**United
      States**




**Securities
      and Exchange Commission**


Washington,
      D.C.  20549




**Form
      10-K**




(X)   Annual
      Report Pursuant to Section 13 or 15 (d) of the Securities


Exchange
      Act of 1934


For
      the fiscal year ended June 30, 2007


or


( )   Transition
      Report Pursuant to Section 13 or 15 (d) of the Securities


Exchange
      Act of 1934


For
      the transition period from ________ to ________





Commission
      File Number: 0-10832





**AFP
      Imaging Corporation**


(Exact
      name of registrant as specified in its charter)





New
                York
            13-2956272(State
                or other jurisdiction of incorporation or organization)
            (I.R.S.
                Employer Identification No.)




250
                  Clearbrook Road, Elmsford, NY
              10523(Address
                  of principal executive offices)
              (Zip
                  Code)


Registrant’s
      telephone number, including area code:  (914) 592-6100





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





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





Common
      Stock, par value .01 per share


(Title
      of
      Class)





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. YES (  )    NO ( X
      ).





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act.  YES
      (  )    NO ( X ).





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or 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 (  ).





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





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer.  See definition of
“accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange
      Act.





Large
      Accelerated
      Filer  (  )                                                      Accelerated
      Filer  (  )                                           Non-Accelerated
      Filer  ( X )





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


YES
      (  )    NO ( X).









The
      aggregate market value of the registrant’s common stock held by non-affiliates
      of the registrant as of December 29, 2006 was approximately
      $12,540,373.  On such date, the average of the closing bid and asked
      prices of the Registrant’s Common Stock, as reported by the OTC Bulletin Board,
      was $1.40.





The
      registrant had 17,928,800 shares of Common Stock outstanding as of September
      24,
      2007.





The
      information required by Part III of Form 10-K is incorporated by reference
      to
      the registrant’s Proxy Statement for the 2007 Annual Meeting of
      Shareholders.






2




**Introductory
      Note – Forward - Looking Statements**





This
      Annual Report on Form 10-K contains certain forward-looking statements, within
      the meaning of the Private Securities Reform Act of
      1995.  Forward-looking statements involve known and unknown risks,
      uncertainties and other factors that could cause actual results of AFP Imaging
      Corporation (collectively with its subsidiaries, “We”, “Our”, “Us” or, the
“Company”) or achievements expressed or implied by such forward-looking
      statements to not occur, not be realized or differ materially from that stated
      in such forward-looking statements.  Forward-looking statements may be
      identified by terminology such as “may,”  “will,”
project,”  “expect,”  “believe,” “would,”
“could,”  “estimate,”  “anticipate,”  “intend,”
“continue,”  “potential,”  “opportunity” or similar terms,
      variations of such terms, or the negative of such terms or
      variations.  Potential risks, uncertainties and factors include, but
      are not limited to,


·
            adverse
                changes in general economic
                conditions,


·
            the
                Company’s ability to repay its debts when
                due,


·
            changes
                in the markets for the Company’s products and
                services,


·
            the
                ability of the Company to successfully design, develop, manufacture
                and
                sell new products,


·
            the
                Company’s ability to successfully market its existing and new
                products,


·
            adverse
                business conditions,


·
            changing
                industry and competitive
                conditions,


·
            the
                effect of technological advancements on the marketability of the
                Company’s
                products,


·
            the
                Company’s ability to protect its intellectual property rights and/or where
                its intellectual property rights may infringe on the intellectual
                property
                rights of others,


·
            maintaining
                operating efficiencies,


·
            pricing
                pressures,


·
            risk
                associated with foreign sales,


·
            risk
                associated with the loss of services of the key executive
                officers,


·
            the
                Company’s ability to attract, train and retain key
                personnel,


·
            difficulties
                in maintaining adequate long-term financing to meet the Company’s
                obligations, and fund the Company’s
                operations,


·
            changes
                in the nature or enforcement of laws and regulations concerning the
                Company’s products, services, suppliers, or the Company’s
                customers,


·
            determinations
                in various outstanding legal
                matters,


·
            the
                success of the Company’s strategy to increase its market share in the
                industries in which it competes,


·
            the
                Company’s ability to successfully integrate the operations of any entity
                acquired by the Company with the Company’s
                operations,


·
            changes
                in currency exchange rates and regulations,
                and


·
            other
                factors set forth in this Form 10-K and from time to time in the
                Company’s
                other filings with the Securities and Exchange
                Commission.





Readers
      are urged to carefully review and consider the various disclosures made by
      the
      Company in this Annual Report on Form 10-K for the year ended June 30, 2007,
      and
      the Company’s other filings with the SEC.  These reports attempt to
      advise interested parties of the risks and factors that may affect the Company’s
      business, financial condition and results of operations and
      prospects.  The forward - looking statements made in this Annual
      Report on Form 10-K speak only as of the date hereof and the Company disclaims
      any obligation to provide updates, revisions or amendments to any
      forward-looking statements to reflect changes in the Company’s expectations or
      future events.







3




**Part
      I**





**Item
      1.  Business**





**a)
      General Development of Business**





AFP
      Imaging Corporation was organized on September 20, 1978 under the laws of the
      State of New York.  Since then, the Company has been engaged in the
      business of designing, developing, manufacturing and distributing equipment
      for
      generating and/or capturing medical and dental diagnostic images.  The
      products utilize electronic and radiographic technologies, as well as the
      chemical processing of photosensitive materials.  The Company is ISO
      9001 certified.  Veterinary and industrial professionals also use the
      Company’s imaging products.  The Company distributes in world-wide
      markets, under various brand names and trademarks, through a network of
      independent and unaffiliated dealers.  Certain digital imaging
      products are also sold and distributed by the Company directly to dental
      professional end users, through a new distribution channel, acquired in fiscal
      year 2007.





The
      Company’s primary objective is to be a leading provider of cost effective,
      diagnostic radiographic products for applications in the medical, dental,
      veterinary and industrial imaging fields.  The Company is
      concentrating on:


·
            continually
                broadening is product offerings in the transition from x-ray film
                to
                electronic imaging,


·
            enhancing
                both its domestic and international distribution channels,
                and


·
            expanding
                its world-wide market presence in the diagnostic, dental imaging
                field.





On
      April
      19, 2007, the Company completed the acquisition of Quantitative Radiology srl,
      an Italian corporation (“QR”), by acquiring all of the outstanding share capital
      of QR from the shareholders.  QR is a global supplier of
      state-of-the-art, in-office three-dimensional dental computed tomography
      (CT).  QR uses an imaging technology that features a cone shaped beam
      of x-rays (a CBCT scanner).  The Company, prior to April 19, 2007, had
      acted as QR’s exclusive distributor in North and South America, excluding
      Brazil.  Funding for the acquisition was principally derived from two
      sources; the first was the proceeds raised from a private offering of the
      Company’s common stock to equity investors and the second was a portion of the
      loan proceeds from ComVest Capital, LLC in connection with a term loan and
      revolving credit facility.  In connection with the acquisition, the
      Company, entered into employment agreements with each of the former
      shareholders’ of QR.  Each agreement contains a non-compete clause
      which prohibits the employee from engaging in activities competitive with the
      business of QR for a period of five years from the date of termination of
      employment.





On
      April
      12, 2007, the Company completed the sale of an aggregate of 5,500,000 shares
      of
      its common stock to certain accredited investors for an aggregate consideration
      of $8,140,000 pursuant to previously executed subscription
      agreements.  The common stock was issued and sold pursuant to the
      exemption from registration afforded by Regulation D of the Securities Act
      of
      1933, as amended.  In connection with the transaction, the Company
      paid the placement agent for the offering $407,000, or five percent of the
      gross
      proceeds of the offering.  The proceeds were used for the purchase of
      QR.  The Company has granted the investors certain registration rights
      with respect to the resale of the shares acquired and agreed to register these
      shares of common stock.  The Company is subject to specific penalties
      if the registration statement is not filed within a certain time.  The
      Company has received an extension of the time allowed to file this registration
      statement from the investors until October 15, 2007, so as to incorporate the
      information contained within this Annual Report on Form 10K.  The
      Company believes that any payments of penalties related to this registration
      statement are remote.





On
      April
      13, 2007, the Company entered into a Revolving Credit and Term Loan Agreement
      with ComVest Capital, LLC (“ComVest”) whereby ComVest agreed to lend the Company
      an aggregate of up to $8 million in the form of a $5 million term loan and
      a $3
      million revolving loan facility.  The term loan bears interest at a
      rate of ten percent (10%) per annum and provides for repayment over five years
      commencing in November 2007; and the revolving loans bear interest at a rate
      per
      annum of two percent (2%) plus the prime rate and is payable in full on April
      30, 2012.  The Company and each of its wholly-owned subsidiaries
      executed a Collateral Agreement pursuant to which each such party agreed to
      grant a security interest in all of its respective assets to ComVest as
      collateral security for repayment of the loans.  This new senior
      secured Revolving Credit and Term Loan Agreement replaced the Company’s previous
      $2.5 million senior secured credit facility, which was due to expire on
      September 21, 2007.  As part of the transaction, the Company granted
      to ComVest an aggregate of 800,000 warrants to purchase shares of the Company’s
      common stock at exercise prices per share equal to $1.85 with respect to 266,666
      warrants, $2.02 with respect to an additional 266,666 warrants, and $2.19 with
      respect to the remaining 266,668 warrants.  The Company entered into a
      Registration Rights Agreement pursuant to which it has agreed to register the
      shares of common stock issuable upon exercise of the warrants and conversion
      of
      the term note. The Company is subject to specific penalties if the registration
      statement is not filed within a certain time and then declared effective within
      a certain time.  The Company must also use its best efforts to keep
      the registration statement effective during the applicable registration
      period.  The Company has received an extension of the time allowed to
      file this registration statement from ComVest until October 15, 2007, so as
      to
      incorporate the information contained within this Annual Report on Form
      10K.  The Company believes that any payments of penalties related to
      this registration statement are remote.





4





In
      December 2006, the Company completed the acquisition of a domestic distribution
      channel for a portion of its digital, dental product line.  This
      channel will provide the Company with an additional sales and support function
      and will focus on direct sales to the actual professional end user . The Company
      will also maintain its historic dealer sales, where
      applicable.  Digital, dental products sold through this channel will
      also utilize the Company’s various brands.  Evolving market trends,
      distributor consolidations and competition requires that the Company develop
      this capability for direct, domestic sales representation.





In
      May
      2006, the Company completed a private offering of its common stock to selected
      institutional and other accredited investors.  The offering was priced
      at $1.80 per share and 2,777,777 shares of common stock were
      sold.  The proceeds were used for the purchase of QR.





In
      February 2005, the Company settled an outstanding environmental litigation
      claim
      which had been filed in 2001 as a civil complaint by the current owners of
      property, which the Company had owned between August 1984 and June
      1985.  The Company paid $325,000, which represented its entire
      liability under the settlement offer.  See Item 3, Legal Proceedings
      for a further discussion of this matter.





**b)
      Financial Information about Industry Segments**





The
      Company is engaged in one industry segment; the manufacture and distribution
      of
      medical and dental x-ray imaging equipment and accessories.  Prior to
      July 2001, when the Company sold the assets related to its graphic arts
      subsidiary, the Company had been engaged in two industry segments, the
      manufacture and distribution of medical/dental x-ray equipment and accessories,
      and graphic arts, film processing equipment.  The Company has agreed
      not to compete in this same business line of graphic arts film processing
      equipment for ten years, to expire in July 2011.  The Company’s
      business segments, until July 2001, were based on significant differences in
      the
      nature of the Company’s operations, including distribution channels and
      customers.  The composition of the current industry segment is
      consistent with that used by the Company’s management in making strategic
      decisions.  See Notes to the Consolidated Financial Statements for
      further discussion of industry segments.





**c)
      Narrative Description of Business**





**Principal
      Products and Services**





Cone
      Beam CT Scanners – Three Dimensional Imaging


The
      Company, through QR, its Italian subsidiary, designs, manufactures and
      distributes a dental CT scanner capable of generating and reconstructing
      three-dimensional images of the teeth, jaws and surrounding dental
      anatomy.  For many clinical procedures, it is an important diagnostic
      improvement over historical two-dimensional film images.  The system
      utilizes a conical shaped x-ray cone beam (“CBCT”) that rotates around the skull
      and passes through the teeth, at many angles, thus creating unique,
      radiographic, dental information that is captured digitally.  The
      Company’s proprietary software then reconstructs a three-dimensional image from
      the data.  QR has been providing this technology to world-wide markets
      for over ten years.  The primary users are dentists, implant
      specialists, oral surgeons and orthodontists, as well as Ear, Nose and Throat
      medical specialists. The configuration includes a horizontal patient table
      support system that assists positioning for complex cases involving the elderly,
      the infirm or small children.  The Company has also introduced a
      vertical, standing CBCT model where a patient can be seated or standing upright
      during the examination.  This model also provides user flexibility for
      smaller examination rooms.  The Company completed the acquisition of
      QR on April 19, 2007.





Digital
      Dental and Large Body Digital Imaging Systems – Two Dimensional
      Imaging


The
      Company manufactures, distributes and services film-less, digital radiography
      sensors in various image format sizes, utilizing x-rays and electronic imaging
      software.  The equipment generates and captures two dimensional,
      dental x-ray images with these sensors, in place of film, and then displays
      them
      using the Company’s software.  Digital radiographic systems, referred
      to as DR Systems (direct radiography), have practical applications in both
      human
      and companion animal diagnostics.  Veterinary dentistry has become a
      growing and important discipline and treatment procedure.





The
      Company has developed proprietary software for each application.  DR
      systems can be either “postage stamp size”, larger for equine applications or in
      the largest format to be installed in x-ray tables for companion animal (pets)
      whole body examinations.  The primary benefit for the professional is
      the improved display of diagnostic information, clinical efficiency and the
      flexibility of electronic radiographs for referrals and storage.






5




Dental
      X-Ray Systems


The
      Company distributes digital and analog dental x-ray machines, manufactured
      by
      others.  The Company has the exclusive distribution rights in the
      North American markets for a well established, European-designed, intraoral
      dental x-ray and a panoramic/cephalometric dental x-ray unit. The latter
      provides, all in one view, a full format image for the diagnosis of the entire
      upper and lower dental arches and jaws.  These dental products can be
      supplied to the market with a digital, filmless x-ray sensor that is compatible
      with the Company’s software.  Panoramic units are typically used by
      dentists, orthodontists, oral surgeons, and endodontists for specific patient
      treatment plans where three dimensional imaging is not required.  When
      existing, installed equipment utilizes analog x-ray film that can be developed
      in the Company’s well established line of processors.





Veterinary
      Imaging and Radiographic Table Systems


The
      Company manufactures and distributes a line of x-ray tables and related
      equipment specifically designed for the veterinary marketplace.  They
      include x-ray systems for film or digital dental radiography, a portable digital
      imaging system for the diagnosis of equine extremities and a large size
      filmless, x-ray sensor used in conjunction with general radiographic equipment.
      The Company distributes general-purpose x-ray systems and related imaging
      components specifically designed for veterinary applications.  They
      are marketed under the Company’s trademark “VetTek.”  These systems
      are designed to offer the user either digital or film based image capture
      systems and allows the veterinarian to perform either dental or general
      radiography.





X-Ray
      Processors & Accessories


The
      Company manufactures and distributes a line of medical, dental and industrial
      x-ray film processors.  These are commonly referred to as analog
      film-based systems.  The machines automatically process or develop
      x-ray films.  The exposed film is inserted into the equipment and
      returned to the operator developed, fixed, washed and dried.  The
      equipment can be located either in a dark room site or adapted to a daylight
      loading system.  These analog units are used for diagnostic x-ray
      imaging and industrial, non-destructive testing applications.  These
      products are distributed worldwide through an unaffiliated dealer network to
      doctors, dentists, veterinarians, hospitals, medical clinics, and the U.S.
      government.





**Patents
      and Trademarks**





The
      Company presently holds or has licensed a number of domestic and foreign utility
      patents, which the Company believes are material to the technology used in
      its
      products.  The Company’s intellectual property includes several
      patents obtained in connection with prior acquisitions.  The Company
      is not aware of any patents or other intellectual property held by others that
      conflict with the Company’s current product designs.  However, there
      can be no assurance that infringement claims will not be asserted against the
      Company in the future.  Patent applications have been filed where
      appropriate.  The Company owns several domestic and foreign
      trademarks, which it uses in connection with the marketing of its products,
      including:  AFP Imaging, DENT-X, ENDOS, EVA,  NewTom 3G,
      VetTek and DIGI-VET, among others.  The Company believes that these
      utility patents and trademarks are important to its operations and the loss
      or
      infringement by others of or to its rights to such patents and trademarks could
      have a material adverse effect on the Company.  Even with the patent
      rights for the Company’s products, the Company’s technology may not preclude or
      inhibit competitors from producing products that have substantially similar
      performance specifications as the Company’s products.





The
      Company has agreed to pay a nominal royalty on the domestic sales of its digital
      dental systems to a third party under a license for the use of the third party’s
      software format for the computer display of such images.  This royalty
      will cease if and when the Company introduces a modified version of its software
      which does not use the third party’s software format.  The Company
      also has agreed to pay a royalty to a third party on the worldwide sales of
      its
      digital dental sensors, under a license to use certain technology developed
      and
      owned by the third party and utilized in the sensor’s internal
      operations.  The Company is dependant to some degree on this
      third-party license, and the loss or inability to replace this license could
      result in increased costs as well as substantial delays or reductions in product
      shipments.  The principal technology applied to the construction of
      the Company’s other products may be considered proprietary.





**Research
      and Development**





The
      amounts spent by the Company during each of the Company’s last three fiscal
      years on primary research activities relating to the development of new products
      and the improvement of existing products, all of which was Company sponsored,
      are as follows:





**Year
      Ended June 30**,


2007
            2006
            2005$1,021,766
            $696,700
            $435,813






6




The
      Company conducts research and development activities internally in its Elmsford,
      New York facility as well as in its Verona, Italy facility, and contracts out
      certain projects to qualified vendors and external consultants.  The
      Company’s research and development efforts and technologies have been
      significantly enhanced by the acquisition of QR on April 19,
      2007.  The Company has integrated its research and development between
      both locations.





**Raw
      Materials**





The
      Company manufactures and  assembles its products at its facilities in
      Elmsford, New York and Verona, Italy, both of which are ISO 9001/2000
      (International Standards Organization) certified.  The Company’s
      products are manufactured from parts and components obtained from numerous
      unaffiliated suppliers and/or fabricated internally.  In most cases,
      the Company does not utilize any unique processes, nor does it traditionally
      have difficulties in obtaining raw materials in the manufacture of its
      products.  The Company owns proprietary designs and tooling to produce
      the digital x-ray sensors and other components that are in the physical
      possession of vendors.  Although the Company anticipates that an
      adequate commercial supply of necessary raw materials and components will remain
      available from various sources, the loss of the Company’s relationship with a
      particular supplier could result in productions delays.  However, such
      a loss is not expected to materially adversely affect the Company’s long term
      business, as the proprietary component or designs can be reproduced
      elsewhere.





**Warranties**





The
      Company generally warrants each of its products against defects in materials
      and
      workmanship for a period of one to two years, depending upon the product, from
      the date of shipment plus any extended warranty period purchased by the
      customer.  The Company offers a three year warranty for the digital,
      dental sensors.  The need to fulfill warranty claims by the Company’s
      customers or dealers could potentially have an adverse effect on the Company
      by
      requiring additional expenditures for replacements, materials and/or
      labor.





**Sales,
      Marketing and Distribution**





The
      Company’s manufactured and outsourced products are distributed both domestically
      and internationally to end users and independent medical and dental dealers
      or
      distributors.  These dealers install and service our
      products.  The Company advertises and markets under its own brands and
      trade names.  Certain 3-D imaging products are imported from its
      Verona, Italy facility.  Others items come from foreign suppliers for
      sale in North America.  The Company has also expanded its dental sales
      efforts by acquiring a direct sales distribution channel.





The
      Company conducts worldwide marketing and regional sales efforts through trade
      show attendance and promotion.  The Company advertises in domestic and
      international journals, provides sales support and literature, prepares
      technical manuals and conducts customer education and training programs in
      order
      to promote its products.  In addition, the Company participates in
      domestic and international technical support.  The Company maintains
      various web sites, which provide an easy-to-navigate, on-line information
      resource.  It includes Company information, product description and
      extensive technical specifications and information.





**Government
      Regulation**





The
      Company’s medical and dental products are subject to government regulation in
      the United States and certain other countries.  The United States Food
      and Drug Administration (“FDA”) regulates the distribution of all equipment used
      as medical devices.  The Company must comply with the procedures and
      standards established by the FDA and comparable foreign regulatory
      agencies.  The Company believes it has registered all of its
      applicable medical and dental products with the FDA, and that all of its
      products and procedures satisfy all the criteria necessary to comply with FDA
      regulations.  The FDA has the right to disapprove the marketing of any
      medical device that fails to comply with FDA regulations.  The
      Company’s manufacturing facilities are ISO 9001/2000 certified.  Where
      applicable, the Company’s products are Conformite’ Europeenne (“CE”) certified
      for sales within the European Union.  Any future changes in existing
      regulations, or adoption of additional regulations, domestically or
      internationally, which govern devices such as the Company’s medical and dental
      products have the potential to have a material adverse effect on the Company’s
      ability to market its existing products or to market new products. The Company
      engages specialized, expert consultants for the preparation of FDA
      applications.





The
      Company is also subject to other international, federal, state, and local laws,
      regulations and recommendations relating to safe working conditions and
      manufacturing processes.  The Company believes it is in compliance
      with such rules.





7




International
      sales of our products are subject to the regulatory agency product registration
      requirements of each country in which the Company’s products are
      sold.  The regulatory review process varies from country to
      country.  The Company typically relies on its distributors in foreign
      countries to obtain the required regulatory approvals.





**Product
      Liability Exposure**





The
      Company’s business involves the inherent risk of product liability
      claims.  The Company currently maintains general product liability
      insurance as well as an umbrella liability policy, which the Company believes
      are sufficient to protect the Company from any potential risks to which it
      may
      be subject.  However, there can be no assurances that product
      liability insurance coverage will continue to be available or, if available,
      that it can be obtained in sufficient amounts or at a reasonable
      cost.  See Item 3. Legal Proceedings, for further discussion of any
      outstanding product liability claims.





**Seasonal
      Nature**





Historically,
      the Company’s fourth quarter revenues of any fiscal year have been higher than
      the subsequent first quarter’s revenues.  This is due to aggressive
      fourth quarter marketing, followed by lower customer demand in the first fiscal
      quarter attributed to summer holidays and traditional foreign business closings
      during July and August.  The Company expects future net sales and
      operating results to continue to reflect this general seasonality.





**Working
      Capital Practices**





The
      Company believes its practices regarding inventories, receivables or other
      items
      of working capital to be typical for the industry involved.  On April
      13, 2007, the Company entered into a new senior secured credit facility (the
      Revolving Credit and Term Loan) with ComVest Capital, LLC that replaced the
      Company’s existing $2.5 million revolving line of credit that was due to expire
      on September 21, 2007.  The Revolving Credit and Term Loan consists of
      a $5 million convertible term note and a $3 million revolving loan
      facility.  The convertible term note bears interest at a rate of ten
      percent per annum and provides for repayment over five years commencing in
      November 2007 with a final balloon payment of all remaining amounts due
      there-under on April 30, 2012.  The convertible term note, in addition
      to being convertible by the Company upon the satisfaction of certain conditions,
      including a trading price equal to 175% of the conversion price and the
      Company’s common stock being traded on Nasdaq, is convertible by the lender at
      any time into shares of common stock at a conversion price of $2.37 per share,
      or 2,109,705 shares based on the initial principal amount of the convertible
      term note.  The revolving loan bears interest at a rate of two percent
      plus prime rate per annum, currently equal to 9.75%, has a specific formula
      to
      calculate available funds based on eligible accounts receivable and inventory,
      is subject to certain maximum borrowing base requirements, has certain reporting
      requirements to the lender, and is payable in full on April 12,
      2012.  The Company and each of its wholly-owned subsidiaries executed
      a Collateral Agreement pursuant to which each such party agreed to grant a
      security interest in all of its respective assets to ComVest as collateral
      security for repayment of the loans.  The Revolving Credit and Term
      Loan is secured by all of our and our wholly-owned subsidiaries inventory,
      accounts receivable, equipment, officer life insurance policies and proceeds
      thereof, trademarks, licenses, patents and general intangibles.  It is
      believed that the Revolving Credit and Term Loan is sufficient to finance our
      ongoing working capital requirements for the foreseeable future.  The
      Revolving Credit and Term Loan Agreement has a specific formula to calculate
      available funds based on eligible accounts receivable and inventory, is subject
      to maximum borrowing base limitations, and has certain reporting
      requirements.  As part of the transaction, the Company granted to
      ComVest an aggregate of 800,000 warrants to purchase shares of the Company’s
      common stock at exercise prices per share equal to $1.85 with respect to 266,666
      warrants, $2.02 with respect to an additional 266,666 warrants, and $2.19 with
      respect to the remaining 266,668 warrants.  The Black-Scholes Method
      was used to value these detachable warrants, and have been recorded in the
      accompanying Consolidated Balance Sheets at $1,114,784.  The Company
      entered into a Registration Rights Agreement pursuant to which it has agreed
      to
      register the shares of common stock issuable upon exercise of the warrants
      and
      conversion of the term note.





