Use these links to rapidly review the documentTABLE OF CONTENTS

Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



FORM 10-K

(Mark One)ý

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended June 30, 2009oro

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from  toCommission File Number 001-10647


PRECISION OPTICS CORPORATION, INC.(Exact name of registrant as specified in its charter)

Massachusetts(State or other jurisdiction
of incorporation or organization)

04-2795294(I.R.S. Employer
Identification No.)


22 East Broadway
Gardner, Massachusetts 01440(Address of principal executive offices) (Zip Code)

(978) 630-1800(Registrant's telephone number, including area code)

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

Securities
registered pursuant to Section 12(g) of the Act:Common Stock, $0.01 par value

Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. o Yes     ý No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the
Act. o Yes     ý No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. ý Yes     o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data file required to be submitted and
posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). o Yes     o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not
contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company ý


Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). o Yes     ý No

State the aggregate market value of the voting and non-voting common equity, consisting solely of common stock, held by non-affiliates computed by
reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed
second fiscal quarter: $48,113 (based on a total of 240,566 shares of the registrant's common stock held by non-affiliates on December 31, 2008, at the closing price of $0.20 per
share).

The
number of shares of outstanding common stock of the registrant as of September 28, 2009 was 1,018,411.

DOCUMENTS
INCORPORATED BY REFERENCE

The
registrant's Proxy Statement for the 2009 Annual Meeting of Stockholders to be held on November 24, 2009 is incorporated by reference into Part III of this
Form 10-K.



---





Table of Contents

PRECISION OPTICS CORPORATION, INC.
FORM 10-K

TABLE OF CONTENTS



PAGEPART IITEM 1.

Business


3ITEM 1A.

Risk Factors


8ITEM 2.

Properties


14ITEM 3.

Legal Proceedings


14ITEM 4.

Submission of Matters to a Vote of Security Holders


14PART IIITEM 5.

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities


14ITEM 6.

Selected Financial Data


15ITEM 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations


15ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risk


22ITEM 8.

Financial Statements and Supplementary Data


22ITEM 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure


43ITEM 9A(T).

Controls and Procedures


43ITEM 9B.

Other Information


44PART IIIITEM 10.

Directors, Executive Officers and Corporate Governance


44ITEM 11.

Executive Compensation


45ITEM 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters


45ITEM 13.

Certain Relationships and Related Transactions, and Director Independence


45ITEM 14.

Principal Accounting Fees and Services


45ITEM 15.

Exhibits, Financial Statement Schedules


45


2

---





Table of Contents

PART I

This annual report contains forward-looking statements as defined under the federal securities laws. Actual results could
vary materially. Factors that could cause actual results to vary materially are described herein and in other documents we file from time to time with the Securities and Exchange Commission. Although
we believe expectations reflected in such forward-looking statements are reasonable based upon the assumptions in this annual report, they may prove to be inaccurate and consequently our actual
results could differ materially from our expectations set out in this annual report.

ITEM 1.    BUSINESS.

HISTORY

We incorporated in Massachusetts in December 1982 and have been publicly-owned since November 1990. References to our Company contained herein
include our two wholly-owned subsidiaries, Precise Medical, Inc. and Wood's Precision Optics Corporation, Limited, except where the context otherwise requires.

OUR BUSINESS

We have been a developer and manufacturer of advanced optical instruments since 1982. We design and produce high-quality medical
instruments, micro-optics with characteristic dimensions less than 1 millimeter, or mm, and other advanced optical systems. Our medical instrumentation line includes laparoscopes, arthroscopes
and endocouplers and a line of world-class 3-D endoscopes for use in minimally invasive surgical procedures. We are registered to the ISO 9001:2000, ISO 13485:2003,
and Canadian Medical Devices Conformity Assessment System, or CMDCAS, Quality Standards, and comply with the FDA Good Manufacturing Practices and the European Union Medical Device Directive for CE
marking of our medical products. Our website is www.poci.com. Information contained on our website does not constitute part of this annual report.

Principal Products and Services and Methods of Distribution.

Medical
Products: Endoscopes and Image Couplers. Since 1982, we have manufactured medical products such as endoscopes, as well as image couplers, beamsplitters and adapters, all of which are used as
accessories to endoscopes. We have developed and sold endoscopes incorporating various optical technologies for use in a variety of minimally invasive surgical and diagnostic procedures. Our 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.

We
produce autoclavable endoscopes for various applications, which are CE mark certified for European use, and have been designed and tested to withstand sterilization by autoclave, which is
sterilization in a 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.

Since
1985, we have developed, manufactured and sold 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 physically connect the endoscope to a video camera system and transmit the image viewed through the
scope to the video camera. Our Series 800 Beamsplitters perform the same function while preserving for the viewer an eye

3

---



Table of Contents

port
for direct, simultaneous viewing through the endoscope. These devices are sold primarily to endoscope and video camera manufacturers and suppliers for resale under our customers' names. All of
the image couplers and beamsplitters that we manufacture are approved for surgery-approved sterilization. We believe we are one of only a few manufacturers of autoclavable image couplers worldwide.

Medical
Products: Next Generation Lenslock Endoscopes. We continue to develop and ship our next generation endoscopes that incorporate our leading proprietary Lenslock
technology (patent pending). We have shipped over 600 ENT endoscopes with diameter of 2.7 mm that incorporate Lenslock technology. We recently completed prototypes of our 4 mm
Lenslock sinuscope, and 5 mm Lenslock laproscope, and are actively pursuing development of our new 4 mm Lenslock wide field arthroscope. We believe
that Lenslock technology has advantages over competitive products due to the ease of manufacture and repair, superior image quality, significant cost effectiveness and quality of repair.
Further, we believe that incorporating this into our endoscope product line could lead to increased sales of this product.

Medical
Products: Sub-millimeter Optics and Endoscopes. Utilizing recently developed proprietary techniques, including patent pending micro-precision lens fabrication
technology, we design and manufacture ultra-small lenses, prisms and assemblies with sizes as small as 0.2 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. Developments in medical procedures requiring minimally invasive visualization in very small
spaces, in such specialties as spinal surgery, neurosurgery, cardiothoracic surgery, cardiology and pulmonology, have led to products requiring lenses and endoscopes as small as 0.2 mm in diameter.

Utilizing
our proprietary technology, we currently manufacture a number of products with length and/or diameter less than 1 mm and are actively expanding our product line in this area.

Medical
Products: Custom Design and Device Production. We design and manufacture custom optical medical products to satisfy our customers' specific requirements. During fiscal year 2007, we completed
development and began shipments of an advanced surgical visualization system to a significant new customer. We have received follow-on orders with deliveries continuing into fiscal year
2010. The size and extent of future follow-on orders will depend on market acceptance and other considerations.

Industrial
Products. In addition to our medical products, we also sell components and assemblies such as 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. Utilizing micro-precision technology, we also
design and manufacture sub-millimeter optical components and assemblies for industrial use.

Night
Vision Optics. We continue to pursue a partnership effort for the proprietary development of a new class of color night vision devices including a new patent-pending eyepiece lens. With a second
round of prototypes recently completed, we expect that the product incorporating our new night vision lenses will be evaluated by the U.S. government in the near future. We cannot control the timing
of current evaluations and cannot therefore predict when, if ever, these night vision lenses might begin to generate revenue.

Optical
System Design and Development Services. We are able to provide customers with advanced lens design, imaging analysis, optical system design, structural design and analysis, prototype
production and evaluation, optics testing, and optical system assembly. Some of our efforts have led to optical system production business for our Company, and we believe our prototype development
service may lead to new product production from time to time.

4

---



Table of Contents

Competition and Markets.

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

We
believe that competition for sales of our medical products and services, which have been principally sold to medical device companies who incorporate our 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. We market and sell our endoscopes to customers 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 these customers and our share of the endoscope
market is nominal. We believe that, while our resources are substantially more limited than those of our competitors, we can compete successfully in this market on the basis of product quality, price,
delivery and innovation.

Marketing.

During the last three years, we have made significant efforts to update our sales and marketing activities. As part of these efforts, we have
generated and continue to generate new marketing materials for recently developed products, including a newly designed website, www.poci.com. Since initiating these efforts, and on an ongoing basis,
we have taken a much more comprehensive view of trade show opportunities, targeting those with specific relevance to recently developed products. We believe these efforts afford us a greater
opportunity to reach and follow up a broader customer base than we have previously been able to achieve. These efforts have contributed to recent year-over-year revenue
increases, and continue to generate prospects for our leading technologies including, Lenslock, micro-precision, and custom applications of our core optical capabilities.
This includes renewed interest in some of our well-developed products such as our "classic" autoclavable endoscopes and endocouplers, as well as new applications with our micro
(fiberoptic) endoscopes.

International Business.

We have had negligible direct export sales to date. However, our medical products have received the CE Mark Certification, which permits sales into
the European marketplace. We may establish or use production facilities overseas to produce key components for our business, such as lenses. Since the 1990s we have maintained a Hong Kong subsidiary
to support business and quality control activities as required throughout Asia. We believe that the cost savings from such production may be essential to our ability to compete on a price basis in the
medical products area particularly and to our profitability generally.

Research and Development.

We believe that our future success depends to a large degree on our ability to continue to conceive and develop new optical products and services to
enhance the performance characteristics and methods of manufacture of existing products. Research and development expenses are incurred on our own proprietary products and technology as well as on
custom projects on behalf of customers. Accordingly, we expect to continue to seek to obtain product-related design and development contracts with customers and to invest our own funds on research and
development. We spent $737,791 and $757,852 of our own funds on research and development, net of reimbursements billed to customers of $181,105 and $224,107 during fiscal years 2009 and 2008,
respectively.

5

---



Table of Contents

We
are currently incorporating our Lenslock technology (patent pending) into our line of endoscopes. This proprietary technology ensures lower cost, easier reparability and enhanced
durability. We are also aggressively pursuing the design, development and manufacture of ultra-small instruments, some with lenses less than 1 mm in diameter, utilizing our
micro-precision lens technology (patent pending).

Raw Materials and Principal Suppliers.

The basic raw material of the majority of our product line is precision grade optical glass, which we obtain from a few suppliers, principally SCHOTT
North America, Inc. and Ohara Corporation. For optical thin film coatings, the basic raw materials we utilize are metals and dielectric compounds, which we obtain from a variety of chemical
suppliers. Certain of the thin film coatings utilized in our products are currently procured from an outside supplier, but most thin film coatings are produced in-house. We believe that
our demand for these raw materials and thin film coating services is small relative to the total supply, and that the materials and services required for the production of our products are currently
available in sufficient production quantities and will be available for fiscal year 2010. We believe, however, that there are relatively few suppliers of the high quality lenses and prisms, which our
endoscopes require. In response, we have established our own optical shop for producing ultra-high quality prisms, micro-optics and other specialized optics for a variety of medical and
industrial applications.

Patents and Trademarks.

