**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


__________________________________





**FORM
      10-KSB**





(Mark
      One)


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


For
      the
      Fiscal Year Ended June 30, 2007




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


For
      transition period from ____ to ____





Commission
      File Number **001-10647**





**PRECISION
      OPTICS CORPORATION, INC.**


(Name
      of
      small business issuer in its charter)





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





**22
      East Broadway**


**Gardner,
      Massachusetts 01440**


(Address
      of principal executive offices) (Zip Code)





**(978)
      630-1800**


(Issuer’s
      telephone number, including area code)





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





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





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





Check
      whether the issuer: (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days.


Yes x No  ̈





Check
      if
      no disclosure of delinquent filers in response to Item 405 of Regulation S-B
      is
      contained in this form, and no disclosure will be contained, to the best of
      registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-KSB or any amendment
      to
      this Form 10-KSB.  ̈





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


Yes  ̈ No x





The
      issuer’s revenues for its most recent fiscal year were $2,477,469.





The
      aggregate market value of the voting stock, consisting solely of common stock,
      held by non-affiliates of the issuer computed by reference to the closing price
      of such stock was $2,278,356 as of August 31, 2007.





The
      number of shares of outstanding common stock of the issuer as of August 31,
      2007
      was 25,458,212.





Transitional
      Small Business Disclosure Format (check one):   Yes  ̈ No x









**DOCUMENTS
      INCORPORATED BY REFERENCE**





The
      issuer’s Proxy Statement for the 2007 Annual Meeting of Shareholders to be held
      on November 27, 2007 is incorporated by reference into Part III of this Form
      10-KSB.




-
          2
          -




**PART
      I**


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







*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.
      Readers should pay particular attention to the considerations described in
      the
      section of this report entitled “* ***Managements
      Discussion and Analysis of Financial Condition and Results of Operations -
      Factors That May Affect Future Results and Market Price of
      Stock.*** *”
      Readers should also carefully review any risk factors described in other
      documents the Company files from time to time with the Securities and Exchange
      Commission.*




*Where
      we say “we”, “us”, “our”, or the “Company”, we mean Precision Optics Corporation
      or Precision Optics Corporation and it subsidiaries, as applicable. Where we
      refer to the “industry”, we mean the optical instruments manufacturing industry.
      Certain statements in this Annual Report contain words such as “could”,
“expects”, “may”, “anticipates”, “believes”, “intends”, “estimates”, “plans”,
“envisions”, “seeks” and other similar language and are considered forward
      looking statements or information under applicable securities laws. These
      statements are based on our current expectations, estimates, forecasts and
      projections about the operating environment, economies and markets in which
      we
      operate. These statements are subject to important assumptions, risks and
      uncertainties, which are difficult to predict and the actual outcome may be
      materially different. 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.*





**HISTORY**





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





**BUSINESS
      OF ISSUER**





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





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





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




-
          3
          -




The
      Company produces autoclavable endoscopes for various applications, which are
      CE
      mark certified for European use, and have been designed and tested to withstand
      sterilization by autoclave (sterilization in superheated steam under pressure),
      as well as all other commonly used medical sterilization means. The major
      benefits of instruments that can be autoclaved include increased patient safety,
      quick turnaround, and elimination of hazardous sterilant and by-product
      materials, all of which provide increased value to the user compared to
      alternative sterilization methods.





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





Medical
      Products: Next Generation LenslockTMEndoscopes. The
      Company continues to develop and ship its next generation endoscopes that
      incorporate its leading proprietary Lenslock TM technology (patent pending). Since December 2005, over 250 ENT endoscopes with
      diameter of 2.7 mm that incorporate LenslockTM technology have been
      shipped. The Company is currently launching its 4 mm LenslockTM
      sinuscope, finalizing development of its 5 mm LenslockTM laproscope,
      and is actively pursuing development of its new 4 mm LenslockTM wide
      field arthroscope. All of these LenslockTM endoscopes are expected to
      be in production in the near future. The Company believes that
      Lenslock TM technology has advantages over competitive products due to ease of manufacture
      and repair, superior image quality, significant cost effectiveness and quality
      of repair and that further incorporating this into its endoscope product line
      will lead to increased sales.





Medical
      Products: Sub-millimeter optics & endoscopes: Utilizing recently developed proprietary techniques, including patent pending
      micro-precisionTM lens fabrication technology, the Company designs
      and manufactures 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 millimeters in diameter. Utilizing its proprietary technology, the
      Company currently manufactures a number of products with length and / or
      diameter less than 1 mm and is actively expanding its product line in this
      area.





Medical
      Products: Custom design & device production. The
      Company designs, prototypes and manufactures custom optical medical products
      to
      satisfy customers’ specific requirements. During fiscal year 2007, the Company
      completed development and began shipments of an advanced surgical visualization
      system to a significant new customer. Possible follow-on orders will be
      dependent on market acceptance and other considerations and no assurances
      regarding any such order can be made.




Industrial
      Products .
      In
      addition to its medical products, the Company also sells 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-precisionTM technology, the
      Company also designs and manufactures sub-millimeter optical components and
      assemblies for industrial use.





Optical
      Thin Films .
      The
      Company designs and manufactures various types of high quality thin film
      coatings for use in a wide range of optical applications. Thin film coatings
      are
      produced in-house for use in the Company’s medical instrumentation and other
      products. In addition, the company designs and manufactures custom thin film
      products. The Company recently began shipping a new, proprietary industrial
      filter which was developed over the past eighteen months for a specific
      customer.





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




-
          4
          -




Optical
      System Design and Development Services .
      The
      Company is 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
      the Company’s efforts have led to optical system production business for the
      Company, and the Company believes its prototype development service may lead
      to
      new product production from time to time.





**Competition
      and Markets**.





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





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




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




-
          5
          -




During
      the past year and one-half, the Company has added significant new resources
      with
      the addition of a director of marketing with special experience in broad market
      initiatives, especially in the medical field. Together with the Company’s
      existing sales and marketing staff, this team has already begun a number of
      efforts to strengthen the Company’s market presence. This has included a newly
      designed website ( www.poci.com ),
      and a
      much more comprehensive view of trade show opportunities. Coupled with the
      recently renewed efforts for select key trade show attendance by the Company’s
      Chief Scientific Officer and its Chief Executive Officer, as well as its overall
      sales and marketing staff, the Company believes it has a greater opportunity
      to
      reach and follow up a broader customer base than the Company has heretofore
      been
      able to achieve. A number of new opportunities are already leading to customer
      discussions for prospects for the Company’s leading technologies including,
      Lenslock TM ,
      micro-precision TM ,
      and
      custom applications of the Company’s core optical capabilities. This includes
      renewed interest in some of the Company’s well-developed products such as its
“classic” autoclavable endoscopes, and endocouplers, as well as new applications
      with the Company’s micro (fiberoptic) endoscopes.





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





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




**Research
      and Development**.





The
      Company believes that its future success depends to a large degree on its
      ability to continue to conceive and to develop new optical products and services
      to enhance the performance characteristics and methods of manufacture of
      existing products. Accordingly, it expects to continue to seek to obtain
      product-related design and development contracts with customers and to invest
      its own funds on its research and development. The Company spent approximately
      $1,312,000 and $1,106,000 of its own funds (net of reimbursements) during fiscal
      years 2007 and 2006, respectively, on research and development.





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





**Raw
      Materials and Principal Suppliers** .





The
      basic
      raw material of the majority of the Company’s product line is precision grade
      optical glass, which the Company obtains from several major suppliers. For
      optical thin film coatings, the basic raw materials are metals and dielectric
      compounds, which the Company obtains from a variety of chemical suppliers.
      Certain of the thin film coatings utilized in the Company’s products are
      currently procured from an outside supplier, but most thin film coatings are
      produced in-house. The Company believes that its demand for these raw materials
      and thin film coating services is small relative to the total supply, and that
      materials and services required for the production of its products are currently
      available in sufficient production quantities and will be available for fiscal
      year 2008. The Company believes, however, that there are relatively few
      suppliers of the high quality lenses and prisms which its endoscopes require.
      In
      response, the Company has established its own optical shop for producing
      ultra-high quality prisms, micro-optics and other specialized optics for a
      variety of medical and industrial applications.




