<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                   FORM 10-KSB

                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934


                     For the Fiscal Year Ended June 30, 1998


                        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                               (I.R.S. Employer
of incorporation or organization)                           Identification No.)


                                22 EAST BROADWAY
                          GARDNER, MASSACHUSETTS 01440
               (Address of principal executive offices) (Zip Code)


                   Issuer's telephone number is (978) 630-1800


           Securities registered pursuant to Section 12(b) of the Act:

                                                       Name of each exchange on
     Title of each class                                   which registered
     -------------------                               ------------------------

COMMON STOCK, $.01 PAR VALUE                                    NONE


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

         Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15 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 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. ___

         The issuer's revenues for its most recent fiscal year were $4,053,051.

         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 $4,243,961 as of August 31, 1998.

         The number of shares of outstanding common stock of the issuer as of
August 31, 1998 was 6,677,595.


                       DOCUMENTS INCORPORATED BY REFERENCE

         The issuer's Proxy Statement for the 1998 Annual Meeting of
Shareholders to be held on November 10, 1998 is incorporated into Part III of
this Form 10-KSB.




<PAGE>   2

                                     PART I


ITEM 1. DESCRIPTION OF BUSINESS


BUSINESS DEVELOPMENT.

         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.

         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. The Company's products and
services fall into the following areas: medical products for use by hospitals
and physicians, advanced optical products and thin films and advanced optical
system design and development services.

         PRINCIPAL PRODUCTS AND SERVICES AND METHODS OF DISTRIBUTION

         MEDICAL PRODUCTS. The Company's medical products include endoscopes and
image couplers, beamsplitters and adapters, the latter of which are used as
accessories to endoscopes.

         Since January 1991, the Company has developed and sold endoscopes using
various optical technologies for use in a variety of minimally invasive surgical
and diagnostic procedures throughout the human body. 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) and stereo
endoscopes (which are currently being tested for use in cardiac surgery). In
addition to its existing line of endoscopes, the Company is continuing to
develop different types of endoscopes that incorporate varying types of
construction and technology for use in various medical specialties.

         In July 1998, the Company entered into a Manufacturing Services
Agreement with a customer that is in the process of developing a sophisticated
system for computer assisted minimally invasive cardiac surgery that employs
advanced electronics and robotics and an enhanced 3-D visualization system.
Under the Agreement, the Company will be this customer's primary supplier of
stereo endoscopes and cameras, both of which will be used as key components in
the customer's surgical system. The Company has received initial orders from
this customer, with deliveries commencing later this calendar year.

         The Company developed and has manufactured and sold since 1985 a
proprietary product line of state-of-the-art instrumentation to couple
endoscopes to video cameras. Included in this product line are image couplers,
which physically connect the endoscope to the video camera system and transmit
the image viewed through the scope to the video camera. Another product -- the
beamsplitter -- performs the same function while preserving for the viewer an
eyeport for direct, simultaneous viewing



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through the endoscope. The Company has sold these devices primarily to endoscope
and video camera manufacturers and suppliers for resale under its customers'
names.

         The Company's image couplers and beamsplitters can withstand
surgery-approved sterilization. The Company also offers autoclavable image
couplers, which are able to withstand sterilization in superheated steam under
pressure. Autoclavability is a preferred method of sterilization because of its
relative speed, safety, and efficiency. The Company believes that it is the only
company in the world that produces autoclavable image couplers.

         Included in the Company's medical products sales are sales of image
couplers and beamsplitters for video-monitored examination of a variety of
industrial cavities and interiors. The Company has developed, and may develop in
the future, specialized borescopes for industrial applications.

         OPTICAL PRODUCTS AND SERVICES. The Company provides on a contract basis
advanced lens design, image analysis, optical system design, structural design
and analysis, prototype production and evaluation, optics testing, and optical
system assembly. Some of the Company's development contracts have led to optical
system production business for the Company, and the Company believes its
prototype development service may lead to new product production from time to
time.

         The Company's recent emphasis in the optical field has been in the
design, development and manufacture of specialty thin film coatings for use in
various optical products. The Company is aggressively pursuing sales, marketing
and technology development opportunities for new optical thin films in the
rapidly growing optical communications and semiconductor industries. During the
last half of fiscal year 1997, the Company began development of prototype
Wavelength Division Multiplexer (WDM) optical filters. WDMs are devices that
allow telecommunications companies to increase the transmission capacity of
fiberoptic lines. Based on development efforts to date, the Company is currently
supporting product evaluations with several potential customers in the
telecommunications and semiconductor industries.

         The Company has in the past earned significant revenue from the sale of
night vision products which permit users to see in extreme low light. In recent
years, the Company has had increasing difficulty competing for and winning
production contracts for night vision products due to lower prices offered by
foreign manufacturers, Government budget uncertainties and efforts to lower the
federal budget deficit and defense spending. As a result of these factors, the
Company anticipates that revenues derived from its night vision products and
technology will continue to decline as the Company pursues opportunities in
other business segments.

         COMPETITION AND MARKETS

         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 experience
in the optics industry and greater financial resources than the Company, may
seek to produce products or services that compete with those of the Company. The
Company may establish or use production facilities overseas to produce key
components to 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





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Company's profitability generally, and that the Company's inability to establish
or maintain such production facilities could materially adversely affect the
Company.

         The Company believes that competition for sales of its products and
services, which have been principally sold to 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 currently sells its image couplers, beamsplitters, and
adapters to a market that consists of approximately 30 potential OEM customers.
These potential customers sell video cameras, endoscopes, or video-endoscopy
systems. The Company has made sales to approximately 20 of these customers. The
Company estimates that it has approximately 30% of the market share in these
products and anticipates growth in this area. The Company's primary competition
in this area is the customers' own in-house capabilities to manufacture such
products. The Company believes that these customers typically purchase products
from the Company, despite their in-house capabilities, because they choose to
devote their own technical resources to their primary products, such as cameras
or endoscopes. The Company estimates that approximately 50% of the market demand
for image couplers, beamsplitters, and adapters is met by "captive" or in-house
capabilities.

         The Company has marketed and sold its endoscopes to OEM video camera
and video endoscopy suppliers for resale under the purchaser's 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 these competitors,
the Company may be able to be more responsive to the needs of endoscope users.

         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 and its employees'
reputations and prior experience.

         While the potential market for thin film coatings is perceived as
growing rapidly, particularly in the telecommunications and semiconductor
industries, the Company's thin film coatings competitors are numerous and have
deep and broad capabilities.

         The Company has had negligible direct export sales to date.

         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 and 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 received approximately $988,000 and $1,410,000 for the
fiscal years ended June 30, 1998 and 1997, respectively, from customers for
customer-sponsored design and development projects. Levels of customer contract
funded research and development can fluctuate greatly in any given period
depending upon the mix between design efforts and hardware development, which is




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generally more expensive and time consuming than the design phases. In addition
to customer-sponsored research and development, the Company spent approximately
$897,000 and $428,000 of its own funds during fiscal years 1998 and 1997,
respectively, on the Company's own research and development. The Company expects
to continue making significant Company-funded expenditures for research and
development, particularly in the thin film coatings area.

         RAW MATERIALS AND PRINCIPAL SUPPLIERS

         For all of the Company's products, except for thin film coatings, the
basic raw material is precision grade optical glass, which the Company obtains
from several major suppliers. Outside vendors grind and polish most of the
Company's lenses and prisms. For optical thin film coatings, the basic raw
materials are metals and dielectric compounds, which the Company obtains from a
variety of chemical suppliers. The Company believes that its demand for these
raw materials and 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 1999. The Company believes, however, that there are relatively few
suppliers of the high quality lenses and prisms which its endoscopes may
require. The Company has therefore established an in-house optical shop for
producing ultra-high quality prisms, micro-optics and other specialized optics
for a variety of medical and industrial applications. Depending upon the market
acceptance of the Company's endoscopes, the Company may seek to assure itself of
a timely supply of lenses, prisms, or other key materials or components through
the acquisition of an outside supplier or expanded in-house manufacturing
facilities.