We rely, 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 our competitive position. We do not believe that our business is dependent upon any patent, patent pending or license,
although we believe that trade secrets and confidential know-how may be important to our scientific and commercial success.

We
plan to file for patents, copyrights and trademarks in the United States and in appropriate countries to protect our intellectual property rights to the extent practicable. We hold the rights to
several United States and foreign patents and have several patent applications pending, including those for our new generation of 3-D endoscopes, our Lenslock endoscope
technology and our innovative micro-precision lens technology. These patents have expiration dates ranging from March 2015 to June 2028. We are not aware of any infringements of our
patents. We plan to protect our patents from infringement in each instance where we determine that doing so would be economical in light of the expense involved and the level and availability of our
financial resources. While we believe that our pending applications relate to patentable devices or concepts, these patents may not be issued and we may not be able to successfully defend these
patents or effectively limit the development of competitive products and services.

Employees.

As of June 30, 2009, we had 28 employees, 19 of which were full-time employees. There were 16 employees in manufacturing, 6 in
engineering/research and development, 1 in sales and marketing and 5 in finance and administration. We are not a party to any collective bargaining agreements. We believe our relations with our
employees are good.

6

---



Table of Contents

Customers.

Revenues from our largest customers, as a percentage of total revenues, for fiscal years 2009 and 2008 were as follows:

2009

2008Customer A


23
%

11
%Customer B


22


25Customer C


20


20Customer D


11


8All Others


24


36100
%

100
%


No
other customer accounted for more than 10% of our revenues in fiscal years 2009 and 2008. At June 30, 2009, receivables from our largest customers were 32%, 21%, 19% and 13% of the total
accounts receivable.

Environmental Matters.

Our 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, we use a small amount of hazardous materials in our operations. We believe that we comply with all applicable
environmental laws and regulations.

Government Regulations on the Business.

Domestic
Regulation. We currently develop, manufacture and sell 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, or 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, or the imposition of various other penalties.

We
notified the FDA of our intent to market our endoscopes, image couplers, beamsplitters, adapters and video ophthalmoscopes, and the FDA has determined that we may market such devices, subject to
the general controls provisions of the Food, Drug and Cosmetic Act. We obtained this FDA permission without the need to undergo a lengthy and expensive approval process due to the FDA's determination
that such devices meet the regulatory standard of being substantially equivalent to an existing approved device.

In
the future, we plan to market additional endoscopes and related medical products that may require the FDA's permission to market such products. We may also develop additional products or seek to
sell some of our current or future medical products in a manner that requires us 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.

7

---



Table of Contents

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 the European 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 our medical products are CE mark certified.

ITEM 1A.    RISK FACTORS.

RISKS RELATED TO OUR BUSINESS

An investment in our common stock involves a high degree of risk. Before making an investment decision, you should give careful consideration to the
following risk factors, in addition to the other information included in this annual report. If any of the following risks actually occur, our business, financial condition or results of operations
could be materially and adversely affected and you may lose some or all of your investment.

Our independent auditors have issued a going concern opinion and, if we do not generate enough cash from operations to sustain our business, we may have to liquidate assets
or curtail our operations.

The accompanying financial statements have been prepared assuming we will continue as a going concern. During the years ended June 30, 2009
and 2008, we incurred net losses of $992,135 and $1,623,354, respectively. Our auditors have issued a going concern qualification in their report related to our financial statements for the period
ended June 30, 2009. This report is based on our history of operating losses, negative cash flows from operations, and our cash position as of June 30, 2009.

Conditions
exist which raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern depends on our ability to generate sufficient cash flows to
meet
our obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain profitable operations. However, we may not be able to obtain additional financing or
achieve profitable operations or sufficient cash flows in the future.

The current worldwide economic downturn could have a negative impact on our business, operating results and financial condition.

If the economic downturn continues, our customers may delay, reduce or cancel their purchases of our products, particularly if they or their
customers have difficulty obtaining credit, which could reduce our revenues. The economic downturn could increase competition which could have the effect of reducing our prices. We could incur losses
if a customer's business fails and is unable to pay us, or pay us on a timely basis. Likewise, if our suppliers have difficulty in obtaining credit or in operating their businesses, they may not be
able to provide us with the materials we use to manufacture our products. These actions could result in reduced revenues and higher operating costs, and have an adverse effect on our results of
operations and financial condition.

8

---



Table of Contents

Our existing and future debt obligations could impair our liquidity and financial condition.

Effective June 25, 2008, we completed a financing in which we issued 10% Senior Secured Convertible Notes and Warrants. As of June 30,
2009, we had outstanding notes payable of $600,000, with accrued interest as of June 30, 2009 of $60,833, and we may incur additional debt in the future to fund all or part of our capital
requirements. Our outstanding debt and future debt obligations could impair our liquidity and could:



It
is highly unlikely that we will be able to generate enough cash from our operations to pay our outstanding debt on the specified due date. If we were to fail in the future to make any required
payment under agreements governing indebtedness, or equity issues, or fail to comply with the financial and operating covenants contained in those agreements, we would be in default in regards to that
financing transaction. A debt default could significantly diminish the market value and marketability of our common stock. Our lenders would have the ability to require that we immediately pay all
outstanding indebtedness, and we might not have sufficient assets to satisfy their demands. In this event, we may be forced to seek protection under bankruptcy laws, which could harm our future
operations and overall financial condition.

We rely on a small number of customers who may not consistently purchase our products in the future and if we lose any one of these customers, our revenues may decline.

In the fiscal year ended June 30, 2009, our four largest customers represented approximately 23%, 22%, 20% and 11%, respectively, of our total
revenues. In the fiscal year ended June 30, 2008, our four largest customers represented approximately 11%, 25%, 20% and 8%, respectively, of our total revenues. No other customer accounted for
more than 10% of our revenues during those periods. At June 30, 2009, receivables from our four largest customers were 32%, 21%, 19% and 13%, respectively, of the total accounts receivable.

In
the future, a small number of customers may continue to represent a significant portion of our total revenues in any given period. These customers may not consistently purchase our products at a
particular rate over any subsequent period. A loss of any of these customers could adversely affect our revenues.

Negative economic conditions increase the risk that we could suffer unrecoverable losses on our customers' accounts receivable which would adversely affect our financial
results.

In the fiscal year ended June 30, 2009, our four largest customers represented approximately 23%, 22%, 20% and 11%, respectively, of our total
revenues. At June 30, 2009, receivables from these customers were 32%, 21%, 19% and 13%, respectively, of the total accounts receivable. While we believe we have a varied customer base and have
experienced strong collections in the past, if current economic conditions fail to improve we may experience change in our customer base, including reductions in their purchasing commitments to us,
which could also have a material adverse effect on our revenues and liquidity. We have not purchased insurance on our accounts receivable balances.

9

---



Table of Contents

Additionally,
if our customer who accounts for 32% of our accounts receivable balance at June 30, 2009 and whose accounts receivable we have not insured, fails and is unable to pay us, our
business may be harmed.

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. The loss of Mr. Forkey's services could severely damage our business.

Additionally,
Dr. Joseph N. Forkey, our Executive Vice President and Chief Scientific Officer, provides highly valuable contributions to our capabilities in optical instrument development, in
management of new technology and in potentially significant longer-term initiatives in biophysics and biomedical instrumentation. The loss of Dr. Forkey's management and scientific
contributions could severely damage our business.

We must continue to be able to attract employees with the scientific and technical skills that our business requires and 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. If we cannot attract such
individuals, we may not be able to produce our products and our business could be damaged.

We are subject to a high degree of regulatory oversight and, if we do not continue to receive the necessary regulatory approvals, our revenues may decline.

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
may not continue to receive the FDA's permission to market our current products or may not 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. If we lose the FDA's permission to market
our current products or we do not obtain regulatory permission to market our future products, our revenues may decline and our business may be harmed.

We face risks inherent in product development and production under fixed price purchase orders and these purchase orders may not 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. Fixed price purchase orders
represented approximately 25% to 50% of our total revenues during the last several years. We expect that revenues from fixed price purchase orders will continue to represent a significant portion of
our total revenues in future fiscal years.

10

---



Table of Contents

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 and 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. If our competitors or other third parties infringe on our patents, our
business may be harmed.

Third parties may claim that we have infringed on their patents and 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 use the technology that was the subject of the claim, or sell products embodying such
technology. If we engage in litigation, our expenses may increase and our business may be harmed. If we are prohibited from using a particular technology in our products, our revenues may decline and
our business may be harmed.

We depend on the availability of certain key supplies and services that are available from only a few sources and if we experience difficulty with a supplier, we may have
difficulty finding alternative sources of these supplies or services.

We require certain key supplies for our products, particularly precision grade optical glass, that 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, subcontractors may produce certain of our products for us, 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. If this occurs, we may not be able to deliver our products on a timely
basis and our revenues may decline.

11

---



Table of Contents

Our customers may claim that the products we sold them were defective and 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 as of September 28, 2009, no such claims have been asserted or threatened against us. However, our insurance may not be sufficient to
cover all possible future product liabilities.

We would be liable if our business operations harmed the environment and a 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.

Our quarterly financial results vary quarter to quarter and depend on factors which may adversely affect our stock price. 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:



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

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.

12

---





Table of Contents

RISKS RELATED TO OUR STOCK

Trading in our common stock is limited and the price of our common stock may be subject to substantial volatility.

Our common stock was delisted from the NASDAQ Capital Market at the opening of business on December 27, 2005, and is now traded on the
Over-The-Counter Bulletin Board, or OTCBB, under the ticker symbol "PEYE.OB," where we expect our common stock to remain for the foreseeable future. Broker-dealers often
decline to trade in OTCBB stocks given the market for such securities is often limited, the stocks are more volatile and the risk to investors is greater. These factors may reduce the potential market
for our common stock by reducing the number of potential investors. This may make it more difficult for investors in our common stock to sell shares to third parties or to otherwise dispose of their
shares. This could cause our stock price to decline.

Additionally,
the price of our common stock may be volatile as a result of a number of factors, including, but not limited to, the following:



"Penny stock" rules may make buying or selling our securities difficult which may make our stock less liquid and make it harder for investors to buy and sell our securities.

Trading in our securities is subject to the SEC's "penny stock" rules and it is anticipated that trading in our securities will continue to be
subject to the penny stock rules for the foreseeable future. The SEC has adopted regulations that generally define a penny stock to be any equity security that has a market price of less than $5.00
per share, subject to certain exceptions. These rules require that any broker-dealer who recommends our securities to persons other than prior customers and accredited investors must, prior to the
sale, make a special written suitability determination for the purchaser and receive the purchaser's written agreement to execute the transaction. Unless an exception is available, the regulations
require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the risks associated with trading in the penny stock market. In
addition, broker-dealers must disclose
commissions payable to both the broker-dealer and the registered representative and current quotations for the securities they offer. The additional burdens imposed upon broker-dealers by these
requirements may discourage broker-dealers from recommending transactions in our securities, which could severely limit the liquidity of our securities and consequently adversely affect the market
price for our securities.

