**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


__________________________________





**FORM
      10-KSB**




(Mark
      One)


x
      ANNUAL
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
      the
      Fiscal Year Ended June 30, 2006





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


For
      transition period from ____ to ____





Commission
      File Number **001-10647**





**PRECISION
      OPTICS CORPORATION, INC.**


(Name
      of
      small business issuer in its charter)




**MASSACHUSETTS**
            
            **04-279-5294**(State
                or other jurisdiction
              of
                incorporation or organization)
            
            (I.R.S.
                Employer
              Identification
                No.)





**22
      East Broadway**


**Gardner,
      Massachusetts 01440**


(Address
      of principal executive offices) (Zip Code)





**(978)
      630-1800**


(Issuer’s
      telephone number, including area code)





Securities
      registered under Section 12(b) of the Act:   **None**





Securities
      registered under Section 12(g) of the Act:   **Common
      Stock, $.01 par value**





Check
      whether the issuer is not required to file reports pursuant to Section 13 or
      15(d) of the Exchange Act.  ̈





Check
      whether the issuer: (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days. Yes x No  ̈





Check
      if
      no disclosure of delinquent filers in response to Item 405 of Regulation S-B
      is
      contained in this form, and no disclosure will 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-KSB or any amendment
      to
      this Form 10-KSB.  ̈





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes  ̈ No x





The
      issuer’s revenues for its most recent fiscal year were $2,284,693.





The
      aggregate market value of the voting stock, consisting solely of common stock,
      held by non-affiliates of the issuer computed by reference to the closing price
      of such stock was $1,536,007 as of August 31, 2006.





The
      number of shares of outstanding common stock of the issuer as of August 31,
      2006
      was 15,458,212.














**DOCUMENTS
      INCORPORATED BY REFERENCE**





The
      issuer’s Proxy Statement for the 2006 Annual Meeting of Shareholders to be held
      on November 28, 2006 is incorporated by reference into Part III of this Form
      10-KSB.









-2-


**PART
      I**





**ITEM
      1.** **DESCRIPTION
      OF BUSINESS**





**HISTORY**





Precision
      Optics Corporation, Inc. (the “Company”) was incorporated in Massachusetts in
      1982 and has been publicly owned since November 1990. References to the Company
      contained herein include its two wholly-owned subsidiaries, except where the
      context otherwise requires.





**BUSINESS
      OF ISSUER**





Precision
      Optics Corporation, Inc., a developer and manufacturer of advanced optical
      instruments since 1982, designs and produces high-quality medical instruments,
      optical thin film coatings, micro-optics with characteristic dimensions less
      than 1 mm, and other advanced optical systems. The Company’s medical
      instrumentation line includes laparoscopes, arthroscopes and endocouplers and
      a
      line of world-class 3-D endoscopes for use in minimally invasive surgical
      procedures. Precision Optics Corporation is registered to the ISO 9001:2000,
      ISO
      13485:2003, and CMDCAS Quality Standards, and complies with the FDA Good
      Manufacturing Practices and the European Union Medical Device Directive for
      CE
      Marking of its medical products. The Company’s internet website is
      www.poci.com.





**Principal
      Products and Services and Methods of Distribution.**





Medical
      Products .
      The
      Company’s medical products include endoscopes, as well as image couplers,
      beamsplitters and adapters, all of which are used as accessories to endoscopes.
      Since January 1991, the Company has developed and sold endoscopes incorporating
      various optical technologies for use in a variety of minimally invasive surgical
      and diagnostic procedures. The Company’s current line of specialized endoscopes
      include arthroscopes (which are used in joint surgery), laryngoscopes (which
      are
      used in the diagnosis of diseases of the larynx), laparoscopes (which are used
      in abdominal surgery), ENT scopes (which are used for Ear, Nose and Throat
      procedures) and stereo endoscopes and cameras (which are used in cardiac and
      general surgery, and enable surgeons to visualize the surgical field in 3-D
      imagery, facilitating greater finesse and minimizing surgical risk).





The
      Company produces autoclavable endoscopes for various applications, which are
      CE
      Mark certified for European use, and have been designed and tested to withstand
      sterilization by autoclave (sterilization in superheated steam under pressure),
      as well as all other commonly used medical sterilization means. The major
      benefits of instruments that can be autoclaved include increased patient safety,
      quick turnaround, and elimination of hazardous sterilant and by-product
      materials, all of which provide increased value to the user compared to
      alternative sterilization methods. The Company believes its autoclavable
      endoscope technology will generate opportunities for endoscope revenue growth,
      particularly in Europe where autoclaving is the preferred method of
      sterilization.





The
      Company began shipments of a 2.7 mm ENT scope utilizing its proprietary
      Lenslock TM technology in December 2005. This new technology has advantages in ease of
      manufacture, and in time, cost and quality of repair. The Company is extending
      this technology to its broader line of endoscopes and believes that the benefits
      of LenslockTM technology may lead to an increase in endoscope sales.





The
      Company developed and has manufactured and sold since 1985 a proprietary product
      line of instrumentation to couple endoscopes to video cameras. Included in
      this
      product line are imaging couplers (for example, the Series 200 Parfocal Zoom
      Couplers and the Series 950 Universal Couplers), which physically connect the
      endoscope to a video camera system and transmit the image viewed through the
      scope to the video camera. The Company’s Series 800 Beamsplitters perform the
      same function while preserving for the viewer an eye port for direct,
      simultaneous viewing through the endoscope. These devices are sold primarily
      to
      endoscope and video camera manufacturers and suppliers for resale under the
      Company’s customers’ names. All of the image couplers and beamsplitters
      manufactured by the Company are approved for surgery-approved sterilization.
      Further, the Company believes it is one of only a few manufacturers of
      autoclavable image couplers worldwide.





-3-


Industrial
      and New Products .
      In
      addition to its medical products, the Company also sells a line of image
      couplers and beamsplitters specially designed for industrial use, including
      the
      video-monitored examination of a variety of industrial cavities and interiors,
      as well as specialized borescopes for industrial applications. The Company
      may
      continue to develop and adapt its products for the industrial market.





The
      Company continues to move forward with new products and technical innovations,
      in particular, the development of a new generation (patent pending) of its
      world-class product line of 3-D endoscopes, the development of a new prototype
      2.7 mm endoscope, and new instruments utilizing the Company’s new
      micro-precision TM lens
      technology (patent pending) for endoscopes under 1 mm. The Company is exploring
      potential applications of single-molecule technology and nanotechnology.





Micro-optics. The
      Company designs and manufactures ultra-small lenses, prisms, and assemblies
      with
      sizes ranging from 0.2 mm to 1 mm. Assemblies range in complexity from the
      combination of two lens elements to entire imaging systems utilizing multiple
      micro-optical elements in combination with larger, conventional optics. These
      optical components and instruments utilize a variety of innovative techniques
      including the Company’s patent-pending micro-precision TM lens
      technology.





Optical
      Thin Films .
      The
      Company designs and manufactures various types of high quality thin film
      coatings for use in a wide range of optical applications. Thin film coatings
      are
      typically produced in-house for the Company’s medical instrumentation and other
      products, but any additional production beyond such uses is limited or very
      specialized.





Night
      Vision Optics. The
      Company has recently completed a partnership effort for the proprietary
      development of a new class of night vision lenses including a new patent-pending
      eyepiece lens. With prototypes completed, the product incorporating the
      Company’s new night vision lenses is currently being evaluated for need and use,
      including field testing. The Company cannot control the timing of current
      evaluations and cannot therefore predict when, if ever, its developed prototypes
      in night vision lenses might begin to generate revenue. Should the Company’s
      customer secure orders for its night vision system, the partnership agreement
      ensures the Company will either be contracted to manufacture the new lenses,
      or
      will receive royalties on lenses manufactured elsewhere.





Optical
      System Design and Development Services .
      On a
      contractual basis, the Company is able to provide advanced lens design, imaging
      analysis, optical system design, structural design and analysis, prototype
      production and evaluation, optics testing, and optical system assembly. Some
      of
      the Company’s development contracts have led to optical system production
      business for the Company, and the Company believes its prototype development
      service may lead to new product production from time to time.





**Competition
      and Markets** .





The
      Company sells its products in a highly competitive market and it competes for
      business with both foreign and domestic manufacturers. Many of the Company’s
      current competitors are larger and have substantially greater resources than
      the
      Company. In addition, there is an ongoing risk for the Company that other
      domestic or foreign companies who do not currently service or manufacture
      products for the Company’s target markets, some with greater experience in the
      optics industry and greater financial resources than the Company, may seek
      to
      produce products or services that compete directly with those of the Company.





The
      Company believes that competition for sales of its medical products and
      services, which have been principally sold to medical device companies who
      incorporate the Company’s products into their systems, is based on performance
      and other technical features, as well as other factors, such as scheduling
      and
      reliability, in addition to competitive pricing. The Company markets and sells
      its endoscopes to original equipment manufacturer (OEM) video camera and video
      endoscopy suppliers for incorporation into their own product lines and for
      resale under their own name. A number of domestic and foreign competitors also
      sell endoscopes to such OEM suppliers, and the Company’s share of the endoscope
      market is nominal. The Company believes that, while its resources are
      substantially more limited than its competitors, the Company can compete
      successfully in this market on the basis of product quality, price and delivery.





-4-


The
      Company currently sells its image couplers, beamsplitters, and adapters to
      a
      market that consists of approximately 30 to 35 potential OEM customers who
      manufacture and sell video cameras, endoscopes, and video-endoscopy systems.
      In
      the past, the Company has been successful in marketing and selling its products
      to approximately two thirds of these customers, and currently estimates that
      it
      maintains approximately 20% to 30% of the market share in these products. The
      Company plans to continue to focus its sales and marketing efforts in this
      area,
      and to work to increase its market share. However, a challenge the Company
      faces
      is customers’ own in-house capabilities to manufacture such products, for which
      it estimates that approximately 50% of the market demand for image couplers,
      beamsplitters, and adapters is met by these “captive” facilities. In general and
      despite in-house capacity, the Company believes that many customers continue
      to
      purchase products from the Company in order to devote their own technical
      resources to their primary products, such as cameras or endoscopes.





The
      Company has recently hired a director of marketing, Brian Spies, to develop
      and
      expand the existing market for its products, to build relationships with OEM
      suppliers and to enhance the Company’s service for its existing customers. Mr.
      Spies will work closely with the Company’s existing sales team to develop and
      implement this marketing plan.





As
      an
      additional service component, the Company offers advanced optical design and
      development services, not related to thin film coatings, to a wide range of
      potential customers and has numerous competitors. The ability to supply design
      and development services to such customers is highly dependent upon a company’s
      reputation and prior experience, which the Company believes it can provide
      to
      its customers on a cost efficient basis.





The
      Company has had negligible direct export sales to date. However, the Company’s
      medical products have received the CE Mark Certification, which permits sales
      into the European marketplace. The Company may establish or use production
      facilities overseas to produce key components for the Company’s business, such
      as lenses. The Company believes that the cost savings from such production
      may
      be essential to the Company’s ability to compete on a price basis in the medical
      products area particularly and to the Company’s profitability generally.





**Research
      and Development** .





The
      Company believes that its future success depends to a large degree on its
      ability to continue to conceive and to develop new optical products and services
      to enhance the performance characteristics and methods of manufacture of
      existing products. Accordingly, it expects to continue to seek to obtain
      product-related design and development contracts with customers and to invest
      its own funds on its research and development. The Company spent approximately
      $860,000 and $1,143,000 of its own funds during fiscal years 2006 and 2005,
      respectively, on research and development.





The
      Company is currently incorporating its patent-pending LENSLOCK TM technology into its line of endoscopes. This proprietary technology ensures
      lower cost, easier reparability and enhanced durability. The Company is also
      aggressively pursuing the design, development and manufacture of ultra-small
      instruments (some with lenses less than one millimeter in diameter) utilizing
      its patent-pending micro-precision TM lens
      technology. The Company is also exploring new initiatives in single-molecule
      technology and nanotechnology for biomedical and other applications





**Raw
      Materials and Principal Suppliers** .





The
      basic
      raw material of the majority of the Company’s product line is precision grade
      optical glass, which the Company obtains from several major suppliers. Outside
      vendors grind and polish most of the Company’s lenses and prisms. For optical
      thin film coatings, the basic raw materials are metals and dielectric compounds,
      which the Company obtains from a variety of chemical suppliers. Certain of
      the
      thin film coatings utilized in the Company’s products are currently procured
      from an outside supplier, but most thin film coatings are produced in-house.
      The
      Company believes that its demand for these raw materials and thin film coating
      services is small relative to the total supply, and that materials and services
      required for the production of its products are currently available in
      sufficient production quantities and will be available for fiscal year 2007.
      The
      Company believes, however, that there are relatively few suppliers of the high
      quality lenses and prisms which its endoscopes require. In response, the Company
      has established its own optical shop for producing ultra-high quality prisms,
      micro-optics and other specialized optics for a variety of medical and
      industrial applications.





-5-


**Patents
      and Trademarks** .





The
      Company relies, in part, upon patents, trade secrets, and proprietary knowledge
      as well as personnel policies and employee confidentiality agreements concerning
      inventions and other creative efforts to develop and to maintain its competitive
      position. The Company does not believe that its business is dependent upon
      any
      patent, patent pending, or license, although it believes that trade secrets
      and
      confidential know-how may be important to the Company’s scientific and
      commercial success.





The
      Company plans to file for patents, copyrights, and trademarks in the United
      States and in appropriate countries to protect its intellectual property rights
      to the extent practicable. The Company holds the rights to several United States
      and foreign patents and has several patent applications pending, including
      those
      for its new generation of 3-D endoscopes, its new Lenslock TM endoscope technology, and its new micro-precision TM lens
      technology. The Company knows of no infringements of its patents. The Company
      plans to protect its patents from infringement in each instance where it
      determines that doing so would be economical in light of the expense involved
      and the level and availability of the Company’s financial resources. While the
      Company believes that its pending applications relate to patentable devices
      or
      concepts, there can be no assurance that patents will be issued or that any
      patents issued can be successfully defended or will effectively limit the
      development of competitive products and services.





**Employees** .





As
      of
      June 30, 2006, the Company had 30 full time employees and 6 part time employees.
      There were 16 employees in manufacturing, 11 in engineering, 3 in sales and
      marketing, and 6 in finance and administration.





**Customers** .





Revenues
      from the Company’s largest customers, as a percentage of total revenues, were as
      follows:







**2006**
            
            
            **2005**Customer
                A
            
            
            17
            %
            
            20
            %Customer
                B
            
            
            14
            
            
            11Customer
                C
            
            
            14
            
            
            —All
                Others
            
            
            55
            
            
            69100
            %
            
            100
            %





No
      other
      customer accounted for more than 10% of the Company’s revenues in fiscal years
      2006 and 2005.





**Environmental
      Matters** .




The
      Company’s operations are subject to a variety of federal, state, and local laws
      and regulations relating to the discharge of materials into the environment
      or
      otherwise relative to the protection of the environment. From time to time
      the
      Company uses a small amount of hazardous materials in its operations. The
      Company believes that it complies with all applicable environmental laws and
      regulations.








**Government
      Regulations on the Business** .




Domestic
      Regulation .
      The
      Company currently develops, manufactures and sells several medical products,
      the
      marketing of which is subject to governmental regulation in the United States. Medical devices are regulated
      in
      the United States by the Food
      and
      Drug Administration (“FDA”) and, in
      some cases, by certain state agencies. The FDA regulates the research, testing,
      manufacture, safety, effectiveness, labeling, promotion and distribution of
      medical devices in the United States. Generally, medical devices require
      clearance or approval prior to commercial distribution. Additionally, certain
      material changes to, and changes in intended use of, medical devices also are
      subject to FDA review and clearance or approval. Non-compliance with applicable
      requirements can result in failure of the FDA to grant pre-market clearance
      or
      approval, withdrawal or suspension of approval, suspension of production, and/or
      the imposition of various other penalties.





-6-


The
      Company provided notification to the FDA of its intent to market its endoscopes,
      image couplers, beamsplitters, and adapters, and the FDA has determined that
      the
      Company may market such devices, subject to the general controls provisions
      of
      the Food, Drug and Cosmetic Act. This FDA permission was obtained without the
      need to undergo a lengthy and expensive approval process on account of the
      FDA’s
      determination that such devices meet the regulatory standard of being
      substantially equivalent to an existing approved device.





In
      the
      future, the Company plans to market additional endoscopes and related medical
      products that may require the FDA’s permission to market such products. The
      Company may also develop additional products or seek to sell some of its current
      or future medical products in a manner that requires the Company to obtain
      the
      permission of the FDA to market such products, as well as the regulatory
      approval or license of other federal, state, and local agencies or similar
      agencies in other countries. The FDA has authority to conduct detailed
      inspections of manufacturing plants in order to assure that “good manufacturing
      practices” are being followed in the manufacture of medical devices, to require
      periodic reporting of product defects to the FDA, and to prohibit the sale
      of
      devices which do not comply with law.





Foreign
      Requirements .
      Sales
      of medical device products outside the United States are subject to foreign
      regulatory requirements that may vary from country to country. Our failure
      to
      comply with foreign regulatory requirements would jeopardize our ability to
      market our products in foreign jurisdictions. The regulatory environment in
      Europe Union for medical device products differs from that in the United States.
      Medical devices sold in the European Economic Area must bear the CE
      mark.  Devices
      are classified by manufacturers according to the risks they represent, with
      a
      classification of Class III representing the highest risk
      devices and
      Class
      I representing the lowest risk devices. Once a device has been classified,
      the
      manufacturer can follow one of a series of conformity assessment routes,
      typically through a registered quality system, and demonstrate compliance to
      a
“European Notified Body.” The CE mark may then be applied to the device.
      Maintenance of the system is ensured through annual on-site audits by the
      notified body and a post-market surveillance system requiring the manufacturer
      to submit serious complaints to the appropriate governmental authority. All
      of
      the Company’s medical products are CE mark
      certified.





**ITEM
      2.** **DESCRIPTION
      OF PROPERTY**





The
      Company conducts its domestic operations at two facilities in Gardner,
      Massachusetts. The main Gardner facility is leased from a corporation owned
      by
      an officer-shareholder-director of the Company. The lease terminated in December
      1999 and the Company is currently a tenant-at-will. The other Gardner facility
      is rented on a month-to-month basis. The Company rents office space in Hong
      Kong
      for sales, marketing and supplier quality control and liaison activities of
      its
      Hong Kong subsidiary.





The
      Company believes these facilities are adequate for its current operations and
      adequately covered by insurance. Significant increases in production or the
      addition of significant equipment additions or manufacturing capabilities in
      connection with the production of the Company’s line of endoscopes, optical thin
      films, and other products may, however, require the acquisition or lease of
      additional facilities. The Company may establish production facilities
      domestically or overseas to produce key assemblies or components, such as
      lenses, for the Company’s products. Overseas facilities may subject the Company
      to the political and economic risks associated with overseas operations. The
      loss of or inability to establish or maintain such additional domestic or
      overseas facilities could materially adversely affect the Company’s competitive
      position and profitability.





**ITEM
      3.** **LEGAL
      PROCEEDINGS**





None.





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





No
      matters were submitted to a vote of the Company’s security holders during the
      fourth quarter of fiscal year 2006.





-7-


**PART
      II**





**ITEM
      5.** **MARKET
      FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**





The
      Company’s common stock is quoted on the OTCBB under the symbol “POCI.OB.” Prior
      to December 27, 2005, the Company’s common stock was listed on the NASDAQ
      Capital Market® under the symbol “POCI.” Set forth below are the high and low
      sales prices or bid prices for the Company’s common stock for each quarter
      during the last two fiscal years as quoted on the OTCBB or listed by NASDAQ,
      as
      applicable. The quotes from the OTCBB reflect inter-dealer prices, without
      retail markup, markdown or commissions and may not represent actual
      transactions. The information below was obtained from those organizations,
      for
      the respective periods.





**2005**
            **2006**Quarter
            High
            Low
            High
            LowFirst
            $1.33
            $0.82
            $0.90
            $0.45Second
            $1.50
            $0.61
            $0.80
            $0.20Third
            $1.75
            $0.88
            $0.50
            $0.20Fourth
            $1.36
            $0.52
            $0.71
            $0.32





On
      April 13, 2006, the Company sold an aggregate of 8,450,000 shares of the
      Company’s common stock, par value $0.01 per share, at a price of $0.25 per
      share, raising gross proceeds of $2,112,500. All
      of
      the following shares of common stock issued were issued in a non registered
      transaction in reliance on Section 4(2) of the Securities Act of 1933, as
      amended:





**Purchaser**
            
            **Common
                Stock**
              **Purchased**AIGH
                Investments
            
            4,755,200Hershel
                Berkowitz
            
            951,040Joshua
                Hirsch
            
            237,760David
                Hoffman
            
            16,000Moshe
                Shuchatowitz
            
            40,000Donald
                A Major (a)
            
            100,000Richard
                B. Miles (a)
            
            100,000Joel
                Pitlor (a)
            
            2,214,419Stephen
                Scheinberg
            
            250,000





(a)
      Director of the Company





These
      shares were subsequently registered on a registration statement on a Form SB-2,
      which was declared effective by the Securities and Exchange Commission on August
      14, 2006.





As
      of
      August 31, 2006, there were approximately 150 holders of record of the Company’s
      common stock. Holders of record include nominees who may hold shares on behalf
      of multiple owners.





The
      Company has not declared any dividends during the last two fiscal years. At
      present, the Company intends to retain its earnings, if any, to finance research
      and development and expansion of its business.





-8-





**ITEM
      6.** **MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS**





**Important
      Factors Regarding Forward-Looking Statements**





When
      used
      in this discussion, the words “believes,” “anticipates,” “intends to,” and
      similar expressions are intended to identify forward-looking statements. Such
      statements are subject to certain risks and uncertainties which could cause
      actual results to differ materially from those projected. These risks and
      uncertainties, many of which are not within our control, include, but are not
      limited to, the uncertainty and timing of the successful development of our
      new
      products; decisions by customers to place orders for our products; the risks
      associated with reliance on a few key customers; our ability to attract and
      retain personnel with the necessary scientific and technical skills; the timing
      and completion of significant orders; the timing and amount of our research
      and
      development expenditures; the timing and level of market acceptance of
      customers’ products for which we supply components; performance of our vendors;
      our ability to control costs associated with performance under fixed price
      contracts; and the continued availability of essential supplies, materials
      and
      services. We caution investors not to place undue reliance on these forward
      looking statements, which speak only as of the date hereof. We undertake no
      obligation to revise or update these forward-looking statements to reflect
      events or circumstances that may occur after the date hereof or to reflect
      the
      occurrence of unanticipated events.





**Overview**





Precision
      Optics Corporation, a developer and manufacturer of advanced optical instruments
      since 1982, designs and produces high-quality optical thin film coatings,
      micro-optics, medical instruments, and other advanced optical systems. The
      Company’s medical instrumentation line includes laparoscopes, arthroscopes and
      endocouplers and a world-class product line of 3-D endoscopes for use in
      minimally invasive surgical procedures.





The
      Company is currently developing specialty instruments incorporating its
      patent-pending LENSLOCK TM technology which ensures lower cost, easier reparability and enhanced
      durability. The Company is also aggressively pursuing ultra-small instruments
      (some with lenses less than one millimeter in diameter) utilizing patent-pending
      micro-precision TM lens
      technology. The Company is also exploring new initiatives in single-molecule
      technology and nanotechnology for biomedical and other applications.





Precision
      Optics Corporation is certified to the ISO 9001 and ISO 13485 Quality Standards
      and complies with the FDA Good Manufacturing Practices and the European Union
      Medical Device Directive for CE marking of its medical products. The Company’s
      internet website is www.poci.com.





The
      areas
      in which the Company does business are highly competitive and include both
      foreign and domestic competitors. Many of the Company’s competitors are larger
      and have substantially greater resources than the Company. Furthermore, other
      domestic or foreign companies, some with greater financial resources than the
      Company, may seek to produce products or services that compete with those of
      the
      Company. The Company routinely outsources specialized production efforts as
      required, both domestic and off-shore to obtain the most cost effective
      production. Over the years, the Company has achieved extensive experience with
      other optical specialists worldwide.





Since
      the
      1990’s the Company has maintained a Hong Kong subsidiary to support business and
      quality control activities as required throughout Asia. The Company believes
      that the cost savings from such production is essential to the Company’s ability
      to compete on a price basis in the medical products area particularly and to
      the
      Company’s profitability in general.





The
      Company believes that competition for sales of its medical products and
      services, which have been principally sold to original equipment manufacturer
      (OEM) customers, is based on performance and other technical features, as well
      as other factors, such as scheduling and reliability, in addition to competitive
      price.





-9-


The
      Company believes that its future success depends to a large degree on its
      ability to continue to conceive and to develop new optical products and services
      to enhance the performance characteristics and methods of manufacture of
      existing products. Accordingly, it expects to continue to seek to obtain
      product-related design and development contracts with customers and to invest
      its own funds on research and development, to the extent funds are available.





**Critical
      Accounting Policies and Estimates** ****





***General***





Management’s
      discussion and analysis of financial condition and results of operations are
      based upon the Company’s consolidated financial statements, which have been
      prepared in accordance with accounting principles generally accepted in the
      United States of America (“U.S. GAAP”). The preparation of these consolidated
      financial statements requires the Company to make estimates and judgments that
      affect the reported amounts of assets, liabilities, revenues and expenses.
      The
      Company bases its estimates on historical experience and on various other
      assumptions that are believed to be reasonable under the circumstances, the
      results of which form the basis for making judgments about the carrying values
      of assets and liabilities that are not readily apparent from other sources.
      Actual results may differ from these estimates under different assumptions
      or
      conditions.





The
      Company believes the following critical accounting policies affect its more
      significant judgments and estimates used in the preparation of its consolidated
      financial statements.





***Revenue
      Recognition***





The
      Company recognizes revenue in accordance with U.S. GAAP and SEC Staff Accounting
      Bulletin (“SAB”) No. 104, Revenue Recognition in Financial Statements. SAB No.
      104 requires that four basic criteria must be met before revenue can be
      recognized: (1) persuasive evidence of an arrangement exists; (2) delivery
      has
      occurred or services rendered; (3) the price to the buyer is fixed or
      determinable; and (4) collectibility is reasonably assured. Determination of
      criteria (3) and (4) are based on management’s judgments regarding the fixed
      nature of the price to the buyer charged for products delivered or services
      rendered and collectibility of the sales price. The Company assesses credit
      worthiness of customers based upon prior history with the customer and
      assessment of financial condition. The Company’s shipping terms are customarily
      FOB shipping point.





***Bad
      Debt***





The
      Company maintains allowances for doubtful accounts for estimated losses
      resulting from the inability of its customers to make required payments.
      Allowances for doubtful accounts are established based upon review of specific
      account balances and historical experience. If the financial condition of the
      Company’s customers were to deteriorate, resulting in an impairment of their
      ability to make future payments, additional allowances may be
      required.





***Inventories***





The
      Company provides for estimated obsolescence on unmarketable inventory based
      upon
      assumptions about future demand and market conditions. If actual demand and
      market conditions are less favorable than those projected by management,
      additional inventory write downs may be required. Inventory, once written down,
      is not subsequently written back up, as these adjustments are considered
      permanent adjustments to the carrying value of the inventory.





***Impairment
      of Long-Lived Assets and Long-Lived Assets to be Disposed of***





The
      Company accounts for impairment of long-lived assets in accordance with SFAS
      No.
      144, Accounting for the Impairment or Disposal of Long-Lived Assets. This
      statement requires that long-lived assets and certain identifiable intangibles
      be reviewed for impairment whenever events or changes in circumstances indicate
      that the carrying amount of an asset may not be recoverable. Recoverability
      of
      assets to be held and used is measured by a comparison of the carrying amount
      of
      an asset to undiscounted future net cash flows expected to be generated by
      the
      asset. If such assets are considered to be impaired, the impairment to be
      recognized is measured by the amount by which the carrying amount of the assets
      exceeds the fair value of the assets. Assets to be disposed of through sale
      are
      reported at the lower of the carrying amount or fair value less estimated costs
      to sell.





-10-


***Income
      Taxes***





Income
      taxes are accounted for under the asset and liability method. Deferred tax
      assets and liabilities are recognized for the future tax consequences
      attributable to differences between the financial statement carrying amounts
      of
      existing assets and liabilities and their respective tax bases and operating
      loss and tax credit carryforwards. Deferred tax assets and liabilities are
      measured using enacted tax rates expected to apply to taxable income in the
      years in which those temporary differences are expected to be recovered or
      settled. The effect on deferred tax assets and liabilities of a change in tax
      rates is recognized in income in the period that includes the enactment date.





In
      assessing the likelihood of utilization of existing deferred tax assets,
      management has considered historical results of operations and the current
      operating environment.





***Stock-Based
      Compensation***





The
      Company accounts for its stock-based compensation using the intrinsic value
      method provided for under Accounting Principles Board Opinion No. 25, Accounting
      for Stock Issued to Employees and related interpretations. Under APB No. 25
      and
      related interpretations, compensation cost is recognized based on the
      difference, if any, on the date of grant between the fair value of the Company’s
      stock and the amount an employee must pay to acquire the stock. Statement of
      Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based
      Compensation, (as amended by SFAS No. 148, Accounting for Stock-Based
      Compensation Transition and Disclosure), establishes a fair-value-based method
      of accounting for stock-based compensation plans. The Company has adopted the
      disclosure-only alternative under SFAS No. 123, which requires the disclosure
      of
      the pro forma effects on net loss and net loss per share as if the fair value
      accounting prescribed by SFAS No. 123 had been adopted.








**Fiscal
      Year 2006 Results of Operations** ****





Total
      revenues for fiscal year 2006 were $2,284,693, an increase of $934,874, or
      69%,
      from fiscal year 2005 revenues of $1,349,819.





The
      revenue increase from the prior year was due principally to growth in sales
      of
      micro-lenses, autoclavable endoscopes and couplers, along with the introduction
      of a number of new products.




Revenues
      from the Company’s largest customers, as a percentage of total revenues, were as
      follows:







**2006**
            
            
            **2005**Customer
                A
            
            17
            %
            
            20
            %Customer
                B
            
            14
            
            
            11Customer
                C
            
            14
            
            
            —All
                Others
            
            55
            
            
            69100
            %
            
            100
            %








No
      other
      customer accounted for more than 10% of the Company’s revenues in fiscal years
      2006 and 2005.





Gross
      profit (loss) for fiscal year 2006 reflected a change of $651,829 compared
      to
      fiscal year 2005. Gross profit as a percentage of revenues increased from a
      negative 48% in fiscal year 2005 to effectively break-even in fiscal year 2006.
      The favorable change in gross profit (loss) was due primarily to increased
      sales
      volume and lower provisions for slow moving and obsolete inventories in fiscal
      year 2006 compared to fiscal year 2005.





-11-


Research
      and development expenses decreased by $283,476, or 25%, during fiscal year
      2006
      compared to the previous year. The decrease was due to a lower level of
      resources being devoted to product development activities, and a shift to more
      customer focused efforts, resulting in initial product shipments to several
      new
      customers.





Selling,
      general and administrative expenses decreased by $239,611 or 13%, during fiscal
      year 2006 compared to the previous year. The decrease was due primarily to
      savings from reduced professional fees, the chief financial officer position
      changing to part time, and through reduced premiums as a result of changing
      the
      Company’s general insurance provider, offset by an increase in consulting
      fees.





Interest
      income decreased by $14,240 or 28% during fiscal year 2006 compared to the
      previous year. The decrease was due to the lower average balance of cash and
      cash equivalents.





The
      income tax provisions in fiscal years 2006 and 2005 represent the minimum
      statutory state income tax liability.








**Fiscal
      Year 2005 Results of Operations** ****


Total
      revenues for fiscal year 2005 were $1,349,819, a decrease of $122,189 or 8%,
      from fiscal year 2004 revenues of $1,472,008.





The
      revenue decrease from the prior year was due principally to lower unit volume
      sales of medical products (down 23%), partially offset by higher unit volume
      sales of non-medical products (up 82%). Medical sales were lower due primarily
      to one-time shipments last year to a customer of specialty endoscopes used
      for
      cardiac surgical applications, as previously reported. Non-medical sales were
      higher due primarily to higher sales of industrial lenses, couplers and thin
      film coatings.





Revenues
      from the Company’s largest customers, as a percentage of total revenues, were as
      follows:







**2005**
            
            
            **2004**Customer
                A
            
            
            20
            %
            
            24
            %Customer
                B
            
            
            11
            
            
            6Customer
                C
            
            
            —
            
            
            22All
                Others
            
            
            69
            
            
            48100
            %
            
            100
            %





No
      other
      customer accounted for more than 10% of the Company’s revenues in fiscal years
      2005 and 2004.





Gross
      profit (loss) for fiscal year 2005 reflected an unfavorable change of $56,873
      compared to fiscal year 2004. Gross profit as a percentage of revenues decreased
      from a negative 40% in fiscal year 2004 to a negative 49% in fiscal year 2005.
      The unfavorable change in gross profit (loss) was due primarily to lower sales
      volume partially offset by lower provisions for slow moving and obsolete
      inventories of approximately $401,900 in fiscal year 2005 compared to
      approximately $500,000 in fiscal year 2004.





Research
      and development expenses decreased by $175,933, or 13%, during fiscal year
      2005
      compared to the previous year. The decrease was due to a lower level of
      resources being devoted to internal product development activities, and a shift
      in certain resources to more customer sponsored development efforts, resulting
      in initial product shipments to several new customers.





-12-


Selling,
      general and administrative expenses increased by $118,575 or 7%, during fiscal
      year 2005 compared to the previous year. The increase was due primarily to
      higher bid and proposal expenses and professional services expenses, partially
      offset by lower insurance expense.





The
      provision for restructuring in fiscal year 2005 of $89,512 consists of a
      provision for severance benefits substantially paid in the quarter ended June
      30, 2005 related to the June 2005 workforce reduction of 3%, or one employee.
      The provision for restructuring in fiscal year 2004 of $52,208 consists of
      a
      provision for severance benefits paid in the quarter ended March 31, 2004
      related to the January 2004 workforce reduction of 15%, or five employees.





The
      following table sets forth the quarterly impacts and cash payments associated
      with the asset impairment and restructuring provisions:





**Provision
                for**
              **Employee
                Severance**Reserve
                Balance, June 30, 2004
            
            $
            —Total
                Provision
            
            
            89,512Cash
                Payments
            
            
            (84,501
            )Reserve
                Balance, June 30, 2005
            
            $
            5,011Total
                Provision
            
            
            —Cash
                Payments
            
            
            (5,011
            )Reserve
                Balance, June 30, 2006
            
            $
            —





Interest
      income increased by $32,484 or 180% during fiscal year 2005 compared to the
      previous year. The increase was due to the higher base of cash and cash
      equivalents because of proceeds received from the rights offering in July 2004.





The
      income tax provisions in fiscal years 2005 and 2004 represent the minimum
      statutory state income tax liability.





**Liquidity
      and Capital Resources**





The
      Company has incurred significant operating losses during the last fiscal year
      and on a historical basis. This trend was primarily the result of the loss
      of
      several significant customers, completion of several large nonrecurring
      government contracts, and operating losses and provision for asset impairment,
      restructuring, and inventory write-downs associated with the downturn in demand
      for optical filters used in telecommunications systems. In fiscal 1998, the
      Company began making significant investments in research and development and
      capital purchases for new products. In August 1999 and March 2000, the Company
      raised gross proceeds of approximately $16 million of additional cash through
      the issuance of common stock. In July 2004, the Company completed a rights
      offering to stockholders of record at June 7, 2004 by issuing 5,256,159 shares
      of common stock, raising net cash proceeds of approximately $5 million.
      Additionally, in April 2006, the Company sold 8,450,000 shares of its common
      stock, raising net cash proceeds of approximately $2 million.





In
      the
      past five fiscal years, the Company has implemented a number of restructuring
      and cost saving measures in an effort to align costs with revenues and
      strengthen financial performance. Full-time employee headcount has been reduced
      from 78 at June 30, 2001 to 30 at June 30, 2006. The Company has discontinued
      the development and manufacturing of telecommunications products, canceled
      the
      lease on its Optical Thin Films Technology Center, and written down and/or
      sold
      certain of the property, equipment and inventories invested in its
      telecommunications business, and has implemented other cost reduction measures.
      As a result of these actions, the Company has incurred asset impairment,
      restructuring and inventory write-down provisions of approximately $177,000,
      $500,000, $491,412 and $32,000 for the years ended June 30, 2003, 2004, 2005
      and
      2006 respectively, and has received net proceeds from the sale of assets of
      approximately $180,000 during the year ended June 30, 2006. In addition, the
      Company will continue its review of other expense areas to determine where
      additional reductions in discretionary spending can be achieved.