**Patents
      and Trademarks**.




-
          6
          -




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





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





**Employees** .





As
      of
      June 30, 2007, the Company had 35 full time employees and 7 part time employees.
      There were 21 employees in manufacturing, 12 in engineering/research and
      development, 3 in sales and marketing, and 6 in finance and
      administration.




**Customers** .





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




**2007**
            
            **2006**Customer
                A
            
            
            27
            %
            
            18
            %Customer
                B
            
            
            22
            
            
            15Customer
                C
            
            
            10
            
            
            15All
                Others
            
            
            41
            
            
            52100
            %
            
            100
            %





No
      other
      customer accounted for more than 10% of the Company’s revenues in fiscal years
      2007 and 2006.





**Environmental
      Matters** .




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





**Government
      Regulations on the Business** .




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





-
          7
          -





The
      Company provided notification to the FDA of its intent to market its endoscopes,
      image couplers, beamsplitters, adapters and video ophthalmoscopes, and the
      FDA
      has determined that the Company may market such devices, subject to the general
      controls provisions of the Food, Drug and Cosmetic Act. This FDA permission
      was
      obtained without the need to undergo a lengthy and expensive approval process
      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, the Company plans to market additional endoscopes and related medical
      products that may require the FDA’s permission to market such products. The
      Company may also develop additional products or seek to sell some of its current
      or future medical products in a manner that requires the Company to obtain
      the
      permission of the FDA to market such products, as well as the regulatory
      approval or license of other federal, state, and local agencies or similar
      agencies in other countries. The FDA has authority to conduct detailed
      inspections of manufacturing plants in order to assure that “good manufacturing
      practices” are being followed in the manufacture of medical devices, to require
      periodic reporting of product defects to the FDA, and to prohibit the sale
      of
      devices which do not comply with law.





Foreign
      Requirements .
      Sales
      of medical device products outside the United States are subject to foreign
      regulatory requirements that may vary from country to country. Our failure
      to
      comply with foreign regulatory requirements would jeopardize our ability to
      market our products in foreign jurisdictions. The regulatory environment in
      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 the Company’s medical products are CE mark
      certified.




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





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





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




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





None.




-
          8
          -




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





No
      matters were submitted to a vote of the Company’s security holders during the
      fourth quarter of fiscal year 2007.




-
          9
          -


**PART
      II**




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





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




**2007**
            
            
            
            **2006**Quarter
            
            High
            
            Low
            
            High
            
            LowFirst
            
            $
            0.49
            
            $
            0.25
            
            $
            0.90
            
            $
            0.45Second
            
            $
            0.49
            
            $
            0.25
            
            $
            0.80
            
            $
            0.20Third
            
            $
            0.60
            
            $
            0.32
            
            $
            0.50
            
            $
            0.20Fourth
            
            $
            0.50
            
            $
            0.32
            
            $
            0.71
            
            $
            0.32





On
      February 1, 2007, the Company sold an aggregate of 10,000,000 shares of common
      stock, par value $0.01 per share, at a price of $0.25 per share and warrants
      to
      purchase an aggregate of 10,000,000 shares of common stock at an exercise price
      of $0.32 per share, which were immediately exercisable, raising gross proceeds
      of $2,500,000. All of the following shares of common stock issued were issued
      in
      a non registered transaction in reliance on Section 4(2) of the Securities
      Act
      of 1933, as amended:




**Purchaser**
            
            **Common
                Stock**
              **Purchased***Special
                Situations Fund III QP, L.P.
            
            8,000,000Special
                Situations Private Equity Fund, L.P.
            
            8,000,000Joel
                Pitlor (a)
            
            2,000,000Arnold
                Schumsky
            
            1,200,000LaPlace
                Group LLC
            
            800,000





*
      Includes shares of common stock and shares underlying outstanding
      warrants


(a)
      Director of the Company





These
      shares and the shares of common stock issuable upon the exercise of the warrants
      were subsequently registered on a registration statement on a Form SB-2, which
      was declared effective by the Securities and Exchange Commission on March 23,
      2007.





As
      of
      August 31, 2007, there were approximately 130 holders of record of the Company’s
      common stock. Holders of record include nominees who may hold shares on behalf
      of multiple owners.





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





-
          10
          -





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





**Important
      Factors Regarding Forward-Looking Statements**





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





**Overview**





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





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





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





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





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




-
          11
          -




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




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





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





***General***





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





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





***Revenue
      Recognition***





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





***Bad
      Debt***





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





***Inventories***





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




-
          12
          -




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





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




***Income
      Taxes***





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





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





***Stock-Based
      Compensation***





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 reflect
      the
      fair value method of expensing share-based awards.




**Fiscal
      Year 2007 Results of Operations**  ****




Total
      revenues for fiscal year 2007 were $2,477,469, an increase of $327,905, or
      15%,
      from fiscal year 2006 revenues of $2,149,564. Revenues for the fourth quarter
      of
      fiscal year 2007 were $1,111,833. These represent the highest quarterly and
      yearly sales levels in six years and were due principally to shipments, to
      a
      significant new customer, of an advanced surgical visualization system, along
      with the introduction of a number of other new products. The advanced surgical
      visualization system relied heavily on the Company’s experience and superior
      technology in the area of medical optics systems, specifically in the area
      of
      advanced optical endoscopic instrumentation.




-
          13
          -


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





**2007**
            
            **2006**Customer
                A
            
            
            27
            %
            
            18
            %Customer
                B
            
            
            22
            
            
            15Customer
                C
            
            
            10
            
            
            15All
                Others
            
            
            41
            
            
            52100
            %
            
            100
            %




No
      other
      customer accounted for more than 10% of our revenues in fiscal years 2007 and
      2006.





Gross
      profit for fiscal year 2007 reflected a change of $225,180, compared to fiscal
      year 2006. Gross profit as a percentage of revenues increased from 12% in fiscal
      year 2006 to 19% in fiscal year 2007. The favorable change in gross profit
      was
      due primarily to increased sales volume as a result of the introduction of
      a new
      advanced surgical visualization system for a significant new customer in fiscal
      year 2007 compared to fiscal year 2006.




Research
      and development expenses increased by $206,273, or 19%, during fiscal year
      2007
      compared to the previous year. The increase was due primarily to activities
      aimed at the development of a new advanced surgical visualization system for
      a
      significant new customer. Research and development expenses were net of
      reimbursement of related costs of $101,309 and $135,129 during fiscal years
      2007
      and 2006, respectively.





Selling,
      general and administrative expenses increased by $645,938 or 44%, during fiscal
      year 2007 compared to the previous year. The increase was primarily a result
      of
      a non-cash charge of $164,831 related to stock-based compensation expense
      following the adoption of SFAS No. 123(R) on July 1, 2006, along with enhanced
      sales and marketing activities focused on increasing sales of recently developed
      products, including a new director of marketing for a full-year and higher
      professional fees. The previous year expense was also lower as it included
      the
      effect of a gain on the sale of fixed assets of $165,700.





Interest
      income increased by $9,677 or 27% during fiscal year 2007 compared to the
      previous year. The increase was due to higher interest rates and a higher
      average balance of cash and cash equivalents.





The
      income tax provisions in fiscal years 2007 and 2006 represent the minimum
      statutory state income tax liability.




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





Total
      revenues for fiscal year 2006 were $2,149,564, an increase of $895,714, or
      71%,
      from fiscal year 2005 revenues of $1,253,850.





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




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





**2006**
            
            **2005**Customer
                A
            
            
            18
            %
            
            20
            %Customer
                B
            
            
            15
            
            
            12Customer
                C
            
            
            15
            
            
            —All
                Others
            
            
            52
            
            
            68100
            %
            
            100
            %





No
      other
      customer accounted for more than 10% of our revenues in fiscal years 2006 and
      2005.




-
          14
          -




Gross
      profit (loss) for fiscal year 2006 reflected a change of $633,462 compared
      to
      fiscal year 2005. Gross profit as a percentage of revenues increased from a
      negative 31% in fiscal year 2005 to a positive 12% in fiscal year 2006. The
      favorable change in gross profit (loss) was due primarily to increased sales
      volume and lower provisions for slow moving and obsolete inventories in fiscal
      year 2006 compared to fiscal year 2005.




Research
      and development expenses decreased by $301,843, or 21%, during fiscal year
      2006
      compared to the previous year. The decrease was due to a lower level of
      resources being devoted to product development activities, and a shift to more
      customer focused efforts, resulting in initial product shipments to several
      new
      customers. Research and development expenses were net of reimbursement of
      related costs of $135,129 and $95,969 during fiscal years 2006 and 2005,
      respectively.