         PATENTS AND TRADEMARKS

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

         The Company plans to file for patents, copyrights, and trademarks in
the United States and in appropriate countries to protect its intellectual
property rights to the extent practicable. The Company holds the rights to
several United States and foreign patents and has several patent applications
pending. The Company knows of no infringements of its patents. Although the
Company plans to protect any patents it has from infringement, it may not be
able to pursue such protection for economic reasons. 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.

         Although the Company seeks to protect its proprietary information,
there can be no assurance that others will not either develop independently the
same or similar information or gain access to the Company's proprietary
information or that disputes will not arise as to proprietary rights to such
information.




                                       -5-


<PAGE>   6


         The Company's products may now or in the future infringe upon others'
patents or proprietary technology. The Company's defense of any such claims
could have a material, adverse effect on the Company.

         EMPLOYEES

         As of June 30, 1998, the Company had forty-four full-time employees and
two part-time employees.

         CUSTOMERS

         Sales to the Company's three largest customers, in terms of total sales
during fiscal year 1998, were approximately 22%, 14% and 10%. Sales to the
Company's two largest customers, in terms of total sales during fiscal year
1997, were approximately 38% and 23%.

         ENVIRONMENTAL PROTECTION AND THE EFFECT OF EXISTING OR PROBABLE
GOVERNMENT REGULATIONS ON THE BUSINESS

         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. Although the Company believes that it complies with all applicable
environmental laws and regulations, any failure to comply with such laws and
regulations could have a material, adverse effect on its capital expenditures,
earnings, and competitive position.

         NEED FOR GOVERNMENT APPROVAL OF PRINCIPAL PRODUCTS OR SERVICES AND
EFFECT OF EXISTING OR PROBABLE GOVERNMENT REGULATIONS ON THE BUSINESS

         The Company currently sells and markets several medical products, the
marketing of which may require the permission of the United States Food and Drug
Administration ("FDA"). Pursuant to the Company's notification to the FDA of its
intent to market its laparoscope, additional types of endoscopes which it has
developed and is developing, image coupler, beamsplitter, and adapters, the FDA
has determined that each such device is substantially equivalent to a device
marketed in interstate commerce and that the Company may market such devices,
subject to the general controls provisions of the Food, Drug and Cosmetic Act.
Furthermore, 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. There can be no assurance that the Company
will be able to maintain the FDA's permission to market its current products or
to obtain such regulatory permission, approvals, or licenses for any of its
other products. Furthermore, potential adverse FDA regulation affecting the
Company which might arise from future legislation or administrative action
cannot be predicted. In addition, FDA regulations may be established that could
prevent or delay regulatory clearances or approval of the Company's products.
The inability of the Company to secure any necessary licenses or regulatory
approvals or permission from the FDA could have a material adverse effect on its
business. The FDA has authority to conduct detailed inspections of manufacturing
plants




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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 exploitation of devices which do not comply with
law. Failure to comply with applicable regulatory requirements can, among other
things, result in fines, suspensions of regulatory clearances or approvals,
product recalls, operating restrictions, and criminal prosecution.

ITEM 2. DESCRIPTION OF PROPERTY

         The Company conducts its domestic operations at two facilities in
Gardner and Fitchburg, Massachusetts. The Gardner facility is leased from a
corporation owned by an officer-shareholder-director of the Company, and the
Company's lease expires in December 1999. The Fitchburg facility is under a
three year lease which commenced on November 1, 1995. 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. 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

         The Company and its subsidiaries and their property are not party or
subject to any material pending legal proceedings.

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 1998.




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<PAGE>   8


                 DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY


         The Company's executive officers and directors are as follows:


                                    Position with the Company
Name                                or Principal Occupation
----                                -------------------------


Richard E. Forkey                   President, Treasurer and Director


Jack P. Dreimiller                  Senior Vice President, Finance, 
                                    Chief Financial Officer and Clerk


Kumar M. Khajurivala                Vice President, Operations


Edward A. Benjamin                  Director. Member of Audit Committee. Mr.
                                    Benjamin is a partner in the law firm of
                                    Ropes & Gray, Boston, Massachusetts.


H. Angus Macleod                    Director. Dr. Macleod is President of the
                                    Thin Film Center, Inc. of Tucson, Arizona,
                                    which provides software consulting and
                                    courses for design and analysis of thin film
                                    optical coatings and filters.


Austin W. Marxe                     Director. Mr. Marxe was appointed to the
                                    Board of Directors in August 1998. Mr. Marxe
                                    is Managing General Partner of Special
                                    Situations Fund III, L.P., a registered
                                    investment company based in New York City,
                                    and several other affiliated investment
                                    funds.


Joel R. Pitlor                      Director. Member of Audit Committee. 
                                    Mr. Pitlor is president of J.R. Pitlor, a
                                    management consulting firm based in
                                    Cambridge, Massachusetts.


Robert R. Shannon                   Director. Member of Audit Committee. 
                                    Mr. Shannon is a professor at the Optical
                                    Sciences Center of the University of Arizona
                                    in Tuscon, Arizona.






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                                     PART II


ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The Company's common stock is listed on the National Association of
Securities Dealers Automated Quotation (NASDAQ) System under the symbol "POCI."
Since January 1992, the NASDAQ SmallCap Market has been the principal market in
which the Company's stock is publicly traded. The high and low sales prices for
the Company's stock for each full quarterly period within the two most recent
fiscal years were as follows:

<TABLE>
<CAPTION>
                           1997                                 1998
                  -----------------------             -------------------------
Quarter             High            Low                 High             Low
                  -----------------------             -------------------------
<S>               <C>             <C>                 <C>              <C>

First             $  1 3/4        $   7/8             $3 15/16         $2 11/16

Second            $  1 3/4        $ 1 1/8             $  4 3/4         $  3 1/2

Third             $1 15/16        $1 1/16             $  4 1/8         $  2 5/8

Fourth            $3 11/16        $ 1 1/8             $  3 1/8         $1 47/64

</TABLE>

         As of August 31, 1998, there were 92 holders of record of the Company's
common stock.

         On June 30, 1998, the Company issued pursuant to Section 4(2) of the
Securities Act of 1933 an aggregate of 500,000 shares of its common stock and
warrants exercisable for an additional aggregate of 500,000 shares of its common
stock to Special Situations Private Equity Fund, L.P. and Special Situations
Technology Fund, L.P., two affiliated private investment funds based in New York
City (the "Special Situations Funds") in exchange for aggregate cash
consideration of $1,000,000.

         The terms of the warrants issued to the Special Situations Funds
provide that the warrants may be exercised at any time at a price per share of
$4.00, subject to adjustment pursuant to customary anti-dilution provisions
triggered by any future below-market issuances of Company common stock. The
warrants provide that they will terminate if not exercised within 10 days of the
Special Situations Funds' receipt of a notice from the Company which may be
delivered at the Company's option in the event that the last sale price of the
Company's common stock on the NASDAQ SmallCap Market equals or exceeds $6.00 on
each of any 20 consecutive trading days.

         In connection with the issuance of common stock and warrants to the
Special Situations Funds, the Company agreed to file with the Securities and
Exchange Commission a registration statement covering the resale of shares of
common stock issued to, or issuable upon the exercise of warrants issued to, the
Special Situations Funds. Pursuant to a Registration Rights Agreement dated June
30, 1998 among the parties, the Company would be obligated to issue additional
shares of common stock



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and additional warrants to the Special Situations Funds for no additional
consideration in the event such registration statement is not declared effective
on or prior to December 31, 1998.