-13-


As
      of
      June 30, 2006, the Company’s cash and cash equivalents were $2,030,428. The
      Company believes, based on its operating and strategic plans that it will have
      sufficient funds to conduct operations through at least the next twelve months.





Contractual
      cash commitments for the fiscal years subsequent to June 30, 2006 are summarized
      as follows:





**2007**
            
            
            **Thereafter**
            
            
            **Total**Operating
                Leases
            
            $
            32,518
            
            $
            6,012
            
            $
            38,530





**Trends
      and Uncertainties That May Affect Future Results**





For
      the
      quarter ended June 30, 2006, cash and cash equivalents increased by $1,537,413
      compared to a decrease of $416,437 for the previous quarter ended March 31,
      2006
      as a result of the receipt of $2,112,500 in gross proceeds from the closing
      of a
      private placement on April 13, 2006.





Capital
      equipment expenditures during the year ended June 30, 2006 were $31,730, down
      from $32,140 for fiscal year 2005. Future capital equipment expenditures will
      be
      dependent upon future sales and success of on-going research and development
      efforts.





For
      the
      quarter ended June 30, 2006, research and development expenses were $252,399,
      up
      8% from $233,194 for the quarter ended June 30, 2005. The level of future
      quarterly R&D expenses is ultimately dependent upon the Company’s assessment
      of new product opportunities.





The
      Company expects its recent pattern of quarter-to-quarter revenue fluctuations
      to
      continue, due to the uncertain timing of orders from customers and their size
      in
      relation to total revenues. The Company continues to move forward with new
      products and technical innovations, in particular, the development of a new
      generation (patent pending) of its world-class product line of 3-D endoscopes,
      the use of Lenslock TM technology in the Company’s 2.7 mm and 4 mm endoscopes, and new instruments
      utilizing the Company’s new micro-precision TM lens
      technology (patent pending) for endoscopes under 1 mm. The Company continues
      to
      explore potential applications of single-molecule technology and nanotechnology.





The
      Company believes that the recent introduction of several new products, along
      with new and on-going customer relationships, will generate additional revenues,
      which are required in order for the Company to achieve profitability. If these
      additional revenues are not achieved on a timely basis, the Company will be
      required and is prepared to implement further cost reduction measures, as
      necessary.





Section
      404 of the Sarbanes-Oxley Act of 2002, requiring companies to report on the
      effectiveness of the Company’s internal controls over financial reporting, will
      first apply to the Company’s Annual Report on Form 10-KSB for the fiscal year
      ending June 30, 2008. The Company expects its operating expense will increase
      as
      a result of the costs associated with the implementation of and maintaining
      compliance with Section 404.








**Factors
      That May Affect Future Results and Market Price of
      Stock**





***Our
      Quarterly Financial Results Depend on a Large Number of Factors and Therefore
      May Vary Quarter to Quarter - As a Result, We Cannot Predict with a High
      Degree of Certainty Our Operating Results in Any Particular Fiscal
      Quarter.***





Our
      quarterly operating results may vary significantly depending upon factors such
      as:




-14-




·
            the
                timing of completion of significant
                orders




·
            the
                timing and amount of our research and development expenditures




·
            the
                costs of initial product production in connection with new
                products




·
            the
                timing of new product introductions -- both by us and by our
                competitors




·
            the
                timing and level of market acceptance of new products or enhanced
                versions
                of our existing products




·
            our
                ability to retain existing customers and customers’ continued demand for
                our products and services




·
            our
                customers’ inventory levels, and levels of demand for our customers’
                products and services




·
            competitive
                pricing pressures





We
      cannot
      be certain whether we will be able to grow or sustain revenues or achieve or
      maintain profitability on a quarterly or annual basis or that levels of revenue
      and/or profitability may not vary from one such period to another.





***We
      May Need to Raise Additional Funds in The Future - If We Cannot Obtain Adequate
      Financing on Acceptable Terms When Required, Our Business Will Be Adversely
      Affected.***





We
      believe that our existing cash and cash equivalents are sufficient to support
      our working capital and investment needs through at least the next twelve
      months, however, we may need to raise additional capital in the future. We
      may
      seek funding through additional pubic or private equity offerings or debt
      financings. Our ability to raise additional capital, however, will be heavily
      influenced by the investment market. Additional financing may not be available
      when needed, or, if available, may not be available on favorable terms. If
      we
      cannot obtain adequate financing on acceptable terms when such financing is
      required, our business will be adversely affected.





***We
      Rely on a Small Number of Customers and Cannot Be Certain They Will Consistently
      Purchase Our Products in the Future.***





In
      the
      fiscal year ended June 30, 2006, our three largest customers represented
      approximately 17%, 14%, and 14% respectively, of our total revenues. In the
      fiscal year ended June 30, 2005, our two largest customers represented
      approximately 20% and 11%, respectively, of our total revenues. No other
      customer accounted for more than 10% of our revenues during those
      periods.





In
      the
      future, a small number of customers may continue to represent a significant
      portion of our total revenues in any given period. We cannot be certain that
      such customers will consistently purchase our products at any particular rate
      over any subsequent period.





***We
      Rely Heavily Upon the Talents of Our Chief Executive Officer and Chief
      Scientific Officer, the Loss of Whom Could Severely Damage Our
      Business.***





Our
      performance depends to a large extent on a small number of key scientific,
      technical, managerial, and marketing personnel. In particular, we believe our
      success is highly dependent upon the services and reputation of our Chief
      Executive Officer, Mr. Richard E. Forkey. Loss of Mr. Forkey’s services could
      severely damage our business.





Additionally,
      Dr. Joseph N. Forkey was appointed our Executive Vice President and Chief
      Scientific Officer in April 2006. Dr. Forkey’s appointment has provided us with
      significant additional capabilities in optical instrument development, in
      management of new technology and in potentially significant longer-term
      initiatives in Biophysics and Biomedical instrumentation, as well as new
      photonics-based market opportunities. The loss of Dr. Forkey’s scientific
      contributions could severely damage our business.





-15-


***We
      Must Continue to Be Able to Attract Employees With the Scientific and Technical
      Skills That Our Business Requires - If We Are Unable to Attract and Retain
      Such Individuals, Our Business Could Be Severely Damaged.***





Our
      ability to attract employees with a high degree of scientific and technical
      talent is crucial to the success of our business. There is intense competition
      for the services of such persons, and we cannot guarantee that we will be able
      to attract and retain individuals possessing the necessary qualifications.





***We
      Have a Number of Large, Well-Financed Competitors Who Have Research and
      Marketing Capabilities That Are Superior to Ours.***





The
      industries in which we compete are highly competitive. Many of our existing
      and
      potential competitors have greater financial resources and manufacturing
      capabilities, more established and larger marketing and sales organizations
      and
      larger technical staffs than we have. Other companies, some with greater
      experience in the telecommunications, optics, semiconductor or medical products
      industries, are seeking to produce products and services that compete with
      our
      products and services.





***We
      Are Subject to a High Degree of Regulatory Oversight - We Cannot Be Certain
      That
      We Will Continue to Receive the Necessary Regulatory
      Approvals.***





The
      FDA
      has allowed us to market the medical products we currently sell in the United
      States. However, prior FDA approval may be required before we can market
      additional medical products that we may develop in the future. We may also
      seek
      to sell current or future medical products in a manner that requires us to
      obtain FDA permission to market such products. We may also require the
      regulatory approval or license of other federal, state or local agencies or
      comparable agencies in other countries.





We
      cannot
      be certain that we will continue to receive the FDA’s permission to market our
      current products or obtain the necessary regulatory permission, approvals or
      licenses for the marketing of any of our future products. Also, we cannot
      predict the impact on our business of FDA regulations or determinations arising
      from future legislation or administrative action.





***We
      Face Risks Inherent in Product Development and Production Under Fixed Price
      Purchase Orders - We Cannot Be Sure That These Purchase Orders Will Be
      Profitable over Time.***





A
      portion
      of our business has been devoted to research, development and production under
      fixed price purchase orders. For our purposes, a fixed price purchase order
      is
      any purchase order under which we will provide products or services for a fixed
      price over an extended period of time (usually six months or longer). In our
      2006 and 2005 fiscal years, fixed price purchase orders represented
      approximately 24% and 15%, respectively, of our total revenues. We expect that
      revenues from fixed price purchase orders will continue to represent a
      significant portion of our total revenues in future fiscal years.





Because
      they involve performance over time, we cannot predict with certainty the
      expenses involved in meeting our obligations under fixed price purchase orders.
      Therefore, we can never be sure at the time we enter into any single fixed
      price
      purchase order that such purchase order will be profitable for us.





***Third
      Parties May Infringe on Our Patents - As a Result, We Could Incur
      Significant Expense in Protecting Our Patents or Not Have Sufficient Resources
      to Protect Them.***





We
      hold a
      number of patents that are important to our business. Although we are not
      currently aware of any past or present infringements of our patents, we plan
      to
      protect these patents from infringement and obtain additional patents whenever
      feasible. To this end, we have obtained confidentiality agreements from our
      employees and consultants and others who have access to the design of our
      products and other proprietary information. Protecting and obtaining patents,
      however, is both time consuming and expensive. We therefore may not have the
      resources necessary to assert all potential patent infringement claims or pursue
      all patents that might be available to us.





-16-


***Third
      Parties May Claim that We Have Infringed on Their Patents - As a Result, We
      Could Be Prohibited from Using All or Part of Any Technology Used in Our
      Products.***





Should
      third parties claim a proprietary right to all or part of any technology that
      we
      use in our products, such a claim, regardless of its merit, could involve us
      in
      costly litigation. If successful, such a claim could also result in us being
      unable to freely to use the technology that was the subject of the claim, or
      sell products embodying such technology.





***We
      Depend on the Availability of Certain Key Supplies and Services That Are
      Available From Only a Few Sources - If We Experience Difficulty with a
      Supplier, We May Have Difficulty Finding Alternative Sources of
      Supply.***





Certain
      key supplies used in our products, particularly precision grade optical glass,
      are available from only a few sources, each of which is located outside the
      United States. Also, outside vendors grind and polish certain of our lenses
      and
      other optical components, such as prisms and windows. Based upon our ordering
      experience to date, we believe the materials and services required for the
      production of our products are currently available in sufficient quantities.
      Our
      requirements are small relative to the total supply, and we are not currently
      encountering problems with availability. However, this does not mean that we
      will continue to have timely access to adequate supplies of essential materials
      and services in the future or that supplies of these materials and services
      will
      be available on satisfactory terms when the need arises. Our business could
      be
      severely damaged if we become unable to procure essential materials and services
      in adequate quantities and at acceptable prices.





From
      time
      to time, certain of our products may be produced for us by subcontractors,
      and
      our business is subject to the risk that these subcontractors fail to make
      timely delivery. Our products and services are also from time to time used
      as
      components of the products and services of other manufacturers. We are therefore
      subject to the risk that manufacturers that integrate our products or services
      into their own products or services are unable to acquire essential supplies
      and
      services from third parties in a timely fashion.





***Our
      Customers May Claim that the Products We Sold Them Were Defective - If Our
      Insurance Is Not Sufficient to Cover a Claim, We Would Be Liable for the
      Excess.***





Like
      any
      manufacturer, we are and always have been exposed to liability claims resulting
      from the use of our products. We maintain product liability insurance to cover
      us in the event of liability claims, and no such claims have been asserted
      or
      threatened against us to date. However, we cannot be certain that our insurance
      will be sufficient to cover all possible future product liabilities.





***We
      Would Be Liable If Our Business Operations Harmed the Environment - Failure
      to Maintain Compliance with Environmental Laws Could Severely Damage Our
      Business.***





Our
      operations are subject to a variety of federal, state and local laws and
      regulations relating to the protection of the environment. From time to time,
      we
      use hazardous materials in our operations. Although we believe that we are
      in
      compliance with all applicable environmental laws and regulations, our business
      could be severely damaged by any failure to maintain such compliance.





**ITEM
      7.** **CONSOLIDATED
      FINANCIAL STATEMENTS**





The
      Consolidated Financial Statements appear on pages 20 through 36 of this Form
      10-KSB.