In
      September 2001, in connection with the entry into a previous line of credit
      with
      its former lender, the Company issued a 5-year warrant for the purchase of
      100,000 shares of the Company’s common stock at $.32 per share, subject to
      adjustment for all subsequent issuances of stock.  The expiration date
      of this warrant was September 21, 2006.  In August and September 2006,
      the former lender exercised the warrant and converted the warrant into 82,806
      shares of common stock in a cashless exercise in a manner as specified in the
      warrant.





**Customers**





In
      the
      Company’s fiscal years ended June 30, 2007, 2006 and 2005 there were no sales to
      any one customer which accounted for 10% or more of the Company’s total
      consolidated sales.  Management believes that the loss of any one
      customer would have an adverse effect on the Company’s consolidated business for
      a short period of time as the Company seeks new customers.





8




**Backlog
      Orders**





As
      of June
      30, 2007, the Company’s backlog of orders for its products was approximately
      $2,668,900 as compared to $1,066,839 as of June 30, 2006.  All of the
      orders included in the backlog at June 30, 2007 are scheduled for delivery
      on or
      before June 30, 2008.  Spare part sales are not included in the
      Company’s backlog calculations.  In the opinion of the Company,
      fluctuations in the backlog and its size at any given time are not necessarily
      indicative of intermediate or long-term trends in the Company’s
      business.  Much of the Company’s backlog can be canceled or the
      delivery dates of orders can be accelerated or extended without
      penalty.  Delivery of capital equipment is frequently subject to
      changing economic or budget conditions of medical institutions and end user
      clinical practitioners, which can vary significantly between fiscal
      periods.





**Government
      Contracts**





The
      Company did not fulfill any significant contracts in Fiscal Years 2007, 2006
      and
      2005 with the United States Government that were material to the Company’s
      consolidated business.  The Company’s policy is to be responsive to
      all governmental Requests for Quotations (RFQ), which can be fulfilled by items
      within the scope of the Company’s product lines.  Several government
      agencies also procure equipment directly, without contract awards.





**Competition**





The
      Company is subject to both foreign and domestic
      competition.  Competitors have made significant investments in
      research and development of new technologies, products and
      services.  Some competitors are well established in similar
      manufacturing and distribution businesses and may have greater financial,
      manufacturing and distribution resources than the Company.  With
      respect to all of its products, the Company competes on the basis of function,
      features, product specifications, price per application, promptness of delivery
      and customer service.  The Company purchases certain products from
      others for resale on a non-exclusive basis, which may be subject to competition
      from the suppliers or other independent distributors.





The
      Company also competes in the dental imaging market on the basis of its
      proprietary and patented technologies.  Certain competitors have
      significant or greater resources and revenues in electronic digital imaging
      technologies and expertise in software development utilized in dental imaging
      products.





The
      market
      for technology professional services is intensely competitive, rapidly evolving
      and subject to rapid technological change.  The Company expects
      competition not only to persist, but also to increase.  Competition
      may result in price reductions, reduced margins and loss of market
      share.  The market for the Company’s goods and services is rapidly
      evolving and is subject to continuous technological change.  As a
      result, the Company’s competitors may be better positioned to address these
      developments or may react more favorably to these changes.





While
      the
      Company believes its products are competitive in terms of capabilities, quality
      and price, increased competition in the marketplace could have an adverse effect
      on the Company’s business and, recent business mergers and acquisitions may have
      potentially adversely affect the Company’s business.  Many of the
      Company’s competitors are much larger with significantly greater financial,
      sales, marketing and other resources than those of the Company.  There
      can be no assurance that these competitors are not currently developing or
      will
      attempt to develop new products that are more effective than those of the
      Company or that might render the Company’s products noncompetitive or
      obsolete.  No assurances can be given that the Company will be able to
      compete successfully with such competitors in the future.





**Environmental**





The
      Company believes it is in compliance with the current laws and regulations,
      in
      the United States and Italy, governing the protection of the environment and
      that continued compliance would not have a material adverse effect on the
      Company or require any material capital expenditures.  Compliance with
      local codes for the installation and operation of the Company’s products is the
      responsibility of the end user, or the dealer who independently provides
      installation services.  See Item 3, Legal Proceedings, for further
      discussion of an environmental claim in which the Company is
      involved.





**Employees**





As
      of June
      30, 2007, the Company employed 115 people on a full-time basis,
      world-wide.  The Company has no collective bargaining agreements and
      considers its relationship with its employees to be satisfactory.  The
      Company’s Italian subsidiary conforms to their statutory, Italian labor
      regulations, which includes a mandatory severance indemnity.  All
      Italian employees are entitled to an indemnity upon termination of their
      employment relationship for any reason.  The respective benefit
      accrues to each employee on a pro-rata basis during their employment period
      and
      is based upon their respective salary.  The vested benefit payable
      accrues interest.





9




**d)
      Financial Information about Foreign and Domestic Operations and Export
      Sales**





Financial
      information related to foreign and domestic operations and export sales for
      the
      last three fiscal years is as follows:




**2007**
              
              **2006**
              
              **2005**SalesUnited
                  States
              $19,781,071
              69%
              $19,306,971
              77%
              $18,858,056
              82%Europe
              2,071,262
              7%
              --
              --
              --
              --US
                  Export Sales
              $6,867,360
              24%
              $5,691,301
              23%
              $4,277,007
              18%Net
                  Income/(loss)United
                  States
              ($1,220,649)
              
              $1,005,348
              
              $1,899,930Europe
              ($3,452,175)
              
              --
              
              --Identifiable
                  assetsUnited
                  States
              $9,942,023
              
              $14,340,564
              
              $8,153,396Europe
              $17,228,803
              
              --
              
              --





Assets
      used in the manufacture of export sales are integrated with the other assets
      of
      the Company.  The intangibles, the amortization of the intangibles,
      and the write-off of the in-process research and development, all associated
      with the acquisition of QR, has been attributed to the Italian
      operations.





Included
      above are the operating results of QR, the Company’s foreign subsidiary,
      effective April 19, 2007, the acquisition date.  Prior to such time,
      the Company only maintained domestic operations.  No one foreign
      country or geographic area comprised 10% or more of consolidated sales for
      the
      fiscal years ended June 30, 2007, 2006 and 2005.





**Item
      1A.  Risk Factors.**





**Business
      Risks**





**We
      are dependent on a limited number of products and any material decrease in
      revenues from any one of these products could have an adverse impact on our
      revenue and financial position.**  Our revenues primarily are
      generated from sales of our digital dental sensors, three-dimensional digital
      Cone Beam CT scanners, panoramic and intra-oral x-ray machines, and analog
      processor products.  We can give no assurance that any of these
      systems and products, or any of the other products which we currently sell,
      or
      may sell in the future, will not be rendered obsolete or inferior as a result
      of
      technological change, changing customer demands, new product introductions
      or
      other developments.  There also can be no assurance that our
      competitors will not succeed in developing or marketing technologies, systems
      and products that are superior to and/or more commercially attractive than
      our
      technologies, systems and products.  The rendering obsolete or
      inferior of our technologies, systems and products could have a material adverse
      effect on us.





Further,
      our success will depend in part on our ability to improve and enhance our
      technologies, systems and products timely in comparison to our
      competitors.  There can be no assurance that we will be able to do
      so.  Our failure to improve and enhance any of our technologies,
      systems and products in a timely manner could have a material adverse effect
      on
      us.





**A
      failure to adapt to technological changes within our industry could have an
      adverse effect on our operating results.**  Our success will
      depend on our ability to keep pace with technological developments of new
      products and services and our ability to fulfill increasingly sophisticated
      customer demands.  The medical, dental and veterinary imaging
      equipment and service markets are characterized by rapidly changing technology
      and frequent introductions of new products, services and product and service
      enhancements, both equipment and software modifications and
      upgrades..  There can be no assurance that we will be able to provide
      the products, services and support necessary to remain
      competitive.  If we were to incur delays in sourcing and developing
      new products and services or enhancements to our current lines of products
      and
      services, such delays could have a material adverse effect on our operations
      and
      financial results.





10




**We
      are subject to substantial competition which could adversely affect our
      operating results.**  The markets in which we operate are
      highly competitive with respect to performance, quality and price.  We
      directly compete with local, regional, national and international manufacturers
      and distributors of medical, dental and veterinary imaging
      equipment.  In the future, we may face further competition from new
      market entrants and possible alliances between existing competitors. Some of
      our
      competitors have, or may have, greater financial, marketing and other resources
      than us.  As a result, competitors may be able to respond more quickly
      to new or emerging technologies and changes in customer requirements, benefit
      from greater purchasing economies, offer more aggressive hardware and service
      pricing to customers, or devote greater resources to the promotion of their
      products and services than we are capable of accomplishing.  There can
      be no assurance that we will be able to successfully compete in the future
      with
      such competitors.  The failure to successfully compete could have an
      adverse effect on our operating results.





**The
      market for professional technology services is intensely competitive, rapidly
      evolving and subject to rapid technological change.**  We
      expect competition not only to persist, but to increase.  Competition
      may result in price reductions, reduced margins and loss of market
      share.  The market for our goods and services is rapidly evolving and
      is subject to continuous technological change.  As a result, our
      competitors may be better positioned to address these developments or may react
      more favorably to these changes.  Existing or future competitors may
      develop or offer strategic services that provide significant technological,
      creative, performance, price or other advantages over the services that we
      offer.





**Our
      growth will depend on our ability to continue to develop our
      brands.**  We believe that strengthening our brands will be
      critical to achieving widespread acceptance of our products and
      services.  Promoting and positioning our brands will depend largely on
      the success of our marketing efforts and ability to provide high quality
      products and services.  In order to promote our brands, we will need
      to increase our marketing budget and otherwise increase our financial commitment
      to creating and maintaining brand loyalty among our customers.  Brand
      promotion activities may not yield increased revenues and, even if they do,
      any
      increased revenues may not offset the expenses that we incur in building our
      brands.  If we fail to promote and maintain our brands or incur
      substantial expenses in an unsuccessful attempt to promote and maintain our
      brands, our  business would be harmed.





**We
      will be dependent on key management and advisors**.  Our
      success is highly dependent on our ability to attract and retain experienced
      management and industry personnel to supplement our present management
      team.  The loss of the services or advice of any one or more of these
      persons, whether part of the present management or new hires, could have a
      material adverse effect on our business. We face considerable competition from
      other entities in the fields in which we operate and with other entities for
      qualified personnel, many of which have significantly greater resources than
      us.  We may be unable to offer key employees compensation of the type
      and quantity that our competitors and other entities can offer.  There
      can be no assurance that we will be able to attract and retain personnel in
      the
      future, and the inability to do so could have material adverse effects on
      us.





**We
      are significantly dependent upon the continued availability of Donald
      Rabinovitch, our president and co-chief executive officer, David Vozick, our
      chairman and co-chief executive officer,  Roberto Molteni, our
      executive vice-president of technology and our new sales and marketing team
      recently hired to help transition the sale of our products to the final
      users**.  We currently do not have employment agreements with
      any of these executive officers.  The loss or unavailability to us of
      any of Messrs. Rabinovitch, Vozick or Molteni for an extended period of time
      could have a material adverse effect on our business operations and
      prospects.  To the extent that their services would be unavailable to
      us for any reason, we would be required to procure other personnel to manage
      and
      operate us.  There can be no assurance that we will be able to locate
      or employ such qualified personnel on acceptable terms.





**We
      are dependent on our key personnel and ability to recruit, train and retain
      technology professionals.**  Our current and planned operations
      will depend in large part on our ability to identify, hire, train and retain
      technology professionals and sales and senior management personnel who can
      provide the technical, strategic, creative, marketing and audience development
      skills required by our clients and for our financial success.  There
      is a shortage of qualified personnel in these fields and we compete with other
      companies, both those within the industry in which we operate and those in
      other
      industries, for this limited pool of technology professionals and sales and
      senior management personnel.  There is no assurance that we will be
      able to attract, train, or retain such qualified personnel.





Further,
      additions of new and departures of existing personnel, particularly in key
      positions, can be disruptive, which also could have a material adverse effect
      upon us, the result of which could have a negative impact on our operations
      and
      financial results.





**Our
      dependence on third party licenses could have adverse
      effects.**  We rely on certain software, technology and
      products that we have licensed from third parties, including software,
      technologies and products that are integrated with internally developed software
      and/or used in our products to perform key functions. These third-party licenses
      may not continue to be available for use on commercially reasonable
      terms.  Also, the licensed software, technologies and products may not
      be appropriately supported, maintained or enhanced by the licensors such that
      the license would not continue to provide the necessary commercial benefits
      to
      us.  In addition, we may not be able to license additional software,
      technologies and products in the future on terms advantageous to
      us.  The loss of or inability to obtain or replace licenses to, or
      inability to support, maintain and enhance, any of such licensed software,
      could
      result in increased costs, including the expense of internally developing the
      required software, technologies and products, as well as delays or reductions
      in
      product shipments.






11




**There
      are a number of uncertainties associated with international sales that could
      adversely affect us.**  In each of our last three fiscal years,
      sales to customers outside of the United States exceeded 18% of our overall
      sales.  We anticipate that international sales will continue to
      account for a similar portion of our overall sales
      revenue.  International revenues are subject to a number of
      uncertainties, including, but not limited to:


§
            contracts
                may be difficult to enforce and receivables difficult to
                collect;


§
            foreign
                customers and distributors may require longer payment
                cycles;


§
            foreign
                governments may impose additional withholding taxes or otherwise
                tax our
                foreign income, as well as  impose tariffs or adopt other
                restrictions on foreign trade;


§
            fluctuations
                in exchange rates may affect product
                demand;


§
            United
                States export licenses may be difficult to obtain;
                and


§
            Intellectual
                property rights in foreign countries may be difficult or impossible
                to
                enforce.





Moreover,
      many foreign countries have their own regulatory approval requirements,
      including obtaining various licenses to operate in specific countries for the
      sale of our products.  As a result, our introduction of new products
      into international markets could be hindered, costly and/or
      time-prohibited.  There can be no assurance that we will be able to
      obtain the required regulatory approvals on a timely basis, if at
      all.





**We
      are subject to pricing pressures and variable foreign exchange rates, which
      could result in lower sales revenues and gross profits.**  We
      believe our prices and payment and delivery terms are
      competitive.  However, certain competitors may offer more aggressive
      pricing and payment terms to customers.  We have experienced, and
      expect to continue to experience pricing pressure, on our products and services
      due to competitive factors, including industry consolidation.  In
      addition, we have seen a general weakness in the U.S. economy negatively
      impacting our operating results as dental, medical and veterinary professionals
      reduced their capital expenditures in response to such general economic
      weakness.  In an attempt to stimulate sales to existing and new
      customers, we believe that pricing pressures may increase in the
      future.  Decreasing prices for our products and services would require
      us to sell a greater number of products and services to achieve the same level
      of net sales and gross profit.





**Seasonality
      can cause fluctuations in our revenues and operating
      results.**  We have seen seasonal variations in our revenues
      and operating results.  Our fourth quarter results for a fiscal year
      have historically exceeded corresponding revenues and operating results for
      the
      first quarter of the following fiscal year. We expect our net sales and
      operating results to continue to reflect this seasonality.  The
      seasonality of our operating results could result in fluctuations of the market
      price of our common stock.





**We
      have had and may continue to have fluctuations in our quarterly operating
      results.**  Our quarterly operating results have and, in the
      future, may fluctuate significantly, depending on a variety of factors, many
      of
      which are outside of our control.  Factors that may affect our
      quarterly results include:


§
            the
                demand for our products and
                services;


§
            the
                size, timing and timely fulfillment of orders for our products and
                services;


§
            the
                level of product, price and service
                competition;


§
            changes
                in average selling prices and product mix, which also could affect
                our
                profit  margins;


§
            changes
                in our sales incentive strategy, as well as sales personnel
                changes;


§
            the
                mix of direct and indirect sales, product returns and
                rebates;


§
            federal,
                state or local government
                regulation;


§
            our
                ability to upgrade and develop our systems and infrastructure to
                accommodate growth;


§
            our
                ability to attract and retain qualified
                personnel;


§
            consumer
                trends;


§
            the
                success of our brand building and marketing
                campaigns;


§
            capital
                spending budgets of our customers;


§
            the
                timing, size and mix of product and service orders and deliveries;
                and


§
            General
                economic conditions and economic conditions specific to the industries
                in
                which we compete.





**Our
      operating expenses and capital expenditures are based in large part on our
      expectations of future revenues**.  Therefore, if revenue
      levels are below expectations, operating results are likely to be adversely
      affected.  Net income may be disproportionately affected by an
      unanticipated decline in revenue for a particular quarter because a relatively
      small amount of our expenses will vary with our revenue in the short
      term.  As a result, we believe that period-to-period comparisons of
      our results of operations are not and will not necessarily be meaningful and
      should not be relied upon as any indication of future
      performance.  Due to all of the foregoing factors, it is likely that
      in some future quarter our operating results will be below
      expectations.





12




**We
      are dependent on third-party distributors and a loss of any of these
      distributors could adversely affect us.**  We distribute our
      products through third-party, independent distributors.  Historically,
      a limited number of distributors have accounted for a significant portion of
      our
      overall revenues.  In general, these distributors could discontinue
      marketing our products with little or no notice.  Certain distributors
      also could market products which compete with our products.  The loss
      of or significant reduction in revenues generated through one or more of our
      distributors could have a material adverse effect on our operating results
      and
      financial position.





**We
      are dependant upon transitioning the Company to selling directly to the end
      user
      in addition to selling to our existing distributor base.  The
      financial operations of the Company are dependant upon a successful
      transition.**We have recently hired a new sales and marketing
      team to sell our products directly to doctors, dentists and other direct users
      of  our equipment.  Their success will directly affect the
      financial results of the Company. ****At this time, we cannot
      predict how successful this transition will be.





**We
      are subject to the uncertainty of litigation results that could adversely impact
      our financial position.**  We are subject to a variety of legal
      actions relating to our business operations.  Recent court decisions,
      legislative activity and regulatory enforcement may increase our exposure for
      claims by third-parties, including environmental claims.  In some
      cases, substantial punitive damages may be sought.  We currently have
      insurance coverage for some of these potential liabilities.  Other
      potential liabilities may not be covered by insurance.  In addition,
      insurers may dispute coverage or the amount of insurance may not be sufficient
      to cover the damages awarded.  Further, certain types of damages, such
      as punitive damages, may not be covered by insurance and insurance coverage
      for
      all or certain forms of liability may become unavailable or prohibitively
      expensive in the future.  An adverse outcome from a litigation matter
      could have a material adverse effect on us.





**We
      are subject to regulatory and legislative risks that could adversely affect
      our
      operations.**  We must obtain certain approvals and marketing
      clearances from governmental authorities, including the U.S. Food and Drug
      Administration (the FDA) and similar health authorities in foreign countries,
      to
      market and sell our products domestically and in such foreign
      countries.  The FDA regulates the marketing, manufacturing, labeling,
      packaging, advertising, sale and distribution of medical devices, as do various
      foreign authorities in their respective jurisdictions.  The FDA also
      enforces additional regulations regarding the safety of equipment utilizing
      x-rays.  Various states impose similar regulations.  Certain
      of our manufactured and imported products and product components, including
      our
      tomography CT systems, x-ray systems and sensors, are currently regulated by
      such authorities and certain of our future products will require approval or
      marketing clearance from such various governmental authorities, including the
      FDA.  In addition, various additional requirements are imposed upon us
      to make us eligible to sell products to the federal government.





The
      FDA
      review process typically requires extended proceedings pertaining to the safety
      and efficacy of new products.  A Section 510(k) application is
      required in order to market a new or modified medical device.  If
      specifically required by the FDA, a pre-market approval may be
      necessary.  This procedure, which must be completed prior to marketing
      a new medical device, is potentially expensive and time
      consuming.  The procedure may delay or hinder a product=s
      timely entry into the marketplace.  Moreover, there can be no
      assurance that the review or approval process for these products by the FDA
      or
      any other applicable governmental authorities will occur in a timely fashion,
      if
      at all, or that additional regulations will not be adopted or current
      regulations amended in such a manner as will adversely affect us.  In
      addition, final approval does not assure, in any manner, the success of the
      approved product.





We
      also
      are subject to other federal, state and local laws, regulations and
      recommendations relating to safe working conditions and manufacturing
      practices.





International
      sales of our products are subject to the regulatory agency product registration
      requirements of each country in which our products are sold.  The
      regulatory review process varies from country to country and may in some cases
      require the submission of clinical data.  We typically rely upon our
      distributors in foreign countries to obtain the required regulatory
      approvals.





The
      extent
      of government regulation that might result from any future legislation or
      administrative action cannot be accurately predicted.  Failure to
      comply with regulatory requirements could have a material adverse effect on
      our
      operating results and financial condition.





13




In
      addition to legislative and regulatory concerns directly affecting us, our
      customers operate in the health care industry, which is highly
      regulated.  Both existing and future governmental regulations directed
      at our customers could adversely impact us indirectly.  Further,
      cost-containment efforts by health maintenance organizations may adversely
      affect the potential market for our products.





**Changes
      or increases in, or failure to comply with, regulations applicable to our
      business could increase our costs.**  The industries in which
      we compete are subject to extensive regulation and licensing requirements under
      federal, state and local laws.





**We
      have product warranty exposure which could adversely affect our operating
      results and financial condition.**  We generally warrant each
      of our products against defects in materials and workmanship for a period of
      one
      to two years from the date of shipment, plus any extended warranty period
      purchased by the customer and three years for our digital
      sensors.  The need for warranty service could have a material adverse
      effect on us by, among other things, requiring additional expenditures for
      parts
      and personnel, as well as damaging our reputation and goodwill.





**Our
      inability to continue to service and install  our various equipment
      could adversely affect our operating results and financial
      performance.**We generally service and install our
      three-dimensional Cone Beam CT equipment as well as install our digital dental
      sensors sold to the end user.  Although we maintain the proper
      personnel and equipment to service our existing and anticipated customers,
      there
      can be no assurances that we can completely satisfy all of our customers’
requirements.





**There
      is a potential for product recall and product liability
      claims**.  Our products may be subject to recall for unforeseen
      reasons.  In addition, certain applications, including projected
      applications, of our products entail the risk of product liability
      claims.  Such risks will exist even with respect to those products
      that have received, or in the future may receive, regulatory approval for
      commercial sale.  These claims may be made by our customers,
      distributors or others.  Although we have maintained insurance
      coverage related to product liability claims, no assurance can be given that
      product liability insurance coverage will continue to be available or, if
      available, that it can be obtained in sufficient amounts or at reasonable cost
      or that it will be sufficient to cover any claims that may arise.  We
      do not maintain any insurance relating to potential recalls of our
      products.  Costs associated with potential product recalls or product
      liability claims could have a material adverse effect on us.





**Our
      inability to protect our intellectual property rights could prevent us from
      selling our products and hinder our financial
      performance.**  The technology and designs underlying our
      products may not be fully protected by patent rights.  Our future
      success is dependent primarily on non-patented trade secrets and on the
      innovative skills, technological expertise and management abilities of our
      employees.  Even with the patent rights in our products, our
      technology may not preclude or inhibit competitors from producing products
      that
      have identical performance as our products.  In addition, we cannot
      guarantee that any protected trade secret could ultimately be proven valid
      if
      challenged.  Any such challenge, with or without merit, could be time
      consuming to defend, result in costly litigation, divert the attention and
      resources of our management and, if successful, require us to pay monetary
      damages.