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

IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS

         When used in this discussion, the words "believes", "anticipates",
"intends to", and similar expressions are intended to identify forward-looking
statements. Such statements are subject to certain risks and uncertainties which
could cause actual results to differ materially from those projected. See
"Important Factors Regarding Forward-Looking Statements" attached hereto as
Exhibit 99 and incorporated herein by reference. Readers are cautioned not to
place undue reliance on these forward- looking statements which speak only as of
the date hereof. The Company undertakes no obligation to publicly release the
result of any revision to these forward-looking statements which may be made
reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.

LIQUIDITY AND CAPITAL RESOURCES

         For the year ended June 30, 1998, the Company's cash and cash
equivalents decreased by approximately $288,000 to $2,060,000. The decrease in
cash and cash equivalents was due to cash used by operating activities of
approximately $961,000, capital expenditures of approximately $269,000,
increases in other assets, primarily patents, of approximately $117,000 and
repayment of a capital lease obligation of approximately $104,000, partially
offset by proceeds received from a private placement of Common Stock
(approximately $931,000), sale of marketable securities (approximately $187,000)
and exercise of stock options and warrants (approximately $45,000).

         During the quarter ending December 31, 1997, the Company entered into a
five-year capital lease obligation for the acquisition of manufacturing
equipment totaling approximately $140,000.

         The Company intends to continue devoting significant resources to
internally funded research and development spending on both new products and the
improvement of existing products. The Company also intends to devote resources
to the marketing and product support of its medical and optical thin film
product lines, and the development of new methods of distribution. These
investments may temporarily result in negative cash flow, but the Company
anticipates that the results of these efforts will translate into increased
revenues and profits.

         Furthermore, depending upon the market acceptance of the Company's
products, the Company believes that it may be obligated to acquire new
facilities, add additional manufacturing or research and development equipment,
or acquire a business that manufactures or sells to the Company components,
materials, supplies, or services used in the manufacture, marketing,
distribution or servicing of the Company's new products, as well as the
Company's existing products.

         The Company continues to maintain a secured line of credit of $500,000
available with a bank at 1/4% over the prime rate. Under the terms of the line
of credit, the Company is required to maintain certain ratios under specified
financial covenants (Debt Service Coverage, Leverage, Current Ratio), and must
maintain a minimum cash liquidity of $1,000,000. The Company was in compliance
with all



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such covenants as of June 30, 1998, except with respect to the Debt Service
Coverage ratio (for which a waiver or forbearance agreement is currently being
negotiated). There can be no assurance that the Company will be able to comply
with all of such terms. As of June 30, 1998, there were no borrowings
outstanding under the line of credit.

         The Company has no material unused sources of liquidity other than its
cash and cash equivalents, accounts receivable and available lines of credit. If
these liquidity sources, along with revenues from operations, are not sufficient
to fund operations or growth, the Company will require additional financing. The
timing and amount of additional financing requirements depend on a number of
factors, including the status of development and commercialization efforts, the
cost of equipment and personnel to support manufacturing of new and existing
products, and the amount of working capital necessary to start up and maintain
operations supporting new products. The Company may seek additional funds
through public or private equity or debt financing. There can be no assurance
that such funds will be available on satisfactory terms, if at all. Lack of
necessary funds may require the Company to delay, scale back, or eliminate some
or all of its development efforts.

         However, the Company believes its sources of liquidity are sufficient
to support working capital and investment needs for the foreseeable future.

FISCAL YEAR 1998 RESULTS OF OPERATIONS

         Total revenues for fiscal year 1998 were approximately $4,053,000, a
decrease of approximately $3,319,000, or 45%, from fiscal year 1997.

         The revenue decrease from the prior year was due to lower sales of
night vision products (down 67%), medical products (down 31%), and industrial
and thin film products (down 27%). The reduction in night vision sales was due
to successful completion during the prior fiscal year of two government
development subcontracts, and lower shipments on two government production
subcontracts. The reduction in medical products sales was due to lower shipments
of endocouplers, partially offset by higher sales of endoscopes. The higher
shipments of endocouplers in the prior year were mainly attributable to sales to
one customer representing approximately 23% of total Company revenues for fiscal
1997. No sales were made to this customer in fiscal 1998. The reduction in
industrial and thin film sales was due to lower sales of industrial lenses.

         Revenues for the Company's three largest customers were approximately
22%, 14% and 10%, respectively, of total revenues for the year ended June 30,
1998. Revenues from the Company's two largest customers were approximately 38%
and 23%, respectively, for the year ended June 30, 1997.

         For the fiscal years ended June 30, 1998, 1997 and 1996, approximately
25%, 38% and 44% of the Company's total revenues, respectively, were derived
from production and development contracts and subcontracts involving the
Government and its agencies. The Company's current Government business is
substantially comprised of one fixed-price production subcontract with one
customer for night-vision lens systems with deliveries scheduled approximately
through July 1998. The Government may terminate a government contract at any
time, with or without cause. After expiration of the current subcontracts, there
can be no assurance that the Government will award future contracts or
subcontracts to the Company.



                                      -11-


<PAGE>   12
         Gross profit decreased by approximately $1,305,000 in fiscal 1998, and
as a percentage of revenues decreased from 23.9% to 11.3% compared to the
previous year. The decrease in gross profit was due primarily to lower sales
volume as discussed above.

         Selling, general and administrative expenses increased by approximately
$309,000 or 13.5% in fiscal year 1998 compared to fiscal 1997. The major reason
for the increase was higher research and development spending on new products,
which increased by approximately $469,000, or 110%, partially offset by lower
professional services and employee benefits expenses.

         Interest expense relates primarily to capital lease obligations
incurred in fiscal years 1994, 1996 and 1998.

         Interest income decreased by approximately $34,000 in fiscal year 1998
due to the lower investment base of cash equivalents.

         The provision for income taxes in fiscal 1998 represents an adjustment
of the net deferred tax asset to an amount the Company believes is more likely
than not to be realized.

FISCAL YEAR 1997 RESULTS OF OPERATIONS

         Total revenues for fiscal 1997 were approximately $7,372,000, a
decrease of approximately $683,000, or 8.5%, from fiscal 1996.

         The revenue decrease was due to lower sales of non-medical products
(down 29%), partially offset by higher sales of medical products (up 22%). The
increase in sales of medical products was attributable to higher sales in all
major product categories. The reduction in non-medical sales was due primarily
to (1) lower sales of night-vision products due to completion of two government
production subcontracts and one government development subcontract and (2) lower
sales of industrial products due to discontinued sales to a significant
customer, both partially offset by higher sales of optical thin films.

         Gross profit decreased by approximately $701,000 in fiscal 1997, and as
a percentage of revenues decreased from 30.6% to 23.9% compared to the previous
year. The decrease in gross profit was due primarily to the lower sales volume
and higher occupancy and depreciation expenses related to equipment and
manufacturing facilities additions.

         Selling, general and administrative expenses increased by approximately
$169,000 or 7.9% in fiscal 1997 compared to fiscal 1996. The increase was due
primarily to higher spending on advertising and bid and proposal expenses
targeted at the industrial and thin films marketplace, and higher legal,
consulting and employee recruiting expenses.

         Interest expense relates primarily to capital lease obligations
incurred in the third quarter of fiscal years 1994 and 1996.

         Interest income decreased by approximately $20,000 in fiscal 1997 due
to the lower investment base of cash equivalents.



                                      -12-
<PAGE>   13
         The benefit for income taxes as a percentage of the pre-tax loss in
fiscal year 1997 was lower than the federal statutory income tax rate primarily
due to the Company's inability to recognize the full amount of deferred tax
assets to offset prior years' taxable income. Such tax benefits will be
recognized in future years if sufficient future taxable income is generated.

