UNITED
STATES


SECURITIES
AND EXCHANGE
COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





(Mark
One)


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




For
the quarterly period ended September 30, 2008




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,
      New York
            
            10523(Address of Principal
      Executive Offices)
            
            (Zip
      Code)




914-592-6100(Registrant's
      Telephone Number, Including Area
Code)




Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90
days.                YesX    No____




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




Large accelerated
      filer_____
            Accelerated
      filer______
            
            Non-accelerated
      filer_____(Do not check if a smaller reporting company)Smaller reporting
      company __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
registrant had 17,928,800 shares of its common stock outstanding as of November
10, 2008.









AFP
Imaging Corporation
 
 Table of
Contents
 
 PagePart I.
              Financial InformationItem 1.
              Financial
      StatementsCondensed Consolidated Balance Sheets as of September 30,
      2008 (unaudited) and June 30, 2008
              4Condensed
      Consolidated Statements
      of Operations for the three months ended September 30, 2008 and
      2007(unaudited)
              5Condensed
      Consolidated Statements of Shareholders’
      Equity for the three months ended September 30, 2008 and 2007(unaudited)
              6Condensed
      Consolidated
      Statements
      of Cash Flows for the
      threemonths
      endedSeptember
      30, 2008and2007(unaudited)
              7Notes
      toConsolidated
      Interim Financial Statements
              8-14Item 2.
              Management’sDiscussion
      and Analysis of Financial Condition and Results of
      Operations
              15-21Item 3.
              Quantitative
      andQualitative
      Disclosures About Market Risk
              21Item 4T.
              Controlsand
      Procedures
              21-22Part II.
              Other InformationItem 1.
              Legal Proceedings
              23Item 6.
              Exhibits
              23Signatures
              24-30




2
 
  This
Quarterly Report on Form 10-Q contains certain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of
1995.  Forward-looking statements involve known and unknown risks and
uncertainties and other factors that could cause the actual results of AFP
Imaging Corporation (collectively with its subsidiaries, 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 “plan,” “may,” “will,” “could,” “would,”
“project,” “expect,” “believe,” “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 cure the default situation with its senior secured
      lender,


●
            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,


●
            risks
      associated with foreign sales,


●
            risks
      associated  with the loss of services of the key executive
      officers,


●
            the
      Company’s ability to attract 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
  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
      Quarterly Report on Form 10-Q, and the Company’s Annual Report on Form
      10-K for the year ended June 30, 2008, 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 Quarterly Report on Form 10-Q, the Company’s Annual Report on
Form 10-K for the year ended June 30, 2008, 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 Form 10-Q 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.





PART I


FINANCIAL
INFORMATION




The
consolidated financial statements included herein have been prepared by the
Company without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission.  While certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles in the United States have been
condensed or omitted pursuant to such rules and regulations, the Company
believes that the disclosures made herein are adequate to make the information
presented not misleading.  It is recommended that these consolidated
financial statements be read in conjunction with the Company’s consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the fiscal year ended June 30, 2008.





In the
opinion of the Company, all adjustments necessary to present fairly the
Company’s consolidated financial position as of September 30, 2008, and its
results of operations for the  three-month periods ended
September  30, 2008 and 2007, and its cash flows for the three-month
periods ended September 30, 2008 and 2007, consisting of normal recurring
adjustