the extent that the installed base of printing systems
expands. As the Company develops new printers, it may need to develop new
consumables to be used by its new printer products.

In the United States, Raster Graphics also derives revenues from maintenance
contracts of installed systems and printers, including the Company's installed
base of 22-inch, 24-inch and 36-inch printers, which it no longer sells.
Revenue is also generated from the sale of spare parts.

Raster Graphics' end user customers, OEMs, VARs, and distributors submit
purchase orders that generally require product shipment within two to eight
weeks from receipt of order. Accordingly, the Company does not use order
backlog as a primary basis for management planning for longer periods.
Revenues are not recognized until products have been shipped and all
contingencies have been removed.

Cost of revenues includes materials, labor, overhead and software royalties.
Cost of revenues as a percentage of revenue varies depending upon the revenue
mix generated through end user, OEM, VAR and distributor sales, and the
revenue mix generated from Onyx software license fees, printing systems sales,
consumables sales and service fees.

Raster Graphics expenses research and development costs as incurred.
Research and development expenses have increased from year to year, and Raster
Graphics expects further increases in research and development expenses in the
future due to the development of new products.

Raster Graphics' sales and marketing expenses and general and administrative
expenses have also increased to support the revenue growth of the Company. The
Company's strategy is to distribute its products through a direct sales force,
as well as through OEMs, VARs and distributors. Raster Graphics also incurs
sales and marketing expenses in connection with product promotional
activities. The Company intends to strengthen its domestic and international
sales and marketing organizations. The Company believes that sales and
marketing expenses may continue to increase in absolute dollar amounts and as
a percentage of revenues.

The Company has a limited operating history upon which an evaluation of the
Company and its prospects can be based. The Company's prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in the early stages of development, particularly
companies in new and rapidly evolving markets. To address these risks, the
Company must, among other things, respond to competitive

developments, attract, retain and motivate qualified persons, and continue to
upgrade its technologies and commercialize products and services incorporating
such technologies. There can be no assurance that the Company will be
successful in addressing these risks. As of December 31, 1997, the Company had
an accumulated deficit of $34.4 million. The Company was profitable in 1996,
and reported a loss in 1997 and 1995. There can be no assurance that the
Company will be profitable in the future.

BUSINESS COMBINATIONS

On September 30, 1997, Raster Graphics acquired Datagraph, a French-based
distributor of large-format digital imaging systems. In exchange for the
outstanding stock of Datagraph, the Company agreed to pay approximately
$1,100,000 in a series of payments through September 30, 1998. The acquisition
was accounted for as a purchase. Including acquisition costs, the transaction
resulted in goodwill of $1,211,000 which, based on the Company's current sales
forecasts, was written off during the fourth quarter. The operating results of
Datagraph prior to the acquisition are not material in relation to the
Company. (See Notes to Consolidated Financial Statements.) In addition, based
on recent developments, it is likely that Datagraph will commence bankruptcy
proceedings in the near term and cease operations.

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated selected items of
the Company's consolidated statements of operations expressed as a percentage
of its net revenues:

YEARS ENDED
-----------------------------------------------------
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- ----------------- -----------------
(RESTATED) (4) (RESTATED) (4)

Net revenues............ 100.0% 100.0% 100.0%
Cost of revenues........ 87.4 59.5 64.7
----- ----- -----
Gross profit............ 12.6 40.5 35.3
Operating expenses:
Research and
development.......... 11.8 10.6 11.7
Sales and marketing... 20.1 17.1 15.5
General and
administrative....... 7.9 4.4 3.2
Allowance for doubtful
accounts............. 9.0 0.9 1.8
Merger related
expenses(1).......... 0.3 -- --
Write off of acquired
Goodwill(2).......... 2.5 -- --
Acquired in-process
research
and development(3)... -- -- 3.1
----- ----- -----
Total operating
expenses............. 51.6 33.0 35.3
----- ----- -----
Operating income
(loss)................. (39.0) 7.5 0.0
Interest income, net.... 0.8 0.7 0.2
----- ----- -----
Income (loss) before
provision for income
taxes.................. (38.2) 8.2 0.2
Provision for income
taxes.................. 0.6 1.0 0.2
----- ----- -----
Net income (loss)....... (38.8%) 7.2% 0.0%
===== ===== =====

- --------
(1) In March 1997 the Company completed a merger with ColourPass and incurred
$139,000 of merger related expenses. (See Notes to Consolidated Financial
Statements.)
(2) In September 1997 the Company acquired Datagraph and recorded goodwill of
$1,211,000; after subsequent review the intangible asset was written off.
(See Notes to Consolidated Financial Statements.)
(3) In August 1995 the Company acquired Onyx and incurred a charge of $889,000
for acquired in-process research and development. (See Notes to
Consolidated Financial Statements.)
(4) Restated for the pooling of interests with ColourPass (See Notes to
Consolidated Financial Statements.)

Raster Graphics' results of operations for fiscal 1997 reflect an increase
in net revenue over the prior fiscal year. Net revenue for the year ended
December 31, 1997, grew 14.8%, to $48.9 million, compared to sales of $42.6
million recorded in fiscal 1996. This increase was primarily due to the growth
in sales of printer systems, increase in sales of consumables, and sales by
the Company's subsidiaries. Sales for the year ended December 31, 1996, grew
47.7%, to $42.6 million, compared to sales of $28.9 million recorded in fiscal
1995. The increase was mainly attributable to growth of sales of printer
systems following the introduction of the DCS 5442 printing system, increase
in sales of consumables, increase in sales of Onyx software and sales by the
Company's German subsidiary.

Future revenue growth will depend on a number of factors, including the
Company's ability to develop, manufacture, market and sell innovative and
reliable new products, customer satisfaction, market growth, competitive
developments, product mix, vendor performance, and the Company's ability to
grow and raise additional capital.

Operating results for the quarters ended March 31, 1998, and June 30, 1998,
based upon trended analysis, indicate that Company revenues have decreased and
expenses have increased. In order to return to profitability, the Company must
take active measures to reverse this trend. There can be no assurances that
this trend will be reversed or that the Company will return to profitability.

International sales, which include export sales and sales shipped by the
Company's European operations, were $19.3 million, $22.0 million and $16.2
million for 1997, 1996 and 1995, respectively. These sales represented 39.5%,
51.6%, and 56.1% of net revenue, respectively. Future international revenues
will depend on international customer acceptance of the PiezoPrint Printing
systems, the establishment of new distribution arrangements and sales by the
Company's German and U.K. subsidiaries, and will be subject to unexpected
changes in economic conditions, regulatory requirements and tariffs, longer
customer payment cycles, fluctuation in currency exchange rates, seasonal
factors and risks associated with managing business operations in
geographically distant locations. No assurance can be given that international
revenues will continue at current rates, or at all.

No customer accounted for more than 10.0% of net revenues in 1997. Oce, a
European distributor, accounted for 4.8% and 10.9% of net revenues for 1996
and 1995, respectively.

Gross Profit. Gross profit was $6.2 million, $17.3 million and $10.2
million, or 12.6%, 40.5% and 35.3% of revenues, for 1997, 1996 and 1995,
respectively. The decrease in gross margin in 1997 over 1996 was primarily due
to a change in product mix, higher manufacturing overhead as a percentage of
sales, the acquisition of Datagraph which has lower gross margins,
significantly increased inventory reserves and higher warranty and repair
expenses. Based on recent developments, it is likely that Datagraph will
commence bankruptcy proceedings in the near term and cease operations. The
improved gross margin in 1996 over 1995 was primarily due to increases in
sales of higher margin Onyx software products as a percentage of net revenue,
higher gross margin for products sold through the Germany subsidiary, as well
as improved manufacturing efficiency. The Company's future level of gross
profit will depend on a number of factors, including product mix and its
ability to control variable expenses relative to revenue levels, maintain a
revenue base over which to allocate fixed costs to develop, manufacture,
market and sell innovative and reliable new products.

Research and Development. Research and development expenses were $5.8
million, $4.5 million and $3.4 million, or 11.8%, 10.6% and 11.7% of net
revenues, for 1997, 1996 and 1995, respectively. The absolute dollar increases
from year to year were primarily due to increased payroll and related
expenses, including the Onyx engineering staff, which the Company purchased in
mid 1995, and increased engineering material expenditures related to the
development of new products. The Company intends to continue to dedicate a
substantial proportion of its resources to research and development activities
in order to expand its product lines, including printers, to achieve higher
throughput speed and higher image quality, and to enhance its PosterShop image
processing software. However, due to depleted cash, cash equivalents and short
term investments, the Company is reviewing measures to reduce research and
development expenses on an on-going basis, but their can be no assurances that
any such measures will be successful.

Sales and Marketing. Sales and marketing expenses were $9.9 million, $7.3
million and $4.5 million, or 20.1%, 17.1% and 15.5% of net revenues, for 1997,
1996 and 1995, respectively. The primary causes of the absolute dollar
increases have been increases in payroll and payroll-related expenses due to
increases in personnel, expenses associated with participation in additional
trade shows and other expenses related to the launch of the PiezoPrint 5000,
and to a lesser degree, travel-related expenses. Due to depleted cash, cash
equivalents and short term investments, the Company is reviewing measures to
reduce Sales and Marketing expenses on an on-going basis but there can be no
assurances that any such measures will be successful.

General and Administrative. General and administrative expenses, including
the allowance for doubtful accounts, were $8.2 million, $2.3 million and $1.4
million, or 16.9%, 5.3% and 5.0% of net revenues, for 1997, 1996 and 1995,
respectively. The increase in absolute amounts of expenditures in 1997
reflected the increase in bad debt reserve, the increased cost of payroll and
related expenses as well as the increased cost of operating as a public
company for a full year. The increase in 1996 was primarily related to
increased cost of payroll and payroll-related expenses as well as the
increased cost of operating as a public company for part of the year. Due to
depleted cash, cash equivalents and short term investments, the Company is
reviewing measures, including head count reductions, to reduce General and
Administrative expenses on an on-going basis but there can be no assurances
that any such measures will be successful.

Merger Related Expenses. In March 1997, the Company completed a merger with
ColourPass, a business in the United Kingdom, in which ColourPass was merged
with Raster Graphics System Limited, a wholly owned subsidiary of the Company.
The combination was accounted for as a pooling of interests. In connection
with the merger the Company incurred $139,000 of merger related expenses.

Write-off of Acquired Goodwill. On September 30, 1997, Raster Graphics
acquired Datagraph, a French-based distributor of large-format digital imaging
systems. In exchange for the outstanding stock of Datagraph, the Company
agreed to pay approximately $1,100,000 in a series of payments through
September 30, 1998. The acquisition was accounted for as a purchase. Including
acquisition costs, the transaction resulted in goodwill of $1,211,000 which,
based on the Company's current sales forecasts, was written off during the
fourth quarter. In addition, based on recent developments, it is likely that
Datagraph will commence bankruptcy proceedings in the near term and cease
operations. The operating results of Datagraph prior to the acquisition are
not material in relation to the Company. (See Notes to Consolidated Financial
Statements.)

Acquired In-Process Research and Development. In August 1995, the Company
acquired Onyx for stock and other consideration valued at $1.5 million. The
assets acquired included tangible assets valued at $866,000, intangible assets
of $454,000, less liabilities assumed of $570,000, and software in the
development stage valued at approximately $750,000 which was expensed in the
September 1995 quarter as it had not yet reached technological feasibility and
did not have alternative future uses. In addition, the Company wrote off
$139,000 in the September 1995 quarter for redundant PostScript licenses that
the Company had purchased for the Company's development of a similar image
processing software product.

Interest Income (Expense). Net interest income was $403,000, $309,000 and
$49,000 for 1997, 1996 and 1995, respectively. Higher interest income in 1997
was a result of investing cash raised from the Company's initial public
offering of common stock for a full year.

Provisions for Income Taxes. The Company recorded a tax provision in 1997
despite generating an operating loss with the Company's effective tax rate on
the consolidated pretax loss for 1997 being 2%, compared to an effective tax
rate of 12% and 121% on consolidated pretax income for 1996 and 1995,
respectively. The tax provision for 1997 results primarily from taxes on
income in foreign jurisdictions despite an overall loss. The effective tax
rate for 1996 differs from the statutory rate primarily due to the tax benefit
of utilizing net operating loss carryforwards and is lower than the 1995 tax
rate due to a high 1995 tax rate caused by alternative minimum taxes.

As of December 31, 1997, the Company has federal and state net operating
loss carryforwards of approximately $23 million and $8 million, respectively.
The Company also has federal and California tax credit carryforwards of
approximately $1.2 million and $704,000, respectively. The net operating loss
and credit carryforwards will expire in the years 2002 through 2012, if not
utilized.

Utilization of the net operating losses and credits may be subject to an
annual limitation due to the ownership change limitations provided by the
Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, the Company has financed its operations primarily through
private sales of preferred stock and common stock of $24.7 million, its
initial public offering of common stock in 1996, issuance of convertible debt,
bank loans, equipment lease financing and private loans. For the year ended
December 31, 1997 and for the same period in 1996 and 1995, $8.3 million,
$283,000 and $599,000 of cash was used in operations, respectively. For fiscal
1997, net cash used in operations was due primarily to net loss incurred
partially offset by a decrease in accounts receivable and increases in amounts
payable and other accrued liabilities. For fiscal 1996 net cash used in
operations was due primarily to increases in inventories and accounts
receivable associated with higher net revenues, which were partially offset by
net income and an increase in accounts payable.

Net cash provided by (used) in investing activities was $9.0 million,
($15.0) million and ($1.1) million for the years ended December 31, 1997, 1996
and 1995, respectively. The Company incurred $2.7 million of capital
expenditure in 1997, $1.9 million in 1996 and $1.1 million in 1995. The
Company had net receipts of $11.5 million from short term cash investments in
1997 and made net purchases of $13.1 million in 1996.

Financing activities provided net cash of $405,000, $16.7 million and $1.6
million for the years ended December 31, 1997, 1996 and 1995, respectively. In
August 1996, the Company successfully completed its initial public offering of
securities which yielded net proceeds of $16.9 million. In fiscal 1995, $1.5
million was raised by issuing Series C preferred stock. The proceeds from the
sale of these equity securities were partially offset by payments on notes and
capital lease obligations.

To date, the Company has not invested in derivative securities or any other
financial instrument that involves a high level of complexity or risk.
Management expects that, in the future, cash in excess of current requirements
will be invested in investment grade, interest-bearing securities.

At December 31, 1997, the Company had $5.3 million of cash and cash
equivalents and short term investments. The Company also has available a $4.1
million bank line of credit agreement that expires on December 31, 1998, which
is secured by the assets of the Company. At December 31, 1997, there were no
borrowings outstanding under the bank line of credit. Currently, the Company
is not in compliance with all bank covenants. However, the Company believes
they are effectively managing this relationship. Credit facilities have
remained in place despite non-compliance.

In order to continue as a going concern, the Company will need to raise
additional capital that will be used to offset expected losses from future
operations. Also, the Company expects the additional capital to be used for
payment of restructuring costs, including headcount reductions in various
functions of the Company. The Company plans to raise the additional capital
through cost containment measures that will align spending levels with revenue
projections, planned reduction of inventory to meet required customer order
levels, improvement for collection of outstanding trade receivables, and
raising additional equity and debt financing. There can be no assurance that
management will be successful in accomplishing these plans and objectives.
Failure to accomplish these plans or objectives would have a material effect
on the Company's business, financial condition, and results of operation.

Operating results for the quarters ended March 31, 1998, and June 30, 1998,
based upon trended analysis, indicate that Company revenues have decreased and
expenses have increased resulting in a significant loss of net income. In
order to return to profitability, the Company must take active measures to
reverse this trend. There can be no assurances that this trend will be
reversed or that the Company will return to profitability.

TRENDS AND UNCERTAINTIES

Risks Associated with Introduction of New Product. The Company introduced
its PiezoPrint 5000 in March 1997. This product is based on relatively new
technology, is complex and must be reliable and durable. The Company is
continuing to make upgrades and improvements in the features of the PiezoPrint
5000. Nevertheless, despite research and testing, the Company and its
customers have experienced some operational issues with the PiezoPrint 5000,
which the Company believes it is successfully addressing. However, these
operational problems have resulted in delayed payments by customers, requests
for return of printers, greater than anticipated expense incurred servicing
printers and actual returns of printers, all of which had a material adverse
effect on the Company's business, financial condition and results of
operations for 1997 and 1998. The Company believes that the upgrade of faulty
printheads will continue into 1998. Management has estimated the expected cost
of performing work under printer warranties, which is based in part on the
numbers of units sold, the likelihood of operating problems occurring and the
cost of repair and has included in cost of revenues approximately $653,000 for
the expected costs. No estimate can be made of the range of amounts of loss
that are reasonably possible should the warranty work not be successful. In
addition, there can be no assurance that the Company will successfully resolve
any future problem in the manufacture or operation of its printers or any

new product. Failure of the Company to resolve any future manufacturing or
operational problems with its printers or any new product in a timely manner
could result in similar material adverse effects on the Company's business,
financial condition and results of operations.

Slower than Expected Revenue Growth. The Company's sales of the PiezoPrint
5000 have been slower than expected due in large part to the lack of certain
types of compatible media that can be run on the PiezoPrint 5000. During the
development of consumables for the PiezoPrint 5000, the Company found that the
oil based inks used in this printer had certain limitations which did not
allow the Company to develop a photogloss media which was compatible with the
printer. This lack of a photogloss media limited the market acceptance of the
printer. The resulting reduction in anticipated revenue from the sale of
PiezoPrint 5000 printers had a material adverse effect on the Company's
business, financial condition and results of operations for 1997. While the
Company is continuing to add additional types of compatible media to its
product line for use on the PiezoPrint 5000, the Company expects that its
revenue growth will be slower than historical growth rates. Additionally,
revenue growth in 1997 was adversely affected by the Company's efforts to
transition its U.S. distribution model from direct to an indirect sales model.
It is expected that this transition will continue into the first half of 1998.

Inventory Reserves. Inventories are stated at the lower of cost (first-in,
first-out) or fair market value. The Company has recorded a write-down of
inventory of $10.4 million to reflect net realizable value at December 31,
1997 and excess and obsolete inventory. Management has developed a program to
reduce inventories to levels that are consistent with forecasted sales.

Allowance for Doubtful Accounts. The Company reports accounts receivable at
net realizable value. The Company has recorded a bad debt allowance of $4.7
million and a charge to general and administrative expenses. Management has
undertaken efforts to collect amounts owed by its customers and to reduce the
accounts receivable balance to more desirable levels in the near term.

Uncertainty Regarding Asian and Latin American Markets. A significant number
of the Company's customers and suppliers are based in Asia and Latin America.
The financial instability in these regions has and may have an adverse impact
on the financial position of customers and suppliers in the region, which
could impact the Company's future revenues and operations, including the
ability of customers to pay the Company. As a result of experiencing
collection problems from its Asian and Latin American customers in 1997 as the
Company did not require letters of credit, the Company is planning to require
sales to these regions to be secured by letters of credit or transacted on a
prepaid wire transfer basis. Should the current volatility in Asia and Latin
America continue, either the Company or the Company's customers may be unable
to sell its products in the region. The inability to generate revenue in this
region, or the inability to collect amounts due, would have a material adverse
impact on the Company's business, financial condition and results of
operations.

OTHER RISK FACTORS

Uncertain Impact of Restatement of Financial Statements; De-listing from
NASDAQ National Market. Subsequent to the filing with the Commission of its
Quarterly Reports on Forms 10-Q for the quarters ended March 31, 1997, June
30, 1997, and September 30, 1997, the Company became aware of errors and
irregularities that effected the timing and dollar amount of reported earned
revenue. These restatements had a material adverse effect on the Company's
financial condition, most notably evident by substantial reductions in
retained earnings and working capital.

The Company's public announcement on April 3, 1998 of the pending
restatements, delays in reporting operating results for 1997 while the
restatements were being compiled, de-listing of the Company's Common Stock
from the NASDAQ National Market as a result of the Company's failure to
satisfy its public reporting obligations, corporate actions to restructure
operations and reduce operating expenses, and customer uncertainty regarding
the Company's financial condition have adversely affected the Company's
ability to sell its product in fiscal year 1998 and consequently caused a
significant reduction in the Company's stock price. Adverse market conditions,
including significant competitive pressures in the Company's markets and
ongoing customer

uncertainty about the Company's financial condition and business prospects,
and product operating issues, may continue to have an adverse effect on the
Company's ability to sell its products and results of operations.

Product Competition. The introduction of the PiezoPrint 5000 has adversely
impacted sales of the Company's DCS 5442 printer to the extent that future
purchasers favor the lower priced inkjet alternatives. Accordingly, there can
be no assurance that revenue generated by sales of the Company's inkjet
products will compensate for the decrease in revenue resulting from declining
sales of its electrostatic products. The corresponding decrease in total
revenue would have a material adverse effect upon the Company's business,
financial condition and results of operations.

Limited History of Profitability and Uncertainty of Future Financial
Results. The Company had an accumulated deficit as of December 31, 1997 of
approximately $34.4 million. The Company has a limited history of
profitability and had a net loss of $19.0 million in 1997. There can be no
assurance that sales of the Company's products will generate significant
revenues or that the Company can return to profitability on a quarterly or
annual basis in the future.

Going Concern. The Company believes its existing capital resources will be
insufficient to satisfy its working capital requirements through the end of
1998. The Company will need to raise additional capital to fund operations
during 1998 and beyond. The Report of Independent Auditors on the Company's
financial statements for the year ended December 31, 1997, contains an
explanatory paragraph regarding the company's need for additional financing
and indicates substantial doubt about the Company's ability to continue as a
going concern. There can be no assurances that such capital will be available
on acceptable terms, if at all, and such terms may be dilutive to existing
stockholders. The Company's inability to secure the necessary funding would
have a material adverse affect on the Company's financial condition and
results of operations. The Company's actual working capital needs will depend
upon numerous factors, including the extent and timing of acceptance of the
Company's products in the market, the Company's operating results, the
progress of the Company's research and development activities, the cost of
increasing the Company's sales and marketing activities and the status of
competitive products, none of which can be predicted with certainty. The
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the
amounts and classification of assets and liabilities that may result from the
outcome of this uncertainty.

The Company's expenses for manufacturing and administrative capabilities,
technical and customer support, research and product development and other
activities are based in significant part on its expectations regarding future
revenues and are fixed to a large extent in the short term. The Company may be
unable to adjust spending

in a timely manner to compensate for any unexpected revenue shortfall, which
would have a material adverse effect on the Company's business, financial
condition and results of operations.

Significant Fluctuations in Quarterly Results. The Company's quarterly
operating results have varied significantly in the past and are likely to vary
significantly in the future based upon a number of factors, including general
economic conditions, the introduction or market acceptance of new products
offered by the Company and its competitors, changes in the pricing policies of
the Company or its competitors, the volume and timing of customer orders, the
level of product and price competition, the relative proportion of printer and
consumables sales, the Company's ability to collect accounts receivables, the
continued availability of sole source components, the continued availability
of consumables from independent vendors, fluctuations in research and
development expenditures, the impact of future Company acquisitions, the
continued availability of financing arrangements for certain of the Company's
customers, the Company's success in expanding its direct sales force and
indirect distribution channels, the risks related to international operations,
the loss of key suppliers and customers, problems incurred in managing
inventories or accounts receivables, a change in the product mix sold by the
Company, price decreases in inventory, trade barriers established by foreign
countries, as well as other factors. Additionally, because the purchase of a
digital printer or printing system involves a significant capital commitment,
the Company's printer and printing system sales cycle is susceptible to delays
and lengthy acceptance procedures associated with large capital expenditures.
Moreover, due to the Company's high average sales price and low unit volume
per month, a delay in the sale of a few units could have a material adverse
effect on the results of operations for a financial quarter.

Quarterly revenues and operating results depend primarily on the volume,
timing, shipping and acceptance of orders during the quarter, which are
difficult to forecast due to the length of the sales cycle. A significant
portion of the Company's operating expenses are relatively fixed in the short
term, and planned expenditures are based on sales forecasts. If revenue levels
are below expectations, net income (loss), if any, may be disproportionately
affected because only a small portion of the Company's expenses vary with
revenue in the short term, which could have a material adverse effect on the
Company's business, financial condition and results of operations. Although
the Company has experienced growth in revenue in recent years, there can be no
assurance that the Company will sustain such revenue growth or return to
profitability on an operating basis in any future period. In particular,
operating results for the quarters ended March 31, 1998, and June 30, 1998,
based upon trended analysis, indicate that Company revenues have decreased and
expenses have increased. In order to return to profitability, the Company must
take active measures to reverse this trend. There can be no assurances that
this trend will be reversed or that the Company will return to profitability.
For the foregoing reasons, the Company believes that period-to-period
comparisons of its results are not necessarily meaningful and should not be
relied upon as indications of future performance. Further, in the third and
fourth quarters of 1997, the Company's revenues and operating results were
below the expectations of public market analysts and investors, which
adversely affected the price of the Company's Common Stock. It is likely that
in some future period the Company's revenues or operating results will again
be below expectations. In such event, the price of the Common Stock could be
materially adversely affected.

Dependence on a Single Product Line. Substantially all of the Company's
sales are derived from its printing systems, printers and related software and
consumables, such as specialized inks, varnish, vinyls and papers. The Company
anticipates that it will continue to derive substantially all of its revenues
in the next several years from sales of this product line. Dependence on a
single product line makes the Company particularly vulnerable to the
successful introduction of competing products. The Company's inability to
generate sufficient sales of the product line and to achieve profitability due
to competitive factors, manufacturing difficulties, or other reasons, would
have a material adverse effect on its business, financial condition and
results of operations. Moreover, some of the Company's printing system and
printer customers have purchased and will continue to purchase consumables
such as ink and paper from suppliers other than the Company. If a significant
number of current or future purchasers of the Company's printing systems were
to purchase consumables from suppliers other than the Company, the Company's
business would be materially adversely affected.

Competition. The market for printing equipment and related software and
consumables is extremely competitive. Suppliers of equipment for the LFDP
market compete on the basis of speed, print quality, price and the ability to
provide complete solutions, including service. Certain of the Company's
competitors are developing or have introduced products to address the LFDP
market. Among these companies are 3M, ColorgrafX, Encad, Hewlett-Packard,
Calcomp, and ColorSpan, which manufacture LFDP printers, and Cactus, (Star)
and Visual Edge, which develop LFDP image processing software. A variety of
potential actions by any of the Company's competitors, could have a material
adverse effect on the Company's business, financial condition and results of
operations. Such actions may include reduction of product prices, increased
promotion, announcement or accelerated introduction of new or enhanced
products, product giveaways, product bundling or other competitive actions. In
addition, companies that are currently targeting the photographic enlargement,
screen and offset printing markets may enter the LFDP market in the future or
may increase the performance or lower the costs of such alternate printing
processes in a manner that would allow them to compete more directly with the
Company for LFDP customers. Furthermore, companies that supply consumables,
such as ink and paper, to the Company could compete with the Company by not
selling such consumables to the Company or by widely selling such consumables
directly or through other channels to the Company's customers. Such
competition would have a material adverse effect on the Company's business,
financial condition and results of operations.

Reliance on Third-Party Distribution. The Company relies heavily on a
network of distributors, original equipment manufacturers ("OEMs") and value
added resellers ("VARs") for both domestic and international sales. The
Company currently maintains distribution, OEM and VAR agreements for its
printing systems and printers with Keundo, 3M and Lisle Kelco for distribution
of its products in Canada; Sumitomo-3M Ltd. ("Sumitomo-3M"), Marubeni
Electronics Co. Ltd. ("Marubeni") and Kimoto Co., Ltd. ("Kimoto") for
distribution of its products in Japan; and Sign-Tronic ("Sign-Tronic") and
Sihl for distribution of its products in Europe. In addition, the Company
distributes its image processing software products through a number of
domestic and international OEMs, VARs and distributors such as Ahearn & Soper.
There can be no assurance that the Company's independent OEMs, VARs and
distributors will maintain their relationships with the Company or that the
Company will be able to recruit additional or, if necessary, replacement OEMs,
VARs or distributors. The loss of one or more of the Company's OEMs, VARs or
distributors could have a material adverse effect on the Company's business,
financial condition and results of operations.

In general, the Company's agreements with its OEMs, VARs and distributors
are not exclusive, and each of the Company's OEMs, VARs and distributors can
cease marketing the Company's products with limited notice and with little or
no penalty. Some of the Company's OEMs, VARs and distributors offer
competitive products manufactured by third parties. In addition, some of these
customers may consider the Company's products to be competitive offerings and,
as a result, there can be no assurance that such customers will continue
marketing the Company's products. Further, there can be no assurance that the
Company's OEMs, VARs and distributors will give a high priority to the
marketing of the Company's products as compared to competitors' products or
alternative solutions, or that such OEMs, VARs and distributors will continue
to offer the Company's products.

Any reduction or delay in sales of the Company's products by its OEMs, VARs or
distributors could have a material adverse effect on the Company's business,
financial condition and results of operations.

Although the Company seeks information from foreign customers that purchase
products from the Company's OEMs, VARs and distributors, it generally does not
deal directly with them and cannot directly observe their experience with the
Company's products. The Company also does not have direct control over the
marketing and support efforts of its OEMs, VARs and distributors in foreign
countries. This may result in the inability of the Company to identify
potential opportunities with these customers and a potential delay by the
Company in the recognition and correction of any problems with such OEM, VAR
or distributor sales or support organizations. Failure of the Company to
respond to customer preferences or experience with its products or the failure
of OEM, VAR or distributor supported customers to market and support the
Company's products successfully, could have a material adverse effect on the
Company's business, financial condition and results of operations. Further,
third-party distribution provides the Company with less information regarding
the amount of inventory that is in the process of distribution. This lack of
information can reduce the Company's ability to predict fluctuations in
revenues resulting from a surplus or a shortage in its distribution channels
and contribute to volatility in the Company's financial results, cash flow,
and inventory balances.

Limited History of Product Manufacturing and Use; Product Defects. The
Company's printers are based on relatively new technology, are complex and
must be reliable and durable. Companies engaged in the development and
production of new, complex technologies and products often encounter
difficulties and delays. The Company began commercial production of the DCS
5400 in June 1994 and the DCS 5442 in January 1996. Since its introduction as
a second generation to the DCS 5400, the DCS 5442 has represented an
increasing percentage of the Company's shipments, and by September 1996,
substantially replaced the DCS 5400.

In December 1996, the Company introduced its first inkjet printer, the
PiezoPrint 1000, which is targeted at the lower priced entry level production
market. In March, 1997, the PiezoPrint 5000 joined the Raster Graphics product
line of printers as a mid-range of price/performance product which complements
the Company's affordable PiezoPrint 1000 inkjet printer and the high-volume
DCS 5442.

The Company is continuing to make upgrades and improvements in the features
of its PiezoPrint line of printers. Despite research and testing, the
Company's experience with volume production of its printers and with their
reliability and durability during customer use is limited. The Company and
users have encountered various operational problems with the PiezoPrint 5000
printers, including printhead quality issues, which the Company believes it is
successfully addressing. However, these operational problems have resulted in
delayed payments by customers, requests for return of printers, greater than
anticipated expense incurred servicing printers and actual returns of
printers, all of which had a material adverse effect on the Company's
business, financial condition and results of operations for 1997 and 1998.
There can be no assurance that the Company will successfully resolve any
future problem in the manufacture or operation of its printers or any new
product. Failure of the Company to resolve any future manufacturing or
operational problems with its printers or any new product in a timely manner
could result in similar material adverse effects on the Company's business,
financial condition and results of operations.

The Company's image processing software products are extremely complex as a
result of such factors as advanced functionality, the diverse operating
environments in which they may be deployed, the need for interoperability, the
multiple versions of such products that must be supported for diverse
operating platforms and languages and the underlying technological standards.
These products may contain undetected errors or failures when first introduced
or as new versions are released. There can be no assurance that, despite
testing by the Company and by current and potential customers, errors will not
be found in new software products after commencement of commercial shipments,
resulting in loss of or delay in market acceptance. Such loss or delay would
likely have a material adverse effect on the Company's business, financial
condition and results of operations.