OTHER FACTORS THAT MAY AFFECT FUTURE RESULTS

         The Company continues to aggressively pursue sales, marketing, and
technology development efforts for new optical thin films in the rapidly growing
telecommunications and semi-conductor industries. Significant progress has been
achieved in the Company's development efforts for Wavelength Division
Multiplexer (WDM) optical filters, which are used in telecommunication systems.

         These successful development efforts have resulted in prototypes of a
10-nanometer bandwidth WDM filter and several narrow (under 1-nanometer)
bandwidth filters. The Company is currently supporting product evaluation tests
with several potential optical thin film filter and coating customers for
applications in the telecommunications and semiconductor industries. The Company
believes that these efforts should lead to significant future thin film sales.

         Based on a recent preliminary assessment, the Company has determined
that it is required to modify portions of its hardware and software so that its
computer systems and other date-sensitive equipment will properly utilize data
beyond December 31, 1999. The Company believes that with upgrades or
modifications to existing software and hardware, the impact of Year 2000 issues
can be mitigated. However, if such upgrades or modifications are not made, or
are not made in a timely manner, Year 2000 issues could have a material adverse
impact on the Company's operations and financial condition. The Company will
utilize primarily external resources to test and/or replace hardware and
software for Year 2000 compliance. The Company plans to complete the Year 2000
project not later than December 31, 1998, and believes the costs of the project
will not be material to the Company's operating results or financial condition.
As the Company's ongoing assessment of its Year 2000 compliance status
progresses, the Company will establish such contingency plans as it deems
necessary to address any residual Year 2000 risks. The Company currently is not
aware of any material risks to its business and operations presented by the Year
2000 compliance status of its customers, suppliers and service providers.

ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS: The Consolidated Financial Statements
        are filed on pages 14 through 29 of this Form 10-KSB.





                                      -13-


<PAGE>   14














               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES




                        CONSOLIDATED FINANCIAL STATEMENTS
                          AS OF JUNE 30, 1998 AND 1997
                         TOGETHER WITH AUDITORS' REPORT











                                      -14-


<PAGE>   15
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To Precision Optics Corporation, Inc.:

We have audited the accompanying consolidated balance sheets of Precision Optics
Corporation, Inc. (a Massachusetts corporation) and subsidiaries as of June 30,
1998 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended June 30, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Precision Optics Corporation,
Inc. and subsidiaries as of June 30, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 1998, in conformity with generally accepted accounting principles.




                                                         /s/ ARTHUR ANDERSEN LLP

                                                         ARTHUR ANDERSEN LLP

Boston, Massachusetts
July 23, 1998





                                      -15-


<PAGE>   16
               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

               CONSOLIDATED BALANCE SHEETS--JUNE 30, 1998 AND 1997



<TABLE>
<CAPTION>
                                     ASSETS
                                                                                              
                                                                      1998             1997
                                                                  -----------       ----------
<S>                                                               <C>               <C>

CURRENT ASSETS:
   Cash and cash equivalents                                      $ 2,060,146       $2,348,382
   Marketable securities                                                   --           30,000
   Accounts receivable (net of allowance for
      doubtful accounts of approximately
      $42,000 and $69,000 in 1998 and 1997, respectively)             486,070          466,811

   Inventories                                                        949,993        1,576,967
   Deferred tax asset                                                 145,000          157,300
   Prepaid expenses                                                    44,870           40,273
   Refundable income taxes                                                 --           52,970
                                                                  -----------       ----------

         Total current assets                                       3,686,079        4,672,703
                                                                  -----------       ----------

PROPERTY AND EQUIPMENT, AT COST:
   Machinery and equipment                                          2,848,555        2,474,478
   Leasehold improvements                                             468,724          433,832
   Furniture and fixtures                                             109,568          109,568
   Vehicles                                                            44,742           44,742
                                                                  -----------       ----------
                                                                    3,471,589        3,062,620

   Less--Accumulated depreciation and amortization                  2,318,380        1,927,578
                                                                  -----------       ----------
                                                                    1,153,209        1,135,042
                                                                  -----------       ----------

OTHER ASSETS:
   Cash surrender value of life insurance policies                     50,156           51,871
   Patents, net                                                       238,034          155,986
                                                                  -----------       ----------

         Total other assets                                           288,190          207,857
                                                                  -----------       ----------

                                                                  $ 5,127,478       $6,015,602
                                                                  ===========       ==========


                      LIABILITIES AND STOCKHOLDERS' EQUITY
                                                                      1998             1997
                                                                  -----------       ----------
<S>                                                               <C>               <C>

CURRENT LIABILITIES:
   Accounts payable                                               $   124,566       $  271,911
   Accrued payroll                                                    121,262           81,122
   Accrued profit sharing and bonuses                                  28,798           30,000
   Accrued professional services                                       80,140           85,556
   Accrued vacation                                                    88,514           64,903
   Accrued warranty expense                                            50,000           50,000
   Accrued income taxes                                                 4,924           18,946
   Other accrued liabilities                                           91,372           42,164
   Customer advances                                                  116,841               --   
   Current portion of capital lease obligation                        105,349           89,532
                                                                  -----------       ----------

        Total current liabilities                                     811,766          734,134
                                                                  -----------       ----------


CAPITAL LEASE OBLIGATION, NET OF CURRENT PORTION                      208,684          189,413
                                                                  -----------       ----------

COMMITMENTS (Note 4)


STOCKHOLDERS' EQUITY:
   Common stock, $.01 par value-
      Authorized--10,000,000 shares
      Issued and outstanding--6,618,619 and 6,021,502 shares
        at June 30, 1998 and 1997, respectively                        66,186           60,215
      Additional paid-in capital                                    6,172,349        5,202,558
      Accumulated deficit                                          (2,131,507)        (170,718)
                                                                  -----------       ----------

        Total stockholders' equity                                  4,107,028        5,092,055
                                                                  -----------       ----------

                                                                  $ 5,127,478       $6,015,602
                                                                  ===========       ==========

</TABLE>



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




                                      -16-


<PAGE>   17

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                FOR THE YEARS ENDED JUNE 30, 1998, 1997 AND 1996



<TABLE>
<CAPTION>

                                                                 1998              1997             1996
<S>                                                           <C>               <C>              <C>       

REVENUES                                                      $ 4,053,052       $7,372,310       $8,055,271

COST OF GOODS SOLD                                              3,595,756        5,610,438        5,592,871
                                                              -----------       ----------       ----------

         Gross profit                                             457,296        1,761,872        2,462,400

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES                    2,606,079        2,296,687        2,128,155
                                                              -----------       ----------       ----------

         Operating (loss) income                               (2,148,783)        (534,815)         334,245

GAIN ON SALE OF MARKETABLE SECURITIES                             157,417               --               --

INTEREST INCOME                                                    70,131          104,423          124,104

INTEREST EXPENSE                                                  (26,254)         (27,241)         (16,639)
                                                              -----------       ----------       ----------

         (Loss) income before provision for income taxes       (1,947,489)        (457,633)         441,710

PROVISION (BENEFIT) FOR INCOME TAXES                               13,300          (15,000)          36,000
                                                              -----------       ----------       ----------

         Net (loss) income                                    $(1,960,789)      $ (442,633)      $  405,710
                                                              ===========       ==========       ==========

BASIC (LOSS) EARNINGS PER SHARE                               $      (.32)      $     (.07)      $      .07
                                                              ===========       ==========       ==========

DILUTED (LOSS) EARNINGS PER SHARE                             $      (.32)      $     (.07)      $      .07
                                                              ===========       ==========       ==========

COMMON SHARES OUTSTANDING                                       6,099,347        5,982,210        5,980,502
                                                              ===========       ==========       ==========