We are contractually obligated to issue shares in the future, diluting your interest in us.

As of June 30, 2009, there were approximately 93,178 shares of our common stock issuable upon exercise of stock options outstanding, at a
weighted average exercise price of $16.17 per share. An additional 135,898 shares of our common stock are reserved for issuance under our 2006 Equity Incentive Plan as of May 22, 2009. Also
outstanding as of June 30, 2009 are warrants for the issuance of an additional 898,621 shares of our common stock, at a weighted average exercise price of $4.18 per

13

---



Table of Contents

share.
The foregoing information gives effect to a 1 for 25 reverse stock split effective December 11, 2008. Moreover, we expect to issue additional shares and options to purchase shares of our
common stock to compensate employees, consultants and directors, and we may issue additional shares to raise capital. Any such issuances will have the effect of further diluting the interest of the
holders of our securities.

ITEM 2.    PROPERTIES.

We conduct our domestic operations at two facilities in Gardner, Massachusetts. The main Gardner facility is leased from a corporation owned by an
individual who is one of our officers and serves on our board of directors. The lease terminated in December 1999 and we are currently a tenant-at-will. We rent the other
Gardner facility on a month-to-month basis. We rent office space in Hong Kong for sales, marketing and supplier quality control and liaison activities of our Hong Kong
subsidiary.

We
believe these facilities are adequate for our 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 our line of endoscopes, optical thin films and other products may; however, require the acquisition or lease of additional facilities.
We may establish production facilities domestically or overseas to produce key assemblies or components, such
as lenses, for our products. Overseas facilities may subject us 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 our competitive position and profitability.

ITEM 3.    LEGAL PROCEEDINGS.

We may be involved from time to time in ordinary litigation, negotiation and settlement matters that will not have a material effect on our
operations or finances. We are not aware of any pending or threatened litigation against us or our officers and directors in their capacity as such that could have a material impact on our operations
or finances.

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

No matters were submitted to a vote of our security holders during the fourth quarter of fiscal year 2009.

PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common stock is quoted on the Over-The-Counter Bulletin Board, or OTCBB, under the symbol "PEYE.OB." The following table
sets forth the high and low bid prices for our common stock for each quarter during the last two fiscal years as quoted on the OTCBB. Such OTCBB market quotations reflect inter-dealer prices, without
retail markup, markdown or commissions and may not necessarily

14

---



Table of Contents

represent
actual transactions. All prices have been adjusted to reflect a 1 for 25 reverse stock split, effective December 11, 2008.

High

LowFor the Fiscal Year Ended June 30, 2009First Quarter ended September 30, 2008

$
3.25

$
1.00Second Quarter ended December 31, 2008

$
2.25

$
0.10Third Quarter ended March 31, 2009

$
1.01

$
0.16Fourth Quarter ended June 30, 2009

$
5.00

$
0.25For the Fiscal Year Ended June 30, 2008First Quarter ended September 30, 2007

$
10.00

$
5.00Second Quarter ended December 31, 2007

$
8.75

$
3.00Third Quarter ended March 31, 2008

$
6.00

$
2.75Fourth Quarter ended June 30, 2008

$
5.00

$
2.50


Holders

As of September 15, 2009, we had approximately 100 holders of record of our common stock. Holders of record include nominees who may hold
shares on behalf of multiple owners.

Dividends

We have not declared any dividends during the last two fiscal years. At present, we intend to retain our earnings, if any, to finance research and
development and expansion of our business.

Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities

None.

ITEM 6.    SELECTED FINANCIAL DATA.

As a Smaller Reporting Company as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of
Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.

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

Important Factors Regarding Forward-Looking Statements

This annual report on Form 10-K contains forward-looking statements that involve risks and uncertainties. You should not place
undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described
in this report and other reports we file with the Securities and Exchange Commission. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only
to events as of the date on which the statements are made. We do not intend to update any of the forward-looking statements after the date of this annual report to conform these statements to actual
results or to changes in our expectations, except as required by law.

The
following discussion and analysis should be read in conjunction with the Financial Statements and Notes thereto, and other financial information included elsewhere in this annual report on
Form 10-K.

15

---





Table of Contents

Overview

We have been a developer and manufacturer of advanced optical instruments since 1982. We design and produce high-quality micro-optics,
medical instruments and other advanced optical systems. Our 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.

We
are currently developing specialty instruments incorporating our Lenslock technology (patent pending) that ensures lower cost, easier reparability and enhanced durability as compared
to other design approaches used in the industry. We are also aggressively pursuing ultra-small instruments, some with lenses less than 1 mm in diameter, utilizing micro-precision lens
technology (patent pending).

We
are certified to the ISO 9001 and ISO 13485 Quality Standards and comply with the FDA Good Manufacturing Practices and the European Union Medical Device Directive for CE marking of
our medical products. Our internet website is www.poci.com.

The
areas in which we do business are highly competitive and include both foreign and domestic competitors. Many of our competitors are larger and have substantially greater resources than we do.
Furthermore, other domestic or foreign companies, some with greater financial resources than we have, may seek to produce products or services that compete with ours. We routinely outsource
specialized production efforts as required, both domestic and offshore, to obtain the most cost effective production. Over the years, we have achieved extensive experience with other optical
specialists worldwide.

Since
the 1990s, we have maintained a Hong Kong subsidiary to support business and quality control activities as required throughout Asia. We believe that the cost savings from such production is
essential to our ability to compete on a price basis in the medical products area particularly and to our profitability in general.

We
believe that competition for sales of our medical products and services, which have been principally sold to original equipment manufacturer, or 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.

We
believe that our future success depends to a large degree on our 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, we expect to continue to seek to obtain product-related design and development contracts with customers and to invest our 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 our consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted in the United States of America, referred to as U.S. GAAP. The preparation of these consolidated financial
statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our 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.

We
believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

16

---



Table of Contents

Revenue Recognition

We recognize revenue in accordance with the Securities and Exchange Commission Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition.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) collectability 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
collectability of the sales price. We assess credit worthiness of customers based upon prior history with the customer and assessment of financial condition. Our shipping terms are customarily Free On
Board, or FOB, shipping point.

Bad Debt

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our 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 our customers were to deteriorate, resulting in an
impairment of their ability to make future payments, additional allowances may be required.

Inventories

We provide 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

We account for impairment of long-lived assets in accordance with Statement of Financial Accounting Standards, or 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 are reported at the lower of the
carrying amount or fair value less estimated costs to sell.

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 carry
forwards. 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.

17

---



Table of Contents

Stock-Based Compensation

On July 1, 2006, we adopted SFAS No. 123(R),Accounting for Stock-Based Compensation("SFAS No. 123(R)"), which requires the measurement and recognition of all compensation costs for all stock based awards made to employees and the Board of Directors based upon fair value over
the requisite service period for awards expected to vest. Prior to adoption, we accounted for stock options under the intrinsic value method set in accordance with Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations, and provided the required pro forma disclosures prescribed by
SFAS No. 123, "Accounting for Share-based Compensation" ("SFAS No. 123"), as amended.

SFAS 123(R)
requires us to estimate the fair value of share-based awards on the date of grant using an option-pricing model. We adopted SFAS 123(R) using the modified prospective
transition method which required the application of the accounting standard starting July 1, 2006, the first day of our fiscal year 2007. Prior period information has not been restated to
reflect the fair value method of expensing share-based awards.

Results of Operations for the Fiscal Year Ended June 30, 2009 Compared to the Fiscal Year Ended June 30, 2008

During the latter part of fiscal year 2008, we implemented plans to reduce costs, including workforce reductions, and to streamline operations in an
effort to reduce net losses. This has resulted in an increase in gross profit and simultaneous decreases in operating expenses, thereby reducing losses, beginning in the third and fourth quarters of
fiscal year 2008 and continuing through fiscal year 2009. We anticipate continuing measures taken to contain costs, and to continue our review of other expense areas to determine where additional
reductions in discretionary spending can be achieved.

Total
revenues for fiscal year 2009 were $3,528,510, an increase of $626,291, or 21.6%, from fiscal year 2008 revenues of $2,902,219. Revenues for fiscal 2009 represent the highest yearly sales level
in eight years and was due principally to higher sales of couplers, beamsplitters, optical components and fiber scopes utilizing our micro-precision lens and prism technology, and sales
of an
advanced surgical visualization system The design of the advanced surgical visualization system relied heavily on our experience with medical optics technologies, specifically in the area of advanced
optical endoscopic instrumentation.

Revenues
from our largest customers, as a percentage of total revenues, were as follows:

2009

2008Customer A


23
%

11
%Customer B


22


25Customer C


20


20Customer D


11


8All Others


24


36100
%

100
%


No
other customer accounted for more than 10% of our revenues in fiscal years 2009 and 2008.

Gross
profit for fiscal year 2009 reflected a favorable change of $803,672, compared to fiscal year 2008. Gross profit as a percentage of revenues increased from 27.3% in fiscal year 2008 to 45.2% in
fiscal year 2009. The favorable change in our gross profit percentage was due primarily to increased manufacturing efficiencies, favorable change in product mix and certain cost containment plans
implemented in fiscal year 2008 and continuing through fiscal year 2009.

18

---



Table of Contents

Research
and development expenses, net were $737,791 for fiscal year 2009 compared to $757,852 for fiscal year 2008. The decrease was due primarily to the recent implementation of certain cost
containment plans including workforce reductions, deferring certain development initiatives and focusing on a limited number of products and technologies expected to provide near term revenues.
Research and development expenses depend on our assessment of new product opportunities and available resources. Research and development expenses were net of reimbursement of related costs of
$181,105 and $224,107 during fiscal years 2009 and 2008, respectively.

Selling,
general and administrative expenses decreased by $417,823, or 22.4%, from $1,449,270 for fiscal year 2009 compared to $1,867,093 for fiscal year 2008. The decrease was primarily attributable
to the implementation of certain cost containment plans including workforce reductions, as mentioned above. The decrease was partially offset by higher nonrecurring legal, accounting and transfer
agent fees amounting to approximately $102,000 related to the preparation and filing of a registration statement and implementation of a 1-for-25 reverse stock split in
December 2008, as contractually required by our June 2008 financing transaction.

Sale
of assets in fiscal year 2009 represents the sale of previously written off assets for proceeds of $48,752.

Gain
on sale of product line of $210,549 in fiscal year 2008 consists of the gain on the sale of our optical thin film product line recognized in the quarter ended March 31, 2008. The purchase
price was $250,000, and we will receive a royalty of 25% of revenues exceeding $300,000 annually from the purchased customer list for a three-year period.

Interest
income decreased by $5,044 during fiscal year 2009 compared to the previous year. The decrease was due to a lower base of cash and cash equivalents.