**Our
      products may infringe the intellectual property rights of others which may
      cause
      us to incur unexpected costs or prevent us from selling our
      products.**  We believe our products do not infringe on the
      intellectual property rights of others.  However, there can be no
      assurance that infringement claims will not be asserted against us in the future
      or that, if asserted, any infringement claim will be successfully defended.
      We
      also may be subject to legal proceedings and claims from time to time, including
      claims of alleged infringement of the patents, trademarks and other intellectual
      property rights of third parties.  Intellectual property litigation is
      expensive and time-consuming and could divert the attention of our management
      away from running our business and seriously harm our business.  If we
      were to discover that our products violated the intellectual property rights
      of
      others, we would have to obtain licenses from these parties in order to continue
      marketing our products without substantial re-engineering.  We might
      not be able to obtain the necessary licenses on acceptable terms or at all
      and,
      if we could not obtain such licenses, we might not be able to re-engineer our
      products successfully or in a timely fashion.  If we fail to address
      any infringement issues timely and successfully, we would be forced to incur
      significant costs, including damages and potentially satisfying indemnification
      obligations that we have with our customers, and we could be prevented from
      selling certain of our products.





**Price
      competition could reduce market share or cause us to reduce prices to retain
      or
      recapture market share, which could reduce revenues and
      margins.**  Our operations generally face intense competition
      in all markets.  The medical, dental and veterinary imaging industries
      have historically experienced price competition.  This price
      competition could result in us losing market share in some markets or force
      us
      to reduce prices and thereby our profit margins in order to retain or recapture
      market share.  Increased price competition in the future could further
      reduce revenues, profit margins and backlog.





14




**Increased
      advertising or better marketing by our competitors could cause us to lose market
      share and revenues, or cause us to incur increased costs in order to retain
      or
      recapture market share.**  Extensive advertising or effective
      marketing by competitors could cause us to lose market share and revenues,
      or
      cause us to increase our own marketing costs.  In addition,
      competitors may change the types or mix of products or services
      offered.  These changes may attract customers, causing us to lose
      market share and revenue or to incur costs to vary our own types or mix of
      products or services in response to such competitive factors.





**If
      we do not respond effectively to changing consumer preferences, our market
      share, revenues and profitability could decrease.**  Our future
      market share, revenues and profits will depend in part on our ability to
      anticipate, identify and respond to changing consumer preferences of
      professionals who utilize medical, dental and veterinary imaging
      equipment.  We may not correctly anticipate or identify trends in
      consumer preferences, or we may identify them later than our competitors
      do.  In addition, any strategies we may implement to address these
      trends may prove excessively costly, incorrect or ineffective.





**We
      are dependent upon our existing credit facility including a term loan and
      revolver to finance our ongoing operations.**There can be no
      assurances that this credit line will be sufficient to properly finance all
      working capital requirements and to adequately finance the required expenditures
      for new product launches and continued product development.  This
      could result in losing market share in some markets and a reduction in
      revenues.





**Risks
      Involving Our Common Stock and Corporate Governance**





**There
      is significant volatility in our stock prices***.*





The
      market
      for our common stock is highly volatile.  The trading price of our
      common stock could widely fluctuate in response to, among other
      things:


§
            quarterly
                variations in our operating and financial
                results;


§
            announcements
                of technological innovations or new products by us, our vendors or
                our
                competitors;


§
            changes
                in prices of our or our competitors=
                products and services;


§
            changes
                in the product and service mix of our
                sales;


§
            changes
                in our revenue and revenue growth rates as a whole or for individual
                geographic areas, products, services or product and sales
                categories;


§
            unscheduled
                system interruptions;


§
            our
                ability to timely develop, introduce and market new products, as
                well as
                enhanced versions of our current
                products;


§
            additions
                or departures of key personnel;


§
            changes
                in financial estimates by securities
                analysts;


§
            conditions
                or trends in the medical imaging
                industries;


§
            changes
                in the market valuations of other medical imaging
                companies;


§
            developments
                in governmental regulations of medical imaging
                products;


§
            announcements
                by us or our competitors of significant acquisitions, strategic
                partnerships, joint ventures or capital
                commitments;


§
            sales
                of our common stock or other securities in the open market;
                and


§
            other
                events or factors that may be beyond our
                control.





Statements
      or changes in opinions, ratings, or earnings estimates made by brokerage firms
      or industry analysts relating to the markets in which we conduct our business
      or
      relating to us or our competitors could result in an immediate and adverse
      effect on the market price of our common stock.  In addition, the
      stock market has from time to time experienced extreme price and volume
      fluctuations which have particularly affected the market price for the
      securities of many companies which often have been unrelated to the operating
      performance of these companies.  These broad market fluctuations may
      adversely affect the market price of our common stock.





**We
      may issue substantial amounts of additional shares of our common stock without
      shareholder approval, which could dilute the equity interests of our
      shareholders.**





We
      have
      outstanding an aggregate of 17,928,800 shares of our common stock, as of the
      date of this prospectus.  We also have 5 million shares of serial
      preferred stock authorized but unissued, all of which shares are not reserved
      for specific purposes, and an additional (a)1,394,400 shares of our common
      stock
      issuable upon the exercise of stock options granted or available for grant
      under
      our various stock plans, (b) 850,000 shares of our common stock issuable upon
      exercise of warrants we previously granted and are currently outstanding
      (including the 800,000 warrants held by certain of the selling security holders,
      the underlying shares for which are being offered pursuant to this prospectus),
      all as of the date of this prospectus and (c) 2,109,705 shares of our common
      stock issuable upon conversion of the initial principal amount of a convertible
      term note we previously issued, which shares are being offered pursuant to
      this
      prospectus, as of the date of this prospectus.  All of such shares may
      be issued without any action or approval by our shareholders.  Any
      shares issued by us in the future would further dilute the percentage ownership
      held by our shareholders.






15




**Substantial
      sales of our common stock could adversely affect the market price of our common
      stock.**





Sales
      of a
      substantial number of shares of our common stock could adversely affect the
      market price of our common stock by introducing a large number of sellers to
      the
      market. This could cause the market price of our common stock to
      decline.





**Our
      acquisition strategy may result in dilution to our
      shareholders***.*





Our
      business strategy to increase our market share in the industries in which we
      compete includes the possibility of strategic acquisitions of other businesses,
      technologies and services.  We anticipate that future acquisitions
      will require cash and issuances of our capital stock, including our common
      stock.  To the extent we are required to pay cash for any acquisition,
      we anticipate that we would be required to obtain additional equity and/or
      debt
      financing.  Equity financing would result in dilution for our then
      current shareholders.  Such stock issuances and financing, if
      obtained, may not be on terms favorable to us and could result in substantial
      dilution to our shareholders at the time(s) of these stock issuances and
      financings.





**We
      have no history of paying dividends***.*





We
      have
      never paid any cash dividends on our common stock and we do not anticipate
      paying any dividends in the foreseeable future.  In addition, if we do
      declare a dividend, the conversion price of the Term Loan with our secured
      credit facility would be reduced by an amount equal to the dividend declared
      and
      paid.





**Limited
      directors’ liability could prevent our shareholders from holding our directors
      responsible for a lack of care.**





Our
      certificate of incorporation provides that our directors will not be held liable
      to us or our shareholders for monetary damages upon breach of a directors’
fiduciary duty, except to the extent otherwise required by law.





**Item
      2.  Properties**





Our
      executive office and United States manufacturing facility is located in
      Elmsford, New York.  This facility, which comprises approximately
      47,735 square feet, is subject to a lease expiring on December 31, 2009 with
      a
      current rental of $525,085 per year through the lease term, plus increases
      for
      real estate taxes, utility costs and common area charges.  We believe
      our facility is well maintained, in good operating condition and sufficient
      to
      meet our present and anticipated needs.  We have a manufacturing
      facility located in Verona, Italy.  This facility, which comprises
      approximately 10,000 square feet, is subject to a lease expiring on November
      14,
      2015, with a current rental of Euro 83,160 plus VAT per year.  We
      believe our facility is well maintained, and in good operating
      condition.  We believe that we may have to expand this facility to
      meet expected demand for the three-dimensional CBCT equipment that is
      manufactured at this facility.  We also maintain a small sales and
      marketing facility in Roswell, Georgia, which is subject to a lease expiring
      on
      May 31, 2009.





**Item
      3.  Legal Proceedings**





The
      Company is a defendant in an environmental claim relating to a property in
      New
      Jersey owned by the Company between August 1984 and June 1985.  This
      claim relates to the offsite commercial disposition of trash and waste in a
      landfill in New Jersey.  The Company maintains that its waste
      materials were of a general commercial nature. This claim was originally filed
      in 1998 by the federal government in United States District Court and the State
      of New Jersey, citing several hundred other third-party
      defendants.  The Company (through its former subsidiary, Kenro
      Corporation) was added, along with many other defendants, to the
      suit.  The Company's claimed liability was potentially assessed by the
      plaintiff at $150,000.  The Company has joined, along with other
      involved defendants in an alternative dispute resolution (ADR) process for
      smaller claims.  A recent settlement amount was offered by this group,
      however, to date, no settlement has been reached.  The potential cost
      to the Company based on this settlement offer has been assessed at
      $18,080.  The Company had accrued $11,550 as of Fiscal Year 2007 and
      Fiscal Year 2006, which represents the Company’s estimate of its potential
      liability, net of the Company’s insurance carrier’s agreed-upon contribution
      towards a potential settlement.  The Company does not expect to
      receive any further information until a status conference is held in late
      November 2007.  The Company cannot, at this time, assess the amount of
      liability that could result from any adverse final outcome of this environmental
      complaint. The Company's insurance carrier has agreed to equally share with
      the
      Company the defense costs incurred in this environmental claim.






16




On
      February 8, 2005, the Company finalized a settlement relating to a separate
      environmental claim filed in 2001 as a civil complaint brought by the current
      owners of the same property owned by the Company between August 1984 and June
      1985.  This action was filed in the Superior Court of New Jersey,
      Morris County, and alleged that the Company’s discontinued graphic art camera
      subsidiary had contaminated a portion of the site during its manufacturing
      process prior to 1985.  The settlement included a release and
      indemnification as well as a stipulation of dismissal with
      prejudice.  The Company paid $325,000 on February 18, 2005, which
      represented the Company’s entire liability under the settlement agreement, net
      of the Company’s insurance carrier’s contribution towards the total and final
      settlement.





On
      October
      1, 2007, a settlement was reached in the product liability insurance action
      filed in May 2005 in the Superior Court in Hartford, Connecticut and later
      transferred to the United States District Court, District of Connecticut, in
      which the Company was a defendant (with several other parties).  The
      plaintiff, through its insurance company, claimed that the Company’s equipment
      caused damages on the plaintiff’s premises in May 2003.  The case was
      settled for less than the originally claimed amount and included mutual releases
      for all participating parties from any liability arising from the
      claim.  The Company’s insurance carrier was responsible for the
      settlement, and therefore there was no financial effect on the
      Company.





The
      Company is involved in two other product liability insurance actions, however,
      to date, no lawsuits have been filed.  The Company maintains that its
      equipment was not the cause of the respective incidents or the resultant
      damage.  The Company’s insurance carriers, and their attorneys, are
      assisting in the Company’s defense in these matters.  The Company does
      not believe that the final outcome of either of these matters will have a
      material adverse effect on the Company.





The
      Company was named as a third party defendant in a lawsuit which was filed in
      May
      2007 in the Supreme Court of Orange County, New York.  The lawsuit
      alleges that the Company’s negligence in manufacturing, designing, assembling
      and distributing its digital radiographic sensors caused damages to the
      plaintiff.  The entire complaint seeks $37,770 in
      damages.  The Company believes its obligation is limited to less than
      $10,000, based on the specifics of the transaction.  The Company has
      offered a full refund on this transaction and is awaiting the
      plaintiff  and defendant to resolve their specific
      differences.  The Company’s attorneys, are assisting in the Company’s
      defense in this matter and are trying to finalize a mutually acceptable
      settlement with all concerned parties.  The Company does not believe
      that the final outcome of this matter will have a material adverse effect on
      the
      Company.





On
      August
      8, 2007, the Company received a letter from counsel to Lightyear Technology,
      Inc. that certain actions that the Company may have taken in regard to the
      acquisition of Lightyear, a small distribution channel, in December 2006, may
      give rise to causes of action including fraud and breach of
      contract.  To date, no legal action has been filed.  The
      Company believes it is currently in full compliance with the terms of the
      contract and maintains that there was neither fraud nor breach of
      contract.  The Company believes that it acted in good faith at all
      times with the management and direction of Lightyear.  At this time,
      the Company cannot assess if the final outcome of this matter will have a
      material adverse effect on the Company.





From
      time
      to time, the Company may be party to other claims and litigation arising in
      the
      ordinary course of business.  The Company does not believe that any
      adverse final outcome of any of these matters, whether covered by insurance
      or
      otherwise, would have a material adverse effect on the Company.





**Item
      4.  Submission of Matters to a Vote of Security
      Holders**





There
      were
      no matters submitted to a vote of security holders during the fourth quarter
      of
      Fiscal Year 2007.






17




**Part
      II**








**Item
      5.  Market for the Registrant’s Common Equity and Related Stockholder
      Matters**





**Market
      Information**





The
      Company’s Common Stock, par value $.01 per share, is the only class of the
      Company’s common equity securities outstanding and is traded on the OTC Bulletin
      Board (Symbol “AFPC”), maintained by FINRA.  The following table,
      based on information supplied by Commodity Systems Inc., shows the range of
      the
      closing high and low bid information for the Company’s Common Stock for each
      quarterly period during the Company’s last two fiscal years.  These
      prices reflect inter-dealer prices and do not include retail mark-ups, markdowns
      or commissions, and may not represent actual transactions.





Quarter
                ended
            High
                Bid
            Low
                BidSeptember
                30, 2005
            3.10
            2.00December
                31, 2005
            2.15
            1.70March
                31, 2006
            2.40
            1.75June
                30, 2006
            2.75
            2.00September
                30, 2006
            2.44
            1.60December
                31, 2006
            1.87
            1.30March
                31, 2007
            1.80
            1.32June
                30, 2007
            2.15
            1.63





The
      market
      for the Company’s Common Stock is highly volatile and the trading price of the
      Common Stock could widely fluctuate in response to numerous
      factors.  In addition, the stock market has from time to time
      experienced extreme price and volume fluctuations, which have particularly
      affected the market price for the securities of many companies, which often
      have
      been unrelated to the operating performance of these companies.  These
      broad market fluctuations may adversely affect the market price of the Company’s
      Common Stock.





**Holders**





As
      of
      September 24, 2007 the closing bid price for the Company’s Common Stock, as
      reported on the OTC Bulletin Board, was $1.27, and there were 302 shareholders
      of record of the Common Stock.  The Company estimates, based on
      surveys conducted by its transfer agent in connection with the Company’s 2006
      Annual Meeting of Shareholders, that there are approximately 1,100 beneficial
      holders of the Common Stock.





**Dividends**





No
      cash
      dividends have been declared on the Company’s Common Stock to date and the
      Company anticipates that any earnings will be retained for use in the Company’s
      business for the foreseeable future.  The Board of Directors will have
      the sole discretion in determining whether to declare of pay dividends in the
      future.  The declaration of dividends will depend on the
      profitability, financial condition, cash requirements, future prospects and
      other factors deemed relevant by the Board of Directors.  In addition,
      provisions contained in the existing credit facility and financing arrangements
      with ComVest Capital, LLC places certain restrictions on the Company’s ability
      to declare and make any cash dividends.  The Company currently does
      not have a set policy with respect to payment of dividends.





**Securities
      Authorized for Issuance Under Equity Compensation Plans**





The
      following table sets forth as of June 30, 2007:




§
            the
                number of shares of the Company’s Common Stock issuable upon exercise of
                outstanding options, warrants and rights, separately identified by
                those
                granted under equity incentive plans approved by the Company’s
                shareholders and those granted under plans, including individual
                compensation contracts, not approved by the Company’s shareholders (column
                A),


§
            the
                weighted average exercise price of such options, warrants and rights,
                also
                as separately identified (column B),
                and


§
            the
                number of shares remaining available for future issuance under such
                plans,
                other than those shares issuable upon exercise of outstanding options,
                warrants and rights (column C).





18




Plan
                Category
            Number
                of securities tobeissued
              upon
                exerciseofoutstanding
                options,
              warrants
                and rights
            
            Weighted
                averageexercise
              price
                ofoutstanding
                options,
              warrants
                and rights
            
            Number
                of securitiesremaining
              available
                forfuture
                issuance under
              equity
                compensation plans
              (excluding
                securities reflected in column (a))Equity
                compensation plans
              approved
                by security holders (1)
            893,900
            
            $.94
            
            500,500Warrants
                issued to a financial advisor  (2)
            50,000
            
            $1.98
            
            N/AWarrants
                issued to ComVest
              Capital,
                LLC (3)
            800,000
            
            $2.02
            
            N/AEquity
                compensation plan not approved by security holders
            0
            
            0
            
            0Total
            1,743,900
            
            $1.47
            
            500,500





1.
            The
                equity compensation plans approved by the security holders are the
                Company’s 2004 Equity Incentive Plan and the 1999 Stock Option
                Plan.


2.
            These
                warrants were issued to our investment banker in March 2006 in connection
                with advisory services  rendered to the
                Company.


3.
            These
                warrants were issued to our senior secured lender in April 2007 in
                connection with the Revolving Credit and Term Loan
                Agreement.








**Performance
      Graph**





The
      following sets forth the annual changes for the five-year period indicated
      in a
      theoretical cumulative total shareholder return of an investment of $100 in
      the
      Company’s common stock and each comparison indices, assuming reinvestment of
      dividends, if any.







19















20





**Item
      6.  Selected Financial Data**





**As
                of and for the Years Ended June 30,**2007
              (c),(d)
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003NET
                SALES
            
            $
            28,719,693
            
            
            $
            24,998,272
            
            
            $
            23,135,063
            
            
            $
            19,832,910
            
            
            $
            18,043,668OPERATING
                INCOME (LOSS)
            
            $
            (4,692,921
            )
            
            $
            1,036,324
            
            
            $
            1,354,617
            
            
            $
            (1,453,628
            )
            
            $
            (545
            )INCOME
                (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
                PRINCIPLE
            
            $
            (4,672,824
            )
            
            $
            1,005,348
            
            
            $
            1,899,930
            
            
            $
            1,345,467
            
            
            $
            (218,338
            )CUMULATIVE
                EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (a)
            
            $
            --
            
            
            $
            --
            
            
            $
            --
            
            
            $
            --
            
            
            $
            (1,297,069
            )NET
                INCOME (LOSS)
            
            $
            (4,672,824
            )
            
            $
            1,005,348
            
            
            $
            899,930
            
            
            $
            1,345,467
            
            
            $
            (1,515,407
            )EARNINGS
                (LOSS) PER SHARE BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
                PRINCIPLEBASIC
            
            $
            (.34
            )
            
            $
            .10
            
            
            $
            .20
            
            
            $
            .15
            
            
            $
            (.02
            )DILUTED
            
            $
            (.34
            )
            
            $
            .10
            
            
            $
            .19
            
            
            $
            .14
            
            
            $
            (.02
            )NET
                EARNINGS (LOSS) PER SHAREBASIC
            
            $
            (.34
            )
            
            $
            .10
            
            
            $
            .20
            
            
            $
            .15
            
            
            $
            (.16
            )DILUTED
            
            $
            (.34
            )
            
            $
            .10
            
            
            $
            .19
            
            
            $
            .14
            
            
            $
            (.16
            )TOTAL
                ASSETS
            
            $
            27,170,826
            
            
            $
            14,340,564
            
            
            $
            8,153,396
            
            
            $
            6,244,895
            
            
            $
            6,043,855GOODWILL
                AND OTHER INTANGIBLES (d)
            
            $
            12,427,167
            
            
            $
            --
            
            
            $
            --
            
            
            $
            --
            
            
            $
            --LONG-TERM
                DEBT
            
            $
            5,822,347
            
            
            $
            --
            
            
            $
            --
            
            
            $
            222,223
            
            
            $
            630,556SHAREHOLDERS’
                EQUITY
            
            $
            14,875,433
            
            
            $
            5,924,746
            (b)
            
            $
            4,662,631
            
            
            $
            2,655,396
            
            
            $
            1,319,929SHAREHOLDERS’
                EQUITY PER COMMON SHARE
            
            $
            .83.
            
            
            $
            .62
            (b)
            
            $
            .50
            
            
            $
            .29
            
            
            $
            .14COMMON
                SHARES OUTSTANDING, at end of period
            
            
            17,928,800
            
            
            
            12,345,994
            
            
            
            9,407,717
            
            
            
            9,270,617
            
            
            
            9,270,617CASH
                DIVIDENDS PER COMMON SHARE
            
            none
            
            
            none
            
            
            none
            
            
            none
            
            
            none








(a)
            Upon
                adoption of SFAS 142 in the first quarter of Fiscal Year 2003, the
                Company
                recorded a one-time, non-cash charge of approximately $1,297,069,
                to
                reduce the carrying value of its goodwill.  Such charge is
                non-operational in nature and is reflected as a cumulative effect
                of an
                accounting change.  See Note 1 to the Consolidated Financial
                Statements for further discussion and required
                disclosures.




(b)
            On
                May 2, 2006, the Company issued 2,777,777 shares of its common stock
                in a
                private placement to selected institutional and other accredited
                investors.  The offering price was at $1.80 per
                share.  In conjunction with the private placement, the Company
                has granted the investors certain registration rights with respect
                to the
                resale of the shares acquired.  The Company filed a registration
                statement which was declared effective on July 14, 2006.  If
                this registration statement is subsequently suspended for a specified
                period of time, the Company could be required to pay a penalty of
                1% of
                the financing per month to the investors.  Additionally, the
                Company is required to file amendments to the registration statement
                as
                necessary to keep the registration effective for 24 months from the
                closing date.  In accordance with the provisions of FSP EITF
                00-19-2, the Company has classified this private placement in
                shareholders’ equity on the accompanying consolidated balance sheets as of
                June 30, 2007.  At June 30, 2006, the net proceeds were
                classified as temporary equity in accordance with the provisions
                of EITF
                Topic D-98.  The Company has maintained this registration
                statement since it was declared effective and believes that any future
                payments related to this registration statement are
                remote.






21




(c)
            Includes
                the operating results of QR srl from April 19, 2007 to June 30,
                2007.  On April 19, 2007, the Company completed the acquisition
                of Quantitative Radiology srl, an Italian corporation (“QR”), by acquiring
                all of the outstanding share capital of QR from the
                shareholders.  QR is a global supplier of state-of-the-art,
                in-office three-dimensional dental computed tomography (CT).  QR
                uses an imaging technology that features a cone shaped beam of x-rays
                (a
                CBCT scanner).  The Company, prior to April 19, 2007, had acted
                as QR’s exclusive distributor in North and South America, excluding
                Brazil.




(d)
            The
                acquisition of QR was accounted for under the purchase method of
                accounting in accordance with FASB Statement No. 141, Business
                Combinations (“SFAS 141”).  The carrying values of QR’s assets
                and liabilities were adjusted to their fair values on April 19, 2007
                and
                the difference between the purchase price and the fair value of the
                net
                assets and liabilities was recorded as goodwill and other
                intangibles.  Other intangibles include technology, customer
                lists and non-compete contracts and are being amortized over useful
                lives
                ranging from 5-10 years.  Included in the results for fiscal
                year 2007 are (1) a charge to expense of $3,760,000 which represents
                the
                write-off of in process research and development acquired with the
                purchase of QR and (2) a charge to expense of $225,054 which represents
                the amortization of the intangibles associated with the acquisition
                of
                QR.





22





**Item
      7.  Management’s Discussion and Analysis of Financial Condition and
      Results of Operation**





The
      following should be read in conjunction with the Company’s Consolidated
      Financial Statements and notes thereto included elsewhere in this Annual Report
      on Form 10-K.  This discussion may contain certain forward-looking
      statements based on current expectations that involve risks and
      uncertainties.  Actual results and timing of certain events may differ
      significantly from those projected in such forward-looking statements due to
      a
      number of factors, including those set forth in elsewhere in this
      report.  Except as otherwise disclosed, all amounts are reported in US
      dollars ($).