COMMON SHARES OUTSTANDING ASSUMING DILUTION                     6,099,347        5,982,210        6,116,569
                                                              ===========       ==========       ==========

</TABLE>


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




                                      -17-


<PAGE>   18

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                FOR THE YEARS ENDED JUNE 30, 1998, 1997 AND 1996




<TABLE>
<CAPTION>
                                              NUMBER OF      COMMON       ADDITIONAL       RETAINED           TOTAL
                                               SHARES         STOCK        PAID-IN         EARNINGS        STOCKHOLDERS'
                                                                           CAPITAL         (DEFICIT)          EQUITY

<S>                                          <C>            <C>          <C>             <C>               <C>        

BALANCE, JUNE 30, 1995                        5,980,502      $59,805      $5,145,655      $  (133,795)      $ 5,071,665

   Net income                                        --           --              --          405,710           405,710
                                              ---------      -------      ----------      -----------       -----------

BALANCE, JUNE 30, 1996                        5,980,502       59,805       5,145,655          271,915         5,477,375

   Proceeds from exercise of options
   to purchase common stock                      41,000          410          56,903               --            57,313

   Net loss                                          --           --              --         (442,633)         (442,633)
                                              ---------      -------      ----------      -----------       -----------

BALANCE, JUNE 30, 1997                        6,021,502       60,215       5,202,558         (170,718)        5,092,055

   Proceeds from exercise of options
   and warrants to purchase common stock         97,117          971          44,121               --            45,092

   Net proceeds from private
   placement of common stock                    500,000        5,000         925,670               --           930,670

   Net loss                                          --           --              --       (1,960,789)       (1,960,789)
                                              ---------      -------      ----------      -----------       -----------

BALANCE, JUNE 30, 1998                        6,618,619      $66,186      $6,172,349      $(2,131,507)      $ 4,107,028
                                              =========      =======      ==========      ===========       ===========

</TABLE>


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





                                      -18-


<PAGE>   19

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                FOR THE YEARS ENDED JUNE 30, 1998, 1997 AND 1996

<TABLE>
<CAPTION>

                                                                   1998              1997             1996
<S>                                                             <C>               <C>              <C>       

CASH FLOWS FROM OPERATING ACTIVITIES:
   Net (loss) income                                            $(1,960,789)      $ (442,633)      $  405,710
   Adjustments to reconcile net (loss) income to net cash
   (used in) provided by operating activities-
     Depreciation and amortization                                  426,976          428,054          308,275
     Deferred income taxes                                           12,300          (38,300)         (67,000)
     Gain on sale of marketable securities                         (157,417)              --               --
     Changes in assets and liabilities-
       Accounts receivable                                          (19,259)         672,993          276,567
       Inventories                                                  626,974          286,727         (395,215)
       Prepaid expenses                                              (4,597)           4,411          (21,810)
       Refundable income taxes                                       52,970          (22,694)         (30,276)
       Accounts payable                                            (147,345)        (557,517)         361,467
       Customer advances                                            116,841               --               --
       Accrued expenses                                              92,319          (41,409)         (21,041)
                                                                -----------       ----------       ----------

        Net cash (used in) provided by operating activities        (961,027)         289,542          816,677
                                                                -----------       ----------       ----------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchases of marketable securities                                    --          (30,000)              --
   Proceeds from the sale of marketable securities                  187,417               --               --
   Purchases of property and equipment                             (269,402)        (444,914)        (615,798)
   Increase in other assets                                        (116,507)         (58,690)         (59,844)
                                                                -----------       ----------       ----------

        Net cash used in investing activities                      (198,492)        (533,604)        (675,642)
                                                                -----------       ----------       ----------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Repayment of capital lease obligation                           (104,479)         (82,682)         (51,068)
   Net proceeds from private placement of common stock              930,670               --               --
   Proceeds from exercise of stock options and warrants              45,092           57,313               --
                                                                -----------       ----------       ----------

        Net cash provided by (used in) financing activities         871,283          (25,369)         (51,068)
                                                                -----------       ----------       ----------

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS               (288,236)        (269,431)          89,967

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                      2,348,382        2,617,813        2,527,846
                                                                -----------       ----------       ----------

CASH AND CASH EQUIVALENTS, END OF YEAR                          $ 2,060,146       $2,348,382       $2,617,813
                                                                ===========       ==========       ==========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
   Cash paid during the year for-
     Interest                                                   $    26,254       $   27,241       $   16,639
                                                                ===========       ==========       ==========
     Income taxes                                               $        --       $  101,461       $  151,325
                                                                ===========       ==========       ==========

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTMENT ACTIVITIES:
   Capital lease obligation                                     $   139,567       $       --       $  299,180
                                                                ===========       ==========       ==========

</TABLE>



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




                                      -19-


<PAGE>   20

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998




(1)    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

       (a)    Nature of Business

              Precision Optics Corporation, Inc. (the Company) designs,
              manufactures and sells optical systems, components and 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.

       (b)    Principles of Consolidation

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

       (c)    Revenues

              Revenues for industrial and medical products sold in the normal
              course of business are recognized upon shipment. Contract revenues
              are recognized under the percentage-of-completion method. The
              percentage of completion is determined by computing the percentage
              of the actual cost of work performed to the anticipated total
              contract costs, or on the basis of units shipped. When the
              estimate on a contract indicates a loss, the Company's policy is
              to record the entire loss in the current period.

       (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. There were no cash equivalents at June
              30, 1998. Cash equivalents at June 30, 1997 included approximately
              $1,529,000 of United States Treasury bills.

       (e)    Marketable Securities

              The Company applies SFAS No. 115, Accounting for Certain
              Investments in Debt and Equity Securities. The Company's
              investments in marketable securities are classified as
              available-for-sale. Marketable securities had a cost and market
              value of $30,000 at June 30, 1997. During fiscal 1998, the Company
              sold these securities and realized a gain of approximately
              $157,000.







                                      -20-


<PAGE>   21

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998

                                   (Continued)


       (f)    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 are as follows at June 30, 1998 and
              1997:

<TABLE>
<CAPTION>

                                                  1998            1997
               <S>                              <C>            <C>    
   
               Raw material                     $588,727       $1,075,294
               Work-in-progress                  246,264          272,980
               Finished goods                    118,502          228,693
                                                --------       ----------  

                                                $949,993       $1,576,967
                                                ========       ==========
</TABLE>

       (g)    Depreciation and Amortization

              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:


                                                   ESTIMATED
               ASSET CLASSIFICATION                USEFUL LIFE

               Machinery and equipment             5-7 years
               Leasehold improvements              Life of lease
               Furniture and fixtures              5 years
               Vehicles                            3 years

       (h)    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 concentrations.
              Financial instruments that subject the Company to credit risk
              consist primarily of cash and cash equivalents and trade accounts
              receivable. The Company places its investments in highly rated
              financial institutions. The Company has not experienced any losses
              on these investments to date. At June 30, 1998 and 1997,
              receivables from the Company's largest customer were approximately
              36% and 29% of the total accounts receivable, respectively. The
              Company has not experienced any material losses related to
              accounts receivable from individual customers.






                                      -21-


<PAGE>   22

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998

                                   (Continued)


              Revenues from the Company's three largest customers were
              approximately 22%, 14% and 10%, respectively, of total revenues
              for the year ended June 30, 1998. Revenues from the Company's two
              largest customers were approximately 38% and 23%, respectively, of
              total revenues for the year ended June 30, 1997. Revenues from the
              Company's three largest customers were approximately 42%, 14% and
              12% of total revenues for the year ended June 30, 1996. No other
              customers accounted for more than 10% of the Company's revenues in
              any of the three years ended June 30, 1998. Approximately 25%, 38%
              and 44% of the Company's revenues for the years ended June 30,
              1998, 1997 and 1996, respectively, were derived from sales to
              agencies of the U.S. government or customers that supply agencies
              of the U.S. government.