Interest
expense increased by $443,496 during fiscal year 2009 compared to the previous year. The increase was due to accrued interest for an entire year in 2009 and non-cash interest
expense as a result of the amortization of debt discount on the 10% Senior Secured Convertible Notes issued on June 25, 2008.

The
income tax provisions in fiscal years 2009 and 2008 represent the minimum statutory state income tax liability.

Liquidity and Capital Resources

We compete in a highly technical, very competitive, and in most cases, price driven segment of the medical instrument marketplace where products can
take years to develop and introduce to distributors and end users. Furthermore, research and development, manufacturing, marketing and distribution activities are strictly regulated by the FDA, ISO
and other regulatory bodies that, while intended to enhance the ultimate quality and functionality of products produced, can contribute to the significant cost and time needed to maintain existing
products and develop and introduce product enhancements and new product innovations.

We
have traditionally funded working capital needs through product sales, management of working capital components of our business, and by cash received from public and private offerings of our common
stock, warrants to purchase shares of our common stock and convertible notes. We have incurred quarter to quarter operating losses during our efforts to develop current products including endoscopes,
image couplers, beamsplitters, thin film coatings, night vision and micro-optic lenses, prisms and assemblies for various applications and utilizing a number of proprietary and patent-pending
technologies including Lenslock endoscope and micro-precision lens technologies. Our management expects that such operating losses will continue until sales increase to
breakeven and profitable levels. Our management also believes that the opportunities represented by these products have the potential to generate sales increases to achieve breakeven and profitable
results.

19

---



Table of Contents

Our
current financial condition may raise doubt among potential equity investors, customers and suppliers regarding our ability to continue as a going concern, as referenced by the Report of
Independent Registered Public Accounting Firm on our financial statements for the year ended June 30, 2009, included in this annual report. We may not be able to obtain working capital funds
necessary in the time frame needed and at satisfactory terms to correct the going concern issue.

As
of June 30, 2009, cash and cash equivalents were $384,593, accounts receivable were $511,807 and current liabilities were $1,492,878. We anticipate that deferred officers' salaries and
director consulting expenses accrued at June 30, 2009 will be settled by issuing restricted common stock rather than by cash payments. These deferred amounts included in current liabilities at
June 30, 2009 total approximately $330,000. We believe that the introduction of several new products during the last four fiscal years, along with new and on-going customer
relationships, will continue to generate additional revenues, which are required in order for us to achieve profitability. If these additional revenues are not achieved on a timely basis, we will be
required and are prepared to implement further cost reduction measures, as necessary.

Capital
equipment expenditures during fiscal year 2009 were $0, down from $58,718 for fiscal year 2008. Future capital equipment expenditures will be dependent upon future sales and success of
on-going research and development efforts.

Contractual
cash commitments for the fiscal years subsequent to June 30, 2009 are summarized as follows:

2010

2011

Thereafter

TotalOperating Leases

$
30,450

$
800

$
1,150

$
32,400Principal & Interest (1)


720,000








720,000Totals

$
750,450

$
800

$
1,150

$
752,400


---

We
have contractual cash commitments related to open purchase orders for fiscal year 2010 of approximately $71,000.

In
February 2007, we completed a private placement, pursuant to which we sold an aggregate of 400,000 shares of common stock and warrants to purchase an aggregate of 400,000 shares of common stock at
an exercise price of $8.00 per share. Our net cash proceeds, after offering costs of $123,784, were $2,376,216. In June 2008, we issued Senior Secured Convertible Notes and warrants, raising cash
proceeds of $600,000.

Trends and Uncertainties That May Affect Future Results

Our fiscal year 2009 revenues were the highest in eight years. This was due in large part to shipments of the advanced surgical visualization system
discussed in results of
operations above, the design of which relies heavily on our world-class medical optics technologies, specifically in the area of advanced optical endoscopic instrumentation. While we had no orders for
shipments of this product from the third quarter of fiscal year 2008 through the first quarter of fiscal year 2009, we resumed shipments in the second quarter of fiscal year 2009. Our fiscal year 2009
revenues for the year ended June 30, 2009 increased 21.6% from the same period last year.

We
expect our pattern of quarter-to-quarter revenue fluctuations to continue, due to the introductory stage of many of our products and the unpredictable timing of orders from
customers and the size of

20

---



Table of Contents

those
orders in relation to total revenues. Contingent on available funding, we intend to continue to develop and commercialize new products and technical innovations, in
particular:



However,
if we do not have sufficient capital to develop and commercialize these products, our future revenues may decline because we cannot offer the innovative products the market is seeking. Over
the past few years, we have implemented significant changes in new product and technology development by shifting the emphasis of research and development efforts from developing underlying
technologies to commercialization of the applications of these new technologies. These have already been realized to some degree in a number of areas. Over the past two to three years our efforts have
produced revenues from our new micro-precision lens products and new Lenslock
endoscopes. Recent initiatives in the area of micro-precision lenses address specific customer opportunities in different medical specialty applications. In endoscope technologies, we
continue new product offerings in our Lenslock product line. We have shipped over 600 ENT endoscopes with diameter of 2.7 mm that incorporate Lenslock technology. We
recently completed prototypes of our 4 mm Lenslock sinuscope, and 5 mm Lenslock laproscope, and are actively pursuing development of our new 4 mm
Lenslock wide field arthroscope. We believe that our Lenslock technology has advantages over competitive products due to ease of manufacture and repair, superior image
quality, significant cost effectiveness and quality of repair. We anticipate that further incorporating this technology into our endoscope product line will lead to increased sales.

The
principal and interest on the 10% Senior Secured Convertible Notes amounting to $600,000 and $120,000, respectively, is due June 25, 2010. This amount may be reduced to the extent the
holders of the Notes elect to convert some or all of the principal on the Notes into our common stock. Should the holders not elect to convert all or a substantial amount of the balances due on the
Notes into our common stock, it is highly unlikely that we will be able to generate enough cash from our operations to pay these balances in full on the specified due date. Therefore, we may
renegotiate terms with existing holders or refinance this debt and, in either case, if available, the terms may be more burdensome. We are currently exploring the possibility of obtaining additional
funding sources to satisfy this repayment obligation.

In
the event the holders do not elect to convert all or a substantial amount of the balances due on the Notes into our common stock, or if we are not able to renegotiate the terms or obtain financing
on terms satisfactory to us, or at all, we may ultimately be unable to meet our payment obligations under the Notes. In such event, all unpaid principal and interest will become immediately due and
payable and the holders may pursue any other available remedies. The Notes are secured by a pledge of our assets pursuant to a pledge and security agreement and the security documents ancillary
thereto, and in the event we are unable to meet our payment obligations, the holders would have the ability to require that we immediately pay all outstanding indebtedness, and we might not have
sufficient assets to satisfy their demands. While we believe that this eventuality is unlikely, it is possible that in this event, we may be forced to seek protection under bankruptcy laws, which
could harm our future operations and overall financial condition. Additionally, a debt default could significantly diminish the market value and marketability of our common stock.

During
the last two quarters of 2008 and continuing through fiscal year 2009, we implemented certain cost containment plans which included focusing on a limited number of products and technologies

21

---



Table of Contents

expected
to provide near term revenues, streamlining operations, workforce reductions and deferring certain development initiatives. These measures reduced our overhead expenses.

Going
forward, we intend to focus our development efforts on products we believe offer the best prospects to increase our near-term revenues. An example beyond the new instruments
mentioned above includes the lenses we developed for a new color Night Vision system. During the quarter ended December 31, 2008, we shipped first article pre-production lens
systems. These are for use in the new color Night Vision system, and utilize an improved design that offers lower cost and lighter weight.

For
the quarter ended June 30, 2009, our cash and cash equivalents decreased by $124,882 from the quarter ended March 31, 2009, compared to an increase of $170,351 from the quarter ended
December 31, 2008. For the year ended June 30, 2009, our cash and cash equivalents decreased by $501,395 compared to the year ended June 30, 2008. If our cash reserves continue to
decrease, we will be required to seek additional funding for operations. The sale of additional equity or convertible debt securities would result in additional dilution to our stockholders, and debt
financing, if available, may involve restrictive covenants that could restrict our operations or finances. Financing may not be available in amounts or on terms acceptable to us, if at all. If we
cannot raise funds on acceptable terms or achieve positive cash flow, we may not be able to continue to conduct operations, develop new products, grow market share, take advantage of future
opportunities or respond to competitive pressures or unanticipated requirements, any of which would negatively impact our business, operating results and financial condition. If we are not successful
in increasing our revenues, reducing our expenses or raising additional equity capital to generate sufficient cash flows to meet our obligations as they come due, we may not be able to continue as a
going concern.

Beginning
with our annual report on Form 10-K for the fiscal year ending June 30, 2010, we will need to comply with Section 404 of the Sarbanes-Oxley Act of 2002,
which will require our independent registered public accounting firm to provide an attestation report regarding our internal controls over financial reporting. We expect our operating expense may
increase as a result of the costs associated with the implementation of and maintaining compliance with Section 404.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

As a Smaller Reporting Company as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of
Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

22

---





Table of Contents

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 (the Company) as of June 30, 2009 and the related consolidated
statements of operations, stockholders' equity and cash flows for the year 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 audit 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 audit provides 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, 2009 and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United
States of America.

The
accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial
statements, the Company has suffered recurring net losses and negative cash flows from operations, which raises substantial doubt about its ability to continue as a going concern. Management's plans
concerning these matters are described in Note 1. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/
Stowe & Degon LLC

Leominster,
Massachusetts
September 15, 2009

23

---



Table of Contents

PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES
Consolidated Balance Sheets at June 30, 2009 and 2008

2009

2008ASSETSCurrent Assets:Cash and cash equivalents

$
384,593

$
885,988Accounts receivable (net of allowance for doubtful accounts of approximately $7,400 in 2009 and 2008)


511,807


387,224Inventories


709,155


608,431Prepaid expenses


42,617


36,749Total current assets


1,648,172


1,918,392Fixed Assets:Machinery and equipment


2,352,634


2,352,634Leasehold improvements


553,596


553,596Furniture and fixtures


148,303


149,738Vehicles


42,343


42,3433,096,876


3,098,311LessAccumulated depreciation and amortization


2,968,503


2,935,922Net fixed assets


128,373


162,389Other Assets:Cash surrender value of life insurance policies





5,465Patents, net


198,643


195,391Total other assets


198,643


200,856$
1,975,188

$
2,281,637LIABILITIES AND STOCKHOLDERS' EQUITYCurrent Liabilities:10% Senior secured convertible notes

$
464,104

$
Accounts payable


428,282


364,409Customer advances


12,393


91,105Accrued employee compensation


504,187


293,497Accrued professional services


58,000


94,312Accrued warranty expense


25,000


25,000Other accrued liabilities


912


912Total current liabilities


1,492,878


869,23510% Senior secured convertible notes





10,304Commitments (Note 3)Stockholders' Equity:Common stock, $0.01 par value-Authorized50,000,000 shares issued and outstanding1,018,411 shares at June 30, 2009 and June 30,
2008