-17-


**PRECISION
      OPTICS CORPORATION, INC. AND SUBSIDIARIES**





Consolidated
      Financial Statements


as
      of
      June 30, 2006 and 2005


Together
      with Independent Registered Public Accounting Firms’ Reports










-18-


**Report
      of Independent Registered Public Accounting Firm**





To
      the
      Board of Directors and Shareholders of


Precision
      Optics Corporation, Inc.:





We
      have
      audited the accompanying consolidated balance sheets of Precision Optics
      Corporation, Inc. and subsidiaries as of June 30, 2006 and 2005 and the related
      consolidated statements of operations, stockholders’ equity and cash flows for
      the years then ended. These consolidated financial statements are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these consolidated financial statements based on our
      audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. The Company is not required to
      have, nor were we engaged to perform, an audit of its internal controls over
      financial reporting. An audit includes consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also 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 Precision
      Optics Corporation, Inc. and subsidiaries as of June 30, 2006 and 2005 and
      the
      results of their operations and their cash flows for the years then ended in
      conformity with accounting principles generally accepted in the United States
      of
      America.











/s/
      Vitale, Caturano and Company, Ltd.













Boston,
      Massachusetts


September
      27, 2006







-19-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Consolidated
        Balance Sheets June 30, 2006 and 2005**


**ASSETS**
            
            
            **2006**
            
            
            **2005**Current
                Assets:Cash
                and cash equivalents
            
            $
            2,030,428
            
            $
            2,171,693Accounts
                receivable (net of allowance for doubtfulaccounts
                of approximately $14,550 in 2006 and 2005)
            
            
            381,097
            
            
            177,031Inventories
            
            
            445,802
            
            
            599,619Prepaid
                expenses
            
            
            45,912
            
            
            62,422Total
                current assets
            
            
            2,903,239
            
            
            3,010,765Machinery
                and equipment
            
            
            3,513,736
            
            
            3,539,205Leasehold
                improvements
            
            
            553,596
            
            
            553,596Furniture
                and fixtures
            
            
            93,545
            
            
            96,831Vehicles
            
            
            42,343
            
            
            42,3434,203,220
            
            
            4,231,975Less—Accumulated
                depreciation and amortization
            
            
            4,127,287
            
            
            4,092,20275,933
            
            
            139,773Other
                Assets:Cash
                surrender value of life insurance policies
            
            
            13,246
            
            
            16,440Patents,
                net
            
            
            236,115
            
            
            201,627Total
                other assets
            
            
            249,361
            
            
            218,067$
            3,228,533
            
            $
            3,368,605


**LIABILITIES
                  AND STOCKHOLDERS’ EQUITY**Current
                  Liabilities:Accounts
                  payable
              
              $
              218,658
              
              $
              160,593Customer
                  advances
              
              
              -
              
              
              18,000Accrued
                  employee compensation
              
              
              227,892
              
              
              208,851Accrued
                  professional services
              
              
              90,000
              
              
              74,000Accrued
                  warranty expense
              
              
              50,000
              
              
              50,000Other
                  accrued liabilities
              
              
              2,086
              
              
              7,566Total
                  current liabilities
              
              
              588,636
              
              
              519,010Commitments
                  (Note 2)Stockholders’
                  Equity:Common
                  stock, $0.01 par value-Authorized—20,000,000
                  sharesIssued
                  and outstanding— 15,458,212
                shares
                  at June 30, 2006 and 7,008,212
                shares
                  at June 30, 2005
              
              
              154,582
              
              
              70,082Additional
                  paid-in capital
              
              
              34,729,873
              
              
              32,751,598Accumulated
                  deficit
              
              
              (
                  32,244,558
              )
              
              (29,972,085
              )Total
                  stockholders’ equity
              
              
              2,639,897
              
              
              2,849,595$
              3,228,533
              
              $
              3,368,605




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





-20-


**PRECISION
      OPTICS CORPORATION, INC. AND SUBSIDIARIES**


Consolidated
        Statements of Operations for the
 Years
        Ended June 30, 2006 and 2005


**2006**
            
            
            **2005**Revenues
            
            $
            2,284,693
            
            $
            1,349,819Cost
                of Goods Sold
            
            
            2,280,631
            
            
            1,997,586Gross
                profit (loss)
            
            
            4,062
            
            
            (647,767
            )Research
                and Development Expenses
            
            
            859,936
            
            
            1,143,412Selling,
                General and Administrative Expenses
            
            
            1,617,721
            
            
            1,857,332Gain
                on Sale of Fixed Assets
            
            
            (165,700
            )
            
            -Provision
                for Restructuring
            
            
            -
            
            
            89,512Total
                operating expenses
            
            
            2,311,957
            
            
            3,090,256Operating
                loss
            
            
            (2,307,895
            )
            
            (3,738,023
            )Interest
                Income, net
            
            
            36,334
            
            
            50,574Loss
                before provision for income taxes
            
            
            (2,271,561
            )
            
            (3,687,449
            )Provision
                for Income Taxes
            
            
            912
            
            
            912Net
                loss
            
            $
            (2,272,473
            )
            $
            (3,688,361
            )Loss
                per Share - Basic and Diluted
            
            
            ($0.26
            )
            
            ($0.55
            )Weighted
                Average Common Shares Outstanding - Basic and Diluted
            
            
            8,768,629
            
            
            6,749,003





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





-21-





**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 
 Consolidated
        Statements of Stockholders’ Equity
 for
        the
        Years Ended June 30, 2006 and 2005


Number
              of
                Shares
            
            
            Common
              Stock
            
            
            Additional
              Paid-in
              Capital
            
            
            Accumulated
              Deficit
            
            
            Total
              Stockholders’
              EquityBalance,
                June 30, 2004
            
            
            1,752,053
            
            $
            17,521
            
            $
            27,770,175
            
            $
            (26,283,724
            )
            $
            1,503,972Proceeds
                from rights offering, net
            
            
            5,256,159
            
            
            52,561
            
            
            4,981,423
            
            
            -
            
            
            5,033,984Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            (3,688,361
            )
            
            (3,688,361
            )Balance,
                June 30, 2005
            
            
            7,008,212
            
            
            70,082
            
            
            32,751,598
            
            
            (29,972,085
            )
            
            2,849,595Proceeds
                from private placement, net
            
            
            8,450,000
            
            
            84,500
            
            
            1,978,275
            
            
            -
            
            
            2,062,775Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            (2,272,473
            )
            
            (2,272,473
            )Balance,
                June 30, 2006
            
            
            15,458,212
            
            $
            154,582
            
            $
            34,729,873
            
            $
            (32,244,558
            )
            $
            2,639,897








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





-22-


**PRECISION
      OPTICS CORPORATION, INC. AND SUBSIDIARIES**


Consolidated
      Statements of Cash Flows for the


Years
      Ended June 30, 2006 and 2005




**2006**
            
            **2005**Cash
                Flows from Operating Activities:Net
                loss
            
            $
            (2,272,473
            )
            $
            (3,688,361
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities-Depreciation
                and amortization
            
            
            130,110
            
            
            241,966Gain
                on Sale of Fixed Assets
            
            
            (165,700
            )
            
            -Provision
                for inventory write-down
            
            
            32,000
            
            
            401,900Changes
                in operating assets and liabilities-Accounts
                receivable, net
            
            
            (204,066
            )
            
            (96,836
            )Inventories
            
            
            121,817
            
            
            (83,521
            )Prepaid
                expenses
            
            
            16,510
            
            
            18,224Accounts
                payable
            
            
            58,066
            
            
            78,850Customer
                advances
            
            
            (18,000
            )
            
            18,000Accrued
                expenses
            
            
            29,559
            
            
            (17,875
            )Net
                cash used in operating activities
            
            
            (2,272,177
            )
            
            (3,127,653
            )Cash
                Flows from Investing Activities:Purchases
                of property and equipment
            
            
            (31,735
            )
            
            (32,140
            )Proceeds
                from sale of fixed assets
            
            
            180,000
            
            
            -Increase
                in other assets
            
            
            (80,128
            )
            
            (64,336
            )Net
                cash used in investing activities
            
            
            68,137
            
            
            (96,476
            )Cash
                Flows from Financing Activities:Gross
                proceeds from private placement
            
            
            2,112,500
            
            
            -Gross
                proceeds from rights offering
            
            
            -
            
            
            5,256,159Payment
                of offering costs
            
            
            (49,725
            )
            
            (203,597
            )Net
                cash provided in financing activities
            
            
            2,062,775
            
            
            5,052,562Net
                Increase (Decrease) in Cash and Cash Equivalents
            
            
            (141,265
            )
            
            1,828,433Cash
                and Cash Equivalents, beginning of year
            
            
            2,171,693
            
            
            343,260Cash
                and Cash Equivalents, end of year
            
            $
            2,030,428
            
            $
            2,171,693Supplemental
                Disclosure of Cash Flow Information:Cash
                paid during the year for-Income
                taxes
            
            $
            912
            
            $
            912





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





-23-


**PRECISION
      OPTICS CORPORATION, INC. AND SUBSIDIARIES**


**Notes
      to Consolidated Financial Statements**


**(1)**  **SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES**




**(a)**  **Nature
      of Business and Liquidity**




Precision
      Optics Corporation, Inc. (the “Company”) designs, develops, manufactures and
      sells specialized optical systems and components and optical thin-film coatings.
      The Company conducts business in one industry segment only and its customers
      are
      primarily domestic. The Company’s products and services fall into two principal
      areas: (i) medical products for use by hospitals and physicians and (ii)
      advanced optical system design and development services and products used by
      industrial customers.




The
      Company has incurred significant operating losses during the last ten fiscal
      years. This trend was primarily the result of the loss of several significant
      customers, completion of several large nonrecurring government contracts, and
      operating losses and provision for asset impairment, restructuring, and
      inventory write-downs associated with the downturn in demand for optical filters
      used in telecommunications systems. In fiscal 1998, the Company began making
      significant investments in research and development and capital purchases for
      new products. In August 1999 and March 2000, the Company raised gross
      proceeds of approximately $16 million of additional cash through the
      issuance of common stock. In July 2004, the Company completed a rights offering
      to stockholders by issuing 5,256,159 shares of common stock. Net cash proceeds
      to the Company (after offering costs of $222,175) were $5,033,984. In April
      2006
      the Company completed a private placement, issuing 8,450,000 shares of common
      stock. Net cash proceeds to the Company (after offering costs of $49,725) were
      $2,062,775.




In
      the
      past five fiscal years, the Company has implemented a number of restructuring
      and cost saving measures in an effort to align costs with revenues and
      strengthen financial performance. Full-time employee headcount has been reduced
      from 78 at June 30, 2001 to 30 at June 30, 2006. The Company has discontinued
      the development and manufacturing of telecommunications products, canceled
      the
      lease on its Optical Thin Films Technology Center, and written down and/or
      sold
      certain of the property, equipment and inventories invested in its
      telecommunications business. As a result of these actions, the Company has
      incurred a provision for excess and obsolete inventory of approximately $32,000
      and $401,900 for the years ended June 30, 2006, and 2005, respectively and
      restructuring costs of approximately $89,500 for the year ended June 30, 2005.
      In addition, the Company will continue its review of other expense areas to
      determine where additional reductions in discretionary spending can be achieved.





The
      Company’s current sources of liquidity consist of its cash and cash equivalents
      and accounts receivable. At June 30, 2006 the Company had $2,030,428 in cash
      and
      cash equivalents and $381,097 in accounts receivable.




The
      Company expects its recent pattern of quarter-to-quarter revenue fluctuations
      to
      continue, due to the uncertain timing of individual orders and their size in
      relation to total revenues. The Company remains confident in the value of its
      technology and expertise both in medical and surgical applications and
      elsewhere. In addition, despite strict controls on R&D spending, the Company
      continues to move forward with new products and technical innovations.




During
      the past year, the introduction of several new products, along with new and
      on-going customer relationships, has resulted in significant revenue growth.
      The
      Company believes that with continued promotion, these opportunities will
      continue the general trend of increasing revenues, which are required in order
      for the Company to achieve profitability. If these additional revenues are
      not
      achieved on a timely basis, the Company will be required and is prepared to
      implement further cost reduction measures, as necessary. The Company believes,
      based on its operating and strategic plans, that it will have sufficient funds
      to conduct operations through at least the next twelve months.




-24-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




**(b)**  **Principles
      of Consolidation**




The
      accompanying consolidated financial statements include the accounts of the
      Company and its two wholly owned subsidiaries. All inter-company accounts and
      transactions have been eliminated in consolidation.




**(c)**  **Revenues**




In
      December 2003, the Securities and Exchange Commission issued Staff Accounting
      Bulletin (“SAB”) No. 104 which establishes guidance in applying generally
      accepted accounting principles to revenue recognition in financial statements
      and was effective for the Company’s fiscal year 2004. SAB No. 104 requires that
      four basic criteria must be met before revenue can be recognized: (1) persuasive
      evidence of an arrangement exists; (2) delivery has occurred or services
      rendered; (3) the price to the buyer is fixed and determinable; and (4)
      collectibility is reasonably assured. The Company’s shipping terms are
      customarily FOB shipping point. The Company’s revenue recognition practices
      comply with the guidance in the bulletin.