Selling,
      general and administrative expenses decreased by $405,311 or 22%, during fiscal
      year 2006 compared to the previous year. The decrease was due primarily to
      the
      effect of a gain on the sale of fixed assets of $165,700, along with savings
      from reduced professional fees, the chief financial officer position changing
      to
      part time, and through reduced premiums as a result of changing our general
      insurance provider, offset by an increase in consulting fees.





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





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




**Liquidity
      and Capital Resources**





The
      company competes in a highly technical, very competitive, and in most cases,
      price driven segments of the medical instrument market place 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 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.





The
      company has traditionally funded working capital needs through product sales,
      management of working capital components of its business, and most prominently,
      by cash received from public and private offerings of its common stock. In
      July
      2004, the Company completed a rights offering to stockholders of record at
      June
      7, 2004 by issuing 5,256,159 shares of common stock, raising net cash proceeds
      of approximately $5 million. In April 2006, the Company sold 8,450,000 shares
      of
      its common stock, raising net cash proceeds of approximately $2 million.
      Additionally, in February 2007, the Company sold an aggregate of 10,000,000
      shares of common stock and warrants to purchase an aggregate of 10,000,000
      shares of common stock at an exercise price of $0.32 per share, raising net
      cash
      proceeds of approximately $2.4 million.





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 LenslockTMendoscope
      and micro-precisionTM lens technologies. Management expects that such
      operating losses will continue through fiscal year 2008 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’s current financial condition may raise
      doubt among potential equity investors, customers and suppliers regarding the
      Company’s ability to continue as a going concern, as referenced by the Report of
      Independent Registered Public Accounting Firm on the Company's financial
      statements for the year ended June 30, 2007, included in this Annual Report
      on
      Form 10-KSB. There can be no assurance that the Company will be able to obtain
      working capital funds necessary in the time frame needed and at satisfactory
      terms to correct the current going concern issue.




As
      of
      June 30, 2007, cash and cash equivalents were $840,179, accounts receivable
      were
      $801,206 and current liabilities were $718,387, resulting in a net liquid asset
      amount of $922,998. Based on the current financial condition of the company
      and
      the expectation of future continued quarterly operating losses during fiscal
      2008, Management is currently investigating and evaluating alternatives for
      raising additional capital through private and public equity offerings that
      can
      be completed sometime during the first half of fiscal 2008.




-
          15
          -


Contractual
      cash commitments for the fiscal years subsequent to June 30, 2007 are summarized
      as follows:





**2008**
            
            **Thereafter**
            
            **Total**Operating
                Leases
            
            $
            30,068
            
            $
            371
            
            $
            30,439




The
      Company currently has contractual cash commitments for open purchase orders
      subsequent to June 30, 2007 of approximately $118,000.




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





Fiscal
        year 2007 yearly and fourth quarter revenues were the highest in six years.
        This
        was due in large part to shipments of the advanced surgical visualization
        system
        discussed below, the design of which relies heavily on the Company’s world class
        medical optics technologies, specifically in the area of advanced optical
        endoscopic instrumentation. The Company expects its recent pattern of
        quarter-to-quarter revenue fluctuations to continue, due to the introductory
        stage of many of the Company’s products currently under development and the
        uncertain timing of orders from customers and their size in relation to total
        revenues. The Company continues to move forward with new products and technical
        innovations, in particular, a new generation of endoscopes that incorporate
        Lenslock TM technology (patent pending), new components and instruments utilizing the
        Company’s new micro-precision TM lens
        technology (patent pending) for optical components and endoscopes under 1
        mm,
        new custom medical products, new night vision lenses and new thin film
        products.





Over
      the
      past few years new product and technology development has undergone significant
      changes in shifting the emphasis of R&D efforts from the development of
      underlying technologies to market exploitation in 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 these developments have produced
      revenues from new micro- precisionTM lens products and new Lenslock TM endoscopes. Recent initiatives in the area of micro-precisionTM
      lenses address specific customer opportunities in different medical specialty
      applications. In endoscope technologies we continue new product offerings in
      our
      Lenslock TM product
      line. Since December 2005, over 250 ENT endoscopes with diameter of 2.7 mm
      that
      incorporate LenslockTM technology have been shipped. The Company is
      currently launching its 4 mm LenslockTM sinuscope, is finalizing
      prototypes of its 5 mm LenslockTM laproscope, and is actively
      pursuing development of its 4 mm LenslockTM wide field arthroscope.
      All of these LenslockTM endoscopes are expected to be in production
      in the near future. The Company believes that Lenslock TM technology has advantages over competitive products due to ease of manufacture
      and repair, superior image quality, significant cost effectiveness and quality
      of repair and that further incorporating this into its endoscope product line
      will lead to increased sales.





During
      fiscal year 2007, the Company began shipments of an advanced surgical
      visualization system to a significant new customer. These shipments are pursuant
      to production orders totaling over $1 million. Shipments of the advanced
      surgical visualization system were in excess of $600,000 in fiscal year 2007
      with the balance of the order delivered in the first quarter of fiscal year
      2008. Possible follow-on orders will be dependent on market acceptance and
      other
      considerations at that time and no assurances regarding any such order can
      be
      made.




-
          16
          -




Going
      forward, our expectations are aimed at applied development for revenue bearing
      products. Some examples beyond the new instruments mentioned above include
      the
      lenses we developed for a new color Night Vision system that we are beginning
      to
      manufacture in pre-production quantities, as well as a new line of industrial
      filter thin film coatings, which we have developed over the last 18 months
      and
      just recently began to ship to a specific customer.





Notwithstanding
      the need to obtain additional financing, the Company believes that the recent
      introduction of several new products, along with new and on-going customer
      relationships, have the potential to generate additional revenues, which
      are required in order for the Company to achieve profitability.




For
        the
        quarter ended June 30, 2007, cash and cash equivalents decreased by $1,270,980
        compared to an increase of $1,558,869 for the previous quarter ended March
        31,
        2007 as a result of the receipt of $2,500,000 in gross proceeds from the
        closing
        of a private placement on February 1, 2007, offset by negative cash flows
        from
        operating activities.
 
 Capital
        equipment expenditures during the year ended June 30, 2007 were $139,667,
        up
        from $31,735 for fiscal year 2006. Future capital equipment expenditures
        will be
        dependent upon future sales and success of on-going research and development
        efforts.
 
 For
        the
        quarter ended June 30, 2007, research and development expenses were $345,353,
        up
        37% from $252,295 for the quarter ended June 30, 2006. The level of future
        quarterly R&D expenses is ultimately dependent upon the Company’s assessment
        of new product opportunities.


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




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





***Our
      Auditor’s Report Contains a Statement That Our Net Loss and Negative Cash Flows
      From Operations Raise Substantial Doubt About our Ability to Continue as a
      Going
      Concern.***




After
      conducting an audit of the Company’s consolidated financial statements for the
      fiscal year ended June 30, 2007, our independent auditors issued an unqualified
      opinion on the financial statements that included a material uncertainty related
      to our ability to continue as a going concern due to net losses from operations
      combined with negative cash flows from operations. The Company’s ability to
      continue as a going concern is dependent upon its ability to meet its
      obligations on a timely basis. Management anticipates that the Company will
      require additional financing to fund operating activities during fiscal 2008,
      and anticipates seeking to raise capital through offering equity securities
      in
      private or public offerings.  The fact that we have received this “going
      concern opinion” from our auditors may make it more difficult for us to raise
      capital on favorable terms.  If the Company is unable to obtain additional
      funds when they are required or if the funds cannot be obtained on terms
      favorable to the Company, management may be required to delay or scale back
      its
      current operations and business strategy.




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





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




·
            the
                timing of completion of significant
                orders




·
            the
                timing and amount of our research and development
                expenditures




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




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




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




-
          17
          -




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




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




·
            competitive
                pricing pressures





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





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





In
      the
      fiscal year ended June 30, 2007, our three largest customers represented
      approximately 27%, 22%, and 10% respectively, of our total revenues. In the
      fiscal year ended June 30, 2006, our three largest customers represented
      approximately 18%, 15%, and 15% respectively, of our total revenues. No other
      customer accounted for more than 10% of our revenues during those
      periods.