Susceptibility of Certain Customers to Economic and Financing
Conditions. Many of the Company's end user customers are small businesses that
are more susceptible than large businesses to general downturns in the
economy. In some cases, these customers finance the purchase of the Company's
products through third-party financing arrangements. To the extent that such
customers are unable to obtain acceptable financing terms or to the extent
that a rise in interest rates makes financing arrangements generally
unattractive, these factors would impact adversely sales of the Company's
products. Consequently, the Company's access to a significant portion of its
present customer base would be limited. Moreover, competitors, such as Hewlett
Packard, that have significantly greater financial resources than the Company,
may be able to provide more attractive financing terms to potential customers
than those available through the Company or through third parties. There can
be no assurance that the Company's small business customers will, if
necessary, be able to obtain acceptable financing terms or that the Company
will be able to offer financing terms that are competitive with those offered
by the Company's competitors. The Company has extended payment terms to its
customers as well as established a leasing program for its customer's benefit
through Integrated Lease Management. The Company's inability to continue to
generate sufficient levels of product revenue from sales to such customers due
to the unavailability of financing arrangements or due to a general economic
downturn would have a material adverse effect on the Company's business,
financial condition and results of operations.

Uncertainty Regarding Development of LFDP Market; Uncertainty Regarding
Market Acceptance of New Products. The LFDP market is relatively new and
evolving. The Company's future financial performance will depend in large part
on the continued growth of this market and the continuation of present large
format printing trends such as use and customization of large format
advertisements, use of color, transferring of color images onto a variety of
substrates, point-of-purchase printing, in-house graphics design and
production and the demand for limited printing runs of less than 200 copies.
The failure of the LFDP market to achieve anticipated growth levels or a
substantial change in large format printing customer preferences would have a
material adverse effect on the Company's business, financial condition and
results of operations. Additionally, in a new market, customer preferences can
change rapidly and new technology can quickly render existing technology
obsolete. Failure by the Company to respond effectively to changes in the LFDP
market, to develop or acquire new technology or to successfully conform to
industry standards would have a material adverse effect on the business,
financial condition and results of operations of the Company.

The markets for the Company's products are characterized by rapidly changing
technology, evolving industry standards, frequent new product introductions
and rapid product obsolescence. The Company's success will be substantially
dependent upon its ability to continue to develop and introduce competitive
products and technologies on a timely basis with features and functionality
that meet changing customer requirements. The Company's business would be
adversely affected if the Company were to incur delays in developing new
products or enhancements, or if such products or enhancements did not gain
widespread market acceptance. In addition, there can be no assurance that
products or technologies developed by others will not render the Company's
products or technologies noncompetitive or obsolete. The Company must
continually assess emerging technologies and standards, and evolving market
needs, and must continually decide which technologies and product directions
to pursue. If the Company were to focus its efforts on technologies, standards
or products that do not meet emerging end user needs and do not achieve market
acceptance, the Company could miss one or more product cycles. In such an
event, the Company's business, financial conditions and results of operations
would be materially adversely affected.

The Company's products currently target the high-performance production
segment of the LFDP market. The future success of the Company will likely
depend on its ability to develop and market new products that provide superior
performance at acceptable prices within this segment and to introduce lower-
cost products aimed at a broader segment of the LFDP market. Also, as the
Company develops new printers, it may need to develop new consumables to be
used by its new printer products. During the development process of
consumables for the PiezoPrint 5000, the Company found that the oil based inks
used in this printer had certain limitations which did not allow the Company
to develop a photogloss media which was compatible with the printer. This lack
of a photogloss media limited the market acceptance of the printer. The
resulting reduction in

anticipated revenue from the sale of PiezoPrint 5000 printers had a material
adverse effect on the Company's business, financial condition and results of
operations for 1997and 1998. Additionally, any quality, durability or
reliability problems with new products, regardless of materiality, or any
other actual or perceived problems with new Company products, could have a
material adverse effect on market acceptance of such products. There can be no
assurance that such problems or perceived problems will not arise or that,
even in the absence of such problems, new Company products will receive market
acceptance. A failure of future Company products to receive market acceptance
for any reason would have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the announcement
by the Company of new products and technologies could cause customers to defer
purchases of the Company's existing products, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.

International Revenues. The Company's international revenues accounted for
approximately 39.5%, 51.6%, and 56.1% of the Company's revenues in 1997, 1996
and 1995, respectively. The Company makes a material amount of sales to third
party distributors in international markets. The Company expects that
international sales will continue to account for a significant portion of its
total revenues in future periods.

International sales are subject to certain inherent risks, including
instability of foreign economies, such as the weak economic conditions
effecting certain Asian and Latin America economies in the latter part of 1997
and 1998, unexpected changes in regulatory requirements and tariffs,
government controls, political instability, longer payment cycles, increased
difficulties in collecting accounts receivable and potentially adverse tax
consequences. The Company's inability to obtain foreign regulatory approvals
on a timely basis could also have a material adverse effect on the Company's
business, financial condition and results of operations. Sales from the
Company's German, French and UK subsidiaries are denominated in local
currencies. Accordingly, fluctuations in currency exchange rates could cause
the Company's products to become relatively more expensive to end users in a
particular country, leading to a reduction in sales in that country. The
Company utilized foreign currency forward exchange contracts to manage some of
its foreign currency firm purchase commitments. At December 31, 1997, the
Company held a foreign currency forward contract which matured in January 1998
to buy 25.6 million Japanese yen for $200,000. The fair value of the yen
underlying this instrument at December 31, 1997, was $196,000. Purchases of
the PiezoPrint 1000 from the Company's sole source supplier are denominated in
Japanese yen and have resulted in some foreign currency exchange rate
fluctuation exposure. The impact of future exchange rate fluctuations cannot
be predicted adequately. There can be no assurance that any hedging techniques
implemented by the Company would be successful or that the Company's results
of operations will not be materially adversely affected by exchange rate
fluctuations. In general, certain seasonal factors and patterns impact the
level of business activities at different times in different regions of the
world. For example, sales in Europe are adversely affected in the third
quarter of each year as many customers and end users reduce their business
activities during the summer months. These seasonal factors and currency
fluctuation risks could have a material adverse effect on the Company's
quarterly results of operations. Further, because the Company has operations
in different countries, the Company's management must address differences in
regulatory environments and cultures. Failure to address these differences
successfully could be disruptive to the Company's operations.

Dependence on Sole Source Subcontractors and Suppliers. The Company relies
on subcontractors and suppliers to manufacture, subassemble, and perform
first-stage testing of its printer components and may, in the future, rely on
third parties to develop or provide printer components, some of which are, or
may be, critical to the operation of the Company's products. The Company
relies on single suppliers for certain critical components, such as the
printhead for the PiezoPrint 5000, rubber drive rollers, electrostatic writing
head circuit boards, and application-specific integrated circuits. Also, the
Company's PiezoPrint 1000 inkjet printer is originally manufactured by a third
party. It is the Company's intent to discontinue actively marketing and
selling the PiezoPrint 1000 in 1998 when existing inventory has been
exhausted. The Company has no current plans to replace the PiezoPrint 1000
with another entry level printer. The Company also relies on limited source
suppliers for consumables, such as specialized inks, varnish, vinyls and
papers, that the Company sells under the Raster Graphics brand name. The
Company's agreements with its subcontractors and suppliers are not exclusive,
and

each of the Company's subcontractors and suppliers can cease supplying
printing system components or consumables with limited notice and with little
or no penalty. In the event it becomes necessary for the Company to replace a
key subcontractor or supplier, the Company could incur significant
manufacturing set-up costs and delays while new sources are located and
alternate components and consumables are integrated into the Company's
manufacturing process. There can be no assurance that the Company will be able
to maintain its present subcontractor and supplier relationships or that the
Company will be able to find suitable replacement subcontractors and
suppliers, if necessary. During 1997 the Company received from its sole-source
supplier printheads for the PiezoPrint 5000 which displayed quality problems
after shipment of the printer to customer sites. The supplier is reviewing its
manufacturing process, and intends to supply printheads in numbers that will
not adversely affect the Company's ability to produce printers. However, there
can be no assurance that the Company's present subcontractors and suppliers
will continue to provide sufficient quantities of suitable quality product
components and consumables at acceptable prices. The loss of subcontractors or
suppliers or the failure of subcontractors or suppliers to meet the Company's
price, quality, quantity and delivery requirements would have a material
adverse effect on the Company's business, financial condition and results of
operations.

Dependence on Foreign Supplier. The PiezoPrint 1000 is the first product the
Company has purchased under license for marketing under its own label. The
supplier also distributes the product through its own worldwide distribution
network. The success of the Company in selling this product is dependent upon
many variables such as the established distribution network of the Company,
pricing, support, added value from integration of the Company's PosterShop
software and other factors. In addition this is the Company's first major
procurement of a finished product from a Japanese vendor who does not have
significant international trading experience. The inability to maintain a good
vendor relationship would adversely affect sales of the product. Furthermore
the purchase price of the product is denominated in Japanese yen; and the
fluctuation of this foreign currency will have an impact on the profitability
of the product. It is the Company's intent to discontinue actively marketing
and selling the PiezoPrint 1000 in 1998 when existing inventory has been
exhausted. The Company has no current plans to replace the PiezoPrint 1000
with another entry level printer.

Risks Associated with Intellectual Property. As of December 31, 1997, the
Company had seven pending patent applications and has been awarded nine United
States patents covering technical features and fabrication methods used in
Raster Graphics' printers and color rendering techniques used by its image
processing software. Despite the Company's precautions, it may be possible for
a third party to copy or otherwise obtain and use the Company's technologies
without authorization or to develop competing technologies independently.
Furthermore, the laws of certain countries in which the Company does business,
including countries in which the Company does a significant amount of
business, such as Latin America, Korea, France, Germany and Japan, may not
protect the Company's software and intellectual property rights to the same
extent as do the laws of the United States. There can be no assurance that the
Company's means of protecting its proprietary rights will be adequate or that
the Company's competitors will not independently develop similar technology.
If unauthorized copying or misuse of the Company's products were to occur to
any substantial degree, or if a competitor of the Company were to effectively
duplicate the Company's proprietary technology, the Company's business,
financial condition and results of operations would be materially adversely
affected.

Although the Company has not received notices from third parties alleging
infringement claims that the Company believes would have a material adverse
effect on the Company's business, there can be no assurance that third parties
will not claim that the Company's current or future products or manufacturing
processes infringe the proprietary rights of others. Any such claim, with or
without merit, could result in costly litigation or might require the Company
to enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the
Company, or at all, which could have a material adverse effect upon the
Company's business, financial condition and results of operations.

Difficulties in Managing Growth. The Company has experienced growth in
recent years, which has placed demands on the Company's administrative,
operational and financial personnel, information systems and financial and
administrative controls, manufacturing operations, research and development,
technical support and other resources. Additionally, certain of the Company's
officers have recently joined the Company. Failure to

manage the changes in any of these areas would have a material adverse effect
on the Company's business, financial condition and results of operations.

Need to Attract and Retain Highly Skilled Personnel. The success of the
Company depends to a large extent upon its ability to retain and continue to
attract highly skilled personnel. Competition for employees in the high
technology sector in general, and in the LFDP industry in particular, is
intense, and there can be no assurance that the Company will be able to
attract and retain enough qualified employees. If the business of the Company
increases, it may become increasingly difficult to hire, train and assimilate
the new employees needed. The Company believes that the loss of its Chief
Executive Officer could have a material adverse effect on the Company's
business, financial condition or results of operations. With the exception of
employment agreements containing initial compensation terms and severance
obligations with respect to the Company's Chief Executive Officer, Acting
Chief Financial Officer, Executive Vice President and Vice President of
Domestic Sales, the Company has not entered into employment agreements with
any of its key personnel. Additionally, the Company has not required its key
personnel to enter into non-competition agreements with the Company. The
Company has not procured key man insurance for any of its employees. The
Company's inability to retain and attract key employees would have a material
adverse effect on the Company's business, financial condition and results of
operations.

Environmental. The Company is subject to local laws and regulations
governing the use, storage, handling and disposal of the inks, varnishes and
finishing solutions sold for use with the Company's printers. Although the
Company believes that its safety procedures for handling and disposing of such
materials comply with the standards prescribed by such laws and regulations,
and while the Company is not aware of any notice or complaint alleging any
violation of such laws or regulations, risk of accidental contamination,
improper disposal or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held liable
for any damages that result and any such liability could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, there can be no assurance that the Company will not
be required to incur significant costs to comply with environmental laws and
regulations in the future.

Possible Volatility of Stock Price. In recent years, the stock market in
general, and the stock prices of technology companies in particular, have
experienced extreme price fluctuations, sometimes without regard to the
operating performance of particular companies. Factors such as quarterly
variation in actual or anticipated operating results, changes in earnings
estimates by analysts, market conditions in the industry, announcements by
competitors, regulatory actions and general economic conditions may have a
significant effect on the market price of the Common Stock. Following
fluctuations in the market price of a corporation's securities, securities
class action litigation has often resulted

Year 2000 Compliance. The "Year 2000 issue" arises because many computer
systems and programs were designed to handle only a two-digit year, not a
four-digit year. These computers may interpret "00" as the year 1900 and could
either stop processing date-related computations or could process them
incorrectly.

The Company has examined the potential impact of the Year 2000 issue on its
printer and image processing software products and believes that its products
are Year 2000 compliant, meaning that the use or occurrence of dates on or
after January 1, 2000 will not materially affect the performance of Company
products to correctly create, store, process and output information related to
such dates. The Company's printer system products are not effected by the Year
2000 issue because the custom operating systems designed into the DCS and
PiezoPrint systems are insensitive to year code. The Company's PosterShop
image processing software product utilizes more than a 2-digit year code, and
therefore will not be effected by the change to the year 2000.

The Company has determined that with an upgrade to its current information
systems, those systems will be able to process the Year 2000 accurately and
accordingly does not anticipate any Year 2000 issues from its own information
systems, databases or programs as long as it can successfully complete this
upgrade. However, the Company could be adversely impacted by Year 2000 issues
faced by major distributors, suppliers, customers,

vendors, and financial service organizations with which the Company interacts.
The Company is in the process of developing a plan to determine the impact
that third parties which are not Year 2000 compliant may have on the
operations of the Company. There can be no assurance that such plan will be
able to address fully, or at all, the "Year 2000 issue", which could have a
material adverse effect upon the Company's business, financial condition and
results of operations.

Pending Litigation. Commencing in March 1998 several class action lawsuits
were filed in both state and federal courts purportedly on behalf of
stockholders who purchased the Company's stock during various periods in 1997
through early 1998. The complaints name as defendants the Company and its
Chairman, Chief Executive Officer and President, and certain other officers
and directors. The complaints allege, among other things, violation of federal
securities laws and that defendants made false and misleading statements in
press releases, SEC filings and/or other public statements and seek
unspecified damages. The litigation could result in substantial costs and a
diversion of management's attention and resources, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.