10,184


10,184Additional paid-in capital


38,222,002


38,149,655Accumulated deficit


(37,749,876
)

(36,757,741
)Total stockholders' equity


482,310


1,402,098$
1,975,188

$
2,281,637


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

24

---



Table of Contents

PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Operations for the
Years Ended June 30, 2009 and 2008

2009

2008Revenues

$
3,528,510

$
2,902,219Cost of Goods Sold


1,932,836


2,110,217Gross profit


1,595,674


792,002Research and Development Expenses, net


737,791


757,852Selling, General and Administrative Expenses


1,449,270


1,867,093Gain on Sale of Product Line





(210,549
)Gain on Sale of Assets


(48,752
)

Total operating expenses


2,138,309


2,414,396Operating loss


(542,635
)

(1,622,394
)Interest Income


5,212


10,256Interest Expense


(453,800
)

(10,304
)Loss before provision for income taxes


(991,223
)

(1,622,442
)Provision for Income Taxes


912


912Net loss

$
(992,135
)
$
1,623,354
)Loss per ShareBasic and Diluted

$
(0.97
)
$
(1.59
)Weighted Average Common Shares OutstandingBasic and Diluted


1,018,411


1,018,411


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

25

---



Table of Contents

PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
for the Years Ended June 30, 2009 and 2008

Number
of Shares

Common
Stock

Additional
Paid-in
Capital

Accumulated
Deficit

Total
Stockholders'
EquityBalance, July 1, 2007


1,018,411

$
10,184

$
37,441,413

$
(35,134,387
)
$
2,317,210Proceeds from issuance of senior convertible notes and warrants allocated to warrants








399,000





399,000Proceeds from issuance of senior convertible notes and warrants allocated to beneficial conversion feature








201,000





201,000Stock-based compensation








108,242





108,242Net loss











(1,623,354
)

(1,623,354
)Balance, June 30, 2008


1,018,411

$
10,184

$
38,149,655

$
(36,757,741
)
$
1,402,098Stock-based compensation








72,347





72,347Net loss











(992,135
)

(992,135
)Balance, June 30, 2009


1,018,411

$
10,184

$
38,222,002

$
(37,749,876
)
$
482,310


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

26

---



Table of Contents

PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows for the
Years Ended June 30, 2009 and 2008

2009

2008Cash Flows from Operating Activities:Net loss

$
(992,135
)
$
(1,623,354
)Adjustments to reconcile net loss to net cash used in operating activities-Depreciation and amortization


62,195


161,169Gain on sale of product line





(210,549
)Gain on sale of assets


(48,752
)

Gain on cash surrender value of life insurance policies


(8,752
)

Provision for inventory write-down


45,419


39,059Stock-based compensation expense


72,347


108,242Non-cash interest expense


453,800


10,304Changes in operating assets and liabilities-Accounts receivable, net


(124,583
)

413,982Inventories


(146,143
)

237,141Prepaid expenses


(5,868
)

16,290Accounts payable


63,873


20,679Customer advances


(78,712
)

88,415Accrued expenses and other


174,657


41,754Net cash used in operating activities


(532,654
)

(696,868
)Cash Flows from Investing Activities:Purchases of property and equipment





(58,718
)Proceeds from sale of assets


48,752


Proceeds from cash surrender value of life insurance policies


14,217Proceeds from sale of product line





250,000Product line sale costs





(19,051
)Increase in other assets


(31,710
)

(29,554
)Net cash provided by investing activities


31,259


142,677Cash Flows from Financing Activities:Proceeds from issuance of senior convertible notes and warrants





600,000Net cash provided by financing activities





600,000Net increase (decrease) in cash and cash equivalents


(501,395
)

45,809Cash and cash equivalents, beginning of year


885,988


840,179Cash and cash equivalents, end of year

$
384,593

$
885,988Supplemental Disclosure of Cash Flow Information:Cash paid during the year for income taxes

$
912

$
912Supplemental Disclosure of Non-Cash Investing and Financing Activities:Cost of inventory sold as part of product line disposal

$


$
20,105


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

27

---





Table of Contents

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 sustained recurring net losses and negative cash flows from operations for several years. During the year ended June 30, 2009, the Company incurred a net loss of $992,135 and
used cash in operations of $532,654. As of June 30, 2009, cash and cash equivalents were $384,593, accounts receivable were $511,807 and current liabilities were $1,492,878. The Company
anticipates that deferred officers' salaries and director consulting expenses accrued at June 30, 2009 will be settled by issuing restricted common stock rather than by cash payments. These
deferred amounts included in current liabilities at June 30, 2009 total approximately $330,000. These factors raise substantial doubt about the Company's ability to continue as a going concern.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be unable to continue as a going concern. During the latter part of fiscal year 2008, the Company implemented plans to reduce
costs and to streamline operations in an effort to reduce net losses. This has resulted in an increase in gross profit and simultaneous decreases in operating expenses, thereby reducing losses
substantially, particularly in the third and fourth quarters of fiscal year 2008. 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.

The
Company has incurred quarter to quarter operating losses during its recent efforts to develop current products including endoscopes, image couplers, beamsplitters, thin film coatings, night vision
and micro-optic lenses, prisms and assemblies for various applications and utilizing a number of proprietary and patent-pending technologies including Lenslock endoscope and micro-
precision lens technologies. Management expects that such operating losses will continue through fiscal year 2010, and until sales increase to breakeven and profitable levels. Management
also believes that the opportunities represented by these products have the potential to generate sales increases to achieve breakeven and profitable results. The Company will continue its review of
other expense areas to determine where additional reductions in discretionary spending can be achieved. There can be no assurance that the Company's operating plans will be successful, and if so
required, that the Company will be successful in obtaining the capital necessary to continue ongoing operations.

In
April 2006, the Company completed a private placement, issuing 338,000 shares of common stock. Net cash proceeds to the Company (after offering costs of $49,725) were $2,062,775. In February 2007,
the Company completed a private placement, pursuant to which it sold an aggregate of 400,000 shares of common stock and warrants to purchase an aggregate of 400,000 shares of common stock at an
exercise price of $8.00 per share. Net cash proceeds to the Company (after offering costs of $123,784)

28

---



Table of Contents

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

were
$2,376,216 (see Note 4). In June 2008, the Company issued senior secured convertible notes and warrants, raising cash proceeds of $600,000.

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 have the potential to continue the general trend of increasing revenues, which, along with enhanced operations are required in order for the Company to
achieve profitability.

(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. All shares and per share data reflect the effects of a 1-for-25 reverse stock split that became effective on December 11, 2008.

(c)   Revenues

The Company recognized revenue in accordance with Securities and Exchange Commission issued Staff Accounting Bulletin No. 104,Revenue
Recognition("SAB No. 104"), which 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) collectability 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.

The
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 that 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
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. Gross shipping charges reimbursable from customers, to deliver product, are insignificant and are included in Revenues, while shipping costs are classified as the Selling, General and
Administrative Expenses section of the Consolidated Statement of Operations.

(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
$384,593 and $885,988 at

29

---



Table of Contents

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

June 30,
2009 and 2008, respectively, consist primarily of cash at banks and money market funds. The Company maintains its cash and cash equivalents in bank deposit accounts that, at times, may
exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents.

(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, 2009 and 2008 are as follows:

2009

2008Raw material

$
492,712

$
347,298Work-in-progress


116,605


177,464Finished goods


99,838


83,669$
709,155

$
608,431


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 2009 and 2008, the Company recorded pre-tax non-cash provisions for slow-moving and obsolete inventories of approximately $45,000 and $39,000,
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 LifeMachinery and equipment

2-7 yearsLeasehold improvements

Shorter of lease term or estimated useful lifeFurniture and fixtures

5 yearsVehicles

3 years


Depreciation
expense was $33,737 and $53,720 for the years ended June 30, 2009 and 2008, respectively.

(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 with highly rated financial
institutions. The Company has not experienced any losses on these investments to date. At June 30, 2009,

30

---



Table of Contents

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

receivables
from the Company's largest customers were 32%, 21%, 19% and 13% of the total accounts receivable. At June 30, 2008, receivables from the Company's largest customers were 27%, 25%
and 17% of the total accounts receivable. No other customer accounted for more than 10% of the Company's receivables as of June 30, 2009 and 2008. 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.

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

2009

2008Customer A


23
%

11
%Customer B


22


25Customer C


20


20Customer D


11


8All Others


24


36100
%

100
%


No
other customer accounted for more than 10% of the Company's revenues in fiscal years 2009 and 2008.

(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, 2009 and 2008, the effect of
stock options and warrants was anti-dilutive; therefore, they were not included in the computation of diluted loss per share. The number of shares issuable upon the exercise of outstanding
stock options and warrants that were excluded from the computation, as their effect would be anti-dilutive, was approximately 992,000 and 996,000 during fiscal 2009 and 2008, respectively.

(i)    Stock-Based Compensation

On July 1, 2006, the Company adopted SFAS No. 123(R),Accounting for Stock-Based Compensation("SFAS
No. 123(R)"), which requires the measurement and recognition of all compensation costs for all stock-based awards made to employees and the Board of Directors based upon fair value over the
requisite service period for awards expected to vest. Prior to adoption, the Company accounted for stock options under the intrinsic value method set in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, and provided the required pro forma disclosures
prescribed by SFAS No. 123, "Accounting for Share-based Compensation" ("SFAS No. 123"), as amended.

SFAS 123(R)
requires the Company to estimate the fair value of share-based awards on the date of grant using an option-pricing model. The Company adopted SFAS 123(R) using the modified
prospective transition method which required the application of the accounting standard starting July 1, 2006, the first day of the Company's fiscal year 2007. Prior period information has not
been restated to

31

---



Table of Contents

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

reflect
the fair value method of expensing share-based awards. Stock-based compensation costs recognized for the year ended June 30, 2009 and 2008 amounted to $72,347 and $108,242,
respectively.

(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 $651,520 and $623,063 at June 30, 2009 and 2008, respectively. Such costs amortized using the
straight-line method over the shorter of their legal or estimated useful lives, generally five to ten years. Amortization expense was $28,458 and $107,448 for the years ended
June 30, 2009 and 2008, respectively. Amortization expense is expected to be approximately $26,000, $25,000, $25,000, $23,000 and $21,000, respectively, for the years ending June 30,
2010 through June 30, 2014, respectively.

(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 undiscounted 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

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 have been included as a component of cost of goods sold in the
accompanying consolidated

32

---



Table of Contents

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

statements
of operations. The following tables summarize warranty reserve activity for the two years ended June 30, 2009 and 2008:

2009

2008Balance at beginning of period

$
25,000

$
25,000Provision (credit) for warranty claims


9,569


2,619Warranty claims incurred


(9,569
)

(2,619
)Balance at end of period

$
25,000

$
25,000


(o)   Research and Development

Research and development expenses are charged to operations as incurred. The Company groups development and prototype costs and related reimbursements in research and
development. For the years ended June 30, 2009 and 2008, research and development expense is shown net of reimbursements of $181,105 and $224,107, respectively, in the accompanying statements
of operations.