       (i)    Research and Development

              Research and development costs, which are charged to operations as
              incurred, are included in selling, general and administrative
              expenses and include direct costs plus overhead. Such costs
              totaled approximately $897,000, $428,000 and $433,000 for the
              years ended June 30, 1998, 1997 and 1996, respectively.

       (j)    (Loss) Earnings per Share

              Basic (loss) earnings per share is computed by dividing net income
              (loss) by the weighted average number of shares of common stock
              outstanding during the period. Diluted (loss) earnings per share
              for the year ended June 30, 1996 includes the effect of
              outstanding stock options of 136,067 shares computed in accordance
              with the treasury stock method. For the years ended June 30, 1998
              and 1997, the effect of stock options was antidilutive; therefore,
              they were not included in the computation of diluted (loss)
              earnings per share. The Company has adopted SFAS No. 128, Earnings
              per Share, effective December 15, 1997. As a result, the Company's
              reported earnings per share for fiscal 1997 and 1996 were
              restated; however, this had no effect on previously reported
              earnings per share data. The number of shares that were excluded
              from the computation as their effect would be antidilutive were
              1,864,500, 1,045,617 and 94,000, during fiscal 1998, 1997 and
              1996, respectively.

              The calculations of basic and diluted weighted average shares
              outstanding are as follows:


<TABLE>
<CAPTION>
                                                                  1998           1997            1996
               <S>                                              <C>            <C>             <C>   
   
               Basic weighted average shares outstanding        6,099,347      5,982,210       5,980,502

               Dilutive shares                                         --             --         136,067
                                                                ---------      ---------       ---------

               Diluted weighted average shares outstanding      6,099,347      5,982,210       6,116,569
                                                                =========      =========       =========
</TABLE>





                                      -22-


<PAGE>   23

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998

                                   (Continued)


       (k)    Stock-Based Compensation

              The Company accounts for its stock-based compensation under
              Accounting Principles Board Opinion No. 25, Accounting for Stock
              Issued to Employees. In October 1995, the FASB issued SFAS No.
              123, Accounting for Stock-Based Compensation. SFAS No. 123
              establishes a fair-value-based method of accounting for
              stock-based compensation plans. The Company has adopted the
              disclosure-only alternative under SFAS No. 123, which required the
              disclosure of the pro forma effects on earnings and earnings per
              share as if the accounting prescribed by SFAS No. 123 had been
              adopted, as well as certain other information.

       (l)    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. Accordingly,
              translation gains or losses are reflected in the accompanying
              consolidated statements of operations and have not been
              significant.

       (m)    Other Assets

              Patents are carried at cost, less accumulated amortization of
              approximately $107,000 and $71,000 at June 30, 1998 and 1997,
              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.

       (n)    Use of Estimates

              The preparation of financial statements in conformity with
              generally accepted accounting principles 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.

(2)    LINE OF CREDIT

       At June 30, 1998, the Company had available a demand line of credit of
       $500,000 at an interest rate equal to the bank's prime rate (8.5% at June
       30, 1998) plus 0.25%. Under the line of credit agreement, the Company is
       required to maintain certain financial ratios (Debt Service Coverage,
       Leverage, and Current Ratio) and must maintain a minimum cash liquidity
       of $1,000,000. The Company is in compliance with all such financial
       covenants at June 30, 1998, except the Debt Service Coverage Ratio for
       which a waiver or forbearance agreement is currently being negotiated. At
       June 30, 1998, there were no borrowings outstanding under this





                                      -23-


<PAGE>   24

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998

                                   (Continued)


       line of credit. Borrowings under this line of credit are secured by all
       assets of the Company. The line of credit expires on November 30, 1998.

(3)    CAPITAL LEASE OBLIGATION

       At June 30, 1998, future minimum lease payments under capital lease
       obligations are as follows:


<TABLE>
<CAPTION>
         FISCAL YEAR                                                 AMOUNT
         <S>                                                        <C>    
  
         1999                                                       $ 128,283
         2000                                                         107,171
         2001                                                          76,834
         2002                                                          34,363
         2003                                                          15,524
                                                                    ---------

           Total minimum lease payments                               362,175

           Amount representing interest                               (48,142)
                                                                    ---------

           Present value of minimum lease payments                    314,033

           Less-Current portion                                       105,349
                                                                    ---------

                                                                    $ 208,684
                                                                    =========
</TABLE>

       Capital leases are secured by all assets of the Company under a security
       agreement subordinate to the Company's demand line of credit.

(4)    COMMITMENTS

       (a)    Related Party Transactions

              The Company leases one of its facilities from a corporation owned
              by an officer of the Company. The lease terminates in December
              1999 and requires lease payments of $9,000 per month. The Company
              may terminate the lease as of the end of any calendar year during
              the term by providing written notice to the lessor by June 30 of
              such year.

              The Company paid fees to a director of approximately $60,000
              during each of fiscal 1998, 1997 and 1996 for consulting services.
              Another director is a partner in a law firm that has performed
              legal services for the Company during fiscal 1998, 1997 and 1996.





                                      -24-


<PAGE>   25
               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998

                                   (Continued)



       (b)    Operating Lease Commitments

              Total future minimum rental payments under all operating leases
              for fiscal 1999 are $116,000 and $6,000 thereafter.

              Rent expense on operating leases was approximately $217,000,
              $213,000 and $187,000 for the years ended June 30, 1998, 1997 and
              1996, respectively.

(5)    STOCKHOLDERS' EQUITY

       (a)    Warrants

              In conjunction with previous equity offerings, the Company issued
              warrants to acquire a total of 320,000 shares of common stock, of
              which warrants for a total of 100,000 shares expired during fiscal
              1997 and 1996. Warrants for 2,000 shares were exercised during
              fiscal 1998. Warrants for 218,000 shares expire in approximately
              equal amounts on August 21, 1998 and October 23, 1998 and have an
              exercise price of $1.375 per share. As of June 30, 1998, all of
              these warrants were exercisable.

              During fiscal 1998, the Company completed a private placement of
              500,000 shares of common stock with gross proceeds of $1,000,000.
              In conjunction with this offering, the purchasers were issued
              warrants to acquire 500,000 shares of common stock at an exercise
              price of $4.00 per share. The warrants are immediately exercisable
              and expire on June 25, 2003.

       (b)    Stock Options

              During 1989, the stockholders approved a stock option plan (the
              1989 Plan) for key employees. The Plan, as amended, authorizes the
              grant of options to purchase up to 1,110,000 shares of the
              Company's common stock at an exercise price not less than 100% of
              the fair market value per share at the date of grant. Options
              granted are exercisable for a period determined by the Board of
              Directors, not to exceed 10 years from the date of grant.

              During fiscal 1998, the stockholders approved an incentive plan
              (the 1997 Incentive Plan), which provides eligible participants
              (certain employees, directors, consultants, etc.) the opportunity
              to receive a broad variety of equity based and cash awards. A
              total of 1,200,000 shares of common stock have been reserved for
              issuance under the 1997 Incentive Plan. Upon the adoption of the
              1997 Incentive Plan, no new awards will be granted under the 1989
              Plan. At June 30, 1998, 794,000 shares of common stock were
              available for future grants under the 1997 Incentive Plan.