Blank Check Preferred Stock; Anti-Takeover Provisions. The Company's Board
of Directors has the authority to issue up to 2,000,000 shares of Preferred
Stock and to determine the price, rights, preferences and privileges of those
shares without any further vote or action by the stockholders. The rights of
the holders of Common Stock will be subject to, and may be adversely affected
by, the rights of the holders of any Preferred Stock that may be issued in the
future. The issuance of Preferred Stock may have the effect of delaying,
deterring or preventing a change of control of the Company without further
action by the stockholders and may adversely affect the voting and other
rights of the holders of Common Stock. The Company has no present plans to
issue shares of Preferred Stock. The Company's Certificate of Incorporation
and Bylaws provide for, among other things, the prospective elimination of
cumulative voting with respect to the election of directors, the elimination
of actions to be taken by written consent of the Company's stockholders and
certain procedures such as advance notice procedures with regard to the
nomination, other than by or at the direction of the Board of Directors, of
candidates for election as directors. In addition, the Company's charter
documents provide that the Company's Board of Directors be divided into three
classes, each of which serves for a staggered three-year term. The foregoing
provisions could have the effect of making it more difficult for a third party
to effect a change in the control of the Board of Directors. The foregoing
provisions may also result in the Company's stockholders receiving less
consideration for their shares than might otherwise be available in the event
of a takeover attempt of the Company. On February 3, 1998, the Company's Board
of Directors adopted a stockholder rights plan. This plan provides
stockholders with special purchase rights under certain circumstances,
including if any new person or group acquires 15 percent or more of the
Company's common stock. This plan could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire, or of making the Company less attractive to a potential
acquiror of, a majority of the outstanding voting stock of the Company, and
may complicate or discourage a takeover of the Company.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

See Item 14(a) for an index to the Company's consolidated financial
statements and supplementary information. Such financial statements and
information are incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The officers and directors of the Company and their ages as of July 15, 1998
are as follows:

NAME AGE POSITION
---- --- --------

Rakesh Kumar.............................. 53 President, Chief Executive
Officer and Chairman of the
Board
Kathy J. Bagby............................ 35 Acting Chief Financial Officer
Marc Willard.............................. 32 Executive Vice President
Charles Case.............................. 51 Director
Promod Haque (1)(2)....................... 50 Director
Lucio L. Lanza (1)(2)..................... 53 Director
Delbert W. Yocam (1)(2)................... 54 Director

- --------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee

Mr. Kumar joined the Company in 1991 as President and Chief Executive
Officer. From 1988 to 1991, he was Group Marketing Manager, Engineering
Systems, for Digital Equipment Corporation, where he was responsible for
worldwide marketing to technical customers. From 1985 to 1987, he was Vice
President of Sales and Marketing for Precision Image Corporation, a
manufacturer of electrostatic printers. Prior to 1985, Mr. Kumar held a number
of management positions with Phoenix Data Systems, an electronic design
automation software company, Applican, Inc., a CAD systems company, and
Digital Equipment Corporation.

Mr. Willard joined the Company in 1997 through the acquisition of ColourPass
Ltd., where he served as President from 1989 to 1997. After acquisition of
ColourPass by Raster Graphics, Mr. Willard served as Managing Director of the
UK-based subsidiary prior to being named Vice President of Applications and
Market Development. In April 1998 Mr. Willard was appointed to Executive Vice
President of Sales and Marketing for the Company. Prior to 1989, he was a
service manager with Agfa's Digital Film Service Department.

Mr. Case has served as a director of the Company since November 1997. Since
1991, he has been Managing Partner of Roger's Hill Associates, a strategic
consulting firm to the digital printing industry. Prior to founding Roger's
Hill Associates, Mr. Case was Senior Vice President of CAP International Inc.,
which provides market information services for the electronic printing
industry.

Mr. Haque has served as a director of the Company since May 1993. Since
1990, he has served as Vice President of Norwest Venture Capital Management
Inc., a venture capital firm. He also is a general partner of Itasca Partners,
which is a general partner of Norwest Equity Partners IV, a Minnesota limited
partnership. He also serves as director of Prism Solutions, Inc.; Transaction
Systems Architect, Inc.; Connect, Inc.; and Information Advantage, Inc.

Mr. Lanza has served as a director of the Company since May 1994. Since
1990, Mr. Lanza has been a partner of U.S. Venture Partners, a venture capital
firm, and an independent consultant to semiconductor and software companies.
In 1986, Mr. Lanza founded EDA Systems, and served as Chief Executive until
1989. Prior to 1986, he served in a number of marketing, engineering and
general management positions in the electronics industry, including
corporations such as Intel Corporation and Olivetti SpA. Mr. Lanza is also
Chairman of the Board of Artisan Components.

Mr. Yocam has served as a director of the Company since April 1995. Since
December 1996, Mr. Yocam has been Chairman of the Board of Directors and Chief
Executive Officer of Inprise Corporation (formerly Borland International).
From November 1994 to November 1996, he was an independent consultant. From
September 1992 to November 1994, Mr. Yocam was President, Chief Operating
Officer and a director of Tektronix, Inc. Mr. Yocam is also a director of
Adobe Systems, Inc., Hollywood Park, Inc., Xircom, Inc. and several privately
held technology companies.

ITEM 11. EXECUTIVE COMPENSATION

The following table shows the compensation received by (a) the individual
who served as the Company's Chief Executive Officer during the fiscal year
ended December 31, 1997; (b) the other most highly compensated individuals who
were serving as executive officers of the Company for the fiscal year ended
December 31, 1997; and (c) the compensation received by each such individual
for the Company's two preceding fiscal years.

LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
--------------------------- ------------
SECURITIES
BONUS AND UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY COMMISSION OPTIONS
--------------------------- ---- -------- ---------- ------------

Rakesh Kumar 1997 $180,692 $20,000 --
President, Chief 1996 $168,923 $ 755 100,000
Executive Officer and 1995 $161,539 -- 60,000
Chairman of the Board
Dennis R. Mahoney (1) 1997 $124,212 -- --
Former Vice President 1996 $ 82,500(2) 20,000 90,000
and Chief Financial Officer 1995 -- -- --
Sebastian J. Nardecchia (3) 1997 $143,135 $15,000 10,000
Former Vice President, 1996 $123,538 $10,000 20,000
Operations 1995 $111,539 -- 30,000
Michael Willingham (4) 1997 $117,802 $10,000 10,000
Former Vice President, 1996 $106,742 $ 5,000 10,000
Customer Service 1995 $ 95,143 -- 20,000

- --------
(1) Mr. Mahoney's employment was terminated on October 21, 1997.
(2) Mr. Mahoney joined the Company in May 1996 at an annual base salary
level of $150,000, of which $82,500 was paid during fiscal year 1996.
(3) Mr. Nardecchia's employment was terminated on March 31, 1998.
(4) Mr. Willingham's employment was terminated on March 31, 1998.

The following table sets forth information for the executive officers named
in the Summary Compensation Table with respect to grants of options to
purchase Common Stock of the Company made in 1997 and the value of all options
held by such executive officers on December 31, 1997.

OPTION GRANTS DURING YEAR ENDED DECEMBER 31, 1997

POTENTIAL
REALIZABLE
VALUE AT
ASSUMED ANNUAL
RATES OF STOCK
PRICE
INDIVIDUAL GRANTS(1) APPRECIATION
--------------------------------------- FOR OPTION
NUMBER OF PERCENTAGE OF TERM(2)
SECURITIES TOTAL OPTIONS EXERCISE ---------------
UNDERLYING GRANTED TO OR BASE
OPTIONS GRANTED EMPLOYEES IN PRICE EXPIRATION
NAME (SHARES) FISCAL 1996 ($/SHARE) DATE 5%($) 10%($)
---- --------------- ------------- --------- ---------- ------- -------

Sebastian J. Nardecchia
(3).................... 10,000 1.34% $5.25 4/22/07 $33,017 $83,671
Michael Willingham (4).. 10,000 1.34% $5.25 4/22/07 $33,017 $83,671

- --------
(1) Consists of stock options granted pursuant to the Company's 1996 Stock
Plan. The Company's options generally become exercisable at a rate of
12.5% after six months following the date of grant and

approximately 6% per calendar quarter thereafter for as long as the
optionee remains an employee with, consultant to, or director of the
Company. The maximum term of each option granted is ten years from the date
of grant. The exercise price is equal to the fair market value of the stock
on the grant date as determined by the Board of Directors.
(2) The 5% and 10% assumed compounded annual rates of stock price
appreciation are mandated by rules of the Securities and Exchange
Commission. There can be no assurance that the actual stock price
appreciation over the ten-year option term will be at the assumed 5% and
10% levels or at any other defined level. Unless the market price of the
Common Stock appreciates over the option term, no value will be realized
from the option grants made to the persons named in the Summary
Compensation Table.
(3) Mr. Nardecchia's employment was terminated on March 31, 1998.
(4) Mr. Willingham's employment was terminated on March 31, 1998.

AGGREGATED OPTION EXERCISES IN THE YEAR ENDED DECEMBER 31, 1997 AND YEAR-END
OPTION VALUES

The following table sets forth information for the executive officers named
in the Summary Compensation Table with respect to exercises in fiscal year
1997 of options to purchase Common Stock of the Company.

VALUE OF
NUMBER OF UNEXERCISED
SECURITIES UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS AT
OPTIONS FISCAL YEAR
SHARES AT FISCAL YEAR END END(1)
ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/
NAME EXERCISE REALIZED UNEXERCISABLE UNEXERCISABLE
---- ----------- -------- --------------------- ----------------

Rakesh Kumar............ -- -- 265,833/79,167 $933,281/$77,344
Dennis R. Mahoney (2)... -- -- 33,958/56,042 $0/$0
Sebastian J. Nardecchia
(3).................... -- -- 58,958/31,042 $208,828/$38,672
Michael Willingham (4).. 4,000 $26,000 38,083/27,917 $122,719/$25,781

- --------
(1) The value of unexercised in-the-money is based on the closing price of
the Company's Common Stock as reported on the Nasdaq National Market on
December 31, 1997 of $4.625 per share.
(2) Mr. Mahoney's employment was terminated on October 21, 1998.
(3) Mr. Nardecchia's employment was terminated on March 31, 1998.
(4) Mr. Willingham's employment was terminated on March 31, 1998.

COMPENSATION COMMITTEE REPORT

The following is a report of the Compensation Committee of the Board of
Directors (the "Committee") describing the compensation policies applicable to
the Company's executive officers during the fiscal year ended December 31,
1997. The Committee recommends salaries, incentives and other forms of
compensation for directors, officers and other employees of the Company,
administers the Company's various incentive compensation and benefit plans
(including stock plans) and recommends policies relating to such incentive
compensation and benefit plans. Executive officers who are also directors have
not participated in deliberations or decisions involving their own
compensation.

COMPENSATION POLICY

The Company's executive officer compensation philosophies are designed to
attract, motivate and retain senior management by providing an opportunity for
competitive, performance-based compensation. Executive officer compensation
consists of competitive base salaries and stock-based incentive opportunities
in the form of options to purchase the Company's Common Stock. The Company's
executive compensation program consists of three main components: (1) base
salary, (2) potential for bonus based on overall Company performance as well
as individual performance, (3) stock options/grants that provide the executive
officers with the opportunity to build a meaningful stake in the Company, with
the objective of aligning executive officers' long-range

interests with those of the stockholders and encouraging the achievement of
superior results over time. The second and third elements of the compensation
program constitute the "at risk" components. The Committee annually evaluates
the Company's performance, actual compensation and stock ownership of
executive officers on a comparative basis with companies in the same industry
as well as other companies in the same geographical area.

BASE SALARIES FOR 1997

In establishing compensation guidelines with respect to base salary, the
Company utilized data from various surveys prepared by independent firms to
assist it in setting salary levels competitive with those of other similar
industry companies. While it is the Committee's intent to continue to review
periodically base salary information to monitor competitive ranges within the
applicable market, including consideration of the Company's geographic
location and individual job responsibilities, it is further the intent of the
Committee to maintain a close relationship between the Company's performance
and the base salary component of its executive officers' compensation.

STOCK OPTION AWARDS FOR 1997

The Company's 1996 Stock Plan provides for the issuance of stock options to
officers and employees of the Company to purchase shares of the Company's
Common Stock at an exercise price equal to the fair market value of such stock
on the date of grant. The Company's stock options typically vest ratably over
a period of four years. Stock options are granted to the Company's executive
officers and other employees both as a reward for past individual and
corporate performance and as an incentive for future performance. The
Committee believes that stock-based performance compensation arrangements are
essential in aligning the interests of management and the stockholders in
enhancing the value of the Company's equity.

COMPENSATION OF THE CHIEF EXECUTIVE OFFICER

The compensation for Rakesh Kumar, the Company's Chairman, President and
Chief Executive Officer ("CEO") is determined based on a number of factors,
including comparative salaries of CEO's of companies in the Company's peer
group, the CEO's individual performance and the Company's performance as
measured against the stated objectives. The CEO's total compensation package
includes stock option grants with the goal of motivating leadership for long-
term Company success and providing significant reward upon achievement of
Company objectives and enhancing stockholder value. As with other executives,
size of option grants is also based on a review of competitive survey data.

DEDUCTIBILITY OF EXECUTIVE COMPENSATION

The Committee has considered the impact of Section 162(m) of the Internal
Revenue Code adopted under the Omnibus Budget Reconciliation Act of 1993,
which section disallows a deduction for any publicly held corporation for
individual compensation exceeding $1 million in any taxable year for the CEO
and four other most highly compensated executive officers, unless such
compensation meets the requirements for the "performance-based" exception to
the general rule. Since the cash compensation paid by the Company to each of
its executive officers is expected to be well below $1 million and the Company
believes that options granted under the Company's 1996 Stock Option Plan will
meet the requirements for qualifying as performance-based, the Committee
believes that this section will not affect the tax deductions available to the
Company. It will be the Committee's policy to qualify, to the extent
reasonable, the executive officers' compensation for deductibility under
applicable tax law.

SUBMITTED BY THE COMPENSATION
COMMITTEE OF THE BOARD OF DIRECTORS

Promod Haque
Lucio L. Lanza
Delbert W. Yocam

STOCKHOLDER RETURN

The following table compares cumulative total stockholder return, assuming
reinvestment of all dividends, for the Company's Common Stock at December 31,
1997 since August 8, 1996 (the date on which the Company's stock was first
registered under Section 12 of the Securities Exchange Act of 1934, as
amended) to the cumulative return over such period of (i) the Hambrecht &
Quist Technology Index and (ii) the U.S. Index for the NASDAQ National Market.
The data assumes that $100 was invested on August 8, 1996 in the Common Stock
of the Company and each of the comparative indices. The data further assumes
that such amount was initially invested in the Common Stock of the Company at
a price per share of $8.00, the price at which such stock was first offered to
the public by the Company on that date. The stock price performance in the
following chart is not necessarily indicative of future stock price
performance.

COMPARISON OF CUMULATIVE TOTAL RETURN
AMONG RASTER GRAPHICS, INC.,
THE HAMBRECHT & QUIST TECHNOLOGY INDEX
AND THE NASDAQ STOCK MARKET INDEX

AUGUST 8, DECEMBER 31, DECEMBER 31,
1996 1996 1997
--------- ------------ ------------

Raster Graphics, Inc................... 100 148 58
H & Q Technology Index................. 100 113 139
NASDAQ Stock Market Index.............. 100 118 139

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The following table sets forth the beneficial ownership of the Company's
Common Stock as of June 30, 1998 as to (i) each person who is known by the
Company to beneficially own more than five percent of the Company's Common
Stock, (ii) each of the Company's directors, (iii) each of the executive
officers named in the Summary Compensation Table, and (iv) all directors and
executive officers as a group.

SHARES
BENEFICIALLY
OWNED(1)
-----------------
5% STOCKHOLDERS, DIRECTORS
NAMED EXECUTIVE OFFICERS,
AND DIRECTORS AND
EXECUTIVE OFFICERS
AS A GROUP NUMBER PERCENT
------------------------------------------------------- --------- -------

State of Wisconsin Investment Board.................... 865,000 9.01%
P.O. Box 7842
Madison, WI 53707
Norwest Equity Partners IV,............................ 857,584 8.93%
a Minnesota Limited Partnership
245 Lytton Avenue, Suite 250
Palo Alto, CA 94301
Sihl................................................... 618,500 6.44%
Allmendstrasse 125
CH-8021 Zurich, Switzerland
FMR Corp............................................... 550,000 5.73%
82 Devonshire Street
Boston, MA 02109
Promod Haque(2)........................................ 869,251 9.04%
Rakesh Kumar(3)........................................ 312,145 3.16%
Sebastian J. Nardecchia(4)............................. 68,285 *
Delbert W. Yocam(5).................................... 51,667 *
Michael Willingham(6).................................. 44,333 *
Lucio L. Lanza(7)...................................... 14,167 *
Dennis R. Mahoney(8)................................... 238 *
Charles Case........................................... 0 *
All executive officers and directors as a group (8 per-
sons)(9).............................................. 1,360,086 13.49%

- --------
* Less than 1.00%.
(1) Information with respect to beneficial ownership is based upon information
furnished by each director and officer or contained in filings made with
the Securities and Exchange Commission. Except as indicated in the
footnotes to this table, the stockholders named in this table have sole
voting and investment power with respect to all shares of common stock
shown as beneficially owned by them, subject to community property laws
where applicable.
(2) Includes 857,584 shares held by Norwest Equity Partners IV. Because Mr.
Haque is a general partner of Norwest Equity Partners, the general partner
of Norwest Equity Partners IV, he may be deemed to be a beneficial owner
of such shares. Mr. Haque disclaims beneficial ownership of such shares
except to the extent of his interest in such shares arising from his
interest in Norwest Equity Partners. Includes 11,667 shares issuable upon
the exercise of outstanding options exercisable within 60 days of June 30,
1998.
(3) Includes 292,499 shares issuable upon the exercise of outstanding options
exercisable within 60 days of June 30, 1998.
(4) Includes 66,458 shares issuable upon the exercise of outstanding options
exercisable within 60 days of June 30, 1998. Mr. Nardecchia's employment
was terminated on March 31, 1998.
(5) Includes 51,667 shares issuable upon the exercise of outstanding options
exercisable within 60 days of June 30, 1998.
(6) Includes 44,333 shares issuable upon the exercise of outstanding options
exercisable within 60 days of June 30, 1998. Mr. Willingham's employment
was terminated on March 31, 1998.