**Capital
      Resources and Liquidity**





The
      Company’s working capital at June 30, 2007 decreased by approximately $2.79
      million from June 30, 2006.  This decrease is principally due to the
      acquisition of QR on April 19, 2007, which was funded through new debt,
      equity,  and available cash resources.  The Company assumed
      all of QR’s assets and liabilities as of such date.  As of June 30,
      2006, the Company did not have any debt.





Operating
      cash flows were significantly lower in the 12 months ended June 2007 compared
      to
      June 2006 principally due to the loss from operations.  This loss is
      mainly attributable to lower gross margins based on the product mix towards
      more
      distributor goods, the strong Euro in relation to the US dollar, increased
      competition in the marketplace, as well as significantly higher marketing,
      sales
      distribution and administrative expenses.  These expenses related to
      new and existing products and the development and growth of various new
      distribution channels to advance sales growth.  The Company also
      incurred approximately $1.56 million in transaction costs associated with the
      acquisition of QR.  These factors caused the Company to utilize its
      cash resources, resulting in increased borrowings on the new credit
      facility.  The Company is requiring advance deposits from its
      customers on the new-high dollar valued equipment, which is consistent with
      the
      vendor’s terms of sale.  Otherwise, the Company has neither changed
      its payment policies to its vendors nor revised its payment terms with its
      customers.





The
      significant increase in current liabilities is mainly due to the current-portion
      of the newly-acquired debt, the assumption of QR’s current liabilities including
      accounts payable and accrued expenses.  Current assets stayed
      relatively the same, however the significant increases in accounts receivable
      and inventory are mainly due the acquisition of QR, offset by the utilization
      of
      available cash in April 2007 towards the purchase price.





On
      April
      12, 2007, the Company completed the sale of an aggregate of 5,500,000 shares
      of
      its common stock to certain accredited investors for an aggregate consideration
      of $8,140,000 pursuant to previously executed subscription
      agreements.  The Company has granted the investors certain
      registration rights with respect to the resale of the shares
      acquired.  The Company is subject to specific penalties if the
      registration statement is not filed within a certain time.  The
      Company has received an extension of the time allowed to file this registration
      statement by the investors until October 15, 2007, so as to incorporate the
      information contained within this Annual Report on Form 10K.  The
      Company believes that any payments of penalties related to this registration
      statement are remote.  The common stock was issued and sold pursuant
      to the exemption from registration afforded by Regulation D of the Securities
      Act of 1933, as amended.  In connection with the transaction, the
      Company paid the placement agent for the offering $407,000, or five percent
      of
      the gross proceeds of the offering.  The net proceeds were used to
      fund a portion of the purchase price of QR srl, which was completed on April
      19,
      2007.





On
      April
      13, 2007, the Company entered into a Revolving Credit and Term Loan Agreement
      with ComVest Capital, LLC whereby ComVest agreed to lend the Company an
      aggregate of up to $8 million in the form of a $5 million term loan and a $3
      million revolving loan facility.  The term loan bears interest at a
      rate of ten percent (10%) per annum and provides for repayment over five years
      commencing in November 2007 in 53 equal monthly installments of $92,592.60
      with
      a final balloon payment of all remaining amounts due there-under on April 30,
      2012.  The term loan is further subject to mandatory prepayment to the
      extent of 50% of proceeds received by the Company in connection with the sale
      of
      its capital stock unless such proceeds are utilized to acquire another
      business.  The revolving loans bear interest a rate per annum of two
      percent (2%) plus the prime rate and is payable in full on April 30, 2012,
      has a
      specific formula to calculate available funds based on eligible accounts
      receivable and inventory, is subject to maximum “borrowing base” limitations,
      and hascertain
      reporting requirements.  This new senior secured Revolving Credit and
      Term Loan Agreement replaced the Company’s previous $2.5 million senior secured
      credit facility, which was due to expire on September 21, 2007.  The
      proceeds were used to fund a portion of the purchase price of QR srl, which
      was
      completed on April 19, 2007 and for ongoing working capital
      requirements.





As
      of June
      30, 2007, the Company was in compliance with all the terms and conditions of
      the
      Revolving Credit and Term Loan Agreement.





23




Both
      loans
      are subject to mandatory prepayment in full in the event of certain “sale”
events, including merger, sale of assets or change in control.  The
      term loan is convertible by ComVest at any time into shares of the Company’s
      common stock at a conversion price of $2.37 per share.  The term loan
      is convertible at the Company’s option upon the satisfaction of certain
      conditions, including a reported trading price equal to 175% of the conversion
      price, the common stock being traded on NASDAQ, and a certain minimum trading
      volume, among others.  In addition, the Company and each of its
      wholly-owned subsidiaries executed a Collateral Agreement pursuant to which
      each
      such party agreed to grant a security interest in all of its respective assets
      to ComVest as collateral security for repayment of the
      loans.  Further, each subsidiary agreed to guaranty performance of all
      of the Company’s obligations to ComVest.





As
      part of
      the transaction, the Company granted to ComVest an aggregate of 800,000 warrants
      to purchase shares of the Company’s common stock at exercise prices per share
      equal to $1.85 with respect to 266,666 warrants, $2.02 with respect to an
      additional 266,666 warrants, and $2.19 with respect to the remaining 266,668
      warrants.  The Company entered into a Registration Rights Agreement
      pursuant to which it has agreed to register the shares of common stock issuable
      upon exercise of the warrants and conversion of the term note.  The
      Company is subject to specific penalties if the registration statement is not
      filed within a certain time and then declared effective within a certain
      time.  The Company must also use its best efforts to keep the
      registration statement effective during the applicable registration
      period.  The Company has received an extension of the time allowed to
      file this registration statement from ComVest until October 15, 2007, so as
      to
      incorporate the information contained within this Annual Report on Form
      10K.  The Company believes that any payments of penalties related to
      this registration statement are remote.





On
      May 2,
      2006, the Company completed a private placement of its common stock to a group
      of institutional and other accredited investors.  The Company sold a
      total of 2,777,777 shares of its common stock at $1.80 per share.  The
      Company has granted the investors certain registration rights with respect
      to
      the resale of the shares acquired.  The Company used the net proceeds
      to fund a portion of the purchase price of QR srl, which was completed on April
      19, 2007.





With
      respect to the above described financing, the Company filed a registration
      statement which was declared effective on July 14, 2006.  If this
      registration statement is subsequently suspended for a specified period of
      time,
      the Company could be required to pay a penalty of 1% of the financing per month
      to the investors.  Additionally, the Company is required to file
      amendments to the registration statement as necessary to keep the registration
      effective for 24 months from the closing date.  In accordance with the
      provisions of FSP EITF 00-19-2, the Company has reclassified this private
      placement from temporary equity to shareholders’ equity on the accompanying
      balance sheets.  The Company has maintained this registration
      statement since it was declared effective and believes that any future payments
      related to this registration statement are remote.  Therefore, in
      accordance with SFAS 5, *Accounting for Contingencies,*no corresponding
      contingent liability has been recorded.





In
      August
      and September 2006, the Company’s former senior secured lender chose to exercise
      its warrant to purchase 100,000 shares of the Company’s common stock by
      converting the warrant into 82,806 shares of common stock in a cashless exercise
      in a manner as specified in the warrant.  This warrant was due to
      expire in September 2006.





Capital
      expenditures for Fiscal Year 2007 were approximately $251,200, consisting of
      the
      purchase of demonstration equipment to properly display the Company’s equipment
      to potential customers, the purchase of several new high-end sales demonstration
      computers, an additional module for the Customer Relationship Management system,
      a sales tax module, improvements to the Company’s existing network, and tooling
      expenditures related to the redesign, development and production of new imaging
      products.  Most of the capital expenditures were from the operations
      in the United States.  The Company expects to continue to finance any
      future capital requirements principally from internally generated
      funds.  The total amount of capital expenditures is not limited under
      the Company’s new Revolving Credit and Term Loan Agreement





The
      Company’s historical operating cash flows generally have been positive; however,
      the Company is dependent upon its Revolving Credit and Term Loan Agreement
      with
      ComVest to finance its ongoing operations.  The Company expects its
      worldwide working capital requirements will continue to be financed by
      operations, both in the United States and Italy, and from borrowings on the
      Revolving Credit and Term Loan Agreement.  It is believed that the
      Revolving Credit and Term Loan Agreement is sufficient to finance the Company’s
      ongoing worldwide working capital requirements for the foreseeable
      future.  The Company currently believes that there are no significant
      trends, demands, commitments or contingencies, other than an unexpected material
      adverse conclusion to an ongoing environmental litigation case, or any other
      pending litigation, which are reasonably likely to result in a significant
      increase or decrease in its liquidity or capital resources within the
      foreseeable near-term future. As of June 30, 2007, the Company had available
      approximately $575,286 of unused credit under the Revolving Credit and Term
      Loan
      Agreement.  As of September 15, 2007, the Company had available
      approximately $443,324 of unused credit under the Revolving Credit and Term
      Loan
      Agreement.  No assurances can be given that the Company will have
      sufficient cash flow in the long term.





24




The
      Company’s Italian subsidiary has the ability to borrow up to 350,000 Euros under
      two separate lines of credit, and up to an additional one million Euros from
      three different lines, all guaranteed by its accounts receivable and
      inventory.  All the lines are with two different financial
      institutions.  These lines of credit were granted in August 2007 for
      working capital purposes, and no funds were outstanding as of June 30,
      2007.





The
      Company is continuing to investigate various strategies to increase its market
      share.  Some of these strategies could involve the acquisition of one
      or more businesses or product line distributions.  There are no
      assurances that the Company will be able to identify any suitable acquisition
      candidate(s), or, if so identified, be able to enter into a definitive agreement
      with such candidates on terms favorable to the Company.





**Off-Balance
      Sheet Arrangements**





The
      Company has no off-balance sheet financing arrangements or interests in
      so-called special purpose entities.





**Results
      of Operations**





The
      results of operations for the Company have changed significantly as a result
      of
      the acquisition of QR on April 19, 2007.  QR, located in Verona, Italy
      is a global supplier of state-of-the-art, in-office three-dimensional dental
      computed tomography (CT).  QR uses an imaging technology that features
      a cone shaped beam of x-rays (a CBCT scanner).  The carrying values of
      QR’s assets and liabilities were adjusted to their fair values and the
      difference between the purchase price and the fair value of the net assets
      was
      recorded as goodwill and other intangibles, and is subject to periodic
      impairment testing.  The Company’s results of operations have been and
      will continue to be materially effected by the amortization costs associated
      with these other intangibles.





The
      Company’s operating results have varied in the past and are likely to vary in
      the future.  Due to variations that the Company has experienced in
      operating results, management does not believe that period-to-period comparisons
      of results of operations are necessarily meaningful or reliable as indicators
      of
      future performance.  These variations result from several factors,
      many of which many of which are not in the Company’s control, including but not
      limited to:


§
            Changes
                in technology, specifically imaging
                modalities,


·
            Demand
                for products and services,


·
            The
                level of product, price and service
                competition,


·
            Changes
                in product mix, which could effect profit
                margins,


·
            Federal,
                state or local government
                regulation,


·
            The
                timing of industry trade shows


·
            Currency
                fluctuations,


·
            Capital
                spending budgets of customers,


·
            General
                economic trends and conditions specific to the Company’s
                industry,


·
            Changes
                in the prime rate of borrowing in the United
                States





**Fiscal
      2007 vs. Fiscal 2006**





Sales
      increased approximately $3,721,400, or 14.9%, between Fiscal Year 2006 and
      Fiscal Year 2007.  Approximately $2.0 million of this increase can be
      attributed to the sales of the three-dimensional dental x-ray imaging systems
      generated by QR, in Italy, in the current period.  In June 2006, the
      Company became the exclusive distributor in the United States, Canada and Latin
      America (excluding Brazil) for QR’s three-dimensional imaging system and sells
      this product into both the dental and the medical ENT market and experienced
      new
      sales growth of approximately $2.1 million.  The Company’s veterinary
      products business increased 43%, mainly due to the introduction in mid-Fiscal
      Year 2006 of a digital imaging system for equine patients and general purpose
      x-ray systems (analog and digital) specifically designed for all veterinary
      applications.  In addition, there is continuing demand for the
      Company’s filmless digital dental radiography system which showed a 16% increase
      in human and veterinary sales in the current period.  The Company’s
      analog film processor business including related part, accessories and
      consumables showed a decline of approximately 17% in the current period as
      health-care professionals continue to migrate to digital imaging equipment,
      much
      of which the Company also supplies.  There was a slight decline in
      intra-oral and panoramic x-rays due to specific vendor issues, which have since
      been corrected.  The Company has continued its efforts to increase
      worldwide distribution and expand and develop new international markets for
      its
      digital products, resulting in a 20.6% increase in international sales between
      the periods.





25




Gross
      profit as a percent of sales increased slightly, 0.5 percentage points between
      Fiscal Year 2006 and Fiscal Year 2007.  In the United States, material
      costs as a percent of sales increased 3.0 percentage points, as the Company
      is
      selling more of the higher dollar value distributor goods, which tend to have
      lower gross margins.  Many of the distributor goods are imported, and
      the Company has realized additional costs with the strong Euro to the US
      dollar.  The Company also increased its US warranty reserve to reflect
      the extended warranty period on several of its digital
      products.  These were offset by favorable profit margins in
      Italy.





Selling,
      general, and administrative costs increased approximately $2.9 million or 38.8%,
      between Fiscal Year 2006 and Fiscal Year 2007.  Approximately $600,000
      of this increase is due to operating costs, in Italy, associated with the
      acquisition of QR in April 2007.  The balance of this increase is due
      to several factors, including:  (1) the write-off of certain deferred
      financing costs incurred in the previous fiscal year as the Company chose not
      to
      utilize that lender; (2) an approximate 13% increase in general and
      administrative costs associated with the increase in sales and the Company’s
      expanded presence in various markets; (3) approximately a $300,000 increase
      in
      technical support costs related to the new digital equipment the Company is
      selling, that require a devoted infrastructure support system;  (4) an
      increase in marketing and sales costs of approximately $1.3 million in the
      current fiscal year due to (a) the Company’s aggressive launch into the dental
      and medical marketplaces for the new three dimensional x-ray imaging equipment,
      including attendance at two large international tradeshows, development of
      new
      brochures and advertising materials, and the related travel and entertainment
      expenses, (b) pursuing various sales opportunities in both the domestic and
      international markets, with specific emphasis in the growing veterinary markets,
      (c) attendance and exhibition at two other large international trade shows
      in
      Europe and (d) an increase in general operating expenses, based on increased
      sales levels; and  (5) approximately $580,000 related to the
      acquisition in mid-December 2006 of a new distinct distribution channel to
      implement various methods to increase sales levels.





The
      Company wrote-off approximately $3,760,000 of costs related to in process
      research and development that had been acquired as part of the purchase of
      QR.  As of June 30, 2007, no alternative future use was identified for
      these assets and, accordingly, these assets were written off in fiscal year
      2007.  The capitalization and immediate write-off were recorded as a
      result of the allocation of the purchase price of QR.  An independent
      valuation firm assisted the Company in determining the fair value of all the
      assets associated with the acquisition of QR.  These charges will not
      have a continued impact on the Company’s future operating results.





Amortization
      of intangibles increased approximately $225,000 or 100% and resulted from the
      amortization of the other intangibles created from the acquisition of QR and
      the
      purchase price relative to the fair-value of the assets
      acquired.  Prior to April 2007, the Company did not have any such
      intangibles.





Research
      and development costs increased approximately $325,100, or 46.7%, between Fiscal
      Year 2006 and Fiscal Year 2007.  The Company’s research and
      development efforts and technologies were significantly enhanced by the
      acquisition of QR.  Approximately 58% of this increase is due
      to  research and development efforts in Italy.  The Company
      continues to invest in the design, development and refinement of its existing
      digital imaging products, as well as the design and development of new digital
      imaging products for the human dental and broad veterinary applications,
      including both hardware and software enhancements.  Research and
      development costs may fluctuate between reporting periods, due to changing
      research and development consulting agreements, initiation or completion of
      certain project tasks, and market demands.  Research and development
      costs are generally expected to continue to increase over the next several
      years
      as part of the Company’s strategy to develop and market additional high tech
      digital products.  The Company has integrated its research and
      development between both locations.





In
      Fiscal
      Year 2007, the Company recorded income of $352,966 related to a Euro hedge
      contract that was purchased in March 2007 to limit the foreign currency exchange
      risk related to the purchase of QR, which was in Euros.





Interest
      expense, net increased approximately $99,000 between Fiscal Year 2006 and Fiscal
      Year 2007.  There was approximately $185,600 of interest income in
      Fiscal Year 2007 compared to approximately $43,100 in Fiscal Year
      2006.  The increase in interest income is due to the $5 million
      private placement the Company completed in May 2006, whereby all the proceeds
      were invested in a diversified US Treasury Money Market Fund, until they were
      used to acquire QR in April 2007.  There was approximately $319,000 of
      interest expense in Fiscal Year 2007 compared to approximately $77,500 in Fiscal
      Year 2006.  In Fiscal Year 2007, prior to April 2007 and the
      acquisition of QR, the Company’s average borrowings were approximately $900,000;
      upon completion of the acquisition and the assumption of a term loan and new
      revolver, the Company’s average borrowings increased to $6.9
      million.  This is compared to Fiscal Year 2006 which had approximately
      $400,000 more in average borrowings on the senior secured debt.  The
      current fiscal year also had a slightly higher average interest
      rate.





26




The
      Company made several small state and federal tax payments in the US in the
      twelve months ended June 30, 2007, based on payments previously made during
      its
      fiscal year ended June 30, 2006.  The Company also made the required
      tax payments in Italy for the 2007 and 2006.  The Company recorded a
      provision for taxes on its Italian operations at the combined required statutory
      tax rate.  The Company has recorded a deferred tax asset of $1.3
      million, of which $615,000 relates to its foreign operations acquired in April
      2007 and $680,000, which primarily relates to US losses recorded in prior years;
      the Company believes it is likely that it will utilize these prior year net
      operating loss carry forwards.  As of June 30, 2007, the Company had
      approximately $7.24 million in federal net operating loss carryforwards, and
      approximately $12.0 million in state net operating loss
      carryforwards.





**Fiscal
      2006 vs.  Fiscal 2005**





Sales
      increased approximately $1,863,200 or 8.1%, between Fiscal Year 2005 and Fiscal
      Year 2006.  A significant portion of this increase is attributable to
      the continued growth of the Company’s digital imaging systems in both the
      domestic and international dental and veterinarian marketplaces.  In
      the third quarter FY 2006, the Company introduced a mobile digital imaging
      system specifically designed for the equine marketplace, which accounted for
      a
      considerable portion of the increase in sales.  Sales of the digital
      sensor (veterinary and human dental applications) showed a 48% increase in
      the
      current twelve-month period.   The balance of the increase in
      sales is mainly attributable to sales of the general-purpose veterinary x-ray
      systems, introduced in the current fiscal year.  There was a 16%
      decline in intra-oral and panoramic x-ray systems, as intra-oral x-rays are
      becoming more price-sensitive due to competitive
      factors.  Additionally, there was an 8% decrease in analog processor
      sales due to the global transition in diagnostic image recording from analog
      to
      digital.  The Company has continued its efforts to increase worldwide
      distribution and expand and develop new international markets for analog and
      digital products, resulting in a 33% increase in international sales between
      the
      two fiscal years.





Gross
      profit as a percent of sales decreased slightly (1.4 percentage points) between
      Fiscal Year 2005 and Fiscal Year 2006.  Material costs as a percent of
      sales increased .8 percentage points, mainly due a slight change in the product
      mix, with the sale of more distributor goods, which tend to have lower gross
      margins, offset by processing improvements in some of the manufactured
      products.  Due to the higher sales volumes in the current twelve-month
      period, labor and overhead costs increased approximately $380,200, including
      related employee benefits, shipping and transportation costs and other operating
      costs.





Selling,
      general, and administrative costs increased approximately $439,300 or 6.1%,
      between Fiscal Year 2005 and Fiscal Year 2006.  This increase is due
      to several factors, including: (1) the Company began to expense stock options
      issued, in accordance with SFAS No. 123R, (2) marketing and sales costs
      increased approximately $437,000 in the current period, due to the Company
      aggressively pursuing various sales opportunities in both the domestic and
      international markets, with specific emphasis in the growing veterinary markets
      (these costs included increased travel costs, attendance at several national
      and
      regional clinical exhibitions, additional advertising, and increased operating
      costs), (3) costs associated with the purchase and implementation of a new
      customer relationship management software program (CRM), (4) the Company began
      accruing and funding an employee 401K retirement plan, and (5) an increase
      in
      general operating expenses, based on increases sales levels.  This
      increase in costs was partially offset by approximately $300,000 of costs
      associated with two separate environmental lawsuits and accrued in the prior
      year’s second quarter.





Research
      and development costs increased approximately $260,900 or 60%, between Fiscal
      Year 2005 and Fiscal Year 2006.  In June 2005, the Company recruited
      an Executive Vice-President of Technology in order to implement the Company’s
      strategic plans for all engineering development focusing on new products in
      the
      digital imaging field.  The Company continues to invest in the design,
      development and refinement of its existing digital imaging products, as well
      as
      the design and development of new digital imaging products for the human dental
      and broad veterinary applications, including both hardware and software
      enhancements.  The Company also continues to invest in sustaining
      engineering and related costs for its existing products.  Research and
      development costs may fluctuate between reporting periods, due to changing
      research and development consulting requirements, initiation or completion
      of
      certain project tasks, and market demands.  Research and development
      costs are generally expected to continue to increase over the next several
      years, as part of the Company’s strategy to develop and market additional
      digital products.





Interest
      expense, net decreased approximately $90,900 or 73%, between Fiscal Year 2005
      and Fiscal Year 2006.  In January 2006, the Company repaid the
      outstanding balance on the Renewed Revolving Credit Loan.  A
      subordinated note was repaid as of December 2004 and another subordinated note
      was repaid as of April 2006.  Interest expense only decreased
      approximately $52,200 due to significantly less borrowings in Fiscal Year 2006,
      offset in part by an approximately 2% higher interest rate, which was due to
      an
      increase in the prime rate, which is the basis for establishing the interest
      rate under the Renewed Revolving Credit Loan.  The Company recorded
      approximately $38,700 more in interest income in Fiscal Year 2006 due to the
      private placement equity raise of $4.8 million, which has been invested in
      a
      U.S. Treasury money market fund.





27




The
      Company made small federal and state tax payments in March and June 2006 for
      the
      twelve months ended June 30, 2006, based on current earnings and over-payments
      made during Fiscal Year 2005.  The small tax benefit recorded as of
      June 30, 2006 includes federal and state income and capital taxes, and related
      refunds and credits received.  As of June 30, 2006, the Company had a
      deferred tax asset of $680,000, which primarily relates to losses recorded
      in
      prior years; the Company believes it is likely that it will utilize a portion
      of
      these prior year net operating loss carry forwards.  As of June 30,
      2006, the Company had approximately $8.2 million in federal net operating loss
      carryforwards, and approximately $13.0 million in state net operating loss
      carryforwards.





**Aggregate
      Contractual Obligations**





The
      Company’s significant contractual obligations are as follows:





Payments
                due by periodTotal
            
            
            Less
                than 1 year
            
            
            1-3
                years
            
            
            3-5
                years
            
            
            More
                than 5 yearsLong-term
                debt
            
            $
            7,424,714
            
            
            $
            740,741
            
            
            $
            2,222,222
            
            
            $
            4,461,751
            
            
            $
            0Operating
                leases
            
            
            2,538,421
            
            
            
            805,731
            
            
            
            1,170,529
            
            
            
            224,,864
            
            
            
            337,297Total
            
            $
            9,963,135
            
            
            $
            1,546,472
            
            
            $
            3,392,751
            
            
            $
            4,686,615
            
            
            $
            337,297








The
      Company does not have any capital lease obligations or non-cancelable purchase
      obligations.  The Company’s only material operating lease obligation
      is a noncancelable lease for office and manufacturing
      facilities.  Included in long-term debt  due within three to
      five years is the Company’s revolver, which has been classified as a long term
      liability in accordance with Generally Accepted Accounting Principles as applied
      in the United
      States.