(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, 2009 and 2008 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 carry-forwards. 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

33

---



Table of Contents

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

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.

(t)    Recent Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 168,The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting
Principlesa replacement of FASB Statement No. 162. SFAS No. 168 establishes the FASB Accounting Standards Codification as the source of authoritative
accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally
accepted accounting principles in the United States. This SFAS is effective for the Company's interim reporting period ending on September 30, 2009. This SFAS is not expected to have a material
impact on the Company's consolidated financial position, results of operations and cash flows.

In
June 2009, the FASB issued SFAS No. 167,Amendments to FASB Interpretation No. 46(R). SFAS No. 167 changes how a company
determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to
consolidate an entity is based on, among other things, an entity's purpose and design and a company's ability to direct the activities of the entity that most significantly impact the entity's
economic performance. This SFAS is effective for the Company's interim reporting period ending on September 30, 2010. The Company is currently evaluating the impact of the implementation of
SFAS No. 167 on its consolidated financial position, results of operations and cash flows.

In
May 2009, the FASB issued SFAS No. 165,Subsequent Events. SFAS No. 165 is intended to establish general standards of accounting for
and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This SFAS requires the disclosure of the date through which
an entity has evaluated subsequent events and the basis for that date. The disclosure requirement under this SFAS is effective for the Company's annual reporting for the fiscal year ended on
June 30, 2009.

In
April 2009, the FASB issued FSP SFAS No. 141(R)-1,Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from
Contingencies. FSP SFAS No. 141(R)-1 will amend the provisions related to the initial recognition and measurement, subsequent measurement and disclosure of
assets and liabilities arising from contingencies in a business combination under SFAS No. 141(R),Business Combinations. The FSP will carry
forward the requirements in SFAS No. 141,Business Combinations, for acquired contingencies, thereby requiring that such contingencies be
recognized at fair value on the acquisition date if fair value can be reasonably estimated during the allocation period. Otherwise, entities would typically account for the acquired contingencies in
accordance with SFAS No. 5,Accounting for Contingencies. The FSP will have the same effective date as SFAS No. 141(R), and will therefore
be effective for the Company's business combinations for which the acquisition date is on or after July 1, 2009. The Company is currently evaluating the impact of the implementation of FSP SFAS
No. 141(R)-1 on the Company's consolidated financial position, results of operations and cash flows.

34

---



Table of Contents

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

In
April 2009, the FASB issued FSP SFAS No. 157-4,Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly. FSP SFAS No. 157-4 provides guidelines for making fair value measurements more consistent with
the principles presented in SFAS No. 157,Fair Value Measurements. The FSP relates to determining fair values when there is no active market or
where the price inputs being used represent distressed sales. It reaffirms what SFAS No. 157 states is the objective of fair value measurementto reflect how much an asset would be
sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to
use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become
inactive. The FSP is effective for the Company's annual reporting for the fiscal year ended on June 30, 2009. The implementation of FSP SFAS No. 157-4 did not have a material
impact on its consolidated financial position, results of operations and cash flows.

In
April 2009, the FASB issued FSP SFAS No. 107-1 and APB 28-1,Interim Disclosures about Fair Value of Financial
Instruments. FSP SFAS No. 107-1 and APB 28-1 enhances consistency in financial reporting by increasing the frequency of fair value
disclosures. The FSP relates to fair value disclosures for any financial instruments that are not currently reflected on a company's balance sheet at fair value. Prior to the effective date of this
FSP, fair values for these assets and liabilities have only been disclosed once a year. The FSP will now require these disclosures on a quarterly basis, providing qualitative and quantitative
information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. The disclosure requirement under this FSP is effective for the Company's
interim reporting period ending on September 30, 2009.

In
April 2009, the FASB issued FSP SFAS No. 115-2 and SFAS No. 124-2,Recognition and Presentation of
Other-Than-Temporary Impairments. FSP SFAS No. 115-2 and SFAS No. 124-2 provides additional guidance designed to
create greater clarity and consistency in accounting and presenting impairment losses on securities. The FSP is intended to bring greater consistency to the timing of impairment recognition, and
provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains
fair value. The FSP also requires increased and more timely disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. The FSP is effective for the
Company's annual reporting for the fiscal year ended on June 30, 2009. The implementation of FSP SFAS No. 115-2 and SFAS No. 124-2 did not have a material
impact on the Company's consolidated financial position, results of operations or cash flows.

In
December 2008, the FASB issued FSP SFAS No. 132(R)-1,Employers' Disclosures about Postretirement Benefit Plan Assets.FSP SFAS
No. 132(R)-1 amends SFAS No. 132(R) to provide guidance on an employer's disclosures about plan assets of a defined benefit pension or other postretirement plan. The FSP
requires disclosures surrounding how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies. The disclosure
requirement under this FSP is effective for the Company's fiscal year beginning July 1, 2009.

In
October 2008, the FASB issued FSP SFAS No. 157-3,Determining the Fair Value of a Financial Asset When the Market for That Asset is Not
Active.FSP SFAS No. 157-3 clarifies the application of SFAS No. 157, which the Company adopted as of July 1, 2008, in situations where the
market for a particular financial asset is not active. The Company has considered the guidance provided by FSP SFAS No. 157-3 in its determination of estimated fair values, and the
impact was not material.

35

---





Table of Contents

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

On August 27, 2008, the SEC announced that they will issue for comment a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with
International Financial Reporting Standards ("IFRS"). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board. Under the proposed roadmap, the
Company could be required in fiscal year 2014 to prepare financial statements in accordance with IFRS. The SEC is expected to make a determination in 2011 regarding the mandatory adoption of IFRS. The
Company is currently assessing the impact that this potential change would have on its consolidated financial statements, and the Company will continue to monitor the development of the potential
implementation of IFRS.

In April 2008, the FASB adopted FSP SFAS No. 142-3,Determination of the Useful Life of Intangible Assets,
amending the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible
Assets. This FSP is effective for intangible assets acquired on or after July 1, 2009. The Company is currently
evaluating the impact of the implementation of FSP SFAS No. 142-3 on its consolidated financial position, results of operations and cash flows.

In
February 2008, the FASB adopted FSP SFAS No. 157-2,Effective Date of FASB Statement No. 157,delaying the effective date
of SFAS No. 157 for one year for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). The Company is currently evaluating the impact of the implementation of the deferred portion of SFAS No. 157 on its consolidated financial
position, results of operations and cash flows.

In
December 2007, the FASB issued SFAS No. 141 (Revised 2007),Business Combinations. SFAS No. 141(R) retains the fundamental requirements
of the original pronouncement requiring that the purchase method be used for all business combinations. SFAS No. 141(R) defines the acquirer as the entity that obtains control of one or more
businesses in the business combination, establishes the acquisition date as the date that the acquirer achieves control and requires the acquirer to recognize the assets acquired, liabilities assumed
and any noncontrolling interest at their fair values as of the acquisition date. In addition, SFAS No. 141(R) requires expensing of acquisition-related and restructure-related costs,
remeasurement of earn-out provisions at fair value, measurement of equity securities issued for purchase at the date of close of the transaction and non-expensing of
in-process research and development related intangibles. SFAS No. 141(R) is effective for the Company's business combinations for which the acquisition date is on or after
July 1, 2009, except that resolution of certain tax contingencies and adjustments to valuation allowances related to business combinations, which previously were adjusted to goodwill, will be
adjusted to income tax expense for all such adjustments after July 1, 2009, regardless of the date of the original business combination. The Company is currently evaluating the impact of the
implementation of SFAS No. 141(R) on its consolidated financial position, results of operations and cash flows.

In
December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB
No. 51. This SFAS amends Accounting Research Bulletin No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and
for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the
consolidated financial statements. It requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. This SFAS
establishes a single method of accounting for changes in a parent's ownership interest in a subsidiary that do not result in deconsolidation. SFAS No. 160 is effective for the Company's fiscal
year beginning July 1, 2009. This

36

---



Table of Contents

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

SFAS
is not expected to have a material impact on the Company's consolidated financial position, results of operations and cash flows.

(2)   10% SENIOR SECURED CONVERTIBLE NOTES

On June 25, 2008, the Company entered into a Purchase Agreement with institutional and other accredited investors (the "Investors") pursuant to which it sold an
aggregate of $600,000 of 10% Senior Secured Convertible Notes (the "Notes"), which are convertible into an aggregate of 480,000 shares of common stock, par value $0.01 per share, at a conversion price
of $1.25 per share, and warrants to purchase an aggregate of 316,800 shares of common stock at an exercise price of $1.75 per share (the "Warrants"). The Investors are current stockholders of the
Company. Interest accrues on the Notes at a rate of 10% per annum and is payable upon the earlier of conversion or maturity of the Notes. The Notes mature on June 25, 2010, and the Warrants
expire on June 25, 2015. The closing of the sale of the Notes and Warrants occurred on June 25, 2008.

The
Purchase Agreement contains customary representations and warranties of the Company and the Investors, and the Notes contain customary covenants binding on the Company and customary events of
default. If an event of default occurs and is uncured within the allowable grace period, if any, the Investors may declare all amounts under the Notes immediately due and payable and may pursue any
other available remedies.

The
Notes are secured by a pledge of the Company's assets under the terms of a Pledge and Security Agreement and the security documents ancillary thereto.

The
Notes consist of the following:

June 30,
2009

June 30,
200810% Senior Secured Convertible Notes issued on June 25, 2008, convertible into common stock at $1.25 per share, bearing interest at 10% per annum.
Outstanding principal and accrued interest are due at maturity, June 25, 2010.

$
600,000

$
600,000Accrued interest10% coupon


60,833


833Unamortized discount


(196,729
)

(590,529
)$
464,104

$
10,304


Upon
issuance of the Notes and Warrants, the proceeds of $600,000 were allocated between the Notes and Warrants based on relative fair values. The value of the Warrants was recorded as a discount to
the Notes, with a corresponding increase to additional paid-in capital. The fair value of the Warrants was determined using the Black-Scholes method, with the following assumptions:

Expected life


7 yearsRisk-free rate


4.84
%Expected Dividends


0.00
%Volatility factor


154
%


In
accordance with EITF 00-27,Application of EITF Issue No. 98-5, "Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios,"the proceeds from the issuance of the Notes were first allocated between the Notes and the Warrants. The value of the
conversion feature was then calculated, which resulted in an effective conversion ratio that was less

37

---



Table of Contents

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

than
the market price of the Company's common stock. The intrinsic value of this beneficial conversion feature was recorded as a further discount to the Notes, equal to the difference between the
effective conversion ratio and the market price of the Company's common stock, with a corresponding increase to additional paid-in capital.