(7) Includes 14,167 shares issuable upon the exercise of outstanding options
exercisable within 60 days of June 30, 1998.
(8) Mr. Mahoney's employment was terminated on October 21, 1997.
(9) Includes an aggregate 480,791 shares subject to options held by officers
and directors which options are exercisable within 60 days after June 30,
1998. In addition, this total includes an aggregate 857,584 shares held by
a director of the Company, beneficial ownership for such shares is
disclaimed within the meaning of Rule 13d-3 under the Exchange Act.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The Company entered into an employment agreement with its Chief Executive
Officer on July 3, 1991, which provides for a six-month severance payment in
the event of termination of employment. On August 21, 1998, the Compensation
Committee approved the grant of a $300,000 retention bonus payable to the
Chief Executive Officer upon change of control of the Company. On August 21,
1998 the Company entered into a mutual release agreement with Marc Willard, an
officer of the Company. In consideration for Mr. Willard's full release
relating to the Company's acquisition of ColourPass (of which Mr. Willard was
an 80% partner), the parties agreed to a cash bonus of $70,000, a cash payment
of $200,000 upon the acquisition of the Company, and a stock option grant of
175,000 shares. In addition, the Company entered into a consulting agreement
on May 14, 1998 with The Brenner Group LLC pursuant to which the Company has
retained the services of its Acting Chief Financial Officer. Under the terms
of the consulting agreement, the Company is obligated to pay The Brenner Group
LLC a fee of $155.00 per hour and a bonus and additional fees of $85,000 to a
maximum of $200,000 upon change of control or recapitalization which occurs
within six months of the expiration of the agreement or any extensions
thereto. The Company's consulting agreement with The Brenner Group LLC expires
November 13, 1998.

In March 1997, the Company issued an interest-free note receivable to the
Chief Financial Officer of $10,000. In June 1997, the Company issued an
additional note receivable to that officer of $80,000 which bore interest at
6.8% per annum and of which $5,000 was repaid in November 1997. In October
1997 the Chief Financial Officer's employment was terminated. Consulting fees
and severance expenses due to the officer as of December 31, 1997 amounted to
approximately $43,000 and were recorded as a reduction to the principal
amounts of the notes receivable. The remaining unpaid balance at December 31,
1997 of approximately $42,000 was repaid in 1998.

The Company has entered into an indemnification agreement with each of its
executive officers and directors that may require the Company, among other
things, to indemnify them against certain liabilities that may arise by reason
of their status or services as director or officer and to advance their
expenses incurred as a result of any proceeding against them as to which they
could be indemnified.

The Company believes that all of the transactions set forth above were made
on terms no less favorable to the Company than could have been obtained from
unaffiliated third parties. All future transactions, including loans, between
the Company and its officers, directors, principal stockholders and affiliates
will be approved by a majority of the Board of Directors, including a majority
of the independent and disinterested directors on the Board of Directors, and
will be on terms no less favorable to the Company than could be obtained from
unaffiliated third parties.

On March 18, 1997, the Company completed a merger with ColourPass, a
business in the United Kingdom, in which ColourPass was merged with Raster
Graphics System Limited, a wholly owned subsidiary of the Company. Pursuant to
the terms of the merger, the Company's Executive Vice President (who was an
80% stockholder of ColourPass) received 176,340 shares of Common Stock of the
Company.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(A) The following documents are filed as part of this report:

(1) All financial statements:

Index to Financial Statements

Report of Ernst & Young LLP, Independent Auditors

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Stockholders' Equity

Consolidated Statements of Cash Flow

Notes to Consolidated Financial Statements

(2) Financial Statement Schedules:

The following financial statement schedule is included herein:

Schedule II--Valuation and Qualifying Accounts:

All other schedules have been omitted because the information
required to be set forth therein is not applicable or is shown
in the financial statements or notes thereto.

(3) Exhibits (numbered in accordance with Item 601 of Regulation S-K)

NUMBER DESCRIPTION
------ -----------

10.6(1) Form of Indemnification Agreement (Delaware)
10.7(1) Amended and Restated Registration Rights Agreement dated as of
August 4, 1995 between Registrant and holders of its Preferred
Stock and warrant holders
10.8(1) Amended and Restated Product Agreement by and between Registrant,
Inc. and Oce Graphics France S.A. dated October 1, 1990 and
Amendments July 17, 1991, April 29, 1992, January 13, and
September 1, 1994
10.9(1) Purchase Agreement by and between ENCAD, Inc. and Onyx Graphics
Corporation dated March 9, 1996
10.10(1) Lease Agreement by and between Raster Graphics, Inc. and Principal
Mutual Life Insurance Company for facility on 3025 Orchard
Parkway, San Jose, CA
10.11(1)(2) Development and Purchase Agreement dated March 16, 1996
10.12(1) Employment Offer Letter Agreement between the Registrant and
Rakesh Kumar dated July 3, 1991
10.13(1) Employment Offer Letter Agreement between the Registrant and
Dennis Mahoney dated May 16, 1996
10.14(3) Assignment of the Lease Agreement between the Registrant and Kaman
Music Corporation and Coast Wholesale Music Division dated June
27, 1997
10.15(4) The Secured Loan Agreement between the Registrant and Dennis R.
Mahoney dated June 25, 1997
10.16 The Consulting Agreement between the Registrant and The Brenner
Group LLC dated May 14, 1998
10.17 Indemnification Agreement between the Registrant and The Brenner
Group LLC
10.18 Indemnification Agreement between Registrant and Kathy J. Bagby.
10.19 Agreement and Plan of Merger between Registrant and Gretag Imaging
Group, Inc. dated as of October 6, 1998
10.20 Loan and Pledge Agreement between Registrant and Gretag Imaging
Group, Inc. dated as of October 6, 1998
10.21 Asset and Subsidiary Stock Option Agreement between Registrant and
Gretag Imaging Group, Inc. dated as of October 6, 1998
10.22* 1997 Stock Option Plan
10.23 Form of Stockholders Agreement between Gretag Imaging Group, Inc.
and certain stockholders.
21.1(1) Subsidiaries of Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (reference is made to page 44 of this Report).
27 Financial Data Schedule

- --------
(1) Incorporated by reference to exhibits filed in response to Item 16(a),
"Exhibits," of the Registrant's Registration Statement on Form S-1, as
amended (File No. 333-06617), which was filed with the Commission on
August 8, 1996.
(2) Confidential treatment has been granted as to certain portions of this
Exhibit by the Securities and Exchange Commission.
* Management contract or compensatory plan or arrangement
(3) Incorporated by reference to exhibits of the Registrant 10-Q for the
quarter ended June 30, 1997.
(4) Incorporated by reference to exhibits of the Registrant 10-Q for the
quarter ended September 30, 1997.

(b) Reports on Form 8-K:

No Reports on Form 8-K were filed during the quarter ended December 31,
1997.

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED THIS 2ND DAY OF
OCTOBER, 1998.

RASTER GRAPHICS, INC

/s/ Rakesh Kumar
By: _________________________________
RAKESH KUMAR
PRESIDENT, AND CHIEF EXECUTIVE
OFFICER AND CHAIRMAN OF THE BOARD
(PRINCIPAL EXECUTIVE OFFICER)

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE APPEARS
BELOW CONSTITUTES AND APPOINTS RAKESH KUMAR AND KATHY J. BAGBY, JOINTLY AND
SEVERALLY, HIS ATTORNEYS-IN-FACT, EACH WITH THE POWER OF SUBSTITUTION, FOR HIM
OR HER IN ANY AND ALL CAPACITIES, TO SIGN ANY AMENDMENTS TO THIS REPORT ON
FORM 10-K, AND TO FILE THE SAME, WITH EXHIBITS THERETO AND OTHER DOCUMENTS IN
CONNECTION THEREWITH WITH THE SECURITIES AND EXCHANGE COMMISSION, HEREBY
RATIFYING AND CONFIRMING ALL THAT EACH OF SAID ATTORNEYS-IN-FACT, OR HIS
SUBSTITUTE OR SUBSTITUTES MAY DO OR CAUSE TO BE DONE BY VIRTUE HEREOF.

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.

SIGNATURE TITLE DATE

/s/ Rakesh Kumar President, Chief October 2, 1998
- ------------------------------------- Executive Officer
RAKESH KUMAR and Chairman of the
Board (Principal
Executive Officer)

/s/ Kathy J. Bagby Acting Chief October 2, 1998
- ------------------------------------- Financial Officer
KATHY J. BAGBY

/s/ Charles Case Director October 2, 1998
- -------------------------------------
CHARLES CASE

/s/ Promod Haque Director October 2, 1998
- -------------------------------------
PROMOD HAQUE

/s/ Lucio L. Lanza Director October 2, 1998
- -------------------------------------
LUCIO L. LANZA

/s/ Delbert W. Yocam Director October 2, 1998
- -------------------------------------
DELBERT W. YOCAM

RASTER GRAPHICS, INC.

INDEX TO EXHIBITS

EXHIBIT PAGE
NUMBER DESCRIPTION NUMBER
----------- ----------- ------

2.1(1) Agreement and Plan of Reorganization dated as of June 12,
1995 among Registrant, Onyx Graphics Corporation and Bank
of America N.T.S.A., and Amendment dated as of December
31, 1995.
2.2(1) Form of Agreement and Plan of Merger between Registrant
and Raster Graphics, Inc. (a California Corporation)
3.1(1) Amended and Restated Articles of Incorporation of
Registrant (California)
3.2(1) Amended and Restated Articles of Incorporation of
Registrant (California)
3.3(1) Certificate of Incorporation of Registrant (Delaware)
3.4(1) Amended and Restated Certificate of Incorporation of
Registrant (Delaware)
3.5(1) Bylaws of Registrant (California)
3.6(1) Bylaws of Registrant (Delaware)
4.1 Reference is made to 3.1, 3.2, 3.3, 3.4, 3.5, 3.6 and
10.7
4.2(1) Specimen Common Stock Certificate
4.3(1) Form of Warrant of Registrant for Common Stock
4.4(1) Form of Warrant for Series B Preferred Stock
10.1(1)* 1988 Stock Option Plan
10.2(1)* 1996 Stock Plan
10.3(1)* 1996 Directors' Stock Option Plan
10.4(1)* 1996 Employee Stock Purchase Plan
10.5(1) Form of Indemnification Agreement (California)
10.6(1) Form of Indemnification Agreement (Delaware)
10.7(1) Amended and Restated Registration Rights Agreement dated
as of August 4, 1995 between Registrant and holders of
its Preferred Stock and warrant holders
10.8(1) Amended and Restated Product Agreement by and between
Registrant, Inc. and Oce Graphics France S.A. dated
October 1, 1990 and Amendments July 17, 1991, April 29,
1992, January 13, and September 1, 1994
10.9(1) Purchase Agreement by and between ENCAD, Inc. and Onyx
Graphics Corporation dated March 9, 1996
10.10(1) Lease Agreement by and between Raster Graphics, Inc. and
Principal Mutual Life Insurance Company for facility on
3025 Orchard Parkway, San Jose, CA
10.11(1)(2) Development and Purchase Agreement dated March 16, 1996
10.12(1) Employment Offer Letter Agreement between the Registrant
and Rakesh Kumar dated July 3, 1991
10.13(1) Employment Offer Letter Agreement between the Registrant
and Dennis Mahoney dated May 16, 1996
10.14(3) Assignment of the Lease Agreement between the Registrant
and Kaman Music Corporation and Coast Wholesale Music
Division dated June 27, 1997
10.15(4) The Secured Loan Agreement between the Registrant and
Dennis R. Mahoney dated June 25, 1997
10.16 The Consulting Agreement between the Registrant and The
Brenner Group LLC dated May 14, 1998
10.17 Indemnification Agreement between the Registrant and The
Brenner Group LLC
10.18 Indemnification Agreement between Registrant and Kathy J.
Bagby.
10.19 Agreement and Plan of Merger between Registrant and
Gretag Imaging Group, Inc. dated as of October 6, 1998
10.20 Loan and Pledge Agreement between Registrant and Gretag
Imaging Group, Inc. dated as of October 6, 1998
10.21 Asset and Subsidiary Stock Option Agreement between
Registrant and Gretag Imaging Group, Inc. dated as of
October 6, 1998
10.22* 1997 Stock Option Plan
10.23 Form of Stockholders Agreement between Gretag Imaging
Group, Inc. and certain stockholders.
21.1(1) Subsidiaries of Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (reference is made to page 44 of this
Report).
27 Financial Data Schedule

- --------
(1) Incorporated by reference to exhibits filed in response to Item 16(a),
"Exhibits," of the Registrant's Registration Statement on Form S-1, as
amended (File No. 333-06617), which was filed with the Commission on August
8, 1996.
(2) Confidential treatment has been granted as to certain portions of this
Exhibit by the Securities and Exchange Commission.
* Management contract or compensatory plan or arrangement
(3) Incorporated by reference to exhibits of the Registrant 10-Q for the
quarter ended June 30, 1997.
(4) Incorporated by reference to exhibits of the Registrant 10-Q for the
quarter ended September 30, 1997.

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Raster Graphics, Inc.

We have audited the accompanying consolidated balance sheets of Raster
Graphics, Inc. as of December 31, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Raster Graphics, Inc. at December 31, 1997 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1997 in conformity with generally accepted
accounting principles.

The accompanying financial statements have been prepared assuming that
Raster Graphics, Inc. will continue as a going concern. As more fully
disclosed in Note 2 to the financial statements, the Company incurred
significant operating losses in 1997 and has experienced a significant decline
in working capital. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification
of liabilities that may result from the outcome of this uncertainty

/s/ ERNST & YOUNG LLP

San Jose, California
September 25, 1998

RASTER GRAPHICS, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

DECEMBER 31, DECEMBER 31,
1997 1996
------------ -------------
(RESTATED)(1)
ASSETS

Current assets:
Cash and cash equivalents......................... $ 3,727 $ 2,963
Short term investments............................ 1,600 13,100
Accounts receivable, net of allowance for doubtful
accounts of $4,668 in 1997 and $606 in 1996...... 8,050 10,070
Inventories....................................... 6,640 6,705
Prepaid expenses.................................. 523 506
------- -------
Total current assets............................ 20,540 33,344
Property and equipment, net....................... 4,443 2,547
Deposits and other assets......................... 575 585
Intangible assets related to acquisitions......... -- 102
------- -------
Total assets.................................... $25,558 $36,578
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................. $ 8,711 $ 4,953
Accrued payroll and related expenses.............. 1,000 1,089
Accrued warranty.................................. 670 331
Other accrued liabilities......................... 5,122 1,635
Deferred revenues................................. 1,361 1,162
Current portion of long-term borrowing............ 225 303
------- -------
Total current liabilities....................... 17,089 9,473
Long-term borrowing............................... 164 178
Commitments and contingencies
Stockholders' equity:
Preferred stock:
Authorized shares -- 2,000,000
Issued and outstanding shares--none............. -- --
Common stock, $0.001 par value:
Authorized shares -- 50,000,000
Issued and outstanding shares 9,587,748 in 1997
and 9,192,289 in 1996.......................... 10 10
Additional paid-in capital........................ 43,279 42,746
Accumulated deficit............................... (34,382) (15,417)
Cumulative translation adjustment................. (315) --
Deferred compensation............................. (287) (392)
Note receivable from stockholder.................. -- (20)
------- -------
Total stockholders' equity...................... 8,305 26,927
------- -------
Total liabilities and stockholders' equity...... $25,558 $36,578
======= =======

- --------
(1) Restated for the pooling of interest with ColourPass. (See note 5.)