Sales
      price of products and services sold is fixed and determinable after receipt
      and
      acceptance of a customer’s purchase order or properly executed sales contract,
      typically before any work is performed. Management reviews each customer
      purchase order or sales contract to determine that the work to be performed
      is
      specified and there are no unusual terms and conditions which would raise
      questions as to whether the sales price is fixed or determinable. The Company
      assesses credit worthiness of customers based upon prior history with the
      customer and assessment of financial condition. Accounts receivable are stated
      at the amount management expects to collect from outstanding balances. An
      allowance for doubtful accounts is provided for that portion of accounts
      receivable considered to be uncollectible, based upon historical experience
      and
      management’s evaluation of outstanding accounts receivable at the end of the
      year. Bad debts are written off against the allowance when identified. The
      allowance for doubtful accounts at both June 30, 2006 and 2005 was $14,550.





The
      Company’s revenue transactions typically do not contain multiple deliverable
      elements for future performance obligations to customers, other than a standard
      one-year warranty on materials and workmanship, the estimated costs for which
      are provided for at the time revenue is recognized.





Revenues
      for industrial and medical products sold in the normal course of business are
      recognized upon shipment when delivery terms are FOB shipping point and all
      other revenue recognition criteria have been met. Services that the Company
      provides to customers consist of repairs and engineering design and development.
      Recognition of service revenue occurs (assuming all other revenue recognition
      criteria have been met) upon delivery to the customer of the repaired product.
      Service revenue represented 2.3% and 4.6% of total revenue for June 30, 2006
      and
      2005, respectively. Gross shipping charges reimbursable from customers, to
      deliver product, is included in Revenues, while shipping costs are shown in
      Selling, General and Administrative Expenses section of the Consolidated
      Statement of Operations. Shipping charges invoiced to customers were
      approximately $ 7,500 and $6,000 for June 30, 2006 and 2005,
      respectively.





**(d)**  **Cash
      and Cash Equivalents**




The
      Company includes in cash equivalents all highly liquid investments with original
      maturities of three months or less at the time of acquisition. Cash and
      cash equivalents of approximately $2,030,428 and $2,171,693 at June 30,
      2006 and 2005, respectively, consist primarily of cash at banks and money
      market funds.




-25-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




**(e)**  **Inventories**




Inventories
      are stated at the lower of cost (first-in, first-out) or market and include
      material, labor and manufacturing overhead. The components of inventories at
      June 30, 2006 and 2005 are as follows:




**2006**
            
            
            **2005**Raw
                material
            
            $
            251,725
            
            $
            181,548Work-in-progress
            
            
            114,786
            
            
            185,047Finished
                goods
            
            
            79,291
            
            
            233,024$
            445,802
            
            $
            599,619





The
      Company provides for estimated obsolescence on unmarketable inventory based
      upon
      assumptions about future demand and market conditions. If actual demand and
      market conditions are less favorable than those projected by management,
      additional inventory write downs may be required. Inventory, once written down,
      is not subsequently written back up, as these adjustments are considered
      permanent adjustments to the carrying value of the inventory.





During
      fiscal years 2006 and 2005, the Company recorded, in cost of goods sold, pretax
      non-cash provisions for slow-moving and obsolete inventories of approximately
      $32,000 and $401,900, respectively.




**(f)**  **Property
      and Equipment**





Property
      and equipment are recorded at cost. Maintenance and repair items are expensed
      as
      incurred. The Company provides for depreciation and amortization by charges
      to
      operations, using the straight-line and declining-balance methods, which
      allocate the cost of property and equipment over the following estimated useful
      lives:





**Asset
                Classification**
            **Estimated
                Useful Life**Machinery
                and equipment
            2-7
                yearsLeasehold
                improvements
            Shorter
                of lease term or estimated useful lifeFurniture
                and fixtures
            5
                yearsVehicles
            3
                years





Amortization
      of assets under capital leases are included in depreciation expense.
      Depreciation expense was $81,276 and $171,609 for the years ended June 30,
      2006
      and 2005, respectively.





In
      July
      2005, the Company sold equipment previously used in its telecommunications
      business for $180,000, recognizing a gain of approximately $166,000, recorded
      in
      the quarter ending September 30, 2005.





**(g)**  **Significant
      Customers and Concentration of Credit Risk**





Statement
      of Financial Accounting Standards (SFAS) No. 105, *Disclosure
      of Information about Financial Instruments with Off-Balance-Sheet Risk and
      Financial Instruments with Concentrations of Credit Risk,* requires
      disclosure of any significant off-balance sheet and credit risk.





Financial
      instruments that subject the Company to credit risk consist primarily of cash
      equivalents and trade accounts receivable. The Company places its investments
      in
      highly rated financial institutions. The Company has not experienced any losses
      on these investments to date. At June 30, 2006, receivables from the Company’s
      largest customers were 30%, 15%, 12% and 11%, respectively, of the total
      accounts receivable. At June 30, 2005, receivables from the Company’s largest
      customers were 19%, 16%, and 10%, respectively, of the total accounts
      receivable. No other customer accounted for more than 10% of the Company’s
      receivables as of June 30, 2006 and 2005. The Company has not experienced any
      material losses related to accounts receivable from individual customers. The
      Company generally does not require collateral or other security as a condition
      of sale rather relying on credit approval, balance limitation and monitoring
      procedures to control credit risk of trade account financial instruments.
      Management believes that allowances for doubtful accounts, which are established
      based upon review of specific account balances and historical experience, are
      adequate.





-26-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




Revenues
      from the Company’s largest customers, as a percentage of total revenues, were as
      follows:





**2006**
            
            **2005**Customer
                A
            
            
            17
            %
            
            20
            %Customer
                B
            
            
            14
            
            
            11Customer
                C
            
            
            14
            
            
            -All
                Others
            
            
            55
            
            
            69100
            %
            
            100
            %





No
      other
      customer accounted for more than 10% of the Company’s revenues in fiscal years
      2006 and 2005.





**(h)**  **Loss
      per Share**





The
      Company calculates earnings per share according to SFAS No. 128, *Earnings
      per Share* .
      Basic
      loss per share is computed by dividing net loss by the weighted average number
      of shares of common stock outstanding during the period. For each of the two
      years in the periods ended June 30, 2006 and 2005, the effect of stock options
      and warrants was antidilutive; therefore, they were not included in the
      computation of diluted loss per share. The number of shares underlying options
      and warrants that were excluded from the computation, as their effect would
      be
      antidilutive, was 2,277,583 and 1,320,869 during fiscal 2006 and 2005,
      respectively.





**(i)**  **Stock-Based
      Compensation**





The
      Company accounts for its stock-based compensation using the intrinsic value
      method provided for under Accounting Principles Board Opinion No. 25 (APB No.
      25), *Accounting
      for Stock Issued to Employees* and
      related interpretations *.* Under
      APB
      No. 25 and related interpretations, compensation cost is recognized based on
      the
      difference, if any, on the date of grant between the fair value of the Company’s
      stock and the amount an employee must pay to acquire the stock. Statement of
      Financial Accounting Standards (“SFAS”) No. 123, *Accounting
      for Stock-Based Compensation* ,
      (as
      amended by SFAS No. 148, *Accounting
      for Stock-Based Compensation Transition and Disclosure* ),
      establishes a fair-value-based method of accounting for stock-based compensation
      plans. The Company has adopted the disclosure-only alternative under SFAS No.
      123, which requires the disclosure of the pro forma effects on net loss and
      net
      loss per share as if the fair value accounting prescribed by SFAS No. 123 had
      been adopted.





No
      stock-based employee compensation cost is reflected in consolidated results
      of
      operations for the years ended June 30, 2006 and 2005, as all options granted
      had an exercise price equal to the market value of the underlying common stock
      on the date of grant. The following table illustrates the effect on net loss
      and
      net loss per share as if the Company had applied the fair value recognition
      provisions of SFAS No. 123 to stock-based employee compensation:




-27-
 
 **PRECISION
          OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
          to Consolidated Financial Statements**






***Year
                Ended*****2006**
            
            
            **2005**Net
                loss, as reported
            
            $
            (2,272,473
            )
            $
            (3,688,361
            )Add:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards
            
            
            (377,430
            )
            
            (356,753
            )Pro
                forma net loss
            
            $
            (2,649,903
            )
            $
            (4,045,114
            )Net
                loss per share:
              As
                reported - basic and diluted
            
            $
            (.26
            )
            $
            (.55
            )Pro
                forma - basic and diluted
            
            $
            (.30
            )
            $
            (.60
            )





**(j)**  **Foreign
      Currency Translation**





The
      Company translates certain accounts and financial statements of its foreign
      subsidiary in accordance with SFAS No. 52, *Foreign
      Currency Translation.* The
      functional currency of the Company’s foreign subsidiary is the United States
      dollar. Transaction gains or losses are reflected in the accompanying
      consolidated statements of operations and have not been
      significant.





**(k)**  **Patents**





Patents
      are carried at cost, less accumulated amortization of approximately $453,100
      and
      $404,300 at June 30, 2006 and 2005, respectively. Such costs are amortized
      using
      the straight-line method over the shorter of their legal or estimated useful
      lives, generally five to ten years. Amortization expense was $48,834 and $70,357
      for the years ended June 30, 2006 and 2005, respectively. Amortization expense
      is expected to be approximately $47,000, $38,000, $31,000, $26,000 and $23,000,
      respectively for the years ending June 30, 2007 through June 30,
      2011.




**(l)**  **Financial
      Instruments**





SFAS
      No.
      107, *Disclosure
      About Fair Value of Financial Instruments* ,
      requires disclosures about the fair value of financial instruments. Financial
      instruments consist principally of cash equivalents, accounts receivable,
      accounts payable, and accrued expenses. The estimated fair value of these
      financial instruments approximates their carrying value due to the short-term
      nature of these financial instruments.





**(m)**  **Long-Lived
      Assets**





The
      Company accounts for long-lived assets in accordance with SFAS No. 144, *Accounting
      for the Impairment or Disposal of Long-Lived Assets.* This
      statement requires that long-lived assets and certain identifiable intangibles
      be reviewed for impairment whenever events or changes in circumstances indicate
      that the carrying amount of an asset may not be recoverable. Recoverability
      of
      assets to be held and used is measured by a comparison of the carrying amount
      of
      an asset to future net cash flows expected to be generated by the asset. If
      such
      assets are considered to be impaired, the impairment to be recognized is
      measured by the amount by which the carrying amount of the assets exceeds the
      fair value of the assets. Assets to be disposed of are reported at the lower
      of
      the carrying amount or fair value less costs to sell.





**(n)**  **Warranty
      Costs**





-28-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




The
      Company does not incur future performance obligations in the normal course
      of
      business other than providing a standard one-year warranty on materials and
      workmanship to its customers. The Company provides for estimated warranty costs
      at the time product revenue is recognized. Warranty costs were $10,122 and
      $10,417 for the years ended June 30, 2006 and 2005, respectively, and have
      been
      included as a component of cost of goods sold in the accompanying consolidated
      statements of operations.





**(o)**  **Research
      and Development**





Research
      and development expenses are charged to operations as incurred.





**(p)**  **Comprehensive
      Income**





SFAS
      No. 130, *Reporting
      Comprehensive Income* ,
      requires disclosure of all components of comprehensive income on an annual
      and
      interim basis. Comprehensive income is defined as the change in equity of a
      business enterprise during a period from transactions and other events and
      circumstances from non-owners sources.





The
      Company’s comprehensive loss for the years ended June 30, 2006 and 2005 was
      equal to its net loss for the same periods.





**(q)** **Income
      Taxes**





Income
      taxes are accounted for under the asset and liability method. Deferred tax
      assets and liabilities are recognized for the future tax consequences
      attributable to differences between the financial statement carrying amounts
      of
      existing assets and liabilities and their respective tax bases and operating
      loss and tax credit carryforwards. Deferred tax assets and liabilities are
      measured using enacted tax rates expected to apply to taxable income in the
      years in which those temporary differences are expected to be recovered or
      settled. The effect on deferred tax assets and liabilities of a change in tax
      rates is recognized in income in the period that includes the enactment date.