**Critical
      Accounting Policies and Estimates**





The
      preparation of financial statements in conformity with United States generally
      accepted accounting principles requires management to makes estimates and
      assumptions that affect the reported amounts of assets and liabilities and
      the
      reported amounts of revenues and expenses.  These estimates and
      assumptions are evaluated on an ongoing basis based on historical internal
      operations, industry trends and conditions, market conditions and other
      information that management believes to be reasonable or applicable under the
      circumstances.  There can be no assurances that actual results of
      operations will be consistent with management’s estimates and assumptions, and
      that reported results of operations will not be adversely affected by the
      requirement to make accounting adjustments to reflect changes in these estimates
      from time to time.  The following policies are those that management
      believes to be the most sensitive to estimates and judgments.





Revenue
      Recognition


The
      Company recognizes revenue for both its domestic and international sales when
      products are shipped and title passes to the customer.  The Company
      includes shipping and handling costs as a component of cost of
      sales.





Accounts
      Receivable


The
      Company reports accounts receivable net of reserves for doubtful
      accounts.  Credit is extended to distributors on varying terms,
      usually between 30 and 90 days.  Most of the sales to our direct users
      are payment in advance.  Letters of Credit or payment in advance is
      required for certain foreign sales.  The reserve for doubtful accounts
      is management’s best estimate of the amount of probable credit losses in the
      Company’s existing accounts receivable and is based upon continual analysis of
      the accounts receivable aging including credit risk of specific customers,
      historical trends and other related information.  The Company writes
      off accounts receivable when they become uncollectible.  There have
      been no significant changes in the computation methodology of the reserve for
      doubtful accounts in the past three years and the Company has not had
      significant bad debt write-offs in the past few years.  The allowance
      for doubtful accounts is based on the Company’s analysis of aged accounts
      receivable.  Management believes that any potential risk associated
      with the estimate of reserve for doubtful accounts is therefore
      limited.





Inventories


Inventories,
      which include material and a small component of work-in-process labor and
      overhead, are stated at the lower of cost (first in, first out) or market (net
      realizable value).  The Company uses a standard cost accounting system
      in conjunction with an actual perpetual system to properly account for, control
      and maintain the movement of all inventory components.  The Company
      has established inventory reserves based on inventory estimated to be obsolete,
      slow moving, or unmarketable due to changing technological and/or market
      conditions.  If actual market and technical conditions are less
      favorable than those anticipated, additional inventory reserves would be
      required.  There have been no significant changes in the computation
      methodology of the reserves for inventory in the past three years.





28




Warranties


The
      Company records a liability for an estimate of costs that it expects to incur
      under its limited warranty based on revenues.  Various factors affect
      the Company’s warranty liability, including (1) number of units sold, (2)
      historical rates of claims, (3) anticipated rates of claims, as well as (4)
      costs per claim.  The Company periodically assesses the adequacy of
      its warranty liability based on changes in these factors.





In
      March
      2005, the Company began to include an extended warranty with its digital
      sensors.  The Company continues to monitor the rate and costs of
      claims and review the adequacy of its warranty liability and has made changes
      in
      the warranty reserve, as necessary.  If the Company experiences
      significant increased warranty claims or activity, the warranty reserve will
      be
      increased, resulting in decreased gross profit.





Stock-based
      Compensation


Effective
      July 1, 2005, the Company began to account for stock based compensation under
      Financial Accounting Standards Board Statement No. 123R, *Share Based
      Payment*.  The Company determines the fair value of options based
      on the Black-Scholes model, which is based on specific assumptions including
      (1)
      expected life of the option, (2) risk free interest rates, (3) expected
      volatility and (4) expected dividend yield.





Approximately
      $48,000 of stock-based employee compensation cost is included in net income
      for
      Fiscal Year 2005, as certain options were granted at an exercise below market
      value on the date of grant.








Deferred
      Tax Asset and Income Taxes


Income
      taxes are accounted for under the asset and liability
      method.  Deferred income taxes are recorded for temporary differences
      between financial statement carrying amounts and the tax basis of assets and
      liabilities.  Deferred tax assets reflect the tax rates expected to be
      in effect in the period in which the differences are expected to
      reverse.  The Company records a valuation allowance to reduce its tax
      asset when it is more likely than not that a portion of the amount may not
      be
      realized.  The Company estimates its valuation allowance based on an
      estimated forecast of its future profitability.  Any significant
      changes in future profitability resulting from variations in future revenues
      or
      expenses could affect the valuation allowance on its deferred tax asset and
      operating results could be effected, accordingly, deferred income tax benefits
      aggregating approximately $680,000 resulting from a decrease in the Company’s
      valuation allowance against its deferred tax asset were recorded in the third
      and fourth quarters of Fiscal 2005.  Based upon this forecast of
      future profitability, the Company has maintained this deferred tax asset at
      $680,000 as of June 30, 2006 and June 30, 2007.  The deferred tax
      asset primarily relates to losses reported in prior years.  The
      Company believes it is likely that they will utilize a portion of these prior
      year net operating loss carry forwards, based on the Company’s future expected
      earnings from new products and new acquisitions..  In reviewing the
      valuation allowance, the Company has considered future taxable income and has
      determined that it is more likely than not that a portion of the deferred tax
      asset will be realized.  Changes in these circumstances, such as an
      increase or decline in estimated future taxable income would result in a
      re-valuation of the valuation allowance.  The Company also has
      recorded approximately $616,000 in deferred tax assets associated with its
      foreign operations.  These tax benefits were acquired upon the
      acquisition of QR in April 2007 and primarily relate to the financial statement
      carrying amount of existing assets and liabilities and their respective tax
      bases.





Goodwill
      and other intangibles


Prior
      to
      April 2007, the Company did not have any long-lived assets or
      goodwill.  Long-lived assets held for use by the Company will be
      reviewed for impairment whenever circumstances provide evidence that suggests
      the carrying amount of the asset may not be recoverable.  The Company
      will also perform ongoing impairment analysis on intangible assets related
      to
      technology.  Determination of whether impairment exists will be based
      upon comparison of the identifiable cash flows of the assets to the carrying
      values of the respective assets, and if impaired the value of the asset will
      be
      reduced.  Goodwill is not amortized, but will be tested for impairment
      on an annual basis each June 30th, or whenever
      circumstances or events indicate that the carrying amount may not be
      recoverable.  The impairment tests will be based on a comparison of
      the fair value of the reporting entity to the respective goodwill
      amount.  Any identified impairment will result in a charge to reduce
      the carrying value of the associated goodwill.






29




Litigation
      and Contingencies


The
      Company is party to lawsuits arising out of its respective
      operations.  The Company records a liability when it is probable and
      can be reasonably estimated.  The Company believes it has properly
      estimated in the past; however, court decisions and/or other unforeseen events
      could cause liabilities to be incurred in excess of estimates.








**Item
      7A.   Quantitative and Qualitative Disclosures About Market
      Risk**





The
      Company’s earnings and cash flows are subject to changes in interest rates
      (short-term prime based interest rates) primarily from its borrowings under
      its
      senior debt.  The interest rate on the term loan is fixed, however the
      interest rate on the revolver varies with the prime rate of
      interest.  A hypothetical, instantaneous increase of one percentage
      point in the prime rate of borrowing would increase interest expense by $30,000
      for twelve months, assuming that the entire revolver line was
      utilized.  Therefore, the Company does not believe that it is
      materially exposed to changes in interest rates.  The Company does not
      currently use interest rate derivative instruments to manage exposure to
      interest rate changes.





Prior
      to
      April 2007, the Company’s earnings and cash flows were subject to changes in
      interest rates associated with U.S. Treasury Notes and U.S. Treasury
      Bills.  As the Company used its excess cash for the purchase of QR in
      April 2007 and no longer maintains any significant cash balances, the Company
      does not believe that they are materially exposed to market rate
      volatility.





The
      Euro
      is the functional currency of the Company’s foreign operations, which will
      account for a significant portion of the Company’s future sales and
      manufacturing operations, (the amounts for Fiscal Year 2007 were not significant
      as QR was acquired in April 2007).





The
      Company’s earnings and cash flows are subject to foreign currency exchange rate
      risk, specifically the Euro/Dollar and the Yen/Dollar.  The Company
      does not believe that it is materially exposed to foreign currency exchange
      rate
      risk due to the volume of purchases in foreign currency relative to purchases
      in
      the functional currency; however, the relative strength of the Dollar to the
      Euro or to the Yen does affect the Company’s gross profit.  The
      Company continuously monitors all changes in foreign currency and may adjust
      its
      pricing to customers to reflect these changes.  The Company did
      purchase a Euro hedge contract relative to the acquisition of QR, to limit
      the
      Company’s exposure to the Euro/dollar exchange.  As of June 30, 2007,
      the Company did not have any outstanding hedge contracts.


.


**Item
      8. Financial Statements and Supplementary Data**





The
      information that appears following Item 15 of this Annual Report on Form 10-K
      and is incorporated herein by reference.






30




**AFP
          IMAGING CORPORATION AND SUBSIDIARIES**
 
 
 **CONTENTS**
 **June
            30, 2007**
 
  
 **Report
                    of Independent Registered Public Accounting Firm**
                F-1**Consolidated
                    Financial Statements:**Balance
                    Sheet
                F-2Statement
                    of Operations
                F-3Statement
                    of Shareholders' Equity
                F-4Statement
                    of Cash Flows
                F-5Notes
                    to Consolidated Financial Statements
                F-6
                    - F-20**Supplemental
                    Schedule:**Schedule
                    of Valuation and Qualifying Accounts
                F-21
  
  **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 
 
 
 To
        the
        Board of Directors
 AFP
        Imaging Corporation
 
 
 We
        have
        audited the accompanying consolidated balance sheets of AFP Imaging Corporation
        and Subsidiaries (the "Company") as of June 30, 2007 and 2006, and the related
        consolidated statements of operations, shareholders' equity and cash flows
        for
        each of the three years in the period ended June 30, 2007.  Our audits
        also included the financial statement schedule listed in the Index at Item
        15.  These consolidated financial statements and the schedule are the
        responsibility of the Company's management.  Our responsibility is to
        express an opinion on these consolidated financial statements and the schedule
        based on our audits.
 
 We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States).  Those standards require
        that we plan and perform the audit to obtain reasonable assurance about whether
        the financial statements are free of material misstatement.  An audit
        includes examining, on a test basis, evidence supporting the amounts and
        disclosures in the financial statements.  An audit also includes
        assessing the accounting principles used and significant estimates made by
        management, as well as evaluating the overall financial statement
        presentation.  We believe that our audits provide a reasonable basis
        for our opinion.
 
 In
        our
        opinion, the consolidated financial statements referred to above present
        fairly,
        in all material respects, the consolidated financial position of AFP Imaging
        Corporation and Subsidiaries as of June 30, 2007 and 2006 and the results
        of
        their operations and their cash flows for each of the three years in the
        period
        ended June 30, 2007, in conformity with United States generally accepted
        accounting principles.  Also, in our opinion, the related financial
        statement schedule, when considered in relation to the basic consolidated
        financial statements taken as a whole, presents fairly in all material respects
        the information set forth therein.
 
 
 
 
 
 
 **GOLDSTEIN
        GOLUB KESSLER LLP**
 New
        York,
        New York
 
 
 
 October
        11, 2007
   F-1
  **AFP
          IMAGING CORPORATION AND SUBSIDIARIES**
 **CONSOLIDATED
              BALANCE SHEET**
 **June
                    30,**
                
                **2007**
                
                
                **2006****ASSETS**Current
                    Assets:Cash
                    and cash equivalents
                
                $
                921,632
                
                
                $
                5,213,289Accounts
                    receivable, less allowance for doubtful accountsof
                    $130,000 and $90,000, respectively
                
                
                5,030,579
                
                
                
                2,757,114Inventories
                
                
                6,395,052
                
                
                
                4,834,510Prepaid
                    expenses and other current assets
                
                
                179,771
                
                
                
                97,189Deferred
                    income taxes
                
                
                926,603
                
                
                
                680,000**Total
                    current assets**
                
                
                13,453,637
                
                
                
                13,582,102Property
                    and Equipment, net of accumulated depreciationof
                    $1,602,121 and $1,450,484, respectively
                
                
                539,002
                
                
                
                377,665Deferred
                    income taxes
                
                
                369,115
                
                
                
                -Other
                    assets
                
                
                381,905
                
                
                
                380,797Goodwill
                
                
                3,846,405
                
                
                
                -Other
                    intangibles
                
                
                8,580,762
                
                
                
                -**Total
                    Assets**
                
                $
                27,170,826
                
                
                $
                14,340,564**LIABILITIES
                    AND SHAREHOLDERS' EQUITY**Current
                    Liabilities:Current
                    portion of long-term debt
                
                $
                536,727
                
                
                $
                -Accounts
                    payable
                
                
                2,834,875
                
                
                
                2,035,117Accrued
                    expenses
                
                
                2,887,584
                
                
                
                1,565,174**Total
                    current liabilities**
                
                
                6,259,186
                
                
                
                3,600,291Deferred
                    Liabilities
                
                
                213,860
                
                
                
                71,204Long-term
                    debt
                
                
                5,822,347
                
                
                
                -**Total
                    liabilities**
                
                
                12,295,393
                
                
                
                3,671,495Commitments
                    and ContingenciesCommon
                    Stock subject to registration rights
                
                
                -
                
                
                
                4,744,323Shareholders'
                    Equity:Preferred
                    stock - $.01 par value;
                    authorized 5,000,000 shares, none issued
                
                
                -
                
                
                
                -Common
                    stock -$.01 par value; authorized 30,000,000 shares, issued
                    andoutstanding
                    17,928,800 shares at June 30, 2007 and 12,345,994 shares
                    atJune
                    30, 2006 (including 2,777,777
                    shares subject to registrations
                    rights
                
                
                179,288
                
                
                
                95,682Common
                    stock warrants
                
                
                91,131
                
                
                
                110,931Paid-in
                    capital
                
                
                25,404,045
                
                
                
                11,805,852Accumulated
                    deficit
                
                
                (10,760,543
                )
                
                
                (6,087,719
                )Cumulative
                    translation adjustment
                
                
                (38,488
                )
                
                
                -**Total
                    shareholders' equity**
                
                
                14,875,433
                
                
                
                5,924,746**Total
                    Liabilities and Shareholders' Equity**
                
                $
                27,170,826
                
                
                $
                14,340,564
 See
          Notes
          to Consolidated Financial Statements
 F-2
  **AFP
            IMAGING CORPORATION AND SUBSIDIARIES**
 **CONSOLIDATED
                  STATEMENT OF OPERATIONS**
 **Years
                    ended June 30,**
                
                **2007**
                
                
                **2006**
                
                
                **2005**Net
                    sales
                
                $
                28,719,693
                
                
                $
                24,998,272
                
                
                $
                23,135,063Cost
                    of sales
                
                
                17,864,218
                
                
                
                15,670,428
                
                
                
                14,189,096Gross
                    profit
                
                
                10,855,475
                
                
                
                9,327,844
                
                
                
                8,945,967Selling,
                    general and administrative expenses
                
                
                10,541,576
                
                
                
                7,594,820
                
                
                
                7,155,537Amortization
                    of Intangibles
                
                
                225,054
                
                
                
                --
                
                
                
                --Write-off
                    of in process research and development
                
                
                3,760,000
                
                
                
                --
                
                
                
                --Research
                    and development expenses
                
                
                1,021,766
                
                
                
                696,700
                
                
                
                435,813Operating
                    income/(loss)
                
                
                (4,692,921
                )
                
                
                1,036,324
                
                
                
                1,354,617Gain
                    realized on Euro hedge contract
                
                
                (352,966
                )
                
                
                -
                
                
                
                -Interest
                    expense, net of interest income
                
                
                133,418
                
                
                
                34,457
                
                
                
                125,358Income/(loss)
                    before provision/(benefit)for
                    income taxes
                
                
                (4,473,373
                )
                
                
                1,001,867
                
                
                
                1,229,259Income
                    taxes
                
                
                199,451
                
                
                
                (3,481
                )
                
                
                (670,671
                )Net
                    income/(loss)
                
                $
                (4,672,824
                )
                
                $
                1,005,348
                
                
                $
                1,899,930Net
                    income/(loss) per common share:Basic
                
                $
                (.34
                )
                
                $
                .10
                
                
                $
                .20Diluted
                
                $
                (.34
                )
                
                $
                .10
                
                
                $
                .19
 See
          Notes
          to Consolidated Financial Statements
   F-3
  **AFP
            IMAGING CORPORATION AND SUBSIDIARIES**
 **CONSOLIDATED
                    STATEMENT OF SHAREHOLDERS' EQUITY**
 **Years
        ended June 30, 2005, 2006 and 2007**
 **Comprehensive
                  Loss**
              
              
              **Common
                  Stock**
              
              
              **Common
                  Stock Warrants**
              
              
              **Paid-in
                  Capital**
              
              
              **Accumulated
                  Deficit**
              
              
              **Foreign
                  Currency Translation Adjustment**
              
              
              **Total**Balance
                  June 30, 2004
              
              $
              -
              
              
              $
              92,710
              
              
              $
              19,800
              
              
              $
              11,545,883
              
              
              $
              (8,992,997
              )
              
              $
              -
              
              
              $
              2,665,396Issuance
                  of 137,100 shares of common stock in connection with the exercise
                  of stock
                  options
              
              
              -
              
              
              
              1,367
              
              
              
              -
              
              
              
              47,938
              
              
              
              -
              
              
              
              -
              
              
              
              49,305Issuance
                  of 100,000 stock options below market price
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              48,000
              
              
              
              -
              
              
              
              -
              
              
              
              48,000Net
                  income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,899,930
              
              
              
              -
              
              
              
              1,899,930Balance
                  June 30, 2005
              
              
              -
              
              
              
              94,077
              
              
              
              19,800
              
              
              
              11,641,821
              
              
              
              (7,093,067
              )
              
              
              -
              
              
              
              4,662,631Issuance
                  of 2,777,777 shares of common stock
              
              
              -
              
              
              
              27,778
              
              
              
              -
              
              
              
              4,972,222
              
              
              
              -
              
              
              
              -
              
              
              
              5,000,000Fees
                  associated with the issuance of common stock
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (255,677
              )
              
              
              -
              
              
              
              -
              
              
              
              (255,677
              )Reclassification
                  of common stock subject to registration rights
              
              
              -
              
              
              
              (27,778
              )
              
              
              -
              
              
              
              (4,716,545
              )
              
              
              -
              
              
              
              -
              
              
              
              (4,744,323
              )Issuance
                  of 160,500 shares of common stock in connection with the exercise
                  of stock
                  options
              
              
              -
              
              
              
              1,605
              
              
              
              -
              
              
              
              81,633
              
              
              
              -
              
              
              
              -
              
              
              
              83,238Issuance
                  of common stock warrants
              
              
              -
              
              
              
              -
              
              
              
              91,131
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              91,131Stock
                  based compensation expense
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              82,398
              
              
              
              -
              
              
              
              -
              
              
              
              82,398Net
                  income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,005,348
              
              
              
              -
              
              
              
              1,005,348Balance
                  June 30, 2006
              
              
              -
              
              
              $
              95,682
              
              
              $
              110,931
              
              
              $
              11,805,852
              
              
              $
              (6,087,719
              )
              
              
              -
              
              
              $
              5,924,746Issuance
                  of 82,000 shares of common stock in connection with the exercise
                  of common
                  stock warrants
              
              
              -
              
              
              
              828
              
              
              
              (19,800
              )
              
              
              18,972
              
              
              
              -
              
              
              
              -
              
              
              
              -Adjustment
                  to reclassify common stock subject to registration rights from
                  temporary
                  equity
              
              
              -
              
              
              
              27,778
              
              
              
              -
              
              
              
              4,716,545
              
              
              
              -
              
              
              
              -
              
              
              
              4,744,323Issuance
                  of 5,500,000 shares of common stock
              
              
              -
              
              
              
              55,000
              
              
              
              -
              
              
              
              8,085,000
              
              
              
              -
              
              
              
              -
              
              
              
              8,140,000Stock-based
                  compensation expense
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              82,461
              
              
              
              -
              
              
              
              -
              
              
              
              82,461Fees
                  associated with issuance of common stock
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (419,569
              )
              
              
              -
              
              
              
              -
              
              
              
              (419,569
              )Issuance
                  of 800,000 warrants in connection with the issuance of
                  debt
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,114,784
              
              
              
              -
              
              
              
              -
              
              
              
              1,114,784Foreign
                  currency translation loss
              
              
              (38,488
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (38,488
              )
              
              
              (38,488
              )Net
                  loss
              
              
              (4,672,824
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (4,672,824
              )
              
              
              -
              
              
              
              (4,672,824
              )Comprehensive
                  loss
              
              $
              (4,711,312
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Balance
                  June 30, 2007
              
              
              
              
              
              $
              179,288
              
              
              $
              91,131
              
              
              $
              25,404,045
              
              
              $
              (10,760,543
              )
              
              $
              (38,488
              )
              
              $
              14,875,433
  See
          Notes
          to Consolidated Financial Statements
   F-4
  **AFP
            IMAGING CORPORATION AND SUBSIDIARIES**
 **CONSOLIDATED
                      STATEMENT OF CASH FLOWS**
 **Years
                      ended June 30,**
                  
                  **2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Cash
                      flows from operating activities:Net
                      income/(loss)
                  
                  $
                  (4,672,824
                  )
                  
                  $
                  1,005,348
                  
                  
                  $
                  1,899,930Adjustments
                      to reconcile net income/(loss) to netcash
                      provided by/ (used in) operating activities:Write-off
                      of in process research and development
                  
                  
                  3,760,000
                  
                  
                  
                  -
                  
                  
                  
                  -Issuance
                      of stock options below market price
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  48,000Amortization
                      of discount on term loan
                  
                  
                  49,144
                  
                  
                  
                  -
                  
                  
                  
                  -Depreciation
                      and amortization
                  
                  
                  500,257
                  
                  
                  
                  224,939
                  
                  
                  
                  218,682Realized
                      gain on Euro hedge contract
                  
                  
                  (352,966
                  )
                  
                  
                  -
                  
                  
                  
                  -Provision
                      for losses on accounts receivable
                  
                  
                  -
                  
                  
                  
                  16,245
                  
                  
                  
                  38,454Write-off
                      of deferred financing costs
                  
                  
                  75,000
                  
                  
                  
                  -
                  
                  
                  
                  -Deferred
                      income taxes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (680,000
                  )Non-cash
                      compensation expense
                  
                  
                  82,461
                  
                  
                  
                  82,398
                  
                  
                  
                  -Change
                      in assets and liabilities, net of acquisition:(Increase)
                      in accounts receivable
                  
                  
                  (927,095
                  )
                  
                  
                  (69,223
                  )
                  
                  
                  (238,830
                  )(Increase)
                      in inventories
                  
                  
                  (382,044
                  )
                  
                  
                  (913,127
                  )
                  
                  
                  (1,217,374
                  )Decrease
                      (increase) in prepaid expenses and othercurrent
                      assets
                  
                  
                  (44,736
                  )
                  
                  
                  (8,120
                  )
                  
                  
                  178,311(Increase)
                      in other assets and long-term deferred taxes
                  
                  
                  (132,198
                  )
                  
                  
                  (259,365
                  )
                  
                  
                  (31,747
                  )Increase
                      in accounts payable
                  
                  
                  351,003
                  
                  
                  
                  695,866
                  
                  
                  
                  416,752Increase
                      in accrued expenses
                  
                  
                  8,205
                  
                  
                  
                  203,660
                  
                  
                  
                  513,591(Decrease)
                      in deferred rent
                  
                  
                  (20,344
                  )
                  
                  
                  (44,211
                  )
                  
                  
                  (20,345
                  )Increase
                      in deferred liabilities
                  
                  
                  163,000
                  
                  
                  
                  -
                  
                  
                  
                  -**Net
                      cash (used in) provided by operating activities**
                  
                  
                  (1,543,137
                  )
                  
                  
                  934,410
                  
                  
                  
                  1,125,424Cash
                      flows from investing activities:Acquisition
                      of QR srl, net of cash acquired
                  
                  
                  (17,360,931
                  )
                  
                  
                  -
                  
                  
                  
                  -Purchases
                      of property and equipment
                  
                  
                  (251,206
                  )
                  
                  
                  (205,106
                  )
                  
                  
                  (176,981
                  )**Net
                      cash used in investing activities**
                  
                  
                  (17,612,137
                  )
                  
                  
                  (205,106
                  )
                  
                  
                  (176,981
                  )Cash
                      flows from financing activities:Issuance
                      of common stock
                  
                  
                  8,140,000
                  
                  
                  
                  5,000,000
                  
                  
                  
                  -Payment
                      of fees associated with issuance of common stock
                  
                  
                  (419,569
                  )
                  
                  
                  (256,677
                  )
                  
                  
                  -Repayments
                      of debt
                  
                  
                  (749,004
                  )
                  
                  
                  (674,585
                  )
                  
                  
                  (998,732
                  )Borrowing
                      of debt
                  
                  
                  8,173,178
                  
                  
                  
                  -
                  
                  
                  
                  -Deferred
                      financing fees associated with new debt issuance
                  
                  
                  (242,500
                  )
                  
                  
                  -
                  
                  
                  
                  -Exercise
                      of common stock options
                  
                  
                  -
                  
                  
                  
                  83,238
                  
                  
                  
                  49,305**Net
                      cash provided by (used in) financing activities**
                  
                  
                  14,902,105
                  
                  
                  
                  4,159,976
                  
                  
                  
                  (949,427
                  )**Exchange
                      rate effect on cash and cash equivalents**
                  
                  ****
                  (38,488
                  )
                  
                  
                  -
                  
                  
                  
                  -Net
                      increase (decrease) in cash and cash equivalents
                  
                  
                  (4,291,657
                  )
                  
                  
                  4,882,280
                  
                  
                  
                  (984
                  )Cash
                      and cash equivalents at beginning of year
                  
                  
                  5,213,289
                  
                  
                  
                  331,009
                  
                  
                  
                  331,993Cash
                      and cash equivalents at end of year
                  
                  $
                  921,632
                  
                  
                  $
                  5,213,289
                  
                  
                  $
                  331,009**Supplemental
                      disclosures of cash flow information:**Cash
                      paid during the year for:Interest
                  
                  $
                  268,899
                  
                  
                  $
                  81,468
                  
                  
                  $
                  132,441Income
                      taxes
                  
                  $
                  183,486
                  
                  
                  $
                  10,329
                  
                  
                  $
                  24,701**Supplemental
                      schedule of Non Cash Activity**Cashless
                      exercise of common stock warrants
                  
                  $
                  19,800
                  
                  
                  
                  -
                  
                  
                  
                  -Issuance
                      of 800,000 warrants in connection withthe
                      new debt issuance
                  
                  $
                  1,114,784
                  
                  
                  
                  -
                  
                  
                  
                  -
  See
          Notes
          to Consolidated Financial Statements
   F-5
  **AFP
          IMAGING CORPORATION AND SUBSIDIARIES**
 **NOTES
          TO CONSOLIDATED FINANCIAL STATEMENTS**
 **JUNE
          30, 2007**
 **1.   NATURE
        OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES**:  AFP
        Imaging Corporation, together with its subsidiaries (the "Company"), was
        organized on September 20, 1978 under the laws of the State of New
        York.  The Company is engaged in the business of designing,
        developing, manufacturing and distributing equipment for generating, capturing
        and/or producing dental, veterinary and medical diagnostic images through
        digital imaging technologies as well as the chemical processing of
        photosensitive materials.  These products are used by medical, dental,
        veterinary and industrial professionals.  The Company's products are
        sold and distributed to worldwide markets, under various brand names, through
        a
        network of independent and unaffiliated dealers and independent sales
        representatives.
 