                                      -25-


<PAGE>   26
             PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES
                                      
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                JUNE 30, 1998
                                      
                                 (Continued)



       The following is a summary of transactions in the Plans for the three
years ended June 30, 1998:


<TABLE>
<CAPTION>
                                                                        WEIGHTED
                                                                         AVERAGE
                                           NUMBER        OPTION PRICE   EXERCISE
                                          OF SHARES       PER SHARE       PRICE
   <S>                                    <C>          <C>              <C>  

   Options outstanding, June 30, 1995      395,000     $        1.375     $1.38
            Granted                         60,000         1.375-1.50      1.40
                                          --------     --------------     ----- 

   Options outstanding, June 30, 1996      455,000         1.375-1.50      1.38
            Granted                        190,000      1.5625-2.1875      1.89
            Exercised                      (41,000)      1.375-1.5625      1.40
                                          --------     --------------     ----- 

   Options outstanding, June 30, 1997      604,000       1.375-2.1875      1.54
            Granted                        416,000         2.75-3.844      3.72
            Exercised                      (27,500)             1.375      1.38
                                          --------     --------------     ----- 

   Options outstanding, June 30, 1998      992,500        1.375-3.844      2.46
                                          --------     --------------     ----- 

   Options exercisable, June 30, 1998      377,500     $  1.375-3.844     $2.04
                                           =======     ==============     =====

</TABLE>
   
In addition, the Company has granted options outside the Plans, primarily to
directors and consultants at 100% of the fair market value per share at the date
of grant. The following is a summary of all transactions outside the Plans:

<TABLE>
<CAPTION>
                                          NUMBER OF    OPTION PRICE     WEIGHTED
                                           SHARES        PER SHARE       AVERAGE
                                                                        EXERCISE
                                                                          PRICE
   <S>                                    <C>          <C>                <C>  

   Options outstanding, June 30, 1995      161,617      $.07-$5.69        $ .91
            Granted                         60,000            1.30         1.30
                                           -------      ----------        ----- 

   Options outstanding, June 30, 1996      221,617        .07-5.69         1.02
            Granted                             --              --           --
                                           -------      ----------        ----- 

   Options outstanding, June 30, 1997      221,617        .07-5.69         1.02
            Exercised                      (67,617)            .07          .07
                                           -------      ----------        ----- 

   Options outstanding, June 30, 1998      154,000        .50-5.69         1.43
                                           -------      ----------        ----- 

   Options exercisable, June 30, 1998      130,000      $.50-$5.69        $1.46
                                           =======      ==========        =====


</TABLE>




                                      -26-


<PAGE>   27

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998

                                   (Continued)


       The Company has computed the pro forma disclosures required under SFAS
       No. 123 for all stock options granted in fiscal 1998, 1997 and 1996 using
       the Black-Scholes option pricing model prescribed by SFAS No. 123.

       The assumptions used and the weighted average information for the years
       ended June 30, 1998, 1997 and 1996 are as follows:


<TABLE>
<CAPTION>
                                                                                           YEARS ENDED
                                                                            1998               1997               1996
         <S>                                                           <C>                <C>                <C>

         Risk-free interest rates                                            6.06%              6.95%              6.83%
         Expected dividend yield                                               --                 --                 --
         Expected lives                                                   7 years            7 years            7 years
         Expected volatility                                                   90%                87%                87%
         Weighted average fair value of grants                              $3.02              $1.52              $1.12
         Weighted average remaining contractual life of
         options outstanding                                           8.33 years         8.16 years         8.57 years

       The effect of applying SFAS No. 123 would be as follows:

<CAPTION>

                                                                          1998                  1997             1996
         <S>                                                           <C>                <C>                <C>

                   Net (loss) income                                  $(1,960,789)           $(442,633)         $405,710
                       As reported
                       Pro forma                                       (2,340,964)            (520,373)          391,610

                   Net (loss) income per share
                       As reported, basic and diluted                 $      (.32)           $    (.07)         $    .07
                       Pro forma, basic and diluted                          (.38)                (.09)              .06
</TABLE>


(6)    INCOME TAXES

       The Company accounts for income taxes in accordance with SFAS No. 109,
       Accounting for Income Taxes, whereby a deferred tax asset or liability is
       measured by currently enacted tax rates applied to any temporary
       differences between the financial statement and tax bases of assets and
       liabilities.




                                      -27-


<PAGE>   28

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998

                                   (Continued)



       The provision (benefit) for income taxes in the accompanying consolidated
       statements of operations consists of the following for the three years
       ended June 30, 1998:


                                        1998            1997            1996
         Current--
            Federal                   $    --        $ 26,300         $ 67,000
            State                       1,000           1,000            3,000
            Foreign                        --          (4,000)          33,000
                                      -------        --------         --------
                                        1,000          23,300          103,000
                                      -------        --------         --------
         Deferred--
            Federal                    10,500         (34,300)         (57,000)
            State                       1,800          (4,000)         (10,000)
                                      -------        --------         --------
                                       12,300         (38,300)         (67,000)
                                      -------        --------         --------

                                      $13,300        $(15,000)        $ 36,000
                                      =======        ========         ========

       A reconciliation of the federal statutory rate to the Company's effective
       tax rate for the three years ended June 30, 1998 is as follows:


<TABLE>
<CAPTION>
                                                       1998      1997      1996
       <S>                                           <C>        <C>        <C> 
 
       Income tax (benefit) provision at federal     
       statutory rate                                (34.0)%    (34.0)%    34.0%

       Increase (decrease) in tax resulting from-
            Temporary items with no tax benefit        2.2        6.1       7.3
            Tax credits utilized                        --         --      (4.1)
            Change in valuation allowance             32.5       22.9     (35.5)
            Effect of state taxes                       --       (4.6)       --
            Prior year tax adjustments                  --        5.2       5.0
            Other                                       --        1.1       1.5
                                                     -----      -----     -----

                Effective tax rate                     0.7%      (3.3)%     8.2%
                                                     =====      =====     =====

</TABLE>





                                      -28-


<PAGE>   29

               PRECISION OPTICS CORPORATION, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998

                                   (Continued)



       The components of the net deferred tax asset at June 30, 1998 and 1997
       are approximately as follows:


<TABLE>
<CAPTION>
                                                                              1998           1997
         <S>                                                                <C>           <C>      

         Net operating loss carryforward                                    $622,000      $      --
         Reserves and accruals not yet deducted for tax purposes             316,000        311,000
         Other temporary differences                                          18,000         24,000
                                                                            --------      ---------

                                                                             956,000        335,000

         Valuation allowance                                                (811,000)      (178,000)
                                                                            --------      ---------

                  Net deferred tax asset                                    $145,000      $ 157,000
                                                                            ========      =========
</TABLE>


       The Company has provided a valuation allowance to reduce the net deferred
       tax asset to an amount the Company believes it is "more likely than not"
       to be realized. The valuation allowance increased in fiscal 1998 due to
       the generation of a net operating loss carryforward. The net deferred tax
       asset represents the amount that can be carried back to offset the prior
       years' tax liabilities, if necessary. As of June 30, 1998, the Company
       has a net operating loss carryforward for U.S. federal income taxes of
       approximately $1,800,000, which expires in 2013.

(7)    PROFIT SHARING PLAN

       The Company has a defined contribution profit sharing plan that covers
       all eligible employees. The Company has accrued and charged to operations
       an employer contribution to this plan of $50,000 in fiscal 1996. No
       employer contributions were made in fiscal 1998 or 1997.





                                      -29-


<PAGE>   30


ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE: None.

                                    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, 1998. The information required by this item
         is incorporated herein by reference to the Proxy Statement.

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

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS: The information
         required by this item is incorporated herein by reference to the Proxy
         Statement.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K:

         (a)      EXHIBITS.