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





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





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





Additionally,
      Dr. Joseph N. Forkey, 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, as well
      as
      new photonics-based market opportunities. The loss of Dr. Forkey’s 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 - If We Are Unable to Attract and Retain
      Such Individuals, Our Business Could Be Severely
      Damaged.***





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





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





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





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




-
          18
          -


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





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





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





A
      portion
      of our business has been devoted to research, development and production under
      fixed price purchase orders. For our purposes, a fixed price purchase order
      is
      any purchase order under which we will provide products or services for a fixed
      price over an extended period of time (usually six months or longer). In our
      2007 and 2006 fiscal years, fixed price purchase orders represented
      approximately 31% and 26%, respectively, of our total revenues. We expect that
      revenues from fixed price purchase orders will continue to represent a
      significant portion of our total revenues in future fiscal years.





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





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





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




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





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





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




-
          19
          -




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





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





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





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





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





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




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





The
      Consolidated Financial Statements appear on pages 21 through 40 of this
      Form 10-KSB.





-
          20
          -




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





Consolidated
      Financial Statements


as
      of
      June 30, 2007 and 2006


Together
      with Independent Registered Public Accounting Firm’s Report





-
          21
          -




**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, 2007 and 2006
      and the related consolidated statements of operations, stockholders’ equity and
      cash flows for the years then ended. These consolidated financial statements
      are
      the responsibility of the Company’s management. Our responsibility is to express
      an opinion on these consolidated financial statements based on our
      audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. The Company is not required to
      have, nor were we engaged to perform, an audit of its internal controls over
      financial reporting. An audit includes consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements. An audit also includes assessing the accounting
      principles used and significant estimates made by management, as well as
      evaluating the overall financial statement presentation. We believe that our
      audits provide a reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of Precision
      Optics Corporation, Inc. and subsidiaries as of June 30, 2007 and 2006 and
      the
      results of their operations and their cash flows for the years then ended in
      conformity with accounting principles generally accepted in the United States
      of
      America.





As
      discussed in Note 1 of the notes to the consolidated financial statements,
      effective July 1, 2006, the Company adopted Statement of Financial Accounting
      Standards No. 123(R), *Share-Based
      Payment* .





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/
      Vitale, Caturano and Company, Ltd.




Boston,
      Massachusetts


September
      26, 2007





-
          22
          -




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


**Consolidated
      Balance Sheets at June 30, 2007 and 2006**




**ASSETS**
            
            **2007**
            
            **2006**Current
                Assets:Cash
                and cash equivalents
            
            $
            840,179
            
            $
            2,030,428Accounts
                receivable (net of allowance for doubtful accountsof
                approximately $11,159 and $14,550 in 2007 and 2006,
                respectively)
            
            
            801,206
            
            
            381,097Inventories
            
            
            904,736
            
            
            445,802Prepaid
                expenses
            
            
            53,039
            
            
            45,912Total
                current assets
            
            
            2,599,160
            
            
            2,903,239Fixed
                Assets:Machinery
                and equipment
            
            
            3,559,384
            
            
            3,513,736Leasehold
                improvements
            
            
            553,596
            
            
            553,596Furniture
                and fixtures
            
            
            150,603
            
            
            93,545Vehicles
            
            
            42,343
            
            
            42,3434,305,926
            
            
            4,203,220Less—Accumulated
                depreciation and amortization
            
            
            4,148,239
            
            
            4,127,287Net
                fixed assets
            
            
            157,687
            
            
            75,933Other
                Assets:Cash
                surrender value of life insurance policies
            
            
            4,438
            
            
            13,246Patents,
                net
            
            
            274,311
            
            
            236,115Total
                other assets
            
            
            278,749
            
            
            249,361$
            3,035,597
            
            $
            3,228,533**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**Current
                Liabilities:Accounts
                payable
            
            $
            343,730
            
            $
            218,658Accrued
                employee compensation
            
            
            270,437
            
            
            227,892Accrued
                professional services
            
            
            75,616
            
            
            90,000Accrued
                warranty expense
            
            
            25,000
            
            
            50,000Other
                accrued liabilities
            
            
            3,604
            
            
            2,086Total
                current liabilities
            
            
            718,387
            
            
            588,636Commitments
                (Note 2)Stockholders’
                Equity:Common
                stock, $0.01 par value-Authorized—50,000,000
                sharesIssued
                and outstanding— 25,458,212 shares at June 30, 2007
              and
                15,458,212 shares at June 30, 2006
            
            
            254,582
            
            
            154,582Additional
                paid-in capital
            
            
            37,197,015
            
            
            34,729,873Accumulated
                deficit
            
            
            (
                35,134,387
            )
            
            (
                32,244,558
            )Total
                stockholders’ equity
            
            
            2,317,210
            
            
            2,639,897$
            3,035,597
            
            $
            3,228,533


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





-
          23
          -




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


**Consolidated
      Statements of Operations for the**


**Years
      Ended June 30, 2007 and 2006**





**2007**
            
            **2006**(As
                reclassified. See Note 1(u).)Revenues
            
            $
            2,477,469
            
            $
            2,149,564Cost
                of Goods Sold
            
            
            2,002,196
            
            
            1,899,471Gross
                profit
            
            
            475,273
            
            
            250,093Research
                and Development Expenses, net
            
            
            1,312,240
            
            
            1,105,967Selling,
                General and Administrative Expenses
            
            
            2,097,959
            
            
            1,452,021Total
                operating expenses
            
            
            3,410,199
            
            
            2,557,988Operating
                loss
            
            
            (2,934,926
            )
            
            (2,307,895
            )Interest
                Income, net
            
            
            46,011
            
            
            36,334Loss
                before provision for income taxes
            
            
            (2,888,915
            )
            
            (2,271,561
            )Provision
                for Income Taxes
            
            
            914
            
            
            912Net
                loss
            
            $
            (2,889,829
            )
            $
            (2,272,473
            )Loss
                per Share - Basic and Diluted
            
            
            ($0.15
            )
            
            ($0.26
            )Weighted
                Average Common Shares Outstanding - Basic and Diluted
            
            
            19,624,879
            
            
            8,768,629





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





-
          24
          -




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


**Consolidated
      Statements of Stockholders’ Equity**


**for
      the Years Ended June 30, 2007 and 2006**





Number
              of
                Shares
            
            Common
              Stock
            
            Additional
              Paid-in
              Capital
            
            Accumulated
              Deficit
            
            Total
              Stockholders’
              EquityBalance,
                June 30, 2005
            
            
            7,008,212
            
            $
            70,082
            
            $
            32,751,598
            
            $
            (29,972,085
            )
            $
            2,849,595Proceeds
                from sale of common stock, net
            
            
            8,450,000
            
            
            84,500
            
            
            1,978,275
            
            
            -
            
            
            2,062,775Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            (2,272,473
            )
            
            (2,272,473
            )Balance,
                June 30, 2006
            
            
            15,458,212
            
            $
            154,582
            
            $
            34,729,873
            
            $
            (32,244,558
            )
            $
            2,639,897Proceeds
                from sale of common stock and
              warrants,
                net
            
            
            10,000,000
            
            
            100,000
            
            
            2,276,216
            
            
            -
            
            
            2,376,216Stock-based compensation
            
            
            -
            
            
            -
            
            
            190,926
            
            
            -
            
            
            190,926Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            (2,889,829
            )
            
            (2,889,829
            )Balance,
                June 30, 2007
            
            
            25,458,212
            
            $
            254,582
            
            $
            37,197,015
            
            $
            (35,134,387
            )
            $
            2,317,210




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





-
          25
          -




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


**Consolidated
      Statements of Cash Flows for the**


**Years
      Ended June 30, 2007 and 2006**




**2007**
            
            **2006**Cash
                Flows from Operating Activities:Net
                loss
            
            $
            (2,889,829
            )
            $
            (2,272,473
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities-Depreciation
                and amortization
            
            
            120,404
            
            
            130,110Gain
                on Sale of Fixed Assets
            
            
            -
            
            
            (165,700
            )Provision
                for inventory write-down
            
            
            31,100
            
            
            32,000Stock-based
                compensation expense
            
            
            190,926
            
            
            -Changes
                in operating assets and liabilities-Accounts
                receivable, net
            
            
            (420,109
            )
            
            (204,066
            )Inventories
            
            
            (490,034
            )
            