 On
        April
        19, 2007, the Company completed the acquisition of Quantitative Radiology
        srl,
        an Italian corporation (“QR”), by acquiring all of the outstanding share capital
        of QR from the shareholders.  QR is a global supplier of
        state-of-the-art, in-office three-dimensional dental computed tomography
        (CT).  QR uses an imaging technology that features a cone shaped beam
        of x-rays (a CBCT scanner).  The Company, prior to April 19, 2007, had
        acted as QR’s exclusive distributor in North and South America, excluding
        Brazil.  Funding for the acquisition was principally derived from two
        sources; the first was the proceeds raised from a private offering of the
        Company’s common stock to equity investors and the second was the loan proceeds
        from ComVest Capital, LLC in connection with a term loan and revolving credit
        facility.  In connection with the acquisition, the Company, entered
        into employment agreements with each of the former shareholders’ of
        QR.  Each agreement contains a non-compete clause which prohibits the
        employee from engaging in activities competitive with the business of QR
        for a
        period of five years from the date of termination of employment.
 
 On
        April
        12, 2007, the Company completed the sale of an aggregate of 5,500,000 shares
        of
        its common stock to certain accredited investors for an aggregate consideration
        of $8,140,000 pursuant to previously executed subscription
        agreements.  The common stock was issued and sold pursuant to the
        exemption from registration afforded by regulation D of the Securities Act
        of
        1933, as amended.  In connection with the transaction, the Company
        paid the placement agent for the offering $407,000, or five percent of the
        gross
        proceeds of the offering.  The proceeds were used for the purchase of
        QR.  The Company has granted the investors certain registration rights
        with respect to the resale of the shares acquired and agreed to register
        these
        shares of common stock.  The Company is subject to specific penalties
        if the registration statement is not filed within a certain time.  The
        Company has received an extension of time allowed to file this registration
        statement from the investors until October 15, 2007, so as to incorporate
        the
        information contained within this Annual Report on Form 10K.The
        Company believes that any payments of penalties related to this registration
        statement are remote.
 
 On
        April
        13, 2007, the Company entered into a Revolving Credit and Term Loan Agreement
        with ComVest Capital, LLC (“ComVest”) whereby ComVest agreed to lend the Company
        an aggregate of up to $8 million in the form of a $5 million term loan and
        a $3
        million revolving loan facility.  The term loan bears interest at a
        rate of ten percent (10%) per annum and provides for repayment over five
        years
        commencing in November 2007; and the revolving loans bear interest at a rate
        per
        annum of two percent (2%) plus the prime rate and is payable in full on April
        30, 2012.  The Company and each of its wholly-owned subsidiaries
        executed a Collateral Agreement pursuant to which each such party agreed
        to
        grant a security interest in all of its respective assets to ComVest as
        collateral security for repayment of the loans.  This new senior
        secured Revolving Credit and Term Loan Agreement replaced the Company’s previous
        $2.5 million senior secured credit facility, which was due to expire on
        September 21, 2007.  As part of the transaction, the Company granted
        to ComVest an aggregate of 800,000 warrants to purchase shares of the Company’s
        common stock at exercise prices per share equal to $1.85 with respect to
        266,666
        warrants, $2.02 with respect to an additional 266,666 warrants, and $2.19
        with
        respect to the remaining 266,668 warrants.  The Company entered into a
        Registration Rights Agreement pursuant to which it has agreed to register
        the
        shares of common stock issuable upon exercise of the warrants and conversion
        of
        the term note.  The Company is subject to specific penalties if the
        registration statement is not filed within a certain time and then declared
        effective within a certain time.  The Company must also use its best
        efforts to keep the registration statement effective during the applicable
        registration period.  The Company has received an extension of the
        time allowed to file this registration statement from ComVest until October
        15,
        2007, so as to incorporate the information contained within this Annual Report
        on Form 10K.  The Company believes that any payments of penalties
        related to this registration statement are remote.
 
 The
        consolidated financial statements include AFP Imaging Corporation and its
        wholly
        owned subsidiaries.  All significant intercompany transactions have
        been eliminated in consolidation.
   F-6
  The
        preparation of financial statements in conformity with United States generally
        accepted accounting principles requires management to make estimates and
        assumptions that affect the reported amounts of assets and liabilities and
        the
        reported amounts of revenues and expenses during the reporting
        period.  Actual results could differ from those
        estimates.
 
 Revenue
        is
        recognized by the Company when products are shipped and title passes to the
        customer.  The Company includes shipping and handling costs as a
        component of cost of sales.
 
 Cash
        and
        cash equivalents include deposits with original maturities of three months
        or
        less.
 
 The
        Company maintains cash in bank deposit accounts which, at times, exceed
        federally insured limits.  The Company has not experienced any losses
        on these accounts.
 
 Inventories,
        which include material, labor and manufacturing overhead, are stated at the
        lower of cost (first-in, first-out) or market (net realizable
        value).
 
 Machinery
        and equipment are depreciated using straight-line and accelerated methods
        over
        their estimated useful lives, ranging from three to ten
        years.  Leasehold improvements are depreciated on a straight-line
        basis over the shorter of their estimated useful lives or the term of the
        lease.
 
 Research
        and development costs are charged to expense as incurred.  These costs
        are incurred in connection with the design and development of the Company's
        new
        or enhanced products.
 
 Advertising
        costs, included in selling, general and administrative costs, are charged
        to
        expense as incurred and were approximately $322,500, $287,600 and $185,300
        for
        the fiscal years ended June 30, 2007, 2006 and 2005, respectively.
 
 Effective
        July 1, 2005, the Company adopted the fair value based method of accounting
        for
        stock-based employee compensation under the provisions of Statement of Financial
        Accounting Standards No. 123 (Revised 2004), *Share Based Payment* (“SFAS
        No. 123R”), using the modified prospective method without restatement of the
        periods prior to the adoption date, as described in SFAS 123R.  The
        share based compensation cost will be measured based on the fair value of
        the
        equity or liability instruments issued.  SFAS No. 123R also requires
        the benefits of tax deductions in excess of recognized compensation cost
        to be
        reported as a financing cash flow rather than as an operating cash flow as
        required under prior literature.
 
 As
        a
        result, the Company has begun recognizing expense in an amount equal to the
        fair
        value of share-based payments (including stock option awards) on their date
        of
        grant, over the vesting period of the awards.  Under SFAS 123R, the
        Company must recognize compensation expense for (1) all share-based payments
        granted on or after July 1, 2005 and (2) any partially vested options as
        of July
        1, 2005.  Prior to the adoption of SFAS 123R, the Company accounted
        for these plans pursuant to Accounting Principles Board Opinion No. 25
*Accounting for Stock Issued to Employees*.  Therefore,
        compensation expense related to stock option awards was not reflected in
        operating expenses in any period prior to July 2005 (first quarter of Fiscal
        Year 2006), and prior period results have not been restated.  For the
        twelve months ended June 30, 2007 and June 30, 2006, non-cash stock based
        compensation expense related to stock option awards (“Stock Option Expense”) was
        $82,461 and $82,398, respectively, and have been included in selling, general
        and administrative expenses.  The compensation expense did not result
        in a tax benefit as a result of the valuation allowance applied to the related
        deferred tax asset.  For the twelve months ended June 30, 2005 had the
        Company adopted the fair value based method of accounting for stock-based
        compensation under the provisions of SFAS 123R, Stock Option Expense would
        have
        been $151,884, and the effect on the Company’s net income and net income per
        share would approximate the pro forma amounts shown in the following
        table:
   **June
                    30,**
                
                **2005**Net
                    income as reported
                
                $
                1,899,930Deduct:Stock
                    compensation expensedetermined
                    under fair-value-basedmethod
                    for all awards
                
                
                (151,884
                )Pro
                    forma net income (loss)
                
                $
                1,748,046Basic
                    net income per share, as reported
                
                $
                .20Basic
                    net income per share, pro forma
                
                $
                .19Diluted
                    net income per share, as reported
                
                $
                .18Diluted
                    net income per share, pro forma
                
                $
                .18
   F-7
  The
        Company translates the assets and liabilities of its foreign subsidiaries
        into
        US dollars at the closing balance sheet rate of exchange.  Income and
        cash flow statements are translated at the average rates of exchange for
        the
        period.  Gains and loses from translating the financial statements of
        the foreign operations where the functional currency is not the US dollar
        is
        included in Foreign Currency Translation Adjustment within Shareholders’
Equity.  The functional currency for the Company’s foreign
        subsidiaries is the local currency.  The Company did not have any
        foreign operations for the fiscal years ended June 2006 and 2005.  Any
        exchange rate differences arising at the time of collection of
        accounts  receivables or settlement of accounts payable are included
        in net income.
 
 In
        addition to net income (loss), comprehensive income (loss) includes other
        charges or credits to equity other than those resulting from transactions
        with
        shareholders.  Comprehensive income/ (loss) relates to foreign
        currency translation adjustments related to the Company’s foreign
        subsidiaries.
 
 Accounts
        receivable are recorded at the invoiced amount and do not bear
        interest.  The allowance for doubtful accounts is the Company's best
        estimate of the amount of probable credit losses in the Company's existing
        accounts receivable.  The Company establishes an allowance for
        doubtful accounts based upon factors surrounding the credit risk of specific
        customers, historical trends and other information.  Receivable
        balances are reviewed on an aged basis and account balances are charged off
        against the allowance after all means of collection have been exhausted and
        the
        potential for recovery is doubtful.
 
 The
        Company purchased a Euro hedge contract in March 2007 to limit the Company’s
        foreign currency exchange risk associated with the purchase of QR on April
        19,
        2007, as the purchase price was in Euro.  The Company realized a gain
        of $352,966 which is included in the accompanying consolidated statement
        of
        operations.  In accordance with FASB Statement No. 133 (“SFAS 133”),
        Accounting for Derivative Instruments and Hedging Activities, the off-setting
        gain has been recorded as part of the transaction costs associated with the
        purchase of QR.  This derivative financial instrument has been
        designated a fair value hedge and is deemed to be completely
        effective.  There were no derivative financial instruments outstanding
        as of June 30, 2007.
 
 Prior
        to
        April 2007, the Company did not have any long-lived assets or
        goodwill.  Long-lived assets held for use by the Company will be
        reviewed for impairment whenever circumstances provide evidence that suggests
        the carrying amount of the asset may not be recoverable.  The Company
        will also perform ongoing impairment analysis on intangible assets related
        to
        technology.  Determination of whether impairment exists will be based
        upon comparison of the identifiable cash flows of the assets to the carrying
        values of the respective assets, and if impaired the value of the asset will
        be
        reduced.  Goodwill is not amortized, but will be tested for impairment
        on an annual basis each June 30th, or whenever
        circumstances or events indicate that the carrying amount may not be
        recoverable.  The impairment tests will be based on a comparison of
        the fair value of the reporting entity to the respective goodwill
        amount.  Any identified impairment will result in a charge to reduce
        the carrying value of the associated goodwill.
 
 Income
        taxes are accounted for under the asset and liability
        method.  Deferred tax assets and liabilities are recognized for the
        estimated future tax consequences attributable to differences between the
        financial statement carrying amounts of existing assets and liabilities and
        their respective tax bases and operating loss carryforwards.  Deferred
        tax assets and liabilities are measured using enacted tax rates in effect
        for
        the year in which those temporary differences are expected to be recovered
        or
        settled.  The effect on deferred tax assets and liabilities of a
        change in tax rates is recognized in income in the period that includes the
        enactment date.  The Company records a valuation allowance to reduce
        its deferred tax asset to an amount that is more likely than not to be
        realized.
 
 The
        Company’s basic net income per common share is based upon the weighted-average
        number of common shares outstanding during the period.  Diluted net
        income per share is based upon the weighted average number of common shares
        and
        common share equivalents outstanding when conversion would cause
        dilution.  Common share equivalents include (1) outstanding stock
        options and (2) outstanding warrants.
 
 Basic
        and
        diluted income per common share for the fiscal years ended 2007, 2006 and
        2005
        is presented below:
  
 F-8
 
 **June
                    30,**
                
                **2007**
                
                
                **2006**
                
                
                **2005**Net
                    income/(loss)
                
                $
                (4,672,824
                )
                
                $
                1,005,348
                
                
                $
                1,899,930Weighted-average
                    common shares outstanding - Basic
                
                
                13,635,688
                
                
                
                10,009,958
                
                
                
                9,380,855Basic
                    Net income/(loss) per share
                
                $
                (.34
                )
                
                $
                .10
                
                
                $
                .20Weighted-average
                    common shares outstanding – DilutedBasic
                    shares
                
                
                13,635,688
                
                
                
                10,009,958
                
                
                
                9,380,855Dilutive
                    effect of stock options
                
                
                ---
                
                
                
                416,417
                
                
                
                426,758Dilutive
                    effect of warrants
                
                
                ---
                
                
                
                86,864
                
                
                
                78,049Weighted-average
                      common sharesoutstanding
                      - diluted
                
                
                13,635,688
                
                
                
                10,513,239
                
                
                
                9,885,662Diluted
                    Net income/(loss) per share
                
                $
                (.34
                )
                
                $
                .10
                
                
                $
                .19
  The
        diluted income per common share computation reflects the effect of common
        shares
        contingently issuable upon the exercise of warrants and options in periods
        in
        which conversion would cause dilution.  The diluted weighted-average
        number of shares outstanding for the years ended June 30, 2007, 2006, and
        2005
        does not include the potential exercise of the following stock options and
        warrants as such amounts were antidilutive,
 
 **June
                  30**
              **2007**
              **2006**
              **2005**Options
              893,900
              10,000
              18,000Warrants
              850,000
              0
              0Diluted
                  Shares
              1,743,900
              10,000
              18,000
 
  On
        May 2,
        2006, the Company issued 2,777,777 shares of its common stock in a private
        placement to selected institutional and other accredited
        investors.  The offering price was at $1.80 per share.  In
        conjunction with the private placement, the Company has granted the investors
        certain registration rights with respect to the resale of the shares
        acquired.  No warrants were issued to the investors in this private
        placement.  The Company incurred fees of approximately $256,000
        including all placement fees and related legal and accounting
        expenses.  The Company used the entire net proceeds for the
        acquisition of QR on April 19, 2007.
 
 With
        respect to the above described financing, the Company filed a registration
        statement which was declared effective on July 14, 2006.  If this
        registration statement is subsequently suspended for a specified period of
        time,
        the Company could be required to pay a penalty of 1% of the financing per
        month
        to the investors.  Additionally, the Company is required to file
        amendments to the registration statement as necessary to keep the registration
        effective for 24 months from the closing date. In accordance with the provisions
        of FSP EITF 00-19-2, the Company has reclassified this private placement
        from
        temporary equity to shareholders’ equity on the accompanying balance sheet as of
        June 30, 2007.  At June 30, 2006, the net proceeds were classified as
        temporary equity in accordance with the provisions of EITF Topic
        D-98.  The Company has maintained this registration statement since it
        was declared effective and believes that any future payments related to this
        registration statement are remote.  Therefore, in accordance with SFAS
        5, *Accounting for Contingencies,*no corresponding contingent liability
        has been recorded.
 
 On
        March
        28, 2006, the Company issued an aggregate of 50,000 warrants to designees
        of an
        investment banking firm.  Each warrant entitles the holder to purchase
        one share of common stock at a purchase price of $1.98, the closing stock
        price
        on March 28, 2006.  The warrants are for five years and the
        Black-Scholes method was used to value these warrants.
 
 In
        August
        and September 2006, the Company’s previous senior secured lender chose to
        exercise its warrant to purchase 100,000 shares of the Company’s common stock
        into 82,806 shares of common stock in a cashless exercise in a manner as
        specified in the warrant.
 
 In
        February 2006, the FASB issued SFAS No. 155, *Accounting for Certain Hybrid
        Financial Instruments – an amendment of FASB Statements No. 133 and 140*
        (“SFAS No. 155”).  This statement improves financial reporting by
        allowing fair value measurement for hybrid financial instruments that contain
        an
        embedded derivative as well as clarifying certain points of SFAS No. 133
        and
        SFAS No. 140.  SFAS No. 155 is effective for all financial instruments
        acquired or issued in fiscal years beginning after September 15,
        2006.  In March 2006, the FASB issued SFAS No. 156, *Accounting for
        Servicing of Financial Assets – an amendment of FASB Statement No. 140*
        (“SFAS No. 156”).  This statement requires that all separately
        recognized servicing assets and liabilities be initially measured at fair
        value
        if practicable and clarifies certain points of SFAS140.  SFAS No. 156
        is effective for fiscal years that begin after September 15,
        2006.  The Company does not believe that SFAS Nos. 155 and 156 will
        have any material effect on the Company’s financial statements or results of
        operations.
   F-9
  In
        July
        2006, the FASB issued FASB Interpretation No. 48, *Accounting for Uncertainty
        in Income Taxes, an interpretation of FASB No. 109*(“FIN 48”), which
        provides criteria for the recognition, measurement, presentation and disclosure
        of uncertain tax positions.  A tax benefit from an uncertain position
        may be recognized only if it is “more likely than not” that the position is
        sustainable based on its technical merits.  The provisions of FIN 48
        are effective for fiscal years beginning after December 15, 2006.  We
        do not expect FIN 48 will have a material effect on the Company’s financial
        statements.
 
 In
        September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
        No. 157, *Fair Value Measurements*(“SFAS No. 157”).  SFAS No.
        157 establishes a framework for measuring fair value in generally accepted
        accounting principles and expands disclosures about fair value
        measurements.  SFAS No. 157 emphasizes that fair value is a
        market-based measurement, not an entity-specific measurement.  SFAS
        No. 157 also expands disclosures about the use of fair value to measure assets
        and liabilities in interim and annual periods subsequent to initial
        recognition.  The Company is required to adopt SFAS No. 157, as
        applicable, beginning in July 2008.  The Company is evaluating the
        effect of SFAS No. 157, but does not believe that there will be any material
        effect on the Company’s financial statements.
 
 In
        September 2006, the FASB also issued SFAS No. 158, *Employers’ Accounting for
        Defined Benefit Pension and Other Postretirement Plans-an Amendment of FASB
        Statements No. 87, 88, 106 and 132R*(“SFAS No. 158”).  SFAS No.
        158 improves financial reporting by requiring an employer to recognize the
        over
        funded or under funded status of a defined benefit postretirement plan as
        an
        asset or liability in its statement of financial position and to recognize
        changes in that funded status in the year in which the changes occur through
        comprehensive income of a business entity or changes in unrestricted net
        assets
        of a not-for-profit organization.  SFAS No. 158 also improves
        financial reporting by requiring an employer to measure the funded status
        of a
        plan as of the date of its year-end financial position.  The Company
        is required to adopt SFAS No. 158, as applicable, as follows.  The
        Company must recognize the funded status of its defined benefit postretirement
        plans and provide the required disclosures as of June 30, 2007, and the Company
        must measure the plan assets and benefit obligations for the fiscal year
        ended
        June 30, 2009.  The Company does not believe that there will be any
        material effect on the Company’s financial statements.
 
 In
        December 2006, the FASB issued FSP EITF 00-19-2, *Accounting for Registration
        Payment Arrangements*(“FSP EITF 00-19-2”).  FSP EITF 00-19-2
        addresses an issuer’s accounting for registration payment arrangements, and
        specifies that the contingent obligation to make future payments or otherwise
        transfer consideration under a registration payment arrangement should be
        separately recognized and measured in accordance with SFAS No. 5, *Accounting
        for Contingencies.*  The Company adopted FSP EITF 00-19-2
        effective January 1, 2007.
 
 In
        February 2007, the FASB issued SFAS
        No. 159,*The Fair Value
        Option for Financial Assets and Financial Liabilities – Including an Amendment
        of FASB Statement No. 115*(“SFAS No. 159”)*.*SFAS
        159 permits entities to choose to
        measure many financial instruments and certain other items at fair value,
        so as
        to improve financial reporting by providing entities with the opportunity
        to
        alleviate volatility in reported earnings.  This Statement should
        expand the use of fair value measurement and permits all entities to choose
        to
        measure eligible items at fair value at specified election dates.  The
        resulting unrealized gains or losses on items which the fair value option
        has
        been elected are to be reported in earnings.  The Company is required
        to adopt SFAS No. 159, as applicable, beginning in July 2008.  The
        Company is evaluating the effect of SFAS No. 159, but does not believe that
        there will be any material effect on the Company’s financial
        statements.
 
 Management
        does not believe that any other recently issued, but not yet effective,
        accounting standards if currently adopted would have a material effect on
        the
        accompanying consolidated financial statements.
 
 **2.**
              **INVENTORIES:**
  Inventories,
        net of reserves, consist of
        the following:
  **June
                  30**
              
              **2007**
              
              
              **2006**Raw
                  materials and subcomponent parts
              
              $
              2,856,813
              
              
              $
              1,984,979Work-in-process
                  and finished goods
              
              
              3,538,239
              
              
              
              2,849,531$
              6,395,052
              
              
              $
              4,834,510
 
 Inventories,
        which include material and a small component of labor and manufacturing
        overhead, are stated at the lower of cost (first-in, first-out) or market
        (net
        realizable value).  The Company’s US operations uses a standard cost
        accounting system in conjunction with an actual perpetual inventory system
        to
        properly account for, control and maintain the movement of all inventory
        components.  The Company’s foreign operations evaluated various
        inventory control systems, and implemented such in early fiscal year
        2008.  Provision has been made for any potential losses on obsolete or
        slow-moving inventory items.
   F-10
  Demonstration
        equipment which is on consignment with customers is valued at the costs
        described above, reduced for reductions in value in view of its technical
        obsolescence, over periods up to five years.
 