In
      assessing the likelihood of utilization of existing deferred tax assets,
      management has considered historical results of operations and the current
      operating environment.





**(r)**  **Segment
      Reporting**





SFAS
      No.
      131, *Disclosures
      About Segments of an Enterprise and Related Information,* establishes standards for reporting information regarding operating segments
      in
      annual financial statements and requires selected information for those segments
      to be presented in interim financial reports issued to stockholders. SFAS No.
      131 also establishes standards for related disclosures about products and
      services and geographic areas. Operating segments are identified as components
      of an enterprise about which separate discrete financial information is
      available for evaluation by the chief operating decision maker, or decision
      making group, in making decisions about how to allocate resources and assess
      performance. The Company’s chief decision-maker, as defined under SFAS No. 131,
      is the Chief Executive Officer. To date, the Company has viewed its operations
      and manages its business as principally one segment. For all periods presented,
      over 90% of the Company’s sales have been to customers in the United
      States.





**(s)**  **Use
      of Estimates**





The
      preparation of financial statements in conformity with accounting standards
      generally accepted in the United States requires management to make estimates
      and assumptions that affect the reported amounts of assets and liabilities
      and
      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.





-29-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




**(t)** **Recent
      Accounting Pronouncements**





In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
      123R, *Share-Based
      Payment* (SFAS
      123R), an amendment of FASB Statements No. 123 and No. 95 *,
      Statement of Cash Flows,* which
      requires companies to measure and recognize compensation expense for all
      stock-based payments at fair value. Pro forma disclosure will no longer be
      an
      alternative. SFAS 123R is effective for the first annual period beginning after
      December 15, 2005 and thus, will be effective for the Company beginning with
      the
      first quarter of fiscal year 2007 (July 1, 2006). Under SFAS 123R, the Company
      must determine the appropriate fair value model to be used for valuing
      share-based payments, the amortization for compensation cost and the transition
      method to be used at the date of adoption. The transition alternatives include
      retrospective and prospective adoption methods. Under the retrospective method,
      prior periods may be restated based on the amounts previously recognized under
      SFAS 123 for purposes of pro forma disclosures either for all periods presented
      or as of the beginning for the year of adoption.





The
      modified prospective method requires that compensation expense be recognized
      beginning with the effective date, based on the requirements of SFAS 123R,
      for
      all share-based payments granted after the effective date, and based on the
      requirements of SFAS 123, for all awards granted to employees prior to the
      effective date of SFAS 123R that remain unvested on the effective
      date.





The
      Company expects to adopt SFAS 123(R) on the effective date on a modified
      prospective basis without restatement of prior period. The
      Company has not determined the impact on its financial position or the results
      of operations. See Note 1 (i) for information related to the pro forma effects
      on the Company's reported net loss and net loss per share of applying the fair
      value recognition provisions of the previous SFAS 123 to stock-based employee
      compensation.





In
      November 2004, the FASB issued SFAS No. 151, “Inventory Costs” an amendment of
      ARB No. 43, Chapter 4, “Inventory Pricing.” This standard clarifies the
      accounting for abnormal amounts of idle facility expense, freight, handling
      costs, and waste material (spoilage). Such abnormal expenses must be recognized
      in the period in which they are incurred. In addition, SFAS No. 151 requires
      the
      allocation of fixed production overhead to inventory based on the normal
      capacity of the production facilities. Unallocated overheads must be recognized
      as an expense in the period in which they are incurred.





SFAS
      No.
      151 is effective for inventory costs incurred during fiscal years beginning
      after June 15, 2005. Having adopted SFAS No. 151, the Company has not
      encountered a material impact on its financial position or results of operations
      from this new accounting pronouncement.





In
      June
      2006, the FASB issued Interpretation (FIN) No. 48, Accounting for Uncertainty
      in
      Income Taxes. FIN No. 48 clarifies the accounting for uncertainty in income
      taxes recognized in an enterprise’s financial statements in accordance with FASB
      Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes
      a
      recognition threshold and measurement attribute for the financial statement
      recognition and measurement of a tax position taken or expected to be taken
      in a
      tax return. This Interpretation also provides guidance on derecognition,
      classification, interest and penalties, accounting in interim periods,
      disclosure, and transition. This Interpretation is effective for fiscal years
      beginning after December 15, 2006. The Company is in the process of determining
      the impact of this Interpretation on its results of operations.








**(2)**  **COMMITMENTS**





**(a)**  **Related
      Party Transactions**





The
      Company leases one of its facilities from a corporation owned by an
      officer-director-shareholder of the Company. The Company is currently a
      tenant-at-will, paying rent of $9,000 per month. Total rent expense paid to
      related parties was $108,000 in each of fiscal years 2006 and 2005, and is
      included in the accompanying consolidated statements of operations.





-30-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




The
      Company paid or accrued fees to a director of $60,000 in fiscal 2006 and $24,000
      in fiscal 2005 for consulting services. Another director is a former partner
      in
      a law firm that has performed legal services for the Company during fiscal
      2006
      and 2005 totaling approximately $136,000 and $76,400, respectively.





**(b)**  **Operating
      Lease Commitments**





The
      Company has entered into operating leases for its office space and equipment
      that expire at various dates through fiscal year 2008. Total future minimum
      rental payments under all non-cancelable operating leases are approximately
      $32,500 in fiscal 2007 and $6,000 thereafter.





Rent
      expense on operating leases, excluding the related party rent described above,
      was approximately $48,700 and $55,700 for the years ended June 30, 2006 and
      2005, respectively.








**(3)**  **STOCKHOLDERS’
      EQUITY**





**(a)** **Stock
      Options**





During
      fiscal 1989, the stockholders approved a stock option plan (the “1989 Plan”) for
      key employees. The 1989 Plan, as amended, authorizes the grant of options of
      up
      to 185,000 shares of the Company’s common stock at an exercise price of not less
      than 100% of the fair market value per share at the date of grant. Options
      granted vest and are exercisable for periods determined by the Board of
      Directors, not to exceed 10 years from the date of grant. No shares are
      available for future grants under the Company’s 1989 Stock Option
      Plan.





During
      fiscal 1998, the stockholders approved an incentive plan (the “1997 Incentive
      Plan”), which provides eligible participants (certain employees, directors,
      consultants, etc.) the opportunity to receive a broad variety of equity based
      and cash awards. Options granted vest and are exercisable for periods determined
      by the Board of Directors, not to exceed 10 years from the date of grant. A
      total of 3,000,000 shares of common stock have been reserved for issuance under
      the 1997 Incentive Plan, as amended and restated in fiscal year 2006. Upon
      the
      adoption of the 1997 Incentive Plan, no new awards were granted under the 1989
      Plan. At June 30, 2006, 712,438 shares of common stock were available for future
      grants under the 1997 Incentive Plan.





The
      following is a summary of transactions in the plans for the two years ended
      June
      30, 2006:




-31-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


**Number
                of**
              **Shares**
            
            
            **Option
                Price**
              **per
                Share**
            
            
            **Weighted**
              **Average**
              **Exercise
                Price**Options
                outstanding, June 30, 2004
            
            
            131,953
            
            $
            1.74
                - 75.00
            
            $
            11.79Granted
            
            
            1,206,000
            
            $
            0.73
                - 0.87
            
            $
            0.82Canceled
            
            
            (20,418
            )
            $
            8.25
            
            $
            8.25Options
                outstanding, June 30, 2005
            
            
            1,317,535
            
            $
            0.73
                - 75.00
            
            $
            1.79Granted
            
            
            970,800
            
            $
            0.46
                - 0.55
            
            $
            0.55Canceled
            
            
            (10,752
            )
            $
            4.20
                - 23.064
            
            $
            15.63Options
                outstanding, June 30, 2006
            
            
            2,277,583
            
            $
            0.46
                - 0.83
            
            $
            0.66Options
                exercisable, June 30, 2006
            
            
            784,266
            
            $
            0.46
                - 0.86
            
            $
            0.65Options
                exercisable, June 30, 2005
            
            
            450,635
            
            $
            0.73
                - 75.00
            
            $
            3.67






-32-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


The
      following table summarizes information about stock options outstanding and
      exercisable at June 30, 2006:





**Options
                Outstanding**
            
            **Options
                Exercisable**Range
                of
              Exercise
                Prices
            Options
                Outstanding
            Weighted
              Average
              Remaining
                Contractual
              Life
            Weighted
              Average
                Exercise
              Price
            
            Options
              Exercisable
            Weighted
                Average Exercise Price


$0.46
            20,000
            9.42
                years
            $0.46
            
            20,000
            $0.46$0.55
            1,323,583
            9.87
                years
            $0.55
            
            484,066
            $0.55$0.83
            934,000
            9.04
                years
            $0.83
            
            280,200
            $0.83$0.46
                - $0.83
            2,277,583
            9.86
                years
            $0.66
            
            784,266
            $
                0.65




In
      addition, the Company has granted options outside the plans, primarily to
      directors and a consultant at 100% of the fair market value per share at the
      date of grant. As of June 30, 2006 there were no remaining outstanding options
      that existed outside plans, having expired in July 2005. The weighted average
      remaining contractual life of the options outside the plans was .04 years as
      of
      June 30, 2005. The following is a summary of all transactions outside the plans:




**Number
                of**
              **Shares**
            
            
            **Option
                Price**
              **per
                Share**
            
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**Options
                outstanding and exercisable, June 30, 2004
            
            
            9,168
            
            $
            7.78-8.25
            
            $
            8.08Canceled
            
            
            (5,834
            )
            $
            8.25
            
            $
            8.25Options
                outstanding and exercisable, June 30, 2005
            
            
            3,334
            
            $
            7.78
            
            $
            7.78Expired
            
            
            (3,334
            )
            $
            7.78
            
            $
            7.78Options
                outstanding and exercisable, June 30, 2006
            
            
            0





The
      Company has computed the pro forma disclosures required under SFAS
      No. 123 ** for
      fiscal 2006 and 2005 using the Black-Scholes option pricing model prescribed
      by
      SFAS No. 123 (See Note 1(i)).


The
      assumptions used for each of the two years in the period ended June 30, 2006
      are
      as follows:




***Year
                Ended*****2006**
            
            **2005**Risk-free
                interest rates
            
            
            5.0
            %
            
            3.84
            %Expected
                dividend yield
            
            
            -
            
            
            -Expected
                lives
            
            
            5.3
                years
            
            
            5.3
                yearsExpected
                volatility
            
            
            114
            %
            
            107
            %Weighted
                average fair value of grants
            
            $
            0.65
            
            $
            0.65




-33-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




On June
      13, 2005 the Company issued options to purchase 934,000
      shares (“Performance Options”) of common stock at an exercise price of
      $0.83 per share.   At the date of issuance, 30% of
      the options vested immediately, and the vesting of the remaining options is
      subject to achievement of certain financial milestones by the Company.




On
      May 9,
      2006, the Company’s Board of Directors approved the repricing of certain stock
      options held by employees and certain members of the Board of Directors. The
      new
      exercise price per share of common stock subject to such options (“Repriced
      Options”) was set at $0.55. The new exercise price per share applies to all
      stock options with an original exercise price above $0.55 per share, other
      than
      an option to purchase 560,400 shares of common stock held by Joseph Forkey
      and
      an option to purchase 373,600 shares of common stock held by Richard Forkey.
      Approximately 382,783 options were affected in the repricing.




According
      to Accounting Principles Board Opinion No.
      25, "*Accounting
      for Stock Issued to Employees*,"
      the Performance Options and Repriced Options are subject to variable
      accounting until the awards are exercised, forfeited, or expire unexercised,
      which includes periodic measurement of compensation expense based on
      the intrinsic value of the options.   The compensation
      cost will be recognized and adjusted quarterly for vested options or
      ratably over the vesting period for unvested options.  No compensation
      expense related to these stock options is reflected in the
      net loss for the years ended June 30, 2006 and 2005 as
      all options granted had an exercise price greater than the market value of
      the underlying common stock as of June 30, 2006 and 2005.  As
      long as the options remain outstanding, the compensation adjustment remains
      subject to ongoing quarterly adjustments based on changes in the market
      price of the Company's common stock.




**(b)**  **Rights
      Offering**





In
      July
      2004, the Company completed a rights offering to stockholders of record on
      June
      7, 2004 by issuing 5,256,159 shares of common stock at a price of $1.00 per
      share. Net cash proceeds to the Company (after offering costs of $222,175)
      were
      $5,033,984.