See accompanying notes to consolidated financial statements.

RASTER GRAPHICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

YEAR ENDED DECEMBER 31
-------------------------------------
1997 1996 1995
-------- ------------- -------------
(RESTATED)(1) (RESTATED)(1)

Net revenues.............................. $ 48,928 $ 42,629 $ 28,870
Cost of revenues.......................... 42,754 25,343 18,691
-------- -------- --------
Gross profit.............................. 6,174 17,286 10,179
Operating expenses:
Research and development................ 5,763 4,516 3,373
Sales and marketing..................... 9,870 7,302 4,464
General and administrative.............. 3,855 1,887 925
Allowance for doubtful accounts......... 4,394 403 509
Merger related expenses................. 139 -- --
Write-off acquired goodwill............. 1,211 -- --
Acquired in-process research
and development........................ -- -- 889
-------- -------- --------
Total operating expenses.............. 25,232 14,108 10,160
-------- -------- --------
Operating income (loss)................... (19,058) 3,178 19
Interest income, net...................... 403 309 49
-------- -------- --------
Income (loss) before provision
for income taxes......................... (18,655) 3,487 68
Provision for income taxes................ 310 425 82
-------- -------- --------
Net income (loss)......................... $(18,965) $ 3,062 $ (14)
======== ======== ========
Net income (loss) per share--basic........ $ (2.01) $ 0.40 $ --
======== ======== ========
Weighted average number of shares
and equivalents outstanding--basic....... 9,426 7,562 6,025
-------- -------- --------
Net income (loss) per share--diluted...... $ (2.01) $ 0.35 $ --
======== ======== ========
Weighted average number of shares
and equivalents outstanding--diluted..... 9,426 8,642 6,025
======== ======== ========

- --------
(1) Restated for the pooling of interest with ColourPass. (See Note 5).

See accompanying notes to consolidated financial statements.

RASTER GRAPHICS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

CONVERTIBLE PREFERRED
STOCK COMMON STOCK ADDITIONAL
----------------------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT
------------- ------------------- ------ ---------- -----------

Balance at January 1,
1995 (Restated)(1)..... 4,853,988 $ 5 420,852 $ 1 $22,433 $(18,465)
Issuance of convertible
preferred
stock, net of issuance
costs................. 595,368 1 -- -- 1,476 --
Issuance of convertible
preferred
stock for Onyx Acquisi-
tion.................. 443,360 -- -- -- 1,098 --
Issuance of common stock
under
stock option plan and
upon
exercise of warrants... -- -- 144,231 -- 260 --
Net income
(Restated)(1).......... -- -- -- -- -- (14)
------------- ------- --------- --- ------- --------
Balance at December 31,
1995 (Restated)(1)..... 5,892,716 6 565,083 1 25,267 (18,479)
Conversion of preferred
stock.................. (5,892,716) (6) 5,892,716 6 -- --
Proceeds from IPO, net
of
offering expenses of
$2,716................ -- -- 2,450,000 3 16,880 --
Issuance of common stock
under stock option
plans and
upon exercise of war-
rants................. -- -- 284,490 -- 181 --
Unearned compensation
related
to stock options....... -- -- -- -- 418 --
Amortization of unearned
compensation -- -- -- -- -- --
Note receivable from
stockholder............ -- -- -- -- -- --
Net income
(Restated)(1).......... -- -- -- -- -- 3,062
------------- ------- --------- --- ------- --------
Balance at December 31,
1996 (Restated)(1)..... -- -- 9,192,289 10 42,746 (15,417)
Issuance of common stock
under employee stock
purchase plan......... -- -- 59,261 -- 291 --
Issuance of common stock
under stock option
plans................. -- -- 336,198 -- 242 --
Amortization of unearned
compensation........... -- -- -- -- -- --
Repayment of note
receivable from
stockholder............ -- -- -- -- -- --
Foreign currency
translation
adjustment............. -- -- -- -- -- --
Net loss................ -- -- -- -- -- (18,965)
------------- ------- --------- --- ------- --------
Balance at December 31,
1997................... -- $ -- 9,587,748 $10 $43,279 $(34,382)
============= ======= ========= === ======= ========

- --------
(1) Restated for the pooling of interests with ColourPass (see Note 5).

NOTES
CUMULATIVE RECEIVABLE TOTAL
TRANSLATION DEFERRED FROM STOCKHOLDERS'
ADJUSTMENT COMPENSATION STOCKHOLDERS EQUITY
----------- ------------ ------------ -------------

Balance at January 1, 1995
(Restated)(1)............. $ -- $ -- $ -- $ 3,974
Issuance of convertible
preferred stock, net of
issuance costs............ -- -- -- 1,477
Issuance of convertible
preferred stock for Onyx
Acquisition............... -- -- -- 1,098
Issuance of common stock
under stock option plan
and upon exercise of
warrants.................. -- -- -- 260
Net income (Restated)(1)... -- -- -- (14)
------ ------ ----- --------
Balance at December 31,
1995 (Restated)(1)........ -- -- -- 6,795
Conversion of preferred
stock..................... -- -- -- --
Proceeds from IPO, net of
offering expenses of
$2,716.................... -- -- -- 16,883
Issuance of common stock
under stock option plans
and upon exercise of
warrants.................. -- -- -- 181
Unearned compensation
related to stock options.. -- (418) -- --
Amortization of unearned
compensation.............. -- 26 -- 26
Note receivable from
stockholder............... -- -- (20) (20)
Net income (Restated)(1)... -- -- -- 3,062
------ ------ ----- --------
Balance at December 31,
1996 (Restated)(1)........ -- (392) (20) 26,927
Issuance of common stock
under employee stock
purchase plan............. -- -- -- 291
Issuance of common stock
under stock option plans.. -- -- -- 242
Amortization of unearned
compensation.............. -- 105 -- 105
Repayment of note
receivable from
stockholder............... -- -- 20 20
Foreign currency
translation adjustment.... (315) -- -- (315)
Net loss................... -- -- -- (18,965)
------ ------ ----- --------
Balance at December 31,
1997...................... $ (315) $ (287) $ -- $ 8,305
====== ====== ===== ========

See accompanying notes to consolidated financial statements.

RASTER GRAPHICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

YEAR ENDED
---------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996 1995
------------ ------------- ------------
(RESTATED)(1) (RESTATED)(1)

OPERATING ACTIVITIES
Net (loss) income................... $(18,965) $ 3,062 $ (14)
Adjustments to reconcile net (loss)
income to net cash used in
operating activities:
Depreciation...................... 1,139 1,018 697
Amortization...................... 102 156 196
Acquired in-process research and
development...................... -- -- 889
Amortization of deferred
compensation..................... 105 26 --
Changes in operating assets and
liabilities:
Accounts receivable............... 2,757 (4,100) (2,185)
Inventories....................... 926 (3,328) (1,394)
Prepaid expenses and other
assets........................... 100 (817) 274
Accounts payable.................. 1,682 2,437 1,298
Accrued payroll and related
expenses......................... (89) 506 123
Other accrued liabilities......... 3,731 709 429
Deferred revenue from related
parties.......................... -- -- (152)
Deferred revenues................. 199 48 (760)
-------- ------- ------
Net cash used in operating
activities......................... (8,313) (283) (599)
INVESTING ACTIVITIES
Capital expenditures................ (2,746) (1,871) (1,121)
Datagraph acquisition, net of cash
acquired........................... 235 -- 55
Purchases of short term
investments........................ (485) (32,055) --
Proceeds from sale of short term
investments........................ 11,985 18,955 --
-------- ------- ------
Net cash provided by (used in)
investing activities............... 8,989 (14,971) (1,066)
FINANCING ACTIVITIES
Proceeds from notes payable......... -- -- 418
Repayment of term loan.............. (148) (378) (473)
Repayment of note from shareholder.. 20 -- --
Proceeds from Initial Public
Offering........................... -- 16,884 --
Proceeds from exercise of common
stock options...................... 533 161 196
Proceeds from issuance of
convertible preferred stock........ -- -- 1,467
-------- ------- ------
Net cash provided by financing
activities......................... 405 16,667 1,608
-------- ------- ------
Effect of exchange rate changes on
cash and cash equivalent........... (317) -- --
-------- ------- ------
Net increase (decrease) in cash and
cash equivalents................... 764 1,413 (57)
Cash and cash equivalents at
beginning of year.................. 2,963 1,550 1,607
-------- ------- ------
Cash and cash equivalents at end of
year............................... $ 3,727 $ 2,963 $1,550
======== ======= ======
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash paid for interest.............. $ 64 $ 73 $ 57
Cash paid for taxes................. $ 72 $ 85 $ 28

- --------
(1) Restated for the pooling of interest with ColourPass (see Note 5).

See accompanying notes to consolidated financial statements.

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. PREVIOUSLY REPORTED FINANCIAL RESULTS

As a result, for the year ended December 31, 1997 the Company reversed
recorded revenues of $5.8 million, recorded additional cost of revenue of $7.6
million, and additional operating expenses of $4.6 million. In addition, the
Company has restated its previously reported results for each interim period
in the nine months ended September 30, 1997.

2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

Raster Graphics, Inc. (the Company) was incorporated on July 27, 1987. The
Company operates in a single segment consisting of the design, manufacture and
marketing of large format digital printing systems and related software and
consumables.

Basis of Presentation

The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, Onyx Graphics Corporation, Raster Graphics
GmbH, a German corporation, Raster Graphics Limited, a company incorporated in
England and Wales and Datagraph, a French corporation. The functional
currencies of the subsidiaries have been determined to be the local
currencies. Consequently, assets and liabilities of operations outside the
United States are translated into U.S. dollars using period-end exchange
rates, and revenues and expenses are translated at the average monthly
exchange rates. Gains and losses from this translation process are credited or
charged to stockholders' equity. All material inter-company accounts and
transactions have been eliminated.

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

These consolidated financial statements have been restated to include the
amounts of ColourPass, which was merged with the Company's wholly owned
subsidiary, Raster Graphics Systems Ltd., effected March 18, 1997, for
relevant periods prior to the merger (see Note 5). All periods presented have
been restated to reflect the merger which has been accounted for as a pooling
of interests.

As a result of the Company's significant operating losses and the cost of
acquiring and funding its recent acquisitions, the Company's working capital
has been substantially reduced. The Company ended fiscal 1997 with a working
capital of $3.5 million and cash, cash equivalents and short-term investments
of $5.3 million compared with $23.9 million of working capital and $16.1
million of cash, cash equivalents, and short-term investments at the end of
fiscal 1996. The Company's accumulated deficit was $34.4 million at December
31, 1997. The Company's available working capital is not sufficient to
maintain the Company's activities.

The Company has entered into an Agreement and Plan of Merger with Gretag
Imaging Group, Inc. ("Gretag") for the acquisition of the Company for
approximately $1.30 per share (the "Merger"). The Company has also entered
into a Loan and Pledge Agreement and Asset and Subsidiary Stock Option
Agreement and certain of its stockholders have entered into a Stockholders
Agreement with Gretag. Pursuant to the Loan and Pledge Agreement, Gretag is
providing the Company a loan facility secured by 100% of the issued stock of
Onyx, a wholly owned subsidiary of the Company. The Company may draw down
amounts together with accrued interest of up to $5,000,000. The first
installment of $500,000 was received by the Company on September 23, 1998. In
addition, Gretag has the option to purchase up to $5,000,000 of the Company's
Common Stock in exchange for forgiving the loan and paying the balance in
cash. Pursuant to the Asset and Subsidiary Stock Option Agreement, (i) if the
Agreement and Plan of Merger is terminated, Gretag has the option to acquire
Onyx for $5,000,000 less the amount drawn down under the loan facility, or
(ii) if the Company's stockholders do not vote in favor of the Merger, if the
Company accepts a superior offer to sell the Company or upon certain other
events, Gretag has the option to acquire the Company's inkjet technology for
$6,000,000 less the amount drawn down under the loan facility. Pursuant to the
terms of the Stockholders Agreement, stockholders of the Company holding
approximately 20% of the Company's outstanding Common Stock have agreed to
vote in favor of the Merger and against any other proposal to acquire the
Company. The Merger and the Agreement and Plan of Merger requires stockholder
approval and consummation of the Merger is conditioned upon settlement of the
class action lawsuits against the Company. (See Note 12 for a description of
amounts payable on a change in control.)

The Company's future capital requirements, however, depend on numerous
factors, including, without limitation, the success of marketing, sales, and
distribution efforts; the success of its research and development programs;
the costs involved in preparing, filing, prosecuting, defending, and enforcing
intellectual property rights; competition; competing technology and market
developments; and the effectiveness of product commercialization activities
and arrangements.

There can be no assurance that the Company will obtain further additional
financing or product revenue necessary to continue operations. The financial
statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.

Use of Estimates

The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make estimates and
assumptions. These assumptions affect the reported amounts of

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

In particular, the Company has recorded accounts receivable of $8,050,000,
net of an allowance for doubtful accounts of $4,668,000. The allowance for
doubtful accounts is based among other things, upon management's estimate as
to the credit worthiness of its customers and their willingness to pay.
Management has undertaken efforts to collect amounts owed by its customers and
to reduce the accounts receivable balance to more desired levels over the near
term. No estimate can be made of a range of amounts of loss that are
reasonably possible, should Management's efforts not be successful.

Management also determined that the Company's inventory is in excess of its
current requirements and has written down inventory by $10.4 million to
reflect net realizable value and also excess and obsolete inventory.
Management is in the process of developing a plan to reduce the Company's
inventory to more desired levels over the near term. No estimate can be made
of a range of amounts of loss that are reasonably possible should the plan not
be successful.

Furthermore, management has estimated the expected cost of performing work
under printer warranties, which is based in part on the number of units sold,
the likelihood of operating problems occurring and the cost of repair and has
included in cost of revenues of approximately $653,000 for the expected costs.
No estimate can be made of the range of amounts of loss that are reasonably
possible should the warranty work not be successful.

Cash Equivalents and Investments

For financial statement purposes, the Company considers all highly liquid
debt instruments with original maturities of ninety days or less and with
insignificant interest rate risk to be cash equivalents.

The Company classifies all of its investments as "available-for-sale" in
accordance with the provisions of Financial Accounting Standards Board
Statement No. 115 "Accounting for Certain Investments in Debt and Equity
Securities." Accordingly, the Company states its investments at estimated fair
value, with material unrealized gains and losses reported in stockholder's
equity. The cost of securities sold is based on the specific identification
method. Such securities are anticipated to be used for current operations and
are therefore classified as current assets, even though maturities may extend
beyond one year.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or fair
market value.

Property and Equipment

Property and equipment is stated at cost and depreciated, using the
straight-line method, over the shorter of the estimated useful life (one to
five years) or, if applicable, the term of the related lease.

Revenue Recognition

Revenue from product sales is recognized upon the later of shipment,
acceptance of the product by the customer, or when payment from the customer
is assured. In particular, where the Company has made arrangements with
customers, such as resellers, that have resulted in contingencies or
allowances after the product has shipped, revenue is recognized once the
contingency has been removed and cash collection is assured.

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Further, where a customer has obtained financing through a third party
broker, revenue is not recognized until the finance agreement is in place and
the product has been accepted by the customer.

Revenue under maintenance contracts is recognized ratably over the term of
the related contract, generally twelve months.

The Company estimates and maintains a reserve for product returns.

Advertising Costs

Advertising costs are expensed when incurred and amounted to $161,000,
$190,000 and $77,000 for the years ended December 31, 1997, 1996, and 1995
respectively.

Net Income (Loss) Per Share

In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per share. Statement 128 replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported earnings per
share. All earnings per share amounts for all periods presented have been
restated to conform to the Statement 128 requirements.