 **3.**
              **PROPERTY
                  AND
                  EQUIPMENT:**
  Property
        and equipment, at cost, consists of the following:
  **June
                  30,**
              
              **2007**
              
              
              **2006**Leasehold
                  improvements
              
              $
              255,071
              
              
              $
              239,277Machinery
                  and equipment
              
              
              1,886,052
              
              
              
              1,588,8722,141,123
              
              
              
              1,828,149Less
                  accumulated depreciation and amortization
              
              
              (1,602,121
              )
              
              
              (1,450,484
              )**Property
                  and equipment, net**
              
              $
              539,002
              
              
              $
              377,665
  Depreciation
        and amortization was $253,402, $216,179 and $176,514 for the years ended
        June
        30, 2007, 2006 and 2005, respectively.
  The
        Company retired $101,763 and $56,749 of assets during fiscal years 2007 and
        2005, respectively, and did not retire any assets during fiscal year
        2006.
 
 **4.**
              **DEBT:**
  On
        April
        13, 2007, the Company entered into a new senior secured credit facility (the
        Revolving Credit and Term Loan) with ComVest Capital, LLC that replaced the
        Company’s existing $2.5 million revolving line of credit that was due to expire
        on September 21, 2007.  The Revolving Credit and Term Loan consists of
        a $5 million convertible term note and a $3 million revolving loan
        facility.  The convertible term note bears interest at a rate of ten
        percent per annum and provides for repayment over five years commencing in
        November 2007 with a final balloon payment of all remaining amounts due
        there-under on April 30, 2012.  The revolving loan bears interest at a
        rate of two percent plus prime rate per annum, currently equal to 9.75%,
        has a
        specific formula to calculate available funds based on eligible accounts
        receivable and inventory, is subject to certain maximum borrowing base
        requirements, has certain reporting requirements to the lender, and is payable
        in full on April 12, 2012.  The convertible term note, in addition to
        being convertible by the Company upon the satisfaction of certain conditions,
        including a trading price equal to 175% of the conversion price and the
        Company’s common stock being traded on Nasdaq, is convertible by the lender at
        any time into shares of common stock at a conversion price of $2.37 per share,
        or 2,109,705 shares based on the initial principal amount of the convertible
        term note.
 
 The
        Company and each of its wholly-owned subsidiaries executed a Collateral
        Agreement pursuant to which each such party agreed to grant a security interest
        in all of its respective assets to ComVest as collateral security for repayment
        of the loans.  The Revolving Credit and Term Loan is secured by all of
        our and our wholly-owned subsidiaries inventory, accounts receivable, equipment,
        officer life insurance policies and proceeds thereof, trademarks, licenses,
        patents and general intangibles.  It is believed that the Revolving
        Credit and Term Loan is sufficient to finance our ongoing working capital
        requirements for the foreseeable future.  The Revolving Credit and
        Term Loan Agreement has a specific formula to calculate available funds based
        on
        eligible accounts receivable and inventory, is subject to maximum borrowing
        base
        limitations, and has certain reporting requirements.
 
 As
        part of
        the transaction, the Company granted to ComVest an aggregate of 800,000,
        five-year warrants to purchase shares of the Company’s common stock at exercise
        prices per share equal to $1.85 with respect to 266,666 warrants, $2.02 with
        respect to an additional 266,666 warrants, and $2.19 with respect to the
        remaining 266,668 warrants. The Company has assessed whether the warrants
        granted to ComVest should be classified as either a liability or equity in
        accordance with EITF 00-19, “*Accounting for Derivative Financial Instruments
        Indexed to, and Potentially Settled in a Company’s Own Stock*” and concluded
        that these warrants should be classified as equity.  The Black-Scholes
        Method was used to value these detachable warrants, and have been recorded
        in
        the accompanying Consolidated Balance Sheets at $1,114,784.  The
        Company entered into a Registration Rights Agreement pursuant to which it
        has
        agreed to register the shares of common stock issuable upon exercise of the
        warrants and conversion of the term note.
 
 .In
        accordance with Accounting principles Board Opinion No. 14, “*Accounting for
        Convertible Debt and Debt Issued with Stock Purchase warrants*”, proceeds
        received from the sale of debt with detachable stock purchase warrants are
        allocated to both the debt and the warrants.  The portion allocable to
        warrants is accounted for as additional paid in capital, and the remaining
        portion is classified as debt.  The fair value of the warrants issued
        to ComVest is being treated as debt discount, which will be accreted as interest
        expense utilizing the interest method over the 60-month term of the Term
        Loan.  The assumptions used for the Black-Scholes option pricing model
        were as follows:  risk-free interest rate of 4.66%, expected
        volatility of 123%, an expected life of five years, and no expected
        dividends.  A summary of such follows:
   F-11
  **June
                  30, 2007**Term
                  Loan
              
              $
              5,000,000Fair
                  value of warrants (recorded as capital in excess of par)
              
              
              (1,114,784
              )Accretion
                  of debt discount (recorded as interest expense)
              
              
              49,144Recorded
                  value of Term Loan
              
              $
              3,934,360
 
 As
        of June
        30, 2007, the Company was in compliance with all terms and conditions of
        the
        Revolving Credit and Term Loan Agreement.
  There
        was
        no outstanding debt as of June 30, 2006.  As of June 30, 2007, debt
        consisted of the following:
  **June
                  30**
              
              **2007**ComVest
                  Term Loan, net of debt discount
              
              $
              3,934,360$3.0
                  Million Revolving Senior Credit Facility
              
              
              2,424,714$2.5
                  million Revolving Senior
                  Credit Facility(a)
              
              
              -Nystrom
                  subordinated note
                  payable(b)
              
              
              -6,359,074Less
                  current portion
              
              
              536,727**Total
                  long-term debt**
              
              $
              5,822,347
   (a)
              This
                  Revolving Senior Credit Facility was replaced in April 2007 with
                  an $8 million Senior
                  Credit Facility
                  to facilitate the acquisition of QR Srl.  The $2.5 million
                  Revolving Credit Facility was due to expire in September 2007 and
                  was
                  repaid in full prior to the closing of the new $8 million Senior
                  Credit
                  Facility.
  (b)
              This
                  note payable consisted of an $800,000 promissory note to ACG
                  Nystromgruppen AB ("Nystrom"), the former parent of a Swedish dental
                  company.  Under the terms of this note, as amended, interest
                  only was paid quarterly for the first three years, followed by
                  36 equal
                  monthly installments of $22,222 plus interest on the unpaid balance,
                  which
                  began in May 2003.  The Nystrom promissory note had an interest
                  rate reset annually based on the LIBOR plus 2%.  This note was
                  repaid in full as of April 2006.
  At
        June
        30, 2007, there was no foreign debt outstanding.
  Maturities
        of long-term debt, including the Term loan, net of debt discount, and the
        Revolving Loan for the subsequent five years are as follows:
 
 Year
                  ending June 30
              
              
              Payments
                  Due
              
              
              
              Debt
                  Discount2008
              
              $
              740,741
              
              
              $
              204,014
              
              
              $
              536,7272009
              
              
              1,111,111
              
              
              
              213,914
              
              
              
              897,1972010
              
              
              1,111,111
              
              
              
              225,057
              
              
              
              886,0542011
              
              
              1,111,111
              
              
              
              236,694
              
              
              
              874,4172012
              
              
              3,350,640
              
              
              
              185,961
              
              
              
              3,164,679$
              7,424,714
              
              
              $
              1,065,640
              
              
              $
              6,359,074
 
 At
        June
        30, 2007, the Company had available $575,286 of unused lines of credit under
        the
        Revolving Senior Credit Facility.
 
 Due
        to the
        short-term nature of all of the debt as well as borrowing rates currently
        available to the Company, the fair market value of all of the Company's debt
        approximated its carrying value.
 
 **5.**
              **ACCRUED
                  EXPENSES:**
  As
        of June 30, 2007 and 2006, accrued
        expenses consisted of the following:
   F-12
  **June
                  30**
              
              **2007**
              
              
              **2006**Accrued
                  environmental claim (see Note 9)
              
              $
              11,550
              
              
              $
              11,550Accrued
                  payroll expenses
              
              
              933,043
              
              
              
              545,487Accrued
                  amounts due vendors for in-transit inventory
              
              
              446,032
              
              
              
              433,639Current
                  income, sales and VAT taxes payable
              
              
              684,967
              
              
              
              -Accrued
                  expenses – other (none in excess of 5% of  current
                  liabilities)
              
              
              811,992
              
              
              
              574,498$
              2,887,584
              
              
              $
              1,565,174
 
 Included
        in accrued payroll expenses above is approximately $273,000 of severance
        indemnity costs mandated under Italian labor laws.  All employees are
        entitled to an indemnity upon termination of their employment relationship
        for
        any reason.  The respective benefit accrues to each employee on a
        pro-rata basis during their employment period and is based upon their respective
        salary.  The vested benefit payable accrues interest.  The
        amounts reflected in the consolidated balance sheets reflects the total amount
        of the indemnities that each employee would be entitled to receive if
        termination were to occur as of June 30, 2007.
 
 **6.**
              **COMMON
                  STOCK OPTIONS:**
  The
        Company has two employee incentive stock option plans under which approximately
        1,100,000 shares of Company common stock were originally authorized and
        available for issuance.  Most options that are granted under the plans
        are fully vested when granted.  Under the terms of these plans,
        options to purchase common stock of the Company may be granted at not less
        than
        85% of the fair market value of the stock on the date of grant, 100% of the
        fair
        market value in the case of incentive stock options qualifying under Section
        422A of the Internal Revenue Code (“ISOs”), or 110% of the fair market value of
        ISOs granted to persons owning more than 10% of the outstanding stock of
        the
        Company.  As of June 30, 2007, all but 25,000 of the outstanding stock
        options issued by the Company were fully vested.
 
 As
        described in Note 1, effective July 1, 2005, the Company adopted the fair
        value
        based method of accounting for stock-based employee compensation under the
        provisions of Statement of Financial Accounting Standards No. 123 (Revised
        2004), *Share**Based Payment* (“SFAS No. 123R”), using the
        modified prospective method without restatement of the periods prior to the
        adoption date.  As a result, the Company has begun recognizing expense
        in an amount equal to the fair value of share-based payments (including stock
        option awards) on their date of grant, over the vesting period of the
        awards.  Under SFAS 123R, the Company must recognize compensation
        expense for (1) all share-based payments granted on or after July 1, 2005
        and
        (2) any partially vested options as of July 1, 2005.  Prior to the
        adoption of SFAS 123R, the Company accounted for these plans pursuant to
        Accounting Principles Board Opinion No. 25 *Accounting for Stock Issued to
        Employees*.  Therefore, compensation expense related to stock
        option awards was not reflected in operating expenses in any period prior
        to
        July 2005 (first quarter of Fiscal Year 2006), and prior period results have
        not
        been restated.  See Note 1, for the effect on the Company’s net income
        and net income per share amount for the year ended June 30, 2005 had Stock
        Option Expense been determined in accordance with FAS 123.
 
 The
        fair
        value of each option granted under the Company’s incentive stock plans during
        the twelve months ended June 30, 2007, 2006 and 2005 was estimated on the
        date
        of grant using the Black-Scholes option pricing method.  Using this
        model, fair value is calculated based on assumptions with respect to (a)
        expected volatility of the market price of Company common stock, (b) the
        periods
        of time over which employees, directors and other option holders are expected
        to
        hold their options prior to exercise (expected lives), (c) expected dividend
        yield on Company common stock and (d) risk free interest rates which are
        based
        on quoted US Treasury rates for securities with maturities approximating
        the
        options’ expected lives.  Expected volatility has been estimated based
        on actual movements in the Company’s stock price over the most recent historical
        periods equivalent to the options’ expected lives.  Expected lives are
        principally based on the Company’s limited historical exercise experience with
        option grants with similar prices.  The expected dividend yield is
        zero as the Company has never paid dividends and does not currently anticipate
        paying any dividends in the foreseeable future.  The following table
        summarizes the weighted average values of the assumptions used in computing
        the
        fair value of option grants during the twelve months ended June 30, 2007,
        2006
        and 2005.
 
 .
              2007
              2006
              2005Expected
                  volatility
              148%
                  - 151%
              151%
                  - 155%
              80%Expected
                  lives from grant date
              10
                  years
              10
                  years
              10
                  yearsExpected
                  dividend yield
              0%
              0%
              0%Risk-free
                  interest rate
              4.76%
                  - 5.13%
              4.19%
                  - 5.07%
              3.09%
                  - 4.29%
 
 Stock
        options to purchase an aggregate 20,000 shares of Company common stock were
        granted to the Company’s outside Board of Director members in the three-month
        period ended September 30, 2006.  The outside Board of Director
        members elected to forgo the issuance of an additional 20,000 shares of common
        stock, to which they were entitled, in accordance with the Company’s policy for
        non-employee director compensation.Stock options to
        purchase an aggregate of 50,000 shares of Company common stock were granted
        to
        an employee in April 2007, half of these options vested immediately and the
        remainder will vest in April 2008.  Compensation expense amounting to
        $40,131 will be recognized in Fiscal Year 2008, upon the vesting of these
        options.
  F-13
  Transactions
                  under the plans for fiscal 2007, 2006 and 2005 are as
                  follows:**Year
                  ended June 30**
              **2007**
              **2006**
              **2005**Options
              Weighted
                  Average Price
              Options
              Weighted
                  Average
                Price
              Options
              Weighted
                  Average
                PriceOutstanding,
                  beginning of  fiscal year
              827,900
              $.87
              948,400
              $.76
              1,008,500
              $.57Exercised
              0
              0
              (160,500)
              .52
              (137,100)
              .36Granted
              70,000
              1.78
              40,000
              2.14
              140,000
              1.53Forfeited
              (4,000)
              1.15
              0
              0
              (6,0000
              .96Expired
              0
              0
              0
              0
              (57,000)
              .31Outstanding,
                  end of fiscal year
              893,900
              $.94
              827,900
              $.87
              948,400
              $.76Exercisable
                  at June 30
              868,900
              
              827,900
              
              948,400Weighted-average
                  fair value of options granted during years ended June 30
              $1.83
              
              $2.11
              
              $1.09
 
 The
        aggregate intrinsic value of the outstanding options, which are currently
        exercisable, amounted to $665,907 at June 30, 2007.  No options were
        exercised during the twelve months ended June 30, 2007.
 
 At
                  June 30, 2007, stock option information is as follows:Options
                  Outstanding
              Options
                  ExercisableRange
                  of
                Exercise
                  Prices
              Number
                Outstanding
                  at
                June
                  30, 2007
              Weighted-Average
                Remaining
                Contractual
                  Life (Years)
              Weighted-
                Average
                Exercise
                  Price
              Number
                Exercisable
                  at
                June
                  30, 2007
              Weighted-
                average
                Exercise
                  Price$
                  .11 - $ .50
              396,000
              2.67
              $.30
              396,000
              $.30$
                  .53 - $ .81
              25,500
              2.94
              .61
              25,500
              .61$1.06
                  - $1.75
              394,400
              8.87
              1.37
              369,400
              1.35$1.85
                  - $2.45
              78,000
              6.81
              2.15
              78,000
              2.15893,900
              6.24
              $.94
              
              $.92
 
 **7.**
              **INCOME
                  TAXES:**
  Income
        taxes are accounted for under the asset and liability
        method.  Deferred income taxes are recorded for temporary differences
        between financial statement carrying amounts and the tax basis of assets
        and
        liabilities.  Deferred tax assets reflect the tax rates expected to be
        in effect in the period in which the differences are expected to
        reverse.  The Company records a valuation allowance to reduce its
        deferred tax asset to an amount that is more likely than not to be
        realized.  As of June 30, 2007, the Company has recorded a deferred
        tax asset of approximately $1,296,000, which primarily relates to US losses
        recorded in prior years and foreign deferred tax assets acquired related
        to the
        acquisition of QR in April 2007.  The Company believes that it is
        likely that the Company will utilize these prior year net operating loss
        carry
        forwards.  However, should circumstance change and the Company
        determine that it will not be able to utilize its net operating loss
        carryforward, such as a decline in future consolidated taxable income, the
        Company will reevaluate its valuation allowance.  The net tax expense
        recorded as of June 30, 2007 includes foreign taxes at the statutory rates
        on
        the Company’s foreign operations, deferred foreign taxes related to permanent
        tax items, and state income and capital taxes generated in the United
        States.
  Net
        operating loss carryforwards
        ("NOLs") amounting to approximately $7.24 million in federal NOLs and $12.0
        million in state NOLs at June 30, 2007, will expire beginning in
        2010.  The NOLs are subject to review by the Internal Revenue
        Service.  Changes in ownership of the Company, as defined by Section
        382 of the Internal Revenue Code, will limit the amount of NOLs available
        for
        use in any one year.  In assessing the realizability of deferred tax
        assets, management considers whether it is more likely than not that some
        portion of the deferred tax assets will not be realized.  The ultimate
        realization of deferred tax assets is based upon the generation of future
        taxable income during future periods.The
        Company recorded the above valuation
        reserve, based on management's conclusion that it is more likely than not
        that
        consolidated future operations will not generate sufficient taxable income
        to
        realize the entire deferred tax assets during the carryforward period for
        these
        tax attributes
   F-14
  The
        income/(loss) before provision for income taxes is comprised of the
        following:
  June
                  30
              2007
              2006
              2005United
                  States
              ($1,195,502)
              $  1,001,867
              $1,229,259Foreign
              (3,277,871)
              -
              -Total
              ($4,473,373
              $  1,001,867
              $1,229,259
 
 The
        provision/(benefit) for income taxes is comprised of the following:
 
 June
                  30
              2007
              2006
              2005CurrentFederal
                  (US)
              $-
              $     (1,919)
              $  11,775State
                  (US)
              25,147
              (1,562)
              (2,446)Foreign
              84,873
              -
              -Total
                  Current
              110,020
              (3,481)
              9,329DeferredUnited
                  States
              -
              -
              (680,000)Foreign
              89,431
              -
              -Total
                  Deferred
              89,431
              -
              (680,000)Total
              $199,451
              ($3,481)
              $(670,671)
 
 The
        difference between the provision for income taxes at the effective federal
        statutory rates and the amounts provided in the consolidated financial
        statements is summarized as follows:
  June
                  30,
              2007
              2006
              2005Tax
                  provision at federal statutory  rates
              ($1,520,947)
              $    340,635
              $    417,948Increase
                  (decrease) in tax provision resulting from:State
                  income tax provision /(benefit)
              16,597
              (1,562)
              (2,446)Foreign regional tax provision
              47,512
              -
              -Foreign
                  tax benefit
              (7,185)
              -
              -Other
                  non deductible items
              31,216
              -
              -Increase/(decrease)
                  in valuation allowance
              1,632,258
              -
              (680,000)Utilization
                  of federal operating loss carryforwards
              -
              (342,554)
              (406,173)Provision/benefit
                  for income taxes
              $199,451
              $  (3,481)
              $   (670,671)
 
 The
        items that comprise the deferred tax
        balance are as follows:
  June
                  30,
              2007
              2006Depreciation
                  and amortization
              $118,189
              $22,736Amortization
                  of acquisition intangibles
              1,487,754
              -Accrued
                  liabilities and reserves not currently deductible
              287,604
              174,292Inventory
              156,000
              134,082Deferred
                  tax assets acquired
              615,718
              -Net
                  operating loss carryforwards and tax credits
              3,184,139
              3,270,3185,849,404
              3,601,428Deferred
                  tax asset valuation reserve
              (4,553,686)
              (2,921,428)$1,295,718
              $680,000Deferred
                  tax asset - Current
              926,603
              680,000Deferred
                  tax asset – Non-current
              369,115
              -Deferred
                  tax asset - Total
              $1,295,718
              $     680,000
 
  F-15
  **8.**
              **PROFIT
                  SHARING
                  PLAN:**
  The
        Company maintains a defined contribution profit-sharing plan and trust pursuant
        to which its United States participants receive certain benefits upon
        retirement, death, disability and, to a limited extent, upon termination
        of
        employment for other reasons.  In fiscal 2006, the Company established
        a Safe Harbor 401(k) defined contribution plan pursuant to which all eligible
        participants can make contributions.  In addition, the Company is
        required to make either a specified matching contribution or a 3% contribution
        to all participants.  Allocation among participants' interests,
        including officers and directors who are employees, is in accordance with
        IRS
        regulations for both of these plans.
 
 The
        aggregate amount contributed to each of these plans by the Company each fiscal
        year is determined by the board of directors following a review of the profits
        of such fiscal year.  For the years ended June 30, 2007 and 2006, the
        Company contributed $143,112 and $126,716, respectively towards the Safe
        Harbor
        401(k).  The profit sharing plan requires no minimum contribution by
        the Company.  The Company made a contribution of $63,550 for the year
        ended June 30, 2005 towards the profit sharing plan.  In Fiscal Year
        2008, the Company plans to distribute the cash and short-term marketable
        securities contained within the profit sharing plan to each employee’s
        respective 401(k) account, based on their respective pro-rata
        balances.  The profit sharing plan will only contain its existing
        common stock portfolio and the Company does not intend to make any further
        contributions to this plan.
 
 **9.**
              **COMMITMENTS
                  AND
                  CONTINGENCIES:**
  The
        Company is a defendant in an environmental claim relating to a property in
        New
        Jersey owned by the Company between August 1984 and June 1985.  This
        claim relates to the offsite commercial disposition of trash and waste in
        a
        landfill in New Jersey.  The Company maintains that its waste
        materials were of a general commercial nature. This claim was originally
        filed
        in 1998 by the federal government in United States District Court and the
        State
        of New Jersey, citing several hundred other third-party
        defendants.  The Company (through its former subsidiary, Kenro
        Corporation) was added, along with many other defendants, to the
        suit.  The Company's claimed liability was potentially assessed by the
        plaintiff at $150,000.  The Company has joined, along with other
        involved defendants in an alternative dispute resolution (ADR) process for
        smaller claims.  A recent settlement amount was offered by this group,
        however, to date, no settlement has been reached.  The potential cost
        to the Company based on this settlement offer has been assessed at
        $18,080.  The Company had accrued $11,550 as of Fiscal Year 2007 and
        Fiscal Year 2006, which represents the Company’s estimate of its potential
        liability, net of the Company’s insurance carrier’s agreed-upon contribution
        towards a potential settlement.  The Company does not expect to
        receive any further information until a status conference is held in late
        November 2007.  The Company cannot, at this time, assess the amount of
        liability that could result from any adverse final outcome of this environmental
        complaint. The Company's insurance carrier has agreed to equally share with
        the
        Company the defense costs incurred in this environmental claim.
 
 On
        February 8, 2005, the Company finalized a settlement relating to a separate
        environmental claim filed in 2001 as a civil complaint brought by the current
        owners of the same property owned by the Company between August 1984 and
        June
        1985.  This action was filed in the Superior Court of New Jersey,
        Morris County, and alleged that the Company’s discontinued graphic art camera
        subsidiary had contaminated a portion of the site during its manufacturing
        process prior to 1985.  The settlement included a release and
        indemnification as well as a stipulation of dismissal with
        prejudice.  The Company paid $325,000 on February 18, 2005, which
        represented the Company’s entire liability under the settlement agreement, net
        of the Company’s insurance carrier’s contribution towards the total and final
        settlement.
 
 On
        October
        1, 2007, a settlement was reached in the product liability insurance action
        filed in May 2005 in the Superior Court in Hartford, Connecticut and later
        transferred to the United States District Court, District of Connecticut,
        in
        which the Company was a defendant (with several other parties).  The
        plaintiff, through its insurance company, claimed that the Company’s equipment
        caused damages on the plaintiff’s premises in May 2003.  The case was
        settled for less than the originally claimed amount and included mutual releases
        for all participating parties from any liability arising from the
        claim.  The Company’s insurance carrier was responsible for the
        settlement, and therefore there was no financial effect on the
        Company.
 