**(c)**  **Sale
      of Stock**





In
      April
      2006 the Company completed a private placement, issuing 8,450,000 shares of
      common stock. Net cash proceeds (after offering costs of $49,725) to the Company
      were $2,062,775.





**(4)**  **INCOME
      TAXES**





The
      provision for income taxes in the accompanying consolidated statements of
      operations consists of the minimum statutory state income tax liability of
      $912
      for each of the two years ended June 30, 2006 and 2005.





A
      reconciliation of the federal statutory rate to the Company’s effective tax rate
      for the two years ended June 30is as follows:





**2006**
            
            
            **2005**Income
                tax benefit at federal statutory rate
            
            (34.0
            )%
            
            (34.0
            )%Increase
                (decrease) in tax resulting from-State
                taxes, net of federal benefit
            
            (6.0
            )
            
            (6.0
            )Change
                in valuation allowance, net of NOL expirations
            
            587.9
            
            
            27.9Expiration
                of state net operating loss carry forwards
            
            -
            
            
            11.6Impact
                of Change in Control Limitations
            
            (548.4
            )
            
            -Nondeductible
                items
            
            0.6
            
            
            2.3Tax
                credits
            
            -
            
            
            -Other
            
            -
            
            
            (1.8
            )Effective
                tax rate
            
            0.0
            %
            
            0.0
            %




-34-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


The
      components of deferred tax assets and liabilities at June 30, 2006 and 2005
      are
      approximately as follows:





**2006**
            
            
            **2005**Deferred
                tax assets:Net
                operating loss carryforwards
            $
            343,000
            
            $
            9,746,000Tax
                credit carryforwards
            
            -
            
            
            567,000Reserves
                and accruals not yet deducted for tax purposes
            
            18,000
            
            
            3,870,000Total
                deferred tax assets
            
            361,000
            
            
            14,183,000Valuation
                allowance
            
            (361,000
            )
            
            (12,972,000
            )Subtotal
            
            0
            
            
            1,211,000Deferred
                tax liabilities:
            
            -Accumulated
                depreciation
            
            
            
            
            (1,211,000
            )Net
                deferred taxes
            $
            -
            
            $
            -





The
      Company has provided a valuation allowance to reduce the net deferred tax asset
      to an amount the Company believes is “more likely than not” to be realized. The
      valuation allowance decreased in fiscal 2006 by approximately $12,622,000.
      Pursuant to the Tax Reform Act of 1986, the utilization of net operating loss
      carryforwards and other tax benefits are subject to an annual limitation if
      a
      cumulative change of ownership of more than 50% occurs over a three-year period.
      As a result of the 2006 private placement of the Company’s common stock, the
      Company has triggered significant limitations on the utilization of those tax
      attributes. The limitation will allow the use of the value of approximately
      $18,000 of Federal carryforward losses annually for the next twenty years,
      and
      the same amount for state purposes for 15 years. The impact of this limitation
      has been reflected in the current year’s tax provision, and has also caused the
      significant reduction in the valuation allowance necessary. In addition, the
      company has incurred losses of $505,000 since the change in control that are
      not
      subject to those limitations and will be available for Federal purposes until
      2026 and until 2011 for state purposes.








**(5)**  **PROVISION
      FOR RESTRUCTURING**





For
      the
      period ended June 30, 2006, the Company had no provision for restructuring
      charges. In June 2005, the Company reduced its full-time workforce by
      approximately 3%, or one employee. As a result of this action, the Company
      recorded a pretax charge to earnings in the quarter ended June 30, 2005 of
      $89,512 for employee severance benefits.




-35-


**PRECISION
        OPTICS CORPORATION, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


The
      following table sets forth the rollforward of provisions and cash payments
      associated with the restructuring reserve:





**Reserve
                For**
              **Employee**
              **Severance**Reserve
                Balance, June 30, 2004
            
            $
            -Total
                Provision
            
            
            89,512Cash
                Payments
            
            
            (84,501
            )Reserve
                Balance, June 30, 2005
            
            
            5,011Total
                Provision
            
            
            -Cash
                Payments
            
            
            (5,011
            )Reserve
                Balance, June 30, 2006
            
            $
            -





**(6)** **PROVISION
      FOR INVENTORY WRITE-DOWN**




The
      Company determined that certain inventories of telecommunications and medical
      products would not be sold within the Company’s business cycle or the products’
life cycle. Consequently, the Company recorded, in cost of goods sold, a
      provision for excess and obsolete inventory of approximately $32,000 and
      $401,900 during the years ended June 30, 2006 and 2005,
      respectively.




**(7)** **PROFIT
      SHARING PLAN**





The
      Company has a defined contribution 401K profit sharing plan. Employer profit
      sharing and matching contributions to the plan are discretionary. No employer
      profit sharing contributions were made to the plan in fiscal years 2006 and
      2005. Employer matching contributions to the plan amounted to $29,203 and
      $35,310 for fiscal years 2006 and 2005, respectively.






-36-




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




None.





**ITEM
      8A.** **CONTROLS
      AND PROCEDURES**





As
      of the
      end of the period covered by this annual report, the Company’s Chief Executive
      Officer and Principal Financial Officer have conducted an evaluation of the
      Company’s disclosure controls and procedures. Based on their evaluation, the
      Company’s Chief Executive Officer and Principal Financial Officer have concluded
      that the Company’s disclosure controls and procedures are effective to ensure
      that information required to be disclosed by the Company in reports that it
      files or submits under the Securities Exchange Act of 1934 is (i) recorded,
      processed, summarized and reported within the time periods specified in the
      applicable Securities and Exchange Commission rules and forms and (ii)
      accumulated and communicated to the Company’s management, including the
      Company’s Chief Executive Officer and the Company’s Principal Financial Officer,
      as appropriate to allow timely decisions regarding required
      disclosure.





There
      was
      no change in the Company’s internal control over financial reporting during the
      Company’s most recently completed fiscal quarter that has materially affected,
      or is reasonably likely to materially affect, the Company’s internal control
      over financial reporting.





**ITEM
      8B.** **OTHER
      INFORMATION**





None.





-37-


**PART
      III**





**ITEM
      9.** **DIRECTORS,
      EXECUTIVE OFFICERS, AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE
      EXCHANGE ACT**





The
      Company will furnish to the Securities
      and Exchange Commission a
      definitive Proxy Statement (the “Proxy Statement”) not later than 120 days after
      the close of its fiscal year ended June 30, 2006. The information required
      by
      this item, other than with respect to the Company’s Corporate Code of Ethics and
      Conduct, is incorporated herein by reference to the Proxy Statement.





A
      copy of
      the Company’s Corporate Code of Ethics and Conduct applicable to all employees,
      officers and directors of the Company is incorporated by reference as Exhibit
      14.1 to this report and can be obtained free of charge by contacting the
      Company’s Clerk, c/o Precision Optics Corporation, 22 East Broadway, Gardner,
      Massachusetts 01440.








**ITEM
      10.** **EXECUTIVE
      COMPENSATION** ****





The
      information required by this item is incorporated herein by reference to the
      Proxy Statement.








**ITEM
      11.** **SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
      MATTERS**





The
      information required by this item is incorporated herein by reference to the
      Proxy Statement.








**ITEM
      12.** **CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS** ****





The
      information required by this item is incorporated herein by reference to the
      Proxy Statement.








**ITEM
      13.** **EXHIBITS** ****





The
      exhibits listed below are filed with or incorporated by reference in this
      report.




3.1
            Articles
                of Organization of the Company, as amended and corrected. (1)


3.2
            By-laws
                of Precision Optics Corporation, Inc. (2) 4.1
            Specimen
                common stock certificate. (3)


4.2
            Registration
                Rights Agreement dated as of March 17, 2000 by and among the Company
                and
                the Initial Investors as defined therein.
                (4)


4.3
            Registration
                Rights Agreement dated as of June 30, 1998 by and among the Company,
                Special Situations Private Equity Fund, L.P. and Special Situations
                Technology Fund, L.P. (5)


4.4
            Registration
                Rights Agreement dated as of August 5, 1999 by and among the Company,
                Special Situations Cayman Funds, L.P., Special Situations Fund III,
                L.P.,
                Special Situations Private Equity Fund, L.P. and Special Situations
                Technology Fund, L.P. (6)


10.1
            Precision
                Optics Corporation, Inc. 1989 Stock Option Plan, amended to date.
                (7)


10.2
            Three
                separate life insurance policies on the life of Richard E. Forkey.
                (3)


10.3
            Amended
                and Restated Precision Optics Corporation, Inc. 1997 Incentive Plan.
                (8)


10.4
            Securities
                Purchase Agreement dated as of March 13, 2000 by and among the Company
                and
                the Purchasers as defined therein (excluding exhibits). (4)


10.5
            Form
                of Purchase Agreement between the Company and each investor named
                therein.
                (11)


10.6
            Employment
                Offer Letter dated as of September 15, 2006 from Precision Optics
                Corporation, Inc., to Michael T. Pieniazek.
                (12)


14.1
            Corporate
                Code of Ethics and Conduct. (9)


21
            Subsidiaries
                of Precision Optics Corporation, Inc.
                (10)




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23.1
            Consent
                of Vitale Caturano & Company
                Ltd.


31.1
            Certification
                of Chief Executive Officer required by Rule
                13a-14(a)/15d-14(a).


31.2
            Certification
                of Principal Financial Officer required by Rule
                13a-14(a)/15d-14(a).


32.1
            Certification
                of Chief Executive Officer and Principal Financial Officer required
                by
                Rule 13a-14(b) and 18 U.S.C. 1350.





(1)
            Incorporated
                herein by reference to the Company’s Quarterly Report for the quarter
                ended December 31, 2002 on Form 10-QSB (No.
                001-10647).


(2)
            Incorporated
                herein by reference to the Company’s 1991 Annual Report on Form 10-KSB
                (No. 001-10647).


(3)
            Incorporated
                herein by reference to the Company’s Registration Statement on Form S-1
                (No. 33-36710-B).


(4)
            Incorporated
                herein by reference to the Company’s Registration Statement on Form S-3
                (No. 333-35884).


(5)
            Incorporated
                herein by reference to the Company’s 1998 Annual Report on Form 10-KSB
                (No. 001-10647).


(6)
            Incorporated
                herein by reference to the Company’s 1999 Annual Report on Form 10-KSB
                (No. 001-10647).


(7)
            Incorporated
                herein by reference to the Company’s 1994 Annual Report on Form 10-KSB
                (No. 001-10647).


(8)
            Incorporated
                herein by reference to the Company’s Quarterly Report on Form 10-QSB for
                the quarter ended September 30, 2003 (No.
                001-10647).


(9)
            Incorporated
                herein by reference to the Company’s 2005 Annual Report on Form 10-KSB
                (No. 001-10647).


(10)
            Incorporated
                herein by reference to the Company’s 1996 Annual Report on Form 10-KSB
                (No. 001-10647).


(11)
            Incorporated
                herein by reference to the Company’s Current Report on Form 8-K (No.
                001-10647) filed on April 19, 2006.


(12)
            Incorporated
                herein by reference to the Company’s Current Report on Form 8-K (No.
                001-10647) filed on September 21,
                2006.





**ITEM
      14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES**





The
      information required by this item is incorporated herein by reference to the
      Proxy Statement.






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**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized.




Date:
                  October 13, 2006
              PRECISION
                OPTICS CORPORATION, INC.By:
              /s/
                  Richard E.
                  ForkeyRichard
                  E. ForkeyChairman
                  of the Board,Chief
                  Executive Officer, Presidentand
                  Treasurer





In
      accordance with the Exchange Act, 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/
                Richard E.
                Forkey
              Richard
                E. Forkey
            Chairman
                of the Board, Chief Executive Officer, President and Treasurer (Principal
                Executive Officer)
            October
                13, 2006/s/
                Joseph N.
                Forkey
              Joseph
                N. Forkey
            Executive
                Vice President, Chief Scientific Officer and Director
            October
                13, 2006/s/
                Edward A.
                Benjamin
              Edward
                A. Benjamin
            Director
            October
                13, 2006/s/
                Donald A.
                Major
              Donald
                A. Major
            Director
            October
                13, 2006/s/
                Richard
                Miles
              Richard
                Miles
            Director
            October
                13, 2006/s/
                Joel R.
                Pitlor
              Joel
                R. Pitlor
            Director
            October
                13, 2006/s/
                Michael T.
                Pieniazek
              Michael
                T. Pieniazek
            Vice
                President and Chief Financial Officer
              (Principal
                Financial Officer and
              Principal
                Accounting Officer)
            October
                13, 2006






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