Pro forma net income (loss) per share for the years ended December 31, 1995
and 1996 have been computed as described above and also gives effect, even if
antidilutive, to common equivalent shares from preferred stock that
automatically converted upon the closing of the Company's initial public
offering (using the as-if-converted method).

Impact of Recently Issued Accounting Standards

In October 1997 and March 1998 the Accounting Standards Executive Committee
issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition" and
SOP 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2, Software
Revenue Recognition", respectively, which will be effective for the Company's
transactions entered into after December 31, 1997. The Company is assessing
the impact of the implementation of SOP 97-2 and SOP 98-4 on reported revenue
and earnings.

In June 1997, the Financial Accounting Standards Board issued Statement
Number 130, "Reporting of Comprehensive Income". This Statement requires that
all items that are to be required to be recognized under accounting standards
as components of comprehensive income be reported in a financial statement
that is displayed with the same prominence as other financial statements. This
Statement is effective for fiscal years beginning after December 15, 1997 and
will be adopted by the Company for the year ended December 31, 1998. The
Company is assessing the impact of this Statement on its financial statements.

In June 1997, the Financial Accounting Standards Board issued Statement
Number 131, "Disclosures About Segments of an Enterprise and Related
Information. This Statement replaces Statement Number 14 and changes the way
public companies report segment information. This Statement is effective for
fiscal years beginning after December 15, 1997 and will be adopted by the
Company for the year ended December 31, 1998. The Company is assessing the
impact of this Statement on its financial statements.

In June 1988, the Financial Accounting Standards Board issued Statement
Number 133, "Accounting for Derivative Instruments and Hedging Activities",
which establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
to as derivatives) and for hedging activities. This Statement is effective for
fiscal years beginning after June 30, 1999 and will be adopted by the Company
for the year ended December 31, 2000. The Company is assessing the impact of
this Statement on its financial statements.

2. CONCENTRATIONS

Credit Risk

Financial instruments that potentially subject the Company to concentrations
of credit risk consist principally of investments in cash equivalents, short
term investments and receivables from customers. The Company invests in money
market funds, commercial paper and state and municipal bonds of high credit
quality institutions. The Company is exposed to credit risks in the event of
default by these institutions to the extent of the amount recorded on the
balance sheet. The Company maintains reserves for potential credit losses.

A significant number of the Company's customers and suppliers are based in
Asia and Latin America. The financial instability in these regions may have an
adverse impact on the financial position of customers and suppliers in the
region which could impact the Company's future revenues and operations,
including the ability of customers to pay the Company. Should the current
volatility in Asia and Latin America continue, either the Company or the
Company's customers may be unable to sell its products in the region. The
inability to generate revenue in this region, or the inability to collect
amounts due, would have a material adverse impact on the Company's business,
financial condition and results of operations.

Dependence on Major Subcontractors and Suppliers

The Company relies on subcontractors and suppliers to manufacture,
subassemble, and perform first-stage testing of DCS printer components. The
Company relies on single suppliers for the PiezoPrint 1000 printer and for
certain critical components for the PiezoPrint 5000 and DCS printers. The
Company also relies on single suppliers for certain consumables to support its
line of printers. The loss of certain subcontractors or suppliers or the
failure of subcontractors or suppliers to meet the Company's price, quality,
quantity, and delivery requirements would have a material adverse effect on
the Company's business, financial condition, and results of operations.

Dependence on Limited Products

The majority of the Company's sales are derived from two principal product
lines, the DCS and PiezoPrint printing systems, printers and related
consumables, and the Company anticipates that it will derive the bulk of its
future revenues from sales of these products. If the Company is unable to
generate sufficient sales of these product lines due to competitive factors,
manufacturing difficulties, or other reasons, it may be unable to continue its
business.

Major Customers

One customer accounted for 10.9% of net revenues for 1995. No customer
accounted for more than 10% of net revenue during 1997 or 1996.

3. FINANCIAL INSTRUMENTS

Available-For-Sale Securities

As of December 31, 1997, the Company has $1.6 million of investments in
state and municipal bonds. These state and municipal bonds bear interest at a
rate which automatically resets to the prevailing market interest rate

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
at approximately 35-day intervals. As of December 31, 1997, substantially all
the available-for-sale securities have principal maturity dates of over ten
years. The gross unrealized gains and gross unrealized losses at December 31,
1997 were immaterial to the Company and, therefore, no amounts were recorded
to stockholders' equity. There were no sales of available-for-sale securities
during fiscal 1996.

Derivative Financial Instruments

During the period covered by the financial statements, the Company has not
used any derivative instrument for trading purposes.

Although the majority of the Company's transactions are denominated in U.S.
dollars, its operations have resulted in some foreign currency exchange rate
fluctuation exposure. The Company utilized foreign currency forward exchange
contracts to manage some of its foreign currency firm purchase commitments.

At December 31, 1997, the Company held a foreign currency forward contract
which matured in January 1998 to buy 25.6 million Japanese yen for $200,000.
The fair value of the yen underlying this instrument at December 31, 1997, was
$196,000.

Valuation of Financial Instruments

The fair values for cash equivalents and short term investments represent
the quoted market prices at the balance sheet dates. The fair values for
foreign currency forward contracts represent the difference between the
contracted forward rate and the quoted fair value of the underlying yen at the
balance sheet date.

4. BALANCE SHEET COMPONENTS

Inventories

Inventories consist of the following (in thousands):

DECEMBER 31, DECEMBER 31,
1997 1996
------------ -------------
(RESTATED)(1)

Raw materials.................................. $ 2,934 $ 956
Work in progress............................... 958 1,708
Finished goods................................. 2,748 4,041
------- ------
$ 6,640 $6,705
======= ======

--------
(1) Restated for the pooling of interest with ColourPass (see Note 5)

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

PROPERTY AND EQUIPMENT

Property and equipment consist of the following (in thousands):

DECEMBER 31, DECEMBER 31,
1997 1996
------------ -------------
(RESTATED)(1)

Machinery and equipment........................ $8,518 $5,615
Furniture and fixtures......................... 517 400
Leasehold improvements......................... 728 543
------ ------
9,763 6,558
Accumulated depreciation....................... 5,320 4,011
------ ------
$4,443 $2,547
====== ======

--------
(1) Restated for the pooling of interest with ColourPass (see Note 5)

Property and equipment includes approximately $213,000 of equipment under
capital leases as of December 31, 1997. The related depreciation expense
totaled approximately $9,000 for the year ended December 31, 1997. The Company
did not have any property and equipment under capital leases as of December
31, 1996.

INTANGIBLE ASSETS

Intangible assets consist of the following (in thousands):

DECEMBER 31,
1996
-------------
(RESTATED)(1)

Assembled work force........................................ $ 80
Trademarks and tradenames................................... 54
Developed technology........................................ 280
Distributor relationships................................... 40
Goodwill.................................................... --
----
454
Accumulated amortization.................................... 352
----
Net intangible assets....................................... $102
====

--------
(1) Restated for the pooling of interest with ColourPass (see Note 5)

At December 31, 1997 all intangible assets were either fully amortized or
written off.

The Company has adopted FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of".

As a result of the existence of certain impairment indicators, the Company
had determined that the value of certain assets are impaired and has recorded
impairment write-downs of $1.2 million in relation to certain intangible
assets (see Note 5), which have been expensed in fiscal 1997. Those impairment
indicators include a significant operating loss in 1997.

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

5. BUSINESS COMBINATIONS

On September 30, 1997, Raster Graphics acquired Datagraph, a French-based
distributor of large-format digital imaging systems. In exchange for the
outstanding stock of Datagraph, the Company agreed to pay approximately
$1,100,000 in a series of payments through September 30, 1998. The acquisition
was accounted for as a purchase with the results of operations of the acquired
business being included in the consolidated results of operations for the
period subsequent to the acquisition date. Including acquisition costs, the
transaction resulted in goodwill of $1,211,000, which based on the Company's
sales forecasts was written off during the fourth quarter of 1997. The
operating results of Datagraph prior to the acquisition are not material in
relation to the Company. In addition, based on recent developments, it is
likely that Datagraph will commence bankruptcy proceedings in the near term
and cease operations.

On March 18, 1997, the Company completed a merger with ColourPass, a
business in the United Kingdom, in which ColourPass was merged with Raster
Graphics System Limited, a wholly owned subsidiary of the Company. On the
effective date of the merger, the Company issued 220,426 shares of common
stock to the owners of ColourPass. The combination was accounted for as a
pooling of interests. Accordingly, the consolidated statements of operations
for the years ended December 31, 1996 and 1995, the balance sheet as of
December 31, 1996, and all related footnotes presented herein have been
restated to include the accounts of Raster Graphics, Inc. and ColourPass.

The table below sets forth the composition of combined revenues and net
income (loss) for the periods indicated (in thousands). Merger related
expenses of $139,000 incurred in the first quarter of 1997 were included in
the Raster Graphics, Inc. and ColourPass net income (loss).

DECEMBER 31, DECEMBER 31,
1997 1996
------------ -------------
(RESTATED)(1)

Revenues
Raster Graphics, Inc......................... $39,395 $26,045
ColourPass................................... 3,234 2,825
------- -------
Combined................................... $42,629 $28,870
======= =======
Net income (loss)
Raster Graphics, Inc......................... $ 3,298 $ 77
ColourPass................................... (236) (91)
------- -------
Combined................................... $ 3,062 $ (14)
======= =======

On August 10, 1995, the Company acquired Onyx Graphics Corporation ("Onyx")
for 443,359 shares of convertible preferred stock of the Company, the
cancellation of a note due from Onyx and for the assumption of options to
acquire Onyx common stock. The consideration, including acquisition costs,
totaled $1.5 million. The Company expensed $750,000 of acquired in-process
research and development and wrote off $139,000 for redundant PostScript
licenses in the September 1995 quarter. The acquisition has been accounted for
as a purchase with the results of operations of the acquired business being
included in the consolidated results of operations for the period subsequent
to the acquisition date.

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

6. NET INCOME (LOSS) PER SHARE

The following table sets forth the computation of basic and diluted earnings
per share (in thousands, except earnings per share):

YEARS ENDED DECEMBER
31,
----------------------
1997 1996 1995
-------- ------ -----

Numerator for basic and diluted earnings per
share net income (loss)......................... $(18,965) $3,062 $ (14)
======== ====== =====
Denominator for basic earnings per share
Weighted average common shares................... 9,426 4,007 441
Convertible preferred stock (pro forma 1996 and
1995)........................................... -- 3,555 5,584
-------- ------ -----
Shares used in computing basic earnings per share
(pro forma 1996 and 1995)....................... 9,426 7,562 6,025
======== ====== =====
Basic earnings per share (pro forma 1996 and
1995)........................................... $ (2.01) $ 0.40 $ --
======== ====== =====
Denominator for diluted earnings per share
Weighted average common shares................... 9,426 4,007 441
Convertible preferred stock (pro forma 1995)..... -- 3,555 5,584
Stock options and warrants....................... -- 1,080 --
-------- ------ -----
Shares used in computing diluted earnings per
share (pro forma 1995).......................... 9,426 8,642 6,025
======== ====== =====
Diluted earnings per share (pro forma 1995)...... $ (2.01) $ 0.35 $ --
======== ====== =====

Options to purchase 1,735,714 shares and 10,400 shares issuable on the
conversion of warrants were outstanding at December 31, 1997 and 1,112,350
options to purchase shares and 10,400 shares issuable on the conversion of
warrants were outstanding at December 31, 1995 and were excluded from the
computation of diluted net loss per share because the effect would have been
anti-dilutive.

7. BORROWINGS

The Company's long-term debt includes two notes payable. The first note
issued on August 29, 1994 has a principal balance of $13,000 at December 31,
1997 with interest being charged at 1.0% above the lenders prime rate. An
additional note issued on June 5, 1995 has a principal balance of $115,000 at
December 31, 1997 with interest being charged at a rate of 0.5% above the
lenders prime rate. Such prime rate was 8.5% at December 31, 1997.

In December 1997 the Company's bank line of credit agreement was amended.
The facility was increased to $10 million and extended one year to expire on
December 13, 1998 and the line of credit is governed by a borrowing base of
eligible accounts receivable and is secured by the Company's assets. Interest
is charged at the lender's prime rate plus 0.25 percentage points.

In July 1998 the Company's bank line of credit agreement was further
amended. The facility was decreased to $4.1 million, extended to December 31,
1998 and the interest rate was revised to the Lender's prime rate plus 2.0
percentage points. At December 31, 1997, no amounts were outstanding under the
line of credit.

These notes are secured by the tangible assets of the Company. The notes
include various financial covenants which make reference to the Company's
profitability and liquidity. If the Company fails to satisfy these covenants,
all outstanding amounts of the principal and unpaid interest immediately
become due and payable. Currently, the Company is not in compliance with these
Bank covenants.

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

In addition, the Company's wholly owned subsidiary, Datagraph, has various
notes payable which have a total outstanding balance of $56,000 at December
31, 1997. As it is likely that Datagraph will commence bankruptcy proceedings
in the near term and cease operations, all of the outstanding balances have
been classified as being due within one year.

Future principal maturities on the notes payable at December 31, 1997 are as
follows (in thousands):

1998.............................................. $184
====

8. COMMITMENTS

The Company leases its principal facilities under operating lease
arrangements. Future minimum annual rental payments are as follows for the
years ended December 31 (in thousands):

1998............................................ $ 993
1999............................................ 967
2000............................................ 909
2001............................................ 690
2002............................................ 78
------
$3,637
======

Rent expense for the fiscal years ended 1997, 1996, and 1995 was
approximately $895,000, $614,000, and $539,000, respectively.

The Company leases some equipment under capital leases. Future minimum lease
payments under capital leases are as follows for years ended December 31:

CAPITAL
LEASES
--------------
(IN THOUSANDS)

1998.................................... $ 69
1999.................................... 68
2000.................................... 68
2001.................................... 60
2002.................................... 9
----
Total minimum lease and principal pay-
ments.................................. 274
Amount representing interest............ (69)
----
Present value of future payments........ 205
Current portion of capital lease obliga-
tions.................................. 41
----
Noncurrent portion of capital lease ob-
ligations.............................. $164
====

The Company has purchase commitments of approximately $2.1 million to
suppliers at December 31, 1997, including non-cancelable purchase orders
totaling $1 million for products in excess of current requirements which have
been expensed to cost of revenues in 1997.

9. STOCKHOLDERS' EQUITY

In August 1996, the Board of Directors and stockholders approved a one-for-
five reverse split of the Company's common and preferred stock and
reincorporation of the Company into the State of Delaware. All shares and per
share amounts in the accompanying consolidated financial statements have been
adjusted retroactively.

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Initial Public Offering

In August 1996, the Company completed its initial public offering and issued
2,450,000 shares of its common stock to the public at a price of $8.00 per
share. The Company received approximately $16.9 million of cash, net of
underwriting discounts, commissions, and other offering costs incurred to
date. Upon completion of the offering, all outstanding shares of Preferred
Stock and 70,412 warrants were converted into shares of Common Stock on a one-
for-one basis.

Upon completion of the offering, the Board of Directors was authorized to
issue 2,000,000 shares of undesignated preferred stock in one or more series
and to fix the rights, preferences, privileges and restrictions thereof,
including dividend rights, dividend rates, conversion rights, voting rights,
terms of redemption, redemption prices, liquidation preferences, and number of
shares constituting any series or the designation of such series, without
further vote or action by the stockholders.

Stockholder Rights Plan

On February 3, 1998 the Board of Directors approved a Stockholder Rights
Plan where the Board declared a dividend of one right for each share of common
stock outstanding. Each right will entitle stockholders to buy one one-
thousandth of a share of the company's Series A participating Preferred Stock
at an exercise price of $30 and under certain circumstances will entitle
stockholders, other than a potential acquirer, to purchase at the then current
exercise price, that number of shares of Raster Graphics' common stock having
a market value at that time of twice the exercise price. The Rights will
separate from the common stock and become exercisable following the tenth day
after a person or group acquires beneficial ownership of 15% or more of the
Company's common stock or announces a tender or exchange offer, the
consummation of which would result in ownership by a person or group of 15% or
more of the Company's common stock (the Distribution Date). The Rights expire
on the earliest of (a) January 29, 2008, (b) exchange or redemption of the
Rights or (c) consummation of a merger or consolidation or sale of assets
resulting in expiration of the Rights. The Rights will not have any voting
rights.