The
following summarizes the discount on the Notes as of June 30:

2009

2008Discountbeginning balance

$
590,529

$
Proceeds allocated to warrants





399,000Beneficial conversion featureintrinsic value





201,000Less: amortization of discount


(393,800
)

(9,471
)Discountending balance

$
196,729

$
590,529


(3)   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 2009 and 2008, and is included in the
accompanying consolidated statements of operations.

The
Company paid or accrued fees to a director of $60,000 in each of fiscal years 2009 and 2008 for consulting services.

(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 2010. Total future minimum rental payments
under all non-cancelable operating leases are approximately $30,450 in fiscal 2010 and $1,950 thereafter.

Rent
expense on operating leases, excluding the related party rent described above, was approximately $46,844 and $46,900 for the years ended June 30, 2009 and 2008, respectively.

(4)   STOCKHOLDERS' EQUITY

(a)   Stock Options

Stock-based compensation costs recognized for the year ended June 30, 2009 and 2008, included compensation costs for awards granted prior to, but not yet vested as of
July 1, 2006 (adoption date), as well as any new grants issued after July 1, 2006. Total costs recognized during the year ended June 30, 2009 and 2008 amounted to $72,347 and
$108,242, respectively, and were included in the accompanying consolidated statements of operations in: selling, general and administrative expenses (2009  $55,340;
2008  $83,161), cost of goods sold (2009  $14,252; 2008  $18,635), and research and development expenses, net
(2009  $2,755; 2008  $6,446). No compensation has been capitalized because such amounts would have been immaterial. There was no net income tax
benefit recognized related to such compensation for the years ended June 30, 2009 or 2008, as the Company is currently in a loss position. The total number of options granted during the year
ended June 30, 2009 was 1,200.

38

---



Table of Contents

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

As
of June 30, 2009, the unrecognized compensation costs related to options vesting will be primarily recognized over a period of approximately 2 years:

OPTIONS

2010

2011

TOTALCompensation Expense

$
12,703

$
12,703

$
25,406


Upon
adoption of SFAS 123(R), in accordance with Staff Accounting Bulletin No. 107,Share-Based Payment, the Company selected the
Black-Scholes option-pricing model as the most appropriate method for determining the estimated fair value for the stock awards. The Black-Scholes method of valuation
requires several assumptions: (1) the expected term of the stock award; (2) the expected future stock volatility over the expected term; and (3) risk-free interest
rate. The expected term represents the expected period of time the Company believes the options will be outstanding based on historical information. Estimates of expected future stock price volatility
are based on the historic volatility of the Company's common stock and the risk free interest rate is based on the U.S. Zero-Bond rate. The Company utilizes a forfeiture rate based on an
analysis of the Company's actual experience. The fair value of options at date of grant was estimated with the following assumptions:

Years EndedJune 30,
2009

June 30,
2008Assumptions:Option life


5.3 years


5.3 yearsRisk-free interest rate


2.06
%

4.84
%Stock volatility


179
%

147
%Dividend yield


0


0Weighted average fair value of grants

$
1.25

$
7.25


Stock Option and Other Compensation Plans:

The type of share-based payments currently utilized by the Company is stock options.

The
Company has various stock option and other compensation plans for directors, officers, and employees. The Company has the following stock option plans outstanding as of June 30, 2009:
Amended and Restated 1997 Incentive Plan and the 2006 Equity Incentive Plan. Vesting periods are at the discretion of the Board of Directors and typically average five years. Options under these plans
are granted at fair market value and have a term of ten years from the date of grant.

During
fiscal 2007, the stockholders approved an equity incentive plan (the "2006 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 139,898 shares of common stock have been reserved for issuance under the 2006 Incentive Plan. At
June 30, 2009, a total of 4,000 stock options are outstanding and 135,898 shares of common stock were available for future grants under the 2006 Incentive Plan.

During
fiscal 1998, the stockholders approved an incentive plan (the "1997 Incentive Plan"), which provided 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. Options for a total of 94,432 shares of common stock are outstanding at June 30, 2008 under the 1997 Incentive Plan,

39

---



Table of Contents

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

as
amended and restated in fiscal year 2006. Prior to the adoption of the 2006 Incentive Plan, 9,000 stock options were granted in fiscal year 2007 under the 1997 Incentive Plan. Upon the adoption of
the 2006 Incentive Plan, no new awards were granted under the 1997 Incentive Plan. No shares are available for future grants under the Company's 1997 Incentive Plan.

The
following tables summarize stock option activity for the two years ended June 30, 2009:

Options OutstandingNumber of
Shares

Weighted Average
Exercise Price

Weighted Average
Contractual LifeOutstanding at June 30, 2007


101,335

$
15.50

8.57 yearsGrants


1,200


7.75Exercises


Cancellations


(5,303
)

9.00Outstanding at June 30, 2008


97,232

$
15.75

7.56 yearsGrants


1,200


1.25Exercises


Cancellations


(5,254
)

6.61Outstanding at June 30, 2009


93,178

$
16.17

6.56 years


Information
related to the stock options outstanding as of June 30, 2009 is as follows:

Range of Exercise Prices

Number of
Shares

Weighted-Average
Remaining
Contractual
Life (years)

Weighted-Average
Exercise Price

Exercisable
Number
of Shares

Exercisable
Weighted-Average
Exercise Price$1.25


1,200


9.41

$
1.25


1,200

$
1.25$6.25


1,600


7.42


6.25


1,600


6.25$7.75


1,200


8.42


7.75


1,200


7.75$11.50


800


6.42


11.50


800


11.50$13.75


51,018


6.86


13.75


48,352


13.75$20.75


37,360


5.96


20.75


37,360


20.75$1.25$20.75


93,178


6.56

$
16.17


90,512

$
16.24


The
aggregate intrinsic value of the Company's "in-the-money" outstanding and exercisable options as of June 30, 2009 was $0 and $0, respectively.

(b)   Registration Statement

On December 18, 2008, the Company filed a registration statement on Form S-1 to register 1,074,621 shares of common stock, which included 480,000
shares underlying Senior Secured Convertible Notes, 96,000 shares underlying potential interest due on the Notes and 498,621 shares underlying warrants. The Company filed an amendment to the
Form S-1 on April 6, 2009, reducing the number of shares being registered to 960,439 shares, which included 480,000 shares underlying the Notes and 480,439 shares underlying
warrants. The Company will not receive any proceeds from the sale or other disposition of common stock by the selling stockholders. The Company may receive proceeds from the exercise of warrants. On
June 29, 2009, the registration statement was declared effective by the U.S. Securities and Exchange Commission.

40

---



Table of Contents

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

(c)   Reverse Stock Split

Effective as of the open of business on December 11, 2008, the Company effected a reverse stock split of its common stock, par value $0.01 per share. Every 25 shares of
common stock were reclassified and combined into one share of common stock, and the Company's stock ticker symbol on the OTCBB was changed from POCI.OB to PEYE.OB. No fractional shares were issued as
a result of the reverse stock split. Instead, each resulting fractional share of common stock was rounded up to one whole share. The reverse stock split reduced the number of shares of common stock
outstanding from 25,458,212 to 1,018,411. The total number of authorized shares of common stock continued to be 50,000,000 and the par value per share of the common stock continued to be $0.01.

All
shares and per share data in the accompanying consolidated financial statements reflect the effects of the 1-for-25 reverse stock split that became effective on
December 11, 2008. In addition, capital stock has been decreased by $244,398, with a corresponding increase to paid-in capital to reflect the adjusted number of shares of $0.01 par
value common stock outstanding as a result of the 1-for-25 reverse stock split.

(d)   Warrants

In conjunction with the sale of the 10% Senior Secured Convertible Notes on June 25, 2008 mentioned above, the Company issued warrants to purchase an aggregate of
316,800 shares of common stock at an exercise price of $1.75 per share. The warrants expire on June 25, 2015.

In
February 2007, the Company completed a private placement with institutional and other accredited investors pursuant to which it sold an aggregate of 400,000 shares of common stock, at a price of
$6.25 per share and warrants to purchase an aggregate of 400,000 shares of common stock at an exercise price of $8.00 per share. In conjunction with the issuance by the Company of the 10% Senior
Secured Convertible Notes and warrants on June 25, 2008, certain anti-dilution provisions of the existing warrants were triggered. As a result, the number of existing warrants was
increased from 400,000 to 581,821 and the related exercise price was decreased from $8.00 per share to $5.50 per share. The warrants expire on February 1, 2012.

(5)   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 and $912 for the
years ended June 30, 2009 and 2008, respectively.

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

2009

2008Income tax benefit at federal statutory rate


(34.0
)%

(34.0
)%Increase (decrease) in tax resulting from- State
taxes, net of federal benefit


(6.3
)

(6.8
)Change in valuation allowance


66.9


43.0Nondeductible items


0.7


1.1Prior-year tax adjustments


(23.9
)

Other


(3.3
)

(3.2
)Effective tax rate


0.1
%

0.1
%


41

---



Table of Contents

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

The
components of deferred tax assets and liabilities at June 30, 2009 and 2008 are approximately as follows:

2009

2008Deferred tax assets:Net operating loss carry forwards

$
2,403,000

$
2,035,000Tax credit carry forwards


370,000


96,000Reserves and accruals not yet deducted for tax purposes


173,000


151,000Total deferred tax assets


2,946,000


2,282,000Valuation allowance


(2,946,000
)

(2,282,000
)Net deferred tax asset

$


$



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 increased in
fiscal 2009 by approximately $664,000.

At
June 30, 2009, the Company had federal and state net operating loss carry forwards of approximately $5,300,000 and $5,000,000, respectively, which will, if not used, expire at various dates
from 2010 through 2028. In addition, the Company had net operating loss carry forwards from its Hong Kong operations of approximately $1,600,000, which carry forward indefinitely.

(6)   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 2009 and 2008. Employer matching contributions to the plan amounted to $0 and $17,473 for fiscal years 2009 and 2008, respectively.

(7)   SALE OF PRODUCT LINE

On January 18, 2008, the Company entered into an Asset Purchase Agreement for the sale of its custom optical thin film product line and completed the sale on the same
date. The assets sold included equipment, certain inventory, intellectual property, and a customer list. The purchase price was $250,000, and the Company will also receive a royalty of 25% of revenues
exceeding $300,000 annually
from the purchased customer list for a three-year period. The Company recognized a gain of $210,549 from the sale of the product line, recorded in the quarter ended March 31, 2008.

(8)   SALE OF ASSETS

The Company sold equipment that was previously written off for proceeds totaling $48,752 and recorded a gain of $48,752, which is included within operating expenses in the
accompanying consolidated statements of operations.

42

---





Table of Contents

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

None.

ITEM 9A(T).    CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and our Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures as of the end of
the period covered by this annual report on Form 10-K. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure
controls and procedures, including internal control over financial reporting, were not effective as of June 30, 2009, to ensure that information we are required to disclose in reports that we
file or submit under the Securities Exchange Act of 1934, as amended (i) is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission
rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure. Our disclosure controls and procedures are intended to be designed to provide reasonable assurance that such information is accumulated and communicated to our
management.