            121,817Prepaid
                expenses
            
            
            (7,127
            )
            
            16,510Accounts
                payable
            
            
            125,072
            
            
            58,066Customer
                advances
            
            
            2,690
            
            
            (18,000
            )Accrued
                expenses
            
            
            1,989
            
            
            29,559Net
                cash used in operating activities
            
            
            (3,334,918
            )
            
            (2,272,177
            )Cash
                Flows from Investing Activities:Purchases
                of property and equipment
            
            
            (139,667
            )
            
            (31,735
            )Proceeds
                from sale of fixed assets
            
            
            -
            
            
            180,000Increase
                in other assets
            
            
            (91,880
            )
            
            (80,128
            )Net
                cash provided by (used in) investing activities
            
            
            (231,547
            )
            
            68,137Cash
                Flows from Financing Activities:Gross
                proceeds from private placement
            
            
            2,500,000
            
            
            2,112,500Payment
                of offering costs
            
            
            (123,784
            )
            
            (49,725
            )Net
                cash provided by financing activities
            
            
            2,376,216
            
            
            2,062,775Net
                decrease in cash and cash equivalents
            
            
            (1,190,249
            )
            
            (141,265
            )Cash
                and cash equivalents, beginning of year
            
            
            2,030,428
            
            
            2,171,693Cash
                and cash equivalents, end of year
            
            $
            840,179
            
            $
            2,030,428Supplemental
                Disclosure of Cash Flow Information:Cash
                paid during the year for-Income
                taxes
            
            $
            914
            
            $
            912





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




-
          26
          -




**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, 2007, the Company
      incurred a net loss of $2,889,829 and used cash in operations of $3,334,918.
      As
      of June 30, 2007, cash and cash equivalents were $840,179, accounts receivable
      were $801,206 and current liabilities were $718,387, resulting in a net liquid
      asset amount of $922,998. 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.





Based
      on
      the current financial condition of the company and the expectation of future
      continued quarterly operating losses during fiscal 2008, management is currently
      investigating and evaluating alternatives for raising additional capital through
      private and public equity offerings that can be completed sometime during the
      first half of fiscal 2008.





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 TM endoscope
      and micro-precisionTM lens technologies. Management expects that such
      operating losses will continue through fiscal year 2008, 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 8,450,000 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 10,000,000 shares of common stock
      and
      warrants to purchase an aggregate of 10,000,000 shares of common stock at an
      exercise price of $0.32 per share. Net cash proceeds to the Company (after
      offering costs of $123,784) were $2,376,216 (see Note 3).





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.




-
          27
          -




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


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




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




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




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




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 which would raise
      questions as to whether the sales price is fixed or determinable. The Company
      assesses credit worthiness of customers based upon prior history with the
      customer and assessment of financial condition. Accounts receivable are stated
      at the amount management expects to collect from outstanding balances. An
      allowance for doubtful accounts is provided for that portion of accounts
      receivable considered to be uncollectible, based upon historical experience
      and
      management’s evaluation of outstanding accounts receivable at the end of the
      year. Bad debts are written off against the allowance when
      identified.




The
      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 $840,179 and $2,030,428 at June 30, 2007 and 2006,
      respectively, consist primarily of cash at banks and money market funds.
The
      Company maintains its cash and cash equivalents in bank deposit accounts which,
      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, 2007 and 2006 are as follows:




-
          28
          -




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


**2007**
            
            **2006**Raw
                material
            
            $
            511,588
            
            $
            251,725Work-in-progress
            
            
            349,936
            
            
            114,786Finished
                goods
            
            
            43,212
            
            
            79,291$
            904,736
            
            $
            445,802





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 2007 and 2006, the Company recorded pretax non-cash provisions
      for
      slow-moving and obsolete inventories of approximately $31,100 and $32,000,
      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 Life**Machinery
                and equipment
            2-7
                yearsLeasehold
                improvements
            Shorter
                of lease term or estimated useful lifeFurniture
                and fixtures
            5
                yearsVehicles
            3
                years





Amortization
      of assets under capital leases are included in depreciation expense.
      Depreciation expense was $57,911 and $81,276 for the years ended June 30, 2007
      and 2006, respectively.





In
      July
      2005, the Company sold equipment previously used in its telecommunications
      business for $180,000, recognizing a gain of approximately $166,000 in the
      quarter ending September 30, 2005, which was included in the accompanying
      consolidated statements of operations in Selling, General and Administrative
      expenses.





**(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, 2007, receivables from the
      Company’s largest customer was 61% of the total accounts receivable. At June 30,
      2006, receivables from the Company’s largest customers were 30%, 15%, 12% and
      11%, respectively, of the total accounts receivable. No other customer accounted
      for more than 10% of the Company’s receivables as of June 30, 2007 and 2006. 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.




-
          29
          -




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




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





**2007**
            
            **2006**Customer
                A
            
            
            27
            %
            
            18
            %Customer
                B
            
            
            22
            
            
            15Customer
                C
            
            
            10
            
            
            15All
                Others
            
            
            41
            
            
            52100
            %
            
            100
            %





No
      other
      customer accounted for more than 10% of the Company’s revenues in fiscal years
      2007 and 2006.





**(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, 2007 and 2006, the effect of stock options
      was antidilutive; 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 antidilutive, was 12,532,583 and 2,277,583 during
      fiscal 2007 and 2006, 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 reflect
      the
      fair value method of expensing share-based awards. Stock-based compensation
      costs recognized for the year ended June 30, 2007 amounted to $190,926.





The
      Company had previously followed the disclosure-only provisions of SFAS
      No. 123, as amended by SFAS No. 148, *Accounting
      for Share-based Compensation—Transition and Disclosure* .
      No
      stock-based employee compensation cost is reflected in consolidated results
      of
      operations for the year ended June 30, 2006, as all options granted had an
      exercise price equal to the market value of the underlying common stock on
      the
      date of grant. The following table illustrates the effect on net loss and net
      loss per share for the year ended June 30, 2006 as if the Company had applied
      the fair value recognition provisions of SFAS No. 123 to share-based
      employee awards.




-
          30
          -




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




**Year
                Ended**
              **2006**Net
                loss as reported
            
            $
            (2,272,473
            )Add:
                Employee compensation expense for share options included in reported
                net
                income, net of income taxes
            
            
            -Less:
                Total employee compensation expense for share options determined
                under the
                fair value method, net of income taxes
            
            
            (377,430
            )Pro
                forma net loss
            
            $
            (2,649,903
            )Net
                loss per share:Basic
                and diluted - as reported
            
            $
            (0.26
            )Basic
                and diluted - pro forma
            
            $
            (0.30
            )





**(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 $515,615 and $453,100
      at
      June 30, 2007 and 2006, respectively. Such costs are amortized using the
      straight-line method over the shorter of their legal or estimated useful lives,
      generally five to ten years. Amortization expense was $62,493 and $48,834 for
      the years ended June 30, 2007 and 2006, respectively. Amortization expense
      is
      expected to be approximately $48,000, $42,000, $37,000, $33,000 and $29,000,
      respectively, for the years ending June 30, 2008 through June 30,
      2012.




**(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**




-
          31
          -


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




The
      Company does not incur future performance obligations in the normal course
      of
      business other than providing a standard one-year warranty on materials and
      workmanship to its customers. The Company provides for estimated warranty costs
      at the time product revenue is recognized. Warranty costs have been included
      as
      a component of cost of goods sold in the accompanying consolidated statements
      of
      operations. The following tables summarize warranty reserve activity for the
      two
      years ended June 30, 2007:




**2007**
            
            **2006**Balance
                at beginning of period
            
            $
            50,000
            
            $
            50,000Provision
                (credit) for warranty claims
            
            
            (14,197
            )
            
            10,122Warranty
                claims incurred
            
            
            (10,803
            )
            
            (10,122
            )Balance
                at end of period
            
            $
            25,000
            
            $
            50,000




**(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, 2007 and 2006, research and
      development expense is shown net of reimbursements of $101,309 and $135,129,
      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, 2007 and 2006 was
      equal to its net loss for the same periods.