 The
        Company is involved in two other product liability insurance actions, however,
        to date, no lawsuits have been filed.  The Company maintains that its
        equipment was not the cause of the respective incidents or the resultant
        damage.  The Company’s insurance carriers, and their attorneys, are
        assisting in the Company’s defense in these matters.  The Company does
        not believe that the final outcome of either of these matters will have a
        material adverse effect on the Company.
 
 The
        Company was named as a third party defendant in a lawsuit which was filed
        in May
        2007 in the Supreme Court of Orange County, New York.  The lawsuit
        alleges that the Company’s negligence in manufacturing, designing, assembling
        and distributing its digital radiographic sensors caused damages to the
        plaintiff.  The entire complaint seeks $37,770 in
        damages.  The Company believes its obligation is limited to less than
        $10,000, based on the specifics of the transaction.  The Company has
        offered a full refund on this transaction and is awaiting the
        plaintiff  and defendant to resolve their specific
        differences.  The Company’s attorneys, are assisting in the Company’s
        defense in this matter and are trying to finalize a mutually acceptable
        settlement with all concerned parties.  The Company does not believe
        that the final outcome of this matter will have a material adverse effect
        on the
        Company.
   F-16
  On
        August
        8, 2007, the Company received a letter from Lightyear Technology’s counsel that
        alleges certain actions the Company may have taken in subsequent to the
        acquisition of a distribution channel, in December 2006.  The claims
        may give rise to causes of action and claims of fraud and breach of
        contract.  To date, no legal action has been filed.  The
        Company is currently in full compliance with the terms of the contract and
        maintains that there was neither fraud, nor breach of contract.  The
        Company acted in good faith at all times with the management and direction
        of
        this distribution channel.  At this time, the Company cannot access
        the final outcome of this situation.
 
 From
        time
        to time, the Company may be party to other claims and litigation arising
        in the
        ordinary course of business.  The Company does not believe that any
        adverse final outcome of any of these matters, whether covered by insurance
        or
        otherwise, would have a material adverse effect on the Company.
 
 The
        Company has a noncancelable operating lease, as amended in March 2004, for
        office and manufacturing facilities in Elmsford, New York which expires in
        fiscal year 2010.  The lease provides for rent abatements and
        scheduled increases in base rent.  Rent expense is charged to
        operations ratably over the term of the lease resulting in deferred rent
        payable, which represents cumulative rent expense charged to operations from
        inception of this lease in excess of required lease payments. Rent expense
        was
        approximately $508,000 for each of the years ended June 30, 2007, 2006 and
        2005,
        respectively.
 
 The
        Company has a noncancelable operating lease for office and manufacturing
        facilities in Verona, Italy which expires in fiscal year 2015, which it assumed
        in April 2007 with the acquisition of QR srl.  Rent expense is
        approximately $112,000 per year using the average exchange rate for the 12
        months ended June 30, 2007.
 
 As
        part of
        the acquisition of QR srl, the Company granted employment agreements to each
        of
        the four former owners, for a total yearly commitment of 500,000
        Euros.  Each agreement is for a period of five years and contains a
        non-compete clause.  The Company can terminate each agreement after
        the first year of employment, in which event, any employee so terminated
        is
        entitled to one-half of the salary for the remaining term.
 
 The
        Company has a noncancelable operating lease for its small sales and marketing
        facility in Roswell, Georgia, which expires in fiscal year 2009.  The
        Company assumed this lease in December 2007, and rent expense was approximately
        $95,600 in fiscal year 2007.  The Company sub-lets a portion of this
        facility to an unrelated third-party.
 
 Minimum
        annual rental payments under these leases are as follows:
  Year
                  ending June 30,2008
              $    805,7312009
              795,5542010
              374,9752011
              112,4322012
                  and thereafter
              449,729$2,538,423
 
 The
        Company’s Italian subsidiary has the ability to borrow up to 350,000 Euros under
        two separate lines of credit and up to an additional one million Euros from
        three different lines, all guaranteed by its accounts receivables and
        inventory.  All the lines are with two different financial
        institutions.  These lines of credit were granted in August 2007, and
        no funds were outstanding as of June 30, 2007.
 
 **10.**
              **SEGMENT
                  INFORMATION:**
  As
        of June
        30, 2007 and 2006, the Company had only one business segment, medical/dental
        imaging.  The medical/dental segment operations are conducted under
        the Dent-X, EVA, NewTom and AFP trade names and consist of the design,
        development, manufacturing, marketing and distribution of medical and dental
        imaging systems and all related accessories.  The amortization of the
        intangibles and the write-off of the in-process research and development
        associated with the acquisition of QR has been attributed to the Italian
        operations.
 
 
 F-17
  Geographical
                  financial information for the years ended June 30, 2007, 2006 and
                  2005 is
                  as follows:June
                  30,
              
              2007
              
              
              2006
              
              
              2005Sales:United
                  States
              
              $
              19,781,071
              
              
              $
              19,306,971
              
              
              $
              18,858,056Europe
              
              
              2,071,262
              
              
              
              -
              
              
              
              -US
                  Export Sales
              
              
              6,867,360
              
              
              
              5,691,301
              
              
              
              4,277,007$
              28,719,693
              
              
              $
              24,998,272
              
              
              $
              23,135,063Net
                  Income (loss)United
                  States
              
              $
              (1,220,649
              )
              
              $
              1,005,348
              
              
              $
              1,899,930Europe
              
              
              (3,452,175
              )
              
              
              -
              
              
              
              -$
              (4,672,824
              )
              
              $
              1,005,348
              
              
              $
              1,899,930Identifiable
                  assets:United
                  States
              
              $
              9,942,023
              
              
              $
              14,340,564
              
              
              $
              8,153,396Europe
              
              
              17,228,803
              
              
              
              -
              
              
              
              -Total
              
              $
              27,170,826
              
              
              $
              14,340,564
              
              
              $
              8,153,396
 
 During
        the
        years ended June 30, 2007, 2006 and 2005, no one customer aggregated over
        10% of
        consolidated net sales.
 
 **11.  GOODWILL
        AND OTHER INTANGIBLES**
 
 On
        April
        19, 2007 the Company acquired through its wholly-owned subsidiary QR Imaging
        srl, QR srl, (“QR”) an Italian corporation, located in Verona,
        Italy.  The purchase price was 13 million Euros and was funded through
        the issuance of stock and assumption of new debt.  The company
        incurred approximately $1,558,000 of transactions costs, for a total purchase
        price of $18,875,360. The Company granted employment agreements to each of
        the
        four former owners as part of the transaction.  QR is a global
        supplier of three-dimensional dental computed tomography.  The results
        of QR’s operations have been combined with those of the Company since the date
        of acquisition.
 
 The
        acquisition was accounted for under the purchase method of accounting in
        accordance with FASB Statement No. 141, Business Combinations (“SFAS
        141”).  The carrying values of QR’s assets and liabilities were
        adjusted to their fair values on April 19, 2007 and the difference between
        the
        purchase price and the fair value of the net assets and liabilities was recorded
        as goodwill.  The Company used an independent third-party valuation
        firm to assist in determining the fair value of the assets
        acquired.  Many factors were considered including expected worldwide
        sales in the next several years, the existing customer base based on QR being
        a
        dominant supplier of three-dimensional dental imaging prior to the acquisition
        and the value of the in-process development of new products prior to the
        acquisition date.
 
 The
        allocation of the purchase price is as follows:
 
 Current
                  assets
              $   3,673,300Property,
                  plant and equipment
              161,200Deferred
                  Income taxes
              393,000In
                  process research and development
              3,760,000Intangible
                  assets subject to amortization
              8,805,000Goodwill
              3,846,400**Total
                  assets**
              20,638,900Current
                  liabilities
              1,499,800Severance
                  indemnity
              263,700**Total
                  liabilities assumed**
              1,763,500**Purchase
                  Price**
              $
                  18,875,400
 
 The
        Company believes that the acquisition will strengthen its competitive position
        in the technology-driven Imaging Systems marketplace by adding three-dimensional
        imaging to its core products as well as greatly expanding its product
        development capabilities and its world-wide presence.  The acquisition
        is expected to provide certain synergies for both companies.
 
  F-18
  A summary of the identifiable intangible assets acquired
        is as
        follows:
 **Fair
                  Value**
              
              **Amortization
                  Period**Developed
                  technologies
              $5,320,000
              
              7
                  yearsIn-process
                  research and development
              3,760,000
              
              N/ACustomer
                  Relationships
              3,149,000
              
              10
                  yearsNon-compete
                  contracts and other
              336,000
              
              5-10
                  yearsGoodwill
              3,846,405
              
              indefinite
 
 The
        in
        process research and development (“IPR&D”) primarily relates to the
        development of additional 3D imaging equipment.  As of June 30, 2007,
        this equipment was not completely developed, nor certified for use, and was
        therefore classified as IPR&D by the independent evaluation
        firm.  No alternative future use was identified for these assets, and
        therefore the entire value was charged to the income statement, included
        in the
        write-off of in process research and development line item in Fiscal Year
        2007.
 
 The
        useful
        lives of the technology assets was determined based on the expected use of
        the
        technology, any legal or contractual provisions that might limit the useful
        lives of the technology, and the effects of know advances, obsolescence,
        demand
        and competition required to maintain the future cash flows of the intangible
        assets.  Based on these factors, developed technologies were assigned
        useful lives of 7 years.  The useful life of customer relationships
        was based on the length of existing contractual dealer and customer
        relationships as well as the estimated average period of 10 years after which
        the customer or dealer would need to be retrained, similar to a new customer
        or
        dealer.  The useful life of the non-compete contracts was based on
        contractual provisions of the acquisition agreement.  The goodwill of
        $3,846,405 is expected to be deducted for tax purposes over fifteen
        years.
 
 The
        following is a summary of the amortization of the intangible assets subject
        to
        amortization:
 
 **June
                  30, 2007**
              
              **Gross
                  carrying amount**
              
              
              **Accumulated
                  amortization**
              
              
              **Net**Developed
                  technologies
              
              $
              5,320,000
              
              
              $
              149,918
              
              
              $
              5,170,082Customer
                  relationships
              
              
              3,149,000
              
              
              
              62,117
              
              
              
              3,086,883Non-compete
                  contracts and other
              
              
              336,000
              
              
              
              13,019
              
              
              
              322,981Total
              
              $
              8,805,000
              
              
              $
              225,054
              
              
              $
              8,579,946
 
 Amortization
        expense related to intangible assets subject to amortization was $225,054
        for
        2007.
 
 Amortization
        expense related to intangible assets subject to amortization for the next
        five
        years is as follows:
 
 Year
                  ending June 30,2008
              $1,140,9002009
              1,140,9002010
              1,140,9002011
              1,140,9002012
              1,140,900
 
 The
        following summary, pro forma unaudited data of the Company reflects the
        acquisition of QR as if the acquisition has occurred on July 1, 2005 and
        July 1,
        2006.  The write-off of the in process research and development of
        $3,760,000 has only been reflected in the results for Fiscal Year 2007 and
        have
        not been reflected in the results for Fiscal Year 2006.
 
 **Fiscal
                  Year Ended June 30,****2007**
              
              
              **2006**(Dollars
                  in thousands, except for per share amounts)Net
                  sales
              
              $
              33,806
              
              
              $
              32,832Net
                  income/(loss)
              
              
              (4,038
              )
              
              
              1,218Basic
                  net income/(loss) per share
              
              $
              (.23
              )
              
              $
              .08Diluted
                  net income/(loss) per share
              
              $
              (.23
              )
              
              $
              .08Such
                  pro forma data is not necessarily indicative of future results
                  of
                  operations.
  
 F-19
  **12.**
              **QUARTERLY  FINANCIAL
                  DATA (UNAUDITED):**
  Summarized,
        unaudited quarterly financial data for fiscal 2007 and 2006 are as
        follows:
  
  June
                  30, 20071st
              2nd
              3rd
              4th
              TotalQuarter
              Quarter
              Quarter
              Quarter
              YearNet
                  Sales
              $
                  5,492,128
              $7,884,637
              $7,126,326
              $8,216,602
              $28,719,693Gross
                  profit
              1,710,203
              3,182,250
              2,446,206
              3,546,816
              10,885,475Net
                  Income (loss) (A)
              (567,860)
              605,648
              (378,929)
              (4,331,683)
              (4,672,824)Net
                  income (loss) per common shareBasic
              ($.05)
              $.05
              ($.03)
              ($.25)Diluted
              ($.05)
              $.05
              ($.03)
              ($.25)June
                  30, 20061st
              2nd
              3rd
              4th
              TotalQuarter
              Quarter
              Quarter
              Quarter
              YearNet
                  Sales
              $  5,130,114
              $  6,359,879
              $  7,173,942
              $  6,334,337
              $  24,998,272Gross
                  profit
              1,847,518
              2,552,390
              2,692,506
              2,235,430
              9,327,844Net
                  Income (loss)
              (109,896)
              310,256
              490,621
              314,367
              1,005,348Net
                  income (loss) per common shareBasic
              $(.01)
              $.03
              $.05
              $.03Diluted
              $(.01)
              $.03
              $.05
              $.03
 
 
 (A)
        Included in the fourth quarter of Fiscal Year 2007, is a charge for $3,760,000
        to write-off the in process research and development associated with the
        acquisition of QR in April 2007,
 
 
 F-20
   **SCHEDULE
          OF VALUATION AND QUALIFYING ACCOUNTS**
  **Years
                  ended June 30, 2007, 2006 and 2005****Balance
                    at**
                
                
                **Charged
                    to**
                
                
                
                
                
                **Balance
                    at****Beginning**
                
                
                **Costs
                    and**
                
                
                
                
                
                **End
                    of****Description**
                
                **of
                    Year**
                
                
                **Expenses**
                
                
                **Deductions
                    (A)**
                
                
                **Year**June
                    30, 2007Allowance
                    for doubtful accounts and salesreturns
                
                $
                90,000
                
                
                $
                40,000
                
                
                $
                --
                
                
                $
                130,000June
                    30, 2006Allowance
                    for doubtful accounts and salesreturns
                
                
                90,000
                
                
                
                20,245
                
                
                
                (20,245
                )
                
                
                90,000June
                    30, 2005Allowance
                    for doubtful accounts and salesreturns
                
                
                95,000
                
                
                
                38,454
                
                
                
                (43,454
                )
                
                
                90,000
   (A)
              Deductions
                  consist of write-offs of uncollectible
                  accounts.
 
 F-21




**Item
        9.  Changes in and Disagreements with Accountants and Financial
        Disclosure**
 
 None
 
 **Item
        9A.  Controls and Procedures**
 
 An
        evaluation was performed as of June 30, 2007, under the supervision and with
        the
        participation of the Company’s management, including its co-chief executive
        officers and chief financial officer, of the effectiveness of the design
        and
        operation of the Company’s disclosure controls and procedures.  Based
        on such evaluation, the Company’s management has concluded that the Company’s
        disclosure controls and procedures were effective as of June 30,
        2007.  There have been no significant changes in our internal controls
        or in other factors that could significantly affect our internal control
        subsequent to June 30, 2007.
 
 **Item
        9B.  Other Information**
 
 Not
        applicable.
 
 
 **Part
        III**
 
 The
        information required in items 10, 11, 12, 13, and 14 is hereby incorporated
        by
        reference from the Company’s definitive Proxy Statement for the 2007 Annual
        Meeting of Shareholders.
 
 31
  **Part
          IV**
 
 **Item
          15.  Exhibits and Financial Statement
          Schedules**
  (a)
                        Financial Statements.The
                        financial statements and schedules listed in Item 8 are filed
                        as a part of
                        this Annual Report on Form 10K.(b)
                        Exhibits.The
                        following exhibits are filed pursuant to Item 601 of Regulation
                        S-K.  The numbers set forth below opposite the description of
                        each exhibit correspond to the Exhibit Table of Item 601
                        of Regulation
                        S-K.2.
                    (a)
                        -- Stock Purchase Agreement between ACG Nystromgruppen AB
                        and AFP Imaging
                        Corporation, dated April 17, 1997. (4)(b)
                        -- Asset Purchase Agreement between AFP Imaging and ProDen
                        Systems, Inc.,
                        dated December 24, 1997. (5).(c)
                        --Promissory Note between ProDen Systems, Inc. and AFP Imaging
                        Corporation, dated August 10, 1999. (6)(d)
                        -- Amended Promissory Note between ACG Nystromgruppen AB
                        and AFP Imaging
                        Corporation, dated August 11, 1999. (6)3.
                    (a)  --Restated
                        Certificate of Incorporation of Registrant.  (13)(b)
                        -- Revised By-Laws of Registrant, issued December
                        2004.  (12)4.
                    (a)
                        -- Specimen of Common Stock
                        Certificates.  (1)(b)
                        -- Common Stock Purchase Warrant issued to Keltic Financial
                        Partners LP.
                        (7)(c)
                        -- Common Stock Purchase Warrant issued to designees of an
                        investment
                        banking firm in March 2006.     (16),
                        (18)(d)
                        – Form of Subscription Agreement utilized in a private placement
                        of common
                        stock, effective May 2006. (17), (18)(e)
                        – Form of a Subscription Agreement utilized in a private placement
                        of
                        common stock, effective April 12, 2007. (19)(f)
                        – Common Stock Purchase Warrant issued to ComVest Capital LLC,
                        dated April
                        13, 2007. (19)(g)
                        --Common Stock Purchase Warrant issued to ComVest Capital
                        LLC, dated April
                        13, 2007. (19)(h)
                        --Common Stock Purchase Warrant issued to ComVest Capital
                        LLC, dated April
                        13, 2007. (19)10.
                    (a)
                        -- Health and Medical Reimbursement
                        Plan.  (1)(b)
                        -- Lease Agreement dated September 1, 1985, for premises
                        at 250 Clearbrook
                        Road, Elmsford, NY.  (3)(c)
                        -- Profit Sharing Plan of the Registrant, as
                        supplemented.  (1)(d)
                        -- Registrants’ 1999 Incentive Stock Option Plan. (6),
                        (14)(e)
                        --   Registrant’s 2004 Equity Incentive
                        Plan.  (11), (15)(f)
                        --Keltic Financial Partners LP Loan and Security Agreement.
                        (7)(g)
                        -- Keltic Financial Partners LP Revolving Note. (7)(h)
                        -- Keltic Financial Partners LP Fifth Amendment to Loan and
                        Security
                        Agreement.    (10)(i)
                        --  Keltic Financial Partners LP Restated Revolving Note
                        .  (10)(j)
                        --  Contract for Sale of Business Assets between AFP Imaging
                        and
                        Amergraph Corporation, dated July 30, 2001. (7)(k)
                        -- Revolving Credit and Term Loan Agreement by and between
                        ComVest
                        Capital, LLC and AFP Imaging Corporation, dated April 13,
                        2007.  (19)(l)
                        - Guaranty Agreement made by Dent-X International Inc., QR
                        Imaging USA
                        Inc. and Visiplex Instruments Corporation in favor of ComVest
                        Capital,
                        LLC, dated April 13, 2007.  (19)(m)
                        - Collateral Agreement by and among AFP Imaging Corporation,
                        Dent-X
                        International Inc., QR Imaging USA, Inc., Visiplex Instruments
                        Corporation
                        and ComVest Capital, LLC, dated April 13,
                        2007.  (19)(n)
                        -- Registration Rights Agreement by AFP Imaging Corporation,
                        made as of
                        April 13, 2007.  (19)(o)
                        -- Convertible Term Note issued by AFP Imaging Corporation
                        to ComVest
                        Capital, LLC, dated April 13, 2007.  (19)(p)
                        -- Revolving Credit Note issued by AFP Imaging Corporation
                        to ComVest
                        Capital, LLC, dated April 13, 2007.  (19)(q)
                        -- Notice of Patent Security Agreement, dated April 13,
                        2007.  (19)(r)
                        -- Notice of Trademark Security Agreement, dated April 13,
                        2007.  (19)(s)
                        - Cooperation Agreement between QR S.r.l. and Gianmaria Tommasi,
                        effective
                        April 19, 2007.  (19)(t)
                        -- Contract among QR S.r.l., Attilio Tacconi and Mozzo Pierluigi,
                        effective April 19, 2007.  (19)(u)
                        - Contract between QR S.r.l. and Mara Tacconi, effective
                        April 19,
                        2007.  (19)
   32
  (v)
                        - Preliminary Contract for Share transfer by and between
                        QR Imaging
                        S.r.l., NIM S.R.L., Gianmaria Tommasi, Mara Tacconi, Attilio
                        Tacconi and
                        Mozzo Pierluigi, dated February 22,
                        2007.  (19)11.--
                        Statement re computation per share earnings.  (2)14.
                        – Code of Ethics.  (9)21.--
                        Subsidiaries of the Registrant.23.1
                        -- Consent of Goldstein Golub Kessler LLP31.1,
                        31.2, 31.3  - Certifications pursuant to Exchange Act Rule
                        13a-14 (a).32.1,
                        32.2, 32.3  - Certifications pursuant to Section 1350 of the
                        Sarbanes – Oxley Act of 2002.
 33
  (1)
                  Incorporated
                      by reference from the exhibits filed with Registration Statement
                      file
                      #2-G8980 of the Company, as amended, on file with the Securities
                      and
                      Exchange Commission.(2)
                  See
                      Note 1 to “Notes to Financial Statements”.(3)
                  Incorporated
                      by reference from the Exhibits filed with Registrant’s Current Report on
                      Form 8-K, dated July 31, 1995.(4)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Current Report
                      on Form 8-K, dated May 1, 1997.(5)
                  Incorporated
                      by reference from the Exhibits filed with Registrant’s Current Report on
                      Form 8-K, dated January 8, 1998.(6)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Annual Report
                      on Form 10-K for the fiscal year ended June 30, 1999.(7)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Annual Report
                      on Form 10-K for the fiscal year ended June 30, 2001.(8)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Current Report
                      on Form 8-K, dated   October 3, 2003.(9)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Quarterly
                      Report on Form 10-Q for the six months ended December 31,
                      2003(10)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Annual Report
                      on Form 10-K for the fiscal year ended June 30, 2004.(11)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Current Report
                      on Form 8-K, dated October 8, 2004.(12)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Current Report
                      on Form 8-K, dated December 10, 2004.(13)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Quarterly
                      Report on Form 10-Q for the six months ended December 31,
                      2004.(14)
                  Incorporated
                      by reference from the Form S-8, Registration Statement Under
                      the
                      Securities Act of 1933, filed October 12, 2005.(15)
                  Incorporated
                      by reference from the Form S-8, Registration Statement Under
                      the
                      Securities Act of 1933, filed November 17, 2005.(16)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Quarterly
                      Report on Form 10-Q for the nine months ended March 31,
                      2006.(17)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Current Report
                      on Form 8-K, dated May 2, 2006(18)
                  Incorporated
                      by reference from the Form S-1, Registration Statement Under
                      the
                      Securities Act of 1933, filed June 26, 2006.(19)
                  Incorporated
                      by reference from the Exhibits filed with the Registrant’s Quarterly
                      Report on Form 10-Q for the nine months ended March 31,
                      2007.
   34
 **SIGNATURES**
 
 
 Pursuant
          to the requirements of Section 13 or 15 (d) of the Securities Exchange
          Act of
          1934, the registrant has duly caused this report to be signed on its behalf
          by
          the undersigned, thereunto duly authorized.
 
 AFP
          IMAGING CORPORATION
 
 
 By:  __________/s/_________________
 Elise
          Nissen, Chief Financial
          Officer
 Date:  October
          12, 2007
 
 Pursuant
          to the requirements of the Securities Exchange Act of 1934, this report
          has been
          signed below by the following persons on behalf of the registrant and in
          the
          capacities and on the dates indicated.
 
 
 By:  _____________/s/___________
 Donald
          Rabinovitch,
          President
 &
          Director
 (Principal
          Executive
          Officer)
 Date:  October
          12, 2007
 
 
 By:  ____________/s/_____________
 David
          Vozick, Chairman of the
          Board,
 Secretary
          and Treasurer
 Date:  October
          12, 2007
 
 
 By:  __________/s/_______________
 Robert
          Blatt, Director
 Date:  October
          12, 2007
 
 
 By:  _________
          /s/________________
 Jack
          Becker, Director
 Date:  October
          12, 2007
 
 
 By:  _________
          /s/________________
 Elise
          Nissen, Chief Financial
          Officer
 (Principal
          Financial and Accounting
          Officer)
 Date:  October
          12, 2007
    35