Management's Annual Report on Internal Control Over Financial Reporting

Our disclosure controls and procedures include components of our internal control over financial reporting. In designing and evaluating our
disclosure controls and procedures management recognizes that any controls, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that misstatements due to
error or fraud will not occur or that all control issues and instances of fraud, if any, with our Company have been detected.

A
"material weakness" is defined as a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or
interim financial statements will not be prevented or detected. A "significant deficiency" is a control deficiency, or a combination of control deficiencies, that adversely affects a company's ability
to initiate, authorize, record, process or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a
misstatement of the annual or interim financial statements that is more than inconsequential will not be prevented or detected.

Under
the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we conducted an assessment of the effectiveness of our
internal control over financial reporting as of June 30, 2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) inInternal ControlIntegrated Framework.

The
following is a description of two material weaknesses in the Company's internal control over financial reporting:

Segregation
of Duties: As previously disclosed in our annual report on Form 10-K for the fiscal year ended June 30, 2008, our management identified a control deficiency
during the 2008 fiscal year because we lacked sufficient staff to segregate accounting duties. We believe the control deficiency resulted primarily because we have the equivalent of one and
one-half persons performing all accounting-related on-site duties. As a result, we did not maintain adequate segregation of duties within our critical financial reporting
applications, the related modules and financial reporting processes. This control deficiency could result in a misstatement of balance sheet and income statement accounts in

43

---



Table of Contents

our
interim or annual consolidated financial statements that would not be detected. Accordingly, management has determined that this control deficiency constitutes a material weakness. No audit
adjustments to the Company's audited financial statements as of June 30, 2009 were necessary as a result of this condition.

To
address and remediate the material weakness in internal control over financial reporting described above, beginning with the quarter ended September 30, 2008, we instituted a procedure
whereby our President, our Executive Vice President and other members of our Board of Directors will perform a higher level review of the quarterly and annual reports on Form 10-Q
and Form 10-K prior to filing.

We
believe that the step outlined above strengthens our internal control over financial reporting and mitigates the material weakness described above. As part of our 2010 assessment of internal
control over financial reporting, our management will evaluate this additional control to assess whether it is operating effectively.

Inventory
Valuation: There are insufficient controls with respect to the valuation of our inventories. Specifically, the amounts used to value our inventory at June 30, 2009 with respect to
overhead rates and purchased items were often not consistent with the supporting documentation, due to year-to-year changes in overhead rates and costs of purchased items that
were not properly reflected in inventory valuation. Accordingly, management has determined that this control deficiency constitutes a material weakness. No audit adjustments to the Company's audited
financial statements as of June 30, 2009 were necessary as a result of this condition.

To
address and remediate the material weakness in internal control over financial reporting described above, we intend to implement procedures to improve our inventory controls and documentation
surrounding inventory valuation for overhead rates and purchased items.

We
intend to continue to remediate material weaknesses and enhance our internal controls but cannot guarantee that our efforts will result in remediation of our material weaknesses or that new issues
will not be exposed in this process.

This
annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to
attestation by our registered public accounting firm pursuant to the temporary rules of the Securities and Exchange Commission that permit us to provide only management's report in this annual report.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the fourth quarter of our fiscal year covered by this
annual report on Form 10-K that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.    OTHER INFORMATION.

None.

PART III

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

We will furnish to the Securities and Exchange Commission a definitive Proxy Statement not later than 120 days after the close of our fiscal
year ended June 30, 2009. The information required by this item, other than with respect to our Corporate Code of Ethics and Conduct, is incorporated herein by reference to the Proxy Statement.

44

---



Table of Contents

A
copy of our Corporate Code of Ethics and Conduct applicable to all employees, officers and directors of our Company, including our principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar functions can be obtained free of charge by contacting our Clerk, c/o Precision Optics Corporation, 22 East Broadway, Gardner,
Massachusetts 01440.

ITEM 11.    EXECUTIVE COMPENSATION.

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

ITEM 12.    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 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

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

ITEM 14.    PRINCIPAL ACCOUNTING FEES AND SERVICES.

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

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

The
following documents are filed in Part II, Item 8 of this annual report on Form 10-K:

Report
of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at June 30, 2009 and 2008
Consolidated Statements of Operations for the years ended June 30, 2009 and 2008
Consolidated Statements of Stockholders' Equity for the years ended June 30, 2009 and 2008
Consolidated Statements of Cash Flows for the years ended June 30, 2009 and 2008
Notes to Consolidated Financial Statements

All
financial statement schedules have been omitted as they are not required, not applicable, or the required information is otherwise included.

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

Exhibit

Description2.1

Asset Purchase Agreement between the Company and Optometrics Corporation, dated January 18, 2008 (included as Exhibit 2.1 to the Form 8-K filed January 25, 2008 and incorporated herein by
reference).3.1

Articles of Organization of the Company, as amended (included as Exhibit 3.1 to the Form SB-2 filed March 16, 2007 and incorporated herein by reference).3.2

By-laws of Precision Optics Corporation (included as Exhibit 3.2 to the Form S-1 filed on December 18, 2008 and incorporated herein by reference).


45

---



Table of Contents

3.3

Articles of Amendment, dated December 11, 2008 (included as Exhibit 3.1 to the Form 8-K filed December 11, 2008 and incorporated herein by reference).4.1

Registration Rights Agreement, dated March 17, 2000 (included as Exhibit 4.4 to the Form S-3 filed April 28, 2000 and incorporated herein by reference).4.2

Registration Rights Agreement, dated June 30, 1998 (included as Exhibit 4.9 to the Form 10-KSB filed September 29, 1998 and incorporated herein by reference).4.3

Registration Rights Agreement, dated August 5, 1999 (included as Exhibit 4.7 to the Form 10-KSB filed September 28, 1999 and incorporated herein by reference).4.4

Registration Rights Agreement, dated February 1, 2007 (included as Exhibit 4.1 to the Form 8-K filed February 2, 2007 and incorporated herein by reference).4.5

Form of Warrant to Purchase Shares of Common Stock (included as Exhibit 4.2 to the Form 8-K filed February 2, 2007 and incorporated herein by reference).4.6

Registration Rights Agreement by and among the Company and each investor named therein, dated June 25, 2008 (included as Exhibit 4.1 to the Form 8-K filed June 27, 2008 and incorporated herein by
reference).4.7

Form of Warrant, dated June 25, 2008 (included as Exhibit 4.2 to the Form 8-K filed June 27, 2008 and incorporated herein by reference).4.8

Form of 10% Senior Secured Convertible Note, dated June 25, 2008 (included as Exhibit 4.3 to the Form 8-K filed June 27, 2008 and incorporated herein by reference).10.1

Precision Optics Corporation, Inc. 1997 Incentive Plan, as amended and restated (included as Exhibit 10.1 to the Form 10-QSB filed November 13, 2003 and incorporated herein by
reference).10.2

Securities Purchase Agreement between the Company and investors, dated March 13, 2000 (included as Exhibit 2.1 to the Form S-3 filed April 28, 2000 and incorporated herein by
reference).10.3

Form of Securities Purchase Agreement between the Company and investors (included as Exhibit 10.1 to the Form 8-K filed April 19, 2006 and incorporated herein by reference).10.4

Employment Offer Letter from the Company to Michael T. Pieniazek, dated September 15, 2006 (included as Exhibit 10.1 to the Form 8-K filed September 21, 2006 and incorporated herein by
reference).10.5

Precision Optics Corporation, Inc. 2006 Equity Incentive Plan (included as Exhibit 99.1 to the Form 8-K filed December 4, 2006 and incorporated herein by reference).10.6

Purchase Agreement between the Company and investors, dated February 1, 2007 (included as Exhibit 10.1 to the Form 8-K filed February 2, 2007 and incorporated herein by reference).10.7

Form of Incentive Stock Option Certificate (included as Exhibit 10.1 to the Form 10-QSB filed February 14, 2007 and incorporated herein by reference).10.8

Form of Nonstatutory Stock Option Certificate (included as Exhibit 10.2 to the Form 10-QSB filed February 14, 2007 and incorporated herein by reference).10.9

Purchase Agreement by and among the Company and each investor named therein, dated June 25, 2008 (included as Exhibit 10.1 to the Form 8-K filed June 27, 2008 and incorporated herein by
reference).


46

---



Table of Contents

10.10

Pledge and Security Agreement by and among the Company and each investor named therein, dated June 25, 2008 (included as Exhibit 10.2 to the Form 8-K filed June 27, 2008 and incorporated herein by
reference).10.11

Consulting Agreement between the Company and Jack P. Dreimiller, dated August 15, 2008 (included as Exhibit 10.1 to the Form 8-K filed August 18, 2008 and incorporated herein by
reference).10.12

Side Letter Agreement between the Company and the investors signatory to the Purchase Agreement, dated June 25, 2008, dated November 25, 2008 (included as Exhibit 10.1 to the Form 8-K filed
December 11, 2008 and incorporated herein by reference).10.13

Side Letter Agreement between the Company and the holders signatory to the 10% Senior Secured Convertible Note, dated December 11, 2008 (included as Exhibit 10.15 to the Form S-1 filed December 18,
2008 and incorporated herein by reference).10.14

Side Letter Agreement between the Company and the holders signatory to the 10% Senior Secured Convertible Note, dated April 2, 2009 (included as Exhibit 10.16 to the Form S-1/A filed April 6, 2009
and incorporated herein by reference).14.1

Precision Optics Corporation, Inc. Corporate Code of Ethics and Conduct (included as Exhibit 14.1 to the Form 10-K filed September 28, 2008 and incorporated herein by reference).21.1

Subsidiaries of the Registrant (included as Exhibit 21.1 to the Form 10-K filed September 26, 2008 and incorporated herein by reference).23.1

Consent of Independent Registered Public Accounting Firm (filed herewith).31.1

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).31.2

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).32.1

Certification of Officers pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).


47

---





Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

Date: September 28, 2009

PRECISION OPTICS CORPORATION, INC.By:

/s/ Richard E. Forkey Richard E. Forkey
Chairman of the Board,
Chief Executive Officer (Principal
Executive Officer),
President and Treasurer


Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated.

Signature

Title

Date/s/ Richard E. Forkey Richard E. Forkey

Chairman of the Board, Chief Executive Officer, President and Treasurer (Principal Executive Officer)

September 28, 2009/s/ Joseph N. Forkey Joseph N. Forkey

Executive Vice President, Chief Scientific Officer and Director

September 28, 2009/s/ Donald A. Major Donald A. Major

Director

September 28, 2009/s/ Richard B. Miles Richard Miles

Director

September 28, 2009/s/ Joel R. Pitlor Joel R. Pitlor

Director

September 28, 2009/s/ Jack P. Dreimiller Jack P. Dreimiller

Senior Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

September 28, 2009


48

---