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





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





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





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





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




-
          32
          -




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




**(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
      July
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes* ("FIN48"). FIN 48 is an interpretation of FASB Statement No. 109, *Accounting
      for Income Taxes* ,
      and it
      seeks to reduce the diversity in practice associated with certain aspects of
      measurement and recognition in accounting for income taxes. In addition, FIN
      48
      requires expanded disclosure with respect to the uncertainty in income taxes
      and
      is required to be adopted for fiscal years beginning after December 15,
      2006. The Company is currently evaluating the effect the adoption of FIN 48 will
      have on its financial condition or results of operations.





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* ,
      ("SFAS
      No. 157"). SFAS No. 157 defines fair value, establishes a framework
      for measuring fair value, and expands disclosure requirements regarding fair
      value measurement. SFAS No. 157 is effective for the Company beginning July
      1, 2008. The Company is currently reviewing SFAS No. 157 to determine the
      impact and materiality of its adoption.





In
      February 2007, the FASB issued Statement No. 159 *,
      The
      Fair Value Option for Financial Assets and Financial
      Liabilities* ("SFAS
      No. 159"), which permits companies to choose to measure many financial
      instruments and certain other items at fair value. SFAS No. 159 is
      effective for fiscal years beginning after November 15, 2007 and interim
      periods within those fiscal years. The Company is currently evaluating the
      effect SFAS No. 159 will have on its consolidated financial position and
      results of operations.





In
      September 2006, the SEC issued Staff Accounting Bulletin No. 108, *Considering
      the Effects of Prior Year Misstatements When Quantifying Misstatements in
      Current Year Financial Statements*("SAB No. 108") ,
      providing guidance on quantifying financial statement misstatement and
      implementation when first applying this guidance. Under SAB No. 108, companies
      should evaluate a misstatement based on its impact on the current year income
      statement, as well as the cumulative effect of correcting such misstatements
      that existed in prior years still existing in the current year's ending balance
      sheet. SAB No. 108 is effective for fiscal years ending after November 15,
      2006. The
      adoption of SAB No. 108 did not significantly
      affect the Company’s financial condition or results of
      operations.





In
      December 2006, the FASB issued a FASB Staff Position (“FSP”) Emerging Issues
      Task Force (“EITF”) Issue No. 00-19-2, *Accounting
      for Registration Payment Arrangements* (“FSP
      00-19-2”) which addresses an issuer’s accounting for registration payment
      arrangements. FSP 00-19-2 specifies that the contingent obligation to make
      future payments or otherwise transfer consideration under a registration payment
      arrangement, whether issued as a separate agreement or included as a provision
      of a financial instrument or other agreement, should be separately recognized
      and measured in accordance with FASB Statement No. 5, *Accounting
      for Contingencies* .
      The
      guidance in FSP 00-19-2 amends FASB Statements No. 133, *Accounting
      for Derivative Instruments and Hedging Activities* ,
      and No.
      150, *Accounting
      for Certain Financial Instruments with Characteristics of both Liabilities
      and
      Equity* ,
      and
      FASB Interpretation No. 45, *Guarantor’s
      Accounting and Disclosure Requirements for Guarantees, Including Indirect
      Guarantees of Indebtedness of Others* to
      include scope exceptions for registration payment arrangements. FSP 00-19-2
      is
      effective immediately for registration payment arrangements and the financial
      instruments subject to those arrangements that are entered into or modified
      subsequent to the issuance of FSP 00-19-2. For registration payment arrangements
      and financial instruments subject to those arrangements that were entered into
      prior to the issuance of FSP 00-19-2, this is effective for financial statements
      issued for fiscal years beginning after December 15, 2006, and interim periods
      within those fiscal years. The Company entered into a Registration Rights
      Agreement (the "Agreement") in connection with a private placement in February
      2007 (see Note 3). All of the Company’s obligations under the Agreement have
      been met and the Company has determined that no accrual is needed as of June
      30,
      2007 as it is not considered probable that the Company will make any payments
      under the applicable provisions of the Agreement.




-
          33
          -




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


**(u)**  **Reclassification**





The
      Company has revised certain classifications within the statement of operations
      to more appropriately reflect as research and development costs certain
      expenditures associated with product development efforts that previously were
      reflected as cost of sales. The Company also reclassified certain reimbursed
      research and development costs, including costs associated with the production
      of prototypes, as an offset to research and development expense from revenue.
      In
      accordance with SFAS No. 154, *Accounting
      Changes and Error Corrections* ,
      this
      change has been reflected retrospectively to all periods presented. The Company
      believes this better reflects the nature of certain expenditures (and
      reimbursements) due to the fact that the Company does not engage in any
      contractual arrangements to perform research and development. The effect of
      the
      reclassification had no impact on operating income, net income, the Company’s
      financial position or cash flows.





The
      table
      below summarizes the effect of these changes for the following
      periods:





Year
                Ended
              December
                31, 2006Currently
              Reported
            
            Previously
                ReportedRevenues
            
            $
            2,149,564
            
            
            
            
            $
            2,284,693Gross
                Profit
            
            $
            250,093
            
            
            
            
            $
            4,062Research
                and Development Expenses
            
            $
            1,105,967
            
            
            
            
            $
            859,936Total
                Operating Expenses
            
            $
            2,557,988
            
            
            
            
            $
            2,311,957




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





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





The
      Company leases one of its facilities from a corporation owned by an
      officer-director-shareholder of the Company. The Company is currently a
      tenant-at-will, paying rent of $9,000 per month. Total rent expense paid to
      related parties was $108,000 in each of fiscal years 2007 and 2006, 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
      2007 and 2006 for consulting services.





Another
      director is a former partner in a law firm that has performed legal services
      for
      the Company during fiscal 2007 and 2006 totaling approximately $217,000 and
      $136,000, respectively. T his
      director retired from his position as a member of the Board of Directors of
      the
      Company, effective at the close of business on June 28, 2007.




-
          34
          -


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


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





The
      Company has entered into operating leases for its office space and equipment
      that expire at various dates through fiscal year 2008. Total future minimum
      rental payments under all non-cancelable operating leases are approximately
      $30,100 in fiscal 2008 and $400 in fiscal 2009.





Rent
      expense on operating leases, excluding the related party rent described above,
      was approximately $47,500 and $48,700 for the years ended June 30, 2007 and
      2006, respectively.








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





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





Stock-based
      compensation costs recognized for the year ended June 30, 2007, 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, 2007 amounted to $190,926 and
      was included in the accompanying consolidated statements of operations in:
      (1)
      selling, general and administrative expenses ($164,831), cost of goods sold
      ($19,435), and research and development expenses, net ($6,660). 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 year
      ended June 30, 2007, as the Company is currently in a loss position. The total
      amount of options granted during the year ended June 30, 2007 was
      265,000.





As
      of
      June 30, 2007, the unrecognized compensation costs related to options vesting
      will be primarily recognized over a period of approximately 4
      years:




**OPTIONS**
            
            **2008**
            
            **2009**
            
            **2010**
            
            **2011**
            
            **TOT****AL**Compensation
                Expense
            
            $
            108,145
            
            $
            84,720
            
            $
            21,805
            
            $
            21,805
            
            $
            236,475




On
      November 10, 2005, the FASB issued FASB Staff Position SFAS 123R-3, *Transition
      Election Related to Accounting for Tax Effects of Share-Based Payment
      Awards.* The
      Company has elected to adopt the alternative transition method provided by
      the
      FASB Staff Position for calculating the tax effects (if any) of stock-based
      compensation expense pursuant to SFAS 123(R). The alternative transition method
      includes simplified methods to establish the beginning balance of the additional
      paid-in capital pool related to the tax effects of employee stock-based
      compensation, and to determine the subsequent impact to the additional paid-in
      capital pool and the consolidated statement of operation and cash flows of
      the
      tax effects of employee stock-based compensation awards that are outstanding
      upon adoption of SFAS 123(R).





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:




-
          35
          -




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





**Years Ended****June
                30, 2007**
            
            **June
                30, 2006**Assumptions:Option
                life
            
            
            5.3
                years
            
            
            5.3
                yearsRisk-free
                interest rate
            
            
            4.67
            %
            
            5.00
            %Stock
                volatility
            
            
            108
            %
            
            114
            %Dividend
                yield
            
            
            -0-
            
            
            -0-Weighted
                average fair value of grants
            
            $
            0.22
            
            $
            0.65




**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, 2007: 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 3,497,438 shares of common stock have been reserved
      for issuance under the 2006 Incentive Plan. At June 30, 2007, a total of 40,000
      stock options are outstanding and 3,457,438 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 2,492,583 shares of common stock are outstanding at
      June
      30, 2007 under the 1997 Incentive Plan, as amended and restated in fiscal year
      2006. Prior to the adoption of the 2006 Incentive Plan, 225,000 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 Plan. No shares are available for future grants under the Company’s
      1997 Stock Option Plan.