Stock Option Plans

The Company has stock option plans (the "Plans") under which key employees,
consultants and Directors may be granted incentive or nonstatutory stock
options for the purchase of common stock.

The Company's 1988 stock options plan (the "1988 Stock Plan") was adopted by
the Board of Directors in 1988. 1,560,000 shares are authorized for issuance
under this plan.

The Company's 1996 Stock Plan (the "1996 Stock Plan") was adopted by the
Board of Directors and approved by the stockholders in August 1996. An
aggregate of 800,000 shares of the Company's common stock are reserved for
issuance under the 1996 Stock Plan. Upon adoption of the 1996 Stock Plan, the
Company's Board of Directors determined to make no further grants under the
1988 Option Plan. The 1996 Stock Plan provides for the granting to employees
(including officers and employee directors) of "incentive stock options"
within the meaning of Section 422 of the Code, for the granting to employees
and consultants of nonstatutory stock options and for the granting to
employees of stock purchase rights. The 1996 Stock Plan is administered by the
Board of Directors (the 1996 Administrator). The 1996 Administrator determines
the terms of options and stock purchase rights granted under the 1996 Stock
Plan, including the number of shares subject to the option or right, exercise
price, term and exercisability.

The 1996 Directors' Stock Option Plan (the "Directors' Plan") was adopted by
the Board of Directors and approved by the stockholders in August 1996. An
aggregate of 150,000 shares of common stock are reserved for

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
issuance under the Directors' Plan. The Directors' Plan provides for the
granting of nonstatutory stock options to nonemployee directors of the
Company. The Directors' Plan is designed to work automatically without
administration; however, to the extent administration is necessary, it will be
performed by the Board of Directors. To the extent they arise, it is expected
that conflicts of interest will be addressed by abstention of the interested
director from both deliberations and voting regarding matters in which he or
she has a personal interest.

The Directors' Plan provides that each person who is or becomes a
nonemployee director of the Company shall be granted a nonstatutory stock
option to purchase 10,000 shares of common stock on the date on which the
optionee first becomes a nonemployee director of the Company. Thereafter, on
the first calendar day of the Company's fiscal year commencing in 1997, each
nonemployee director shall be granted an additional option to purchase 5,000
shares of common stock if, on such date, he or she shall have served on the
Company's Board of Directors for at least six months.

The Company's 1997 Stock Option Plan (the "1997 Stock Plan") was adopted by
the Board of Directors in December 1997. An aggregate of 400,000 shares of the
Company's common stock are reserved for issuance under the 1997 Stock Plan.
The 1997 Stock Plan provides for the granting to employees (including officers
and employee directors upon joining the Company) and consultants of
nonstatutory stock options. The 1997 Stock Plan is administered by the Board
of Directors or a Committee designated by the Board (the "1997
Administrator"). The 1997 Administrator determines the terms of options
granted under the 1997 Stock Plan, including the number of shares subject to
the option, exercise price, term and exercisability.

There are 2,910,000 shares authorized under the Plans. Under the Plans,
incentive and nonstatutory options may be granted at an exercise price of not
less than 100% and 85%, respectively, of the fair value as determined by the
Board of Directors. The options are exercisable at the discretion of the Board
of Directors and generally vest at the rate of 12.5% of the original grant,
commencing six months after the date of grant or employment, and in monthly
increments of approximately 2.08% or quarterly increments of approximately
6.25% of the total grant thereafter. Expiration dates are determined by the
Board of Directors, but in no event will they exceed ten years from the date
of grant. Unexercised options are cancelable thirty days after the date of
termination of employment.

Because of certain security laws issues applicable to the Company, no stock
option grants or exercises have been made (except for a stock grant to the
Company's Executive Vice President) since the Company was de-listed from the
NASDAQ National Market.

A summary of the Company's stock option activity, and related information
for the years ended December 31 is as follows:

1997 1996 1995
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- -------- --------- -------- --------- --------

Outstanding--beginning
of year................ 1,535,800 $3.52 1,112,350 $0.51 623,770 $0.49
Granted................. 776,050 $7.10 632,841 $7.83 513,280 $0.53
Exercised............... (336,198) $0.72 (141,245) $0.48 (19,787) $0.50
Forfeited............... (239,938) $6.29 (68,146) $0.78 (4,913) $0.50
--------- --------- ---------
Outstanding--end of
year................... 1,735,714 $5.28 1,535,800 $3.52 1,112,350 $0.51
========= ===== ========= ===== ========= =====

At December 31, 1997, there were 633,311 shares of common stock available
for option grants.

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The following table summarizes information about options outstanding and
exercisable by price range as of December 31, 1997:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- -----------------------
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES AS OF LIFE (YEARS) PRICE AS OF PRICE
- --------------- ----------- ------------ -------- ----------- --------
$0.03 15,960 7.59 $0.03 15,960 $0.03
$0.50-$0.75 478,926 5.88 $0.50 413,632 $0.50
$0.80 19,400 7.59 $0.80 19,400 $0.80
$1.25-$1.50 11,600 7.87 $1.36 7,242 $1.36
$4.00-$6.00 344,281 9.43 $5.25 56,600 $5.23
$6.88-$8.75 613,886 8.91 $7.44 155,689 $7.39
$9.50-$11.00 251,661 8.97 $9.97 54,409 $9.96
--------- -------
1,735,714 8.15 $5.28 722,932 $3.07
=========== ============ ======== =========== ========

Deferred Compensation

The Company recorded aggregate compensation of $418,000 during 1996. The
amount recorded represents the difference between the grant price and the
deemed fair value of the Company's common stock for shares subject to options
granted during 1996. The amortization of deferred compensation is charged to
operations and is amortized over the vesting period of the options, which is
typically four years.

Stock Purchase Plans

In 1988, the Company adopted a stock purchase plan (the "1988 Plan") for
consultants and key employees of the Company. There are 90,000 shares
authorized for issuance under this plan. Under this plan, consultants and key
employees may be granted the right to purchase shares of the Company's common
stock at not less than 100% of the fair value on the date of grant as
determined by the Board of Directors. As of December 31, 1997, 24,000 shares
have been issued under the Plan.

The Company's 1996 Employee Stock Purchase Plan (the "1996 Purchase Plan")
was adopted by the Board of Directors and approved by the stockholders in
August 1996. Upon adoption of the 1996 Purchase Plan, the Company's Board of
Directors determined to make no further grants under the 1988 Plan. A total of
400,000 shares of common stock has been reserved for issuance under this plan.
As of December 31, 1997, 54,661 shares have been issued under this plan.

The 1996 Purchase Plan, which is intended to qualify under Section 423 of
the Code, has been implemented by a series of twelve month offering periods
with purchases commencing on or about January 1 and July 1 of each year. The
Purchase Plan is administered by the Board of Directors. Employees (including
officers and employee directors) of the Company, or of any majority owned
subsidiary designated by the Board of Directors, are eligible to participate
in the Purchase Plan if they are employed by the Company or any such
subsidiary for at least 20 hours per week and more than five months per year.
The Purchase Plan permits eligible employees to purchase common stock through
payroll deductions, which may not exceed 10% of an employee's compensation at
a price equal to the lower of 85% of the fair market value of the Company's
common stock at the beginning or end of the offering period. Because of
certain securities law issues applicable to the Company, no purchase was made
under the Plan on June 30, 1998, and all participants will have withdrawn from
the Plan as of September 25, 1998 without any exercise of outstanding options.

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Accounting for Stock Based Compensation

The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock based compensation
because, as discussed below, the alternative fair value accounting provided
for under FASB Statement No. 123, "Accounting for Stock-Based Compensation",
requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, because the exercise price of
the Company's options generally equals the market price of the underlying
stock on the date of the grant, no compensation expense is recognized in the
Company's financial statements.

Pro forma information regarding net income (loss) and net income (loss) per
share is required by Statement 123, which also requires that the information
be determined as if the Company has accounted for its employee stock options
(including shares issued under the Employee Stock Purchase Plan, collectively
called options') granted subsequent to December 31, 1994 under the fair value
method of the Statement. The fair value for these options was estimated at the
date of grant using the minimum value method prior to the Company's Initial
Public Offering ("IPO") in August 1996. Subsequent to the IPO, the fair value
of the options has been estimated using the Black-Scholes option pricing
model. The following weighted-average assumptions were used in the valuation
of options:

EMPLOYEE STOCK
EMPLOYEE STOCK OPTIONS PURCHASE PLAN
------------------------- ------------------
1997 1996 1995 1997 1996
------- ------- ------- -------- --------

Risk-free interest rate... 6.47% 6.41% 6.46% 5.41% 5.64%
Dividend yield............ 0% 0% 0% 0% 0%
Volatility................ 0.85 0.28 0% 0.85 0.28
Average life.............. 5 years 5 years 5 years 6 months 6 months

The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

The weighted average fair value of options granted during the year ended
December 31, 1997, 1996 and 1995 was $5.09, $5.67, and $0.69 per share,
respectively for options granted at an exercise price equal to fair value at
the grant date, and $2.92 and per share, for options granted at an exercise
price less than the fair value at the grant date during the year ended
December 31, 1996. The weighted average estimated fair value of employee stock
purchase rights granted during 1997 was $4.25.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period (for employee
stock options) and the six month purchase period (for stock purchases under
the Employee Stock Purchase Plan). The Company's pro forma information at
December 31 is as follows:

1997 1996 1995
------------ ------------- -------------
(RESTATED)(1) (RESTATED)(1)

Pro forma net income (loss).... $(20,237,000) $2,810,000 $(61,000)
Pro forma basic income (loss)
per share..................... $ (2.16) $ 0.37 $ (0.01)
Pro forma diluted income (loss)
per share..................... $ (2.16) $ 0.33 $ (0.01)

--------
(1) Restated for the pooling of interests with ColourPass. (See Note 5.)

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The effects of applying FAS 123 for either recognizing compensation expense
or providing pro forma disclosures are not likely to be representative of the
effects on reported net income (loss) for future years. As FAS 123 is
applicable only to options granted subsequent to December 31, 1994, its pro
forma effect will not be fully reflected until approximately the year 2000.

Warrants

During 1989, the Company issued warrants to purchase 10,400 shares of stock
at $12.50 per share to a financial institution in connection with an equipment
lease line. The warrants expired in 1998.

Common Stock Reserved

The Company has reserved shares of common stock for future issuance as
follows:

DECEMBER 31,
1997
------------

Stock Option Plans................... 2,369,025
Stock Purchase Plan.................. 345,339
Conversion of warrants............... 10,400
---------
2,724,764
=========

Notes Receivable From Stockholder

On February 28, 1996, the Company issued a note receivable for $20,000 to a
consultant. The note incurred interest at a rate of 5.25% per annum and was
repaid in full in January, 1997.

10. TAXES ON INCOME

The tax provision consists of the following:

DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996 1995
------------ ------------ ------------
(IN THOUSANDS)

Current:
Federal........................... $ -- $193 $40
State............................. 54 56 28
Foreign........................... 256 176 14
---- ---- ---
$310 $425 $82
==== ==== ===

The difference between the tax provision and the amount computed by applying
the federal statutory income tax rate to income before provision for income
taxes is explained below:

DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996 1995
------------ ------------ ------------
(IN THOUSANDS)

Expected provision (benefit) at
statutory rate.................. $ (5,619) $ 1,220 $ 24
State taxes...................... 54 56 28
Federal alternative minimum tax.. -- 81 40
Net operating losses (utilized)
not utilized.................... 5,875 (932) (10)
-------- ------- ----
Provision for income taxes....... $ 310 $ 425 $ 82
======== ======= ====

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. Significant components
of deferred tax assets are as follows (in thousands):

DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------

Net operating loss carryforwards............... $ 8,553 $ 3,238
Tax credit carryforwards....................... 1,640 1,278
Inventory reserve.............................. 673 367
Other accruals and reserves not deductible for
tax purposes.................................. 1,925 890
Other, net..................................... 565 350
-------- -------
Total deferred tax assets...................... 13,356 6,123
Valuation allowance for deferred tax assets.... (13,356) (6,123)
-------- -------
Net deferred tax assets........................ $ -- $ --
======== =======

The net operating loss and credit carryforwards will expire in the years
2002 through 2012, if not utilized.

11. EXPORT AND INTERNATIONAL SALES

YEAR ENDED DECEMBER 31,
--------------------------
1997 1996 1995
-------- ------- -------
(IN THOUSANDS)

Revenue from unaffiliated customers
US.......................................... $ 42,459 $39,071 $25,482
Europe...................................... 6,469 3,558 3,388
-------- ------- -------
Total revenue............................. $ 48,928 $42,629 $28,870
======== ======= =======
Transfers (eliminations)
US.......................................... $ (1,386) $ -- ($ 648)
Europe...................................... (9,684) (1,918) --
Eliminations................................ (450) (3,660) (240)
-------- ------- -------
Total transfers........................... $(11,520) ($5,578) ($ 888)
======== ======= =======
Income (Loss) from Operations
US.......................................... ($17,992) $ 3,594 $ 268
Europe...................................... (586) (181) (166)
Eliminations................................ (480) (235) (83)
-------- ------- -------
Total income (loss)....................... $(19,058) $ 3,178 $ 19
======== ======= =======
Identifiable assets
US.......................................... $ 26,214 $35,860 $12,641
Europe...................................... 11,341 4,314 1,452
Eliminations................................ (11,997) (3,596) (971)
-------- ------- -------
Total assets on balance sheet............. $ 25,558 $36,578 $13,122
======== ======= =======

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Total export sales by geographic region are as follows (in thousands):

YEAR ENDED DECEMBER 31,
-----------------------
1997 1996 1995
------- ------- -------

Europe............................................. $ 4,464 $ 8,386 $ 7,252
Far East........................................... 4,865 4,161 3,184
Other.............................................. 3,497 5,856 2,358
------- ------- -------
$12,826 $18,403 $12,794
======= ======= =======

International sales, including export sales and sales of the Company's
foreign subsidiaries, were $19.3 million, $22.0 million and $16.2 million in
1997, 1996 and 1995, respectively. International sales in 1996 and 1995 have
been restated for the merger with ColourPass (see Note 5).

12. RELATED PARTY TRANSACTIONS

In November 1997, the Company issued an irrevocable standby letter of credit
in favor of Barclays' Bank on behalf of the Executive Vice President for an
unsecured personal line of credit in the amount of $175,000. This letter of
credit expired May 31, 1998. In August 1998 the Company entered into a mutual
release agreement with Marc Willard, an officer of the Company. In
consideration for Mr. Willard's full release relating to the Company's
acquisition of ColourPass (of which Mr. Willard was an 80% partner), the
parties agreed to a cash bonus of $70,000, a cash payment of $200,000 upon a
change in control of the Company, and a stock option grant of 175,000 shares.

In addition, the Company has agreed to make bonus payments to its Chief
Executive Officer, The Brenner Group, LLC, and general counsel to a maximum of
$600,000, on a change of control of the Company.

13. EMPLOYEE BENEFIT PLAN

The Company has adopted a salary deferral plan (the Plan) covering
substantially all employees. The Company has made no contributions to the Plan
through December 31, 1997.

14. PENDING LITIGATION

RASTER GRAPHICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

15. SUBSEQUENT EVENTS

Restructuring

Agreement and Plan of Merger

SCHEDULE II

RASTER GRAPHICS, INC.

VALUATION AND QUALIFYING ACCOUNTS

ADDITIONS
BALANCE AT (REDUCTIONS) BALANCE AT
BEGINNING CHARGE TO END OF
CLASSIFICATIONS (IN THOUSANDS) OF PERIOD EXPENSE DEDUCTIONS PERIOD
------------------------------ ---------- ------------ ---------- ----------

ALLOWANCE FOR DOUBTFUL ACCOUNTS
YEAR ENDED:
December 31, 1997............... $606 $4,394 $(332) $4,668
December 31, 1996
(Restated)(1).................. 467 403 (264) 606
December 31, 1995
(Restated)(1).................. 246 509 (288) 467

- --------
(1) Restated for the pooling of interest with ColourPass. (See Note 5.)