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

         3.1      Articles of Organization of the Company(1)

         3.2      By-laws of Precision Optics Corporation, Inc.(2)

         4.1      Specimen common stock certificate(1)

         4.2      Private Placement Selling Agent Common Stock Warrant No. 4
                  dated April 28, 1992 issued to James L. Davis and Schedule 1
                  of Omitted Documents(3)

         4.3      Initial Public Offering Common Stock Purchase Warrant No. 3
                  dated July 10, 1992 issued to John C. Michalak and Schedule 2
                  of Omitted Documents(3)

         4.4      Warrant No. U-1 to Purchase Shares of Common Stock of the
                  Company dated January 24, 1992 issued to Nathan Newman and
                  Schedule 3 of Omitted Documents(3)

         4.5      Promissory Note dated December 5, 1991 between the Company and
                  The First National Bank of Boston(4)

         4.6      Agreement Restricting Sale of Stock dated January 15, 1992 by
                  and among Richard E. Forkey, the Company, Kennedy, Mathews,
                  Landis, Healy & Pecora Incorporated, and Equity Securities
                  Trading Co., Inc.(3)

         4.7      Common Stock Purchase Warrant dated June 30, 1998 issued to
                  Special Situations Private Equity Fund, L.P.

         4.8      Common Stock Purchase Warrant dated June 30, 1998 issued to
                  Special Situations Technology Fund, L.P.

         4.9      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.

         10.1     Lease dated June 29, 1984 between the Company and Equity,
                  First Amendment to Commercial Lease dated June 25, 1990, and
                  letter agreement dated June 25, 1990 renewing such lease(1)

         10.2     Precision Optics Corporation, Inc. 1989 Stock Option Plan
                  amended to date (the "Plan")(5)

         10.3     Three separate life insurance policies on the life of Richard
                  E. Forkey(1)





                                      -30-


<PAGE>   31

         10.4     Master Lease Finance Agreement dated November 3, 1993 between
                  the Company and BancBoston Leasing(5)

         10.5     Second Amendment to Commercial Lease between the Company and
                  Equity dated December 9, 1994(6)

         10.6     Lease dated November 1, 1995 between the Company and Janice M.
                  Bouchard, Trustee of Authority Drive Realty Trust(6)

         10.7     Precision Optics Corporation, Inc. 1997 Incentive Plan

         10.8     Stock Subscription 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.

         21       Subsidiaries of Precision Optics Corporation, Inc.(6)

         27       Financial Data Schedule

         99       Important Factors Regarding Forward-Looking Statements(7)

(1)  Incorporated herein by reference to the Company's Registration Statement on
     Form S-18 (No. 33-36710-B).

(2)  Incorporated herein by reference to the Company's 1991 Annual Report on
     Form 10-KSB.

(3)  Incorporated herein by reference to the Company's 1992 Annual Report on
     Form 10-KSB.

(4)  Incorporated herein by reference to the Company's Registration Statement on
     Form S-1 (No. 33-43929).

(5)  Incorporated herein by reference to the Company's 1994 Annual Report on
     Form 10-KSB.

(6)  Incorporated herein by reference to the Company's 1996 Annual Report on
     Form 10-KSB.

(7)  Incorporated herein by reference to the Company's Quarterly Report on Form
     10-QSB for the quarter ended March 31, 1996.


         (b)      REPORTS ON FORM 8-K.

                  None.





                                      -31-


<PAGE>   32


                                   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 18, 1998                     PRECISION OPTICS CORPORATION, INC.


                                             By: /s/ Richard E. Forkey
                                                 ------------------------------
                                                 Richard E. Forkey
                                                 Chairman of the Board,
                                                 Chief Executive Officer, 
                                                 President and 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.


By: /s/ Richard E. Forkey                    By: /s/ Jack P. Dreimiller
    -----------------------------                ------------------------------
    Richard E. Forkey                            Jack P. Dreimiller
    President, Treasurer and                     Senior Vice President, Finance,
    Director (principal                          Chief Financial Officer and 
    executive officer)                           Clerk (principal financial and
                                                 accounting officer)

September 18, 1998                           September 18, 1998
---------------------------------            ----------------------------------
Date                                         Date



By: /s/ Joel R. Pitlor                       By: /s/ Edward A. Benjamin
    -----------------------------                ------------------------------
    Joel R. Pitlor                               Edward A. Benjamin
    Director                                     Director

September 18, 1998                           September 18, 1998
---------------------------------            ----------------------------------
Date                                         Date



By: /s/ Robert R. Shannon                    By: /s/ H. Angus Macleod
    -----------------------------                ------------------------------
    Robert R. Shannon                            H. Angus Macleod
    Director                                     Director

September 18, 1998                           September 18, 1998
---------------------------------            ----------------------------------
Date                                         Date



By: /s/ Austin W. Marxe
    -----------------------------                
    Austin W. Marxe
    Director

September 18, 1998
---------------------------------
Date





                                      -32-


<PAGE>   33
                                INDEX TO EXHIBITS


         3.1      Articles of Organization of the Company(1)

         3.2      By-laws of Precision Optics Corporation, Inc.(2)

         4.1      Specimen common stock certificate(1)

         4.2      Private Placement Selling Agent Common Stock Warrant No. 4
                  dated April 28, 1992 issued to James L. Davis and Schedule 1
                  of Omitted Documents(3)

         4.3      Initial Public Offering Common Stock Purchase Warrant No. 3
                  dated July 10, 1992 issued to John C. Michalak and Schedule 2
                  of Omitted Documents(3)

         4.4      Warrant No. U-1 to Purchase Shares of Common Stock of the
                  Company dated January 24, 1992 issued to Nathan Newman and
                  Schedule 3 of Omitted Documents(3)

         4.5      Promissory Note dated December 5, 1991 between the Company and
                  The First National Bank of Boston(4)

         4.6      Agreement Restricting Sale of Stock dated January 15, 1992 by
                  and among Richard E. Forkey, the Company, Kennedy, Mathews,
                  Landis, Healy & Pecora Incorporated, and Equity Securities
                  Trading Co., Inc.(3)

         4.7      Common Stock Purchase Warrant dated June 30, 1998 issued to
                  Special Situations Private Equity Fund, L.P.

         4.8      Common Stock Purchase Warrant dated June 30, 1998 issued to
                  Special Situations Technology Fund, L.P.

         4.9      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.

         10.1     Lease dated June 29, 1984 between the Company and Equity,
                  First Amendment to Commercial Lease dated June 25, 1990, and
                  letter agreement dated June 25, 1990 renewing such lease(1)

         10.2     Precision Optics Corporation, Inc. 1989 Stock Option Plan
                  amended to date (the "Plan")(5)

         10.3     Three separate life insurance policies on the life of Richard
                  E. Forkey(1)

         10.4     Master Lease Finance Agreement dated November 3, 1993 between
                  the Company and BancBoston Leasing(5)

         10.5     Second Amendment to Commercial Lease between the Company and
                  Equity dated December 9, 1994(6)

         10.6     Lease dated November 1, 1995 between the Company and Janice M.
                  Bouchard, Trustee of Authority Drive Realty Trust(6)

         10.7     Precision Optics Corporation, Inc. 1997 Incentive Plan

         10.8     Stock Subscription 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.

         21       Subsidiaries of Precision Optics Corporation, Inc.(6)

         27       Financial Data Schedule

         99       Important Factors Regarding Forward-Looking Statements(7)


(1)  Incorporated herein by reference to the Company's Registration Statement on
     Form S-18 (No. 33-36710-B).

(2)  Incorporated herein by reference to the Company's 1991 Annual Report on
     Form 10-KSB.

(3)  Incorporated herein by reference to the Company's 1992 Annual Report on
     Form 10-KSB.

(4)  Incorporated herein by reference to the Company's Registration Statement on
     Form S-1 (No. 33-43929).

(5)  Incorporated herein by reference to the Company's 1994 Annual Report on
     Form 10-KSB.

(6)  Incorporated herein by reference to the Company's 1996 Annual Report on
     Form 10-KSB.

(7)  Incorporated herein by reference to the Company's Quarterly Report on Form
     10-QSB for the quarter ended March 31, 1996.


                                      -33-