-
          36
          -




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





The
      following tables summarize stock option activity for the two years ended June
      30, 2007:





**Options****Outstanding****Number of**
              **Shares**
            
            
            **Weighted Average**
              **Exercise Price**
            
            
            **Weighted Average**
              **Contractual Life****Outstanding
                at June 30, 2005**
            
            
            1,317,535
            
            $
            1.79
            
            
            9.51
                yearsGrants
            
            
            970,800
            
            
            0.55Exercises
            
            
            —Cancellations
            
            
            (10,752
            )
            
            15.63**Outstanding
                at June 30, 2006**
            
            
            2,277,583
            
            $
            0.66
            
            
            9.86
                yearsGrants
            
            
            265,000
            
            
            0.27Exercises
            
            
            —Cancellations
            
            
            (10,000
            )
            
            0.55**Outstanding
                at June 30, 2007**
            
            
            2,532,583
            
            $
            0.62
            
            
            8.57
                years





Information
      related to the stock options outstanding as of June 30, 2007 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**$0.25
            
            
            165,000
            
            
            9.27
            
            $
            0.25
            
            
            60,835
            
            $
            0.25$0.30
            
            
            100,000
            
            
            9.15
            
            
            0.30
            
            
            -
            
            
            0.30$0.46
            
            
            20,000
            
            
            8.42
            
            
            0.46
            
            
            20,000
            
            
            0.46$0.55
            
            
            1,313,583
            
            
            8.87
            
            
            0.55
            
            
            758,101
            
            
            0.55$0.83
            
            
            934,000
            
            
            7.97
            
            
            0.83
            
            
            280,200
            
            
            0.83$0.25-$0.83
            
            
            2,532,583
            
            
            8.57
            
            $
            0.62
            
            
            1,119,136
            
            $
            0.60




The
      aggregate intrinsic value of the Company’s “in-the-money” outstanding and
      exercisable options as of June 30, 2007 was $19,000 and $5,000,
      respectively.




On
      June
      13, 2005 the Company issued options to purchase 934,000
      shares (“Performance Options”) of common stock at an exercise price of
      $0.83 per share. At the date of issuance, 30% of the options
      vested immediately, and the remaining options were subject to vesting upon
      the achievement of certain financial milestones by the Company. During
      fiscal 2007, certain of these milestones were met, and an additional 35% of
      the
      options vested as of July 31, 2007.





On
      May 9,
      2006, the Company’s Board of Directors approved the repricing of certain stock
      options held by employees and certain members of the Board of Directors in
      order
      to provide those employees and directors holding stock options with exercise
      prices significantly above recent trading prices with better performance
      incentives. The new exercise price per share of common stock subject to such
      options (“Repriced Options”) was set at $0.55. The new exercise price per share
      applies to all stock options with an original exercise price above $0.55 per
      share, other than an option to purchase 560,400 shares of common stock held
      by
      Joseph Forkey and an option to purchase 373,600 shares of common stock held
      by
      Richard Forkey. Approximately 383,000 options were affected in the
      repricing.




-
          37
          -




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




According
      to Accounting Principles Board Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      the
      Performance Options and Repriced Options were subject to variable accounting
      until the awards are exercised, forfeited, or expire unexercised, which includes
      periodic measurement of compensation expense based on the intrinsic value of
      the
      options. The compensation cost, if any, was recognized and adjusted quarterly
      for vested options or ratably over the vesting period for unvested options.
      No
      compensation expense related to these stock options was reflected in the net
      loss for the quarter ended June 30, 2006 as all options granted had an exercise
      price greater than the market value of the underlying common stock as of June
      30, 2006. Upon the adoption of SFAS No. 123(R) by the Company on July 1, 2006,
      these options were no longer subject to variable accounting.  Compensation
      related to these options is included in the amounts disclosed above for the
      year
      ended June 30, 2007.





**(b)**  **Sale
      of Stock**





In
      February 2007, the Company completed a private placement with institutional
      and
      other accredited investors pursuant to which it sold an aggregate of 10,000,000
      shares of common stock, at a price of $0.25 per share and warrants to purchase
      an aggregate of 10,000,000 shares of common stock at an exercise price of $0.32
      per share. Net cash proceeds to the Company (after offering costs of $123,784)
      were $2,376,216. On March 16, 2007, in order to fulfill its contractual
      obligations, the Company filed a registration statement with the Securities
      and
      Exchange Commission, under the Securities Act of 1933, as amended, to register
      for resale the shares of common stock issued and the shares of common stock
      issuable upon the exercise of the warrants sold in this private placement. The
      Company’s registration statement on Form SB-2 covering the securities sold in
      the private placement was
      declared effective on March 23, 2007. The
      Company is obligated to keep the registration statement effective until the
      earlier of (i) such time as all of the shares covered by the prospectus have
      been sold or (ii) the date on which the shares may be resold pursuant to Rule
      144(k) of the Securities Act of 1933 (the “Securities Act”). Except
      in
      the event of adverse market conditions and certain permitted delays, if the
      Company fails to maintain the effectiveness of the prospectus then it will
      be
      required to pay liquidated damages to the holders of shares registered
      thereunder in an amount equal to 1.0% of the aggregate amount invested by such
      holder for each 30-day period or pro rata for any portion thereof following
      the
      date by which such prospectus should have been effective.





In
      April
      2006, the Company completed a private placement, issuing 8,450,000 shares of
      common stock. Net cash proceeds (after offering costs of $49,725) to the Company
      were $2,062,775. On July 25, 2006, in order to fulfill its contractual
      obligations, the Company filed a registration statement with the Securities
      and
      Exchange Commission, under the Securities Act of 1933, as amended, to register
      for resale the shares of common stock sold in this private placement. The
      Company’s registration statement on Form SB-2 covering the securities sold in
      this private placement was
      declared effective on August 14, 2006. The
      Company is obligated to keep the registration statement effective until the
      earlier of (i) two years after the date of the closing of the private placement,
      (ii) the date on which the shares may be resold by the purchasers without
      registration by reason of Rule 144(k) under the Securities Act or any other
      rule
      of similar effect; or (iii) such time as all shares purchased by such
      stockholders have been sold.





**(c)**
            **Warrants**





The
      Company computed $3,522,860 as the fair value for warrants issued in conjunction
      with the February 2007 private placement using the Black-Scholes pricing model.
      The warrants are exercisable anytime within five years of their issue date
      (February 1, 2007) and have met the requirements to be recorded as a component
      of stockholder’s equity. The warrants are exercisable at a per share price of
      $0.32 subject to certain anti-dilution adjustments. The
      fair
      value of the warrants at date of issuance was estimated with the following
      assumptions:




-
          38
          -


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




Assumptions:Warrant
                life
            
            
            5.0
                yearsRisk-free
                interest rate
            
            
            4.84
            %Stock
                volatility
            
            
            129
            %Dividend
                yield
            
            
            -0-Weighted
                average fair value of warrants issued
            
            $
            0.35




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





The
      provision for income taxes in the accompanying consolidated statements of
      operations consists of the minimum statutory state income tax liability of
      $914
      and $912 for the years ended June 30, 2007 and 2006, 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:





**2007**
            
            **2006**Income
                tax benefit at federal statutory rate
            
            
            (34.0
            )%
            
            (34.0
            )%Increase
                (decrease) in tax resulting from-State
                taxes, net of federal benefit
            
            
            (5.6
            )
            
            (6.0
            )Change
                in valuation allowance
            
            
            42.3
            
            
            (587.9
            )Impact
                of Change in Control Limitations
            
            
            -
            
            
            627.3Nondeductible
                items
            
            
            0.6
            
            
            0.6Other
            
            
            (3.3
            )
            
            -Effective
                tax rate
            
            
            0.0
            %
            
            0.0
            %




The
      components of deferred tax assets and liabilities at June 30, 2007 and 2006
      are
      approximately as follows:





**2007**
            
            **2006**Deferred
                tax assets:Net
                operating loss carryforwards
            
            $
            1,510,000
            
            $
            343,000Tax
                credit carryforwards
            
            
            58,000
            
            
            -Reserves
                and accruals not yet deducted for tax purposes
            
            
            17,000
            
            
            18,000Total
                deferred tax assets
            
            
            1,585,000
            
            
            361,000Valuation
                allowance
            
            
            (1,585,000
            )
            
            (361,000
            )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 decreased in fiscal 2006 by approximately $12,622,000 as
      a
      result of change in control limitations. Pursuant to the Tax Reform Act of
      1986,
      the utilization of net operating loss carryforwards and other tax benefits
      are
      subject to an annual limitation if a cumulative change of ownership of more
      than
      50% occurs over a three-year period. As a result of the 2006 private placement
      of the Company’s common stock, the Company has triggered significant limitations
      on the utilization of those tax attributes. The limitation will allow the use
      of
      the value of approximately $18,000 of Federal carryforward losses annually
      for
      the next twenty years, and the same amount for state purposes for 5 years.
      The
      impact of this limitation has caused a significant reduction in the deferred
      tax
      asset valuation allowance during fiscal 2006.




-
          39
          -


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


At
      June
      30, 2007, the Company had federal and state net operating loss carryforwards
      of
      approximately $3,200,000 and $2,900,000, respectively, which will, if not used,
      expire at various dates from 2008 through 2026. In addition, the Company had
      net
      operating loss carryforwards from its Hong Kong operations of approximately
      $1,400,000 which carryforward indefinitely.





**(5)**  **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 2007 and
      2006. Employer matching contributions to the plan amounted to $42,325 and
      $29,203 for fiscal years 2007 and 2006, respectively.




**(6)****Cash
      Surrender Value of Life Insurance Policies**




The
      Company maintains a whole life insurance policy for
      a senior executive, which policy is recorded at its cash surrender
      value. As of June 30, 2007 and June 30, 2006, the cash surrender value of
      these policies are $4,438 and $13,246, respectively.


-
          40
          -




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




None.




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





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





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




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





None.




-
          41
          -




**PART
      III**




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





The
      Company will furnish to the Securities and Exchange Commission a definitive
      Proxy Statement (the “Proxy Statement”) not later than 120 days after the close
      of its fiscal year ended June 30, 2007. The information required by this item,
      other than with respect to the Company’s Corporate Code of Ethics and Conduct,
      is incorporated herein by reference to the Proxy Statement.





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




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





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





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





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





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





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





-
          42
          -




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





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




3.1
            Articles
                of Organization of the Company, as amended and corrected.
                (1)3.2
            By-laws
                of Precision Optics Corporation, Inc. (2)4.1
            Specimen
                common stock certificate. (3)4.2
            Registration
                Rights Agreement dated as of March 17, 2000 by and among the Company
                and
                the Initial Investors as defined therein. (4)4.3
            Registration
                Rights Agreement dated as of June 30, 1998 by and among the Company,
                Special Situations Private Equity Fund, L.P. and Special Situations
                Technology Fund, L.P. (5)4.4
            Registration
                Rights Agreement dated as of August 5, 1999 by and among the Company,
                Special Situations Cayman Funds, L.P., Special Situations Fund III,
                L.P.,
                Special Situations Private Equity Fund, L.P. and Special Situations
                Technology Fund, L.P. (6)4.5
            Registration
                Rights Agreement by and among Precision Optics Corporation, Inc.
                and each
                investor named therein, dated February 1, 2007. (13)4.6
            Form
                of Warrant. (13)10.1
            Precision
                Optics Corporation, Inc. 1989 Stock Option Plan, amended to date.
                (7)10.2
            Three
                separate life insurance policies on the life of Richard E. Forkey.
                (3)10.3
            Amended
                and Restated Precision Optics Corporation, Inc. 1997 Incentive Plan.
                (8)10.4
            Securities
                Purchase Agreement dated as of March 13, 2000 by and among the Company
                and
                the Purchasers as defined therein (excluding exhibits).
                (4)10.5
            Form
                of Purchase Agreement between the Company and each investor named
                therein.
                (11)10.6
            Employment
                Offer Letter dated as of September 15, 2006 from Precision Optics
                Corporation, Inc., to Michael T. Pieniazek. (12)10.7
            2006
                Equity Incentive Plan (14)10.8
            Purchase
                Agreement by and among Precision Optics Corporation, Inc. and each
                investor named therein, dated February 1, 2007. (13)10.9
            Form
                of Incentive Stock Option Certificate. (15)10.10
            Form
                of Nonstatutory Stock Option Certificate. (15)14.1
            Corporate
                Code of Ethics and Conduct. (9)21
            Subsidiaries
                of Precision Optics Corporation, Inc. (10)23.1
            Consent
                of Vitale Caturano & Company Ltd.31.1
            Certification
                of Chief Executive Officer required by Rule
                13a-14(a)/15d-14(a).31.2
            Certification
                of Principal Financial Officer required by Rule
                13a-14(a)/15d-14(a).32.1
            Certification
                of Chief Executive Officer and Principal Financial Officer required
                by
                Rule 13a-14(b) and 18 U.S.C. 1350.





(1)
            Incorporated
                herein by reference to the Company’s Registration Statement on Form SB-2
                (No. 333-141368).(2)
            Incorporated
                herein by reference to the Company’s 1991 Annual Report on Form 10-KSB
                (No. 001-10647).(3)
            Incorporated
                herein by reference to the Company’s Registration Statement on Form S-1
                (No. 33-36710-B).(4)
            Incorporated
                herein by reference to the Company’s Registration Statement on Form S-3
                (No. 333-35884).(5)
            Incorporated
                herein by reference to the Company’s 1998 Annual Report on Form 10-KSB
                (No. 001-10647).(6)
            Incorporated
                herein by reference to the Company’s 1999 Annual Report on Form 10-KSB
                (No. 001-10647).(7)
            Incorporated
                herein by reference to the Company’s 1994 Annual Report on Form 10-KSB
                (No. 001-10647).(8)
            Incorporated
                herein by reference to the Company’s Quarterly Report on Form 10-QSB for
                the quarter ended September 30, 2003 (No. 001-10647).(9)
            Incorporated
                herein by reference to the Company’s 2005 Annual Report on Form 10-KSB
                (No. 001-10647).(10)
            Incorporated
                herein by reference to the Company’s 1996 Annual Report on Form 10-KSB
                (No. 001-10647).(11)
            Incorporated
                herein by reference to the Company’s Current Report on Form 8-K (No.
                001-10647) filed on April 19, 2006.(12)
            Incorporated
                herein by reference to the Company’s Current Report on Form 8-K (No.
                001-10647) filed on September 21,
                2006.




-
          43
          -




(13)
            Incorporated
                herein by reference to the Company’s Current Report on Form 8-K (No.
                001-10647) filed on February 2, 2007.(14)
            Incorporated
                herein by reference to the Company’s Current Report on Form 8-K (No.
                001-10647) filed on December 4, 2006.(15)
            Incorporated
                herein by reference to the Company’s Quarterly Report on Form 10-QSB for
                the quarter ended December 30, 2006
              (No.
                001-10647).




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





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




-
          44 -


**SIGNATURES**





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




Date:
                September 28, 2007
            PRECISION
                OPTICS CORPORATION, INC.By:
            /s/ Richard E. ForkeyRichard
                E. ForkeyChairman
                of the Board,Chief
                Executive Officer, Presidentand
                Treasurer




In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.


**Signature**
              **Title**
              **Date**/s/
                  Richard E. Forkey
                
                Richard
                  E. Forkey
              Chairman
                  of the Board, Chief Executive Officer, President and Treasurer
                  (Principal
                  Executive Officer)
              September
                  28, 2007/s/
                  Joseph N. Forkey
                
                Joseph
                  N. Forkey
              Executive
                  Vice President, Chief Scientific Officer and Director
              September
                  28, 2007/s/
                  Donald A. Major
                
                Donald
                  A. Major
              Director
              September
                  28, 2007/s/
                  Richard B. Miles
                
                Richard
                  Miles
              Director
              September
                  28, 2007/s/
                  Joel R. Pitlor
                
                Joel
                  R. Pitlor
              Director
              September
                  28, 2007/s/
                  Michael T. Pieniazek
                
                Michael
                  T. Pieniazek
              Vice
                  President and Chief Financial Officer
                (Principal
                  Financial Officer andPrincipal
                  Accounting Officer)
              September
                  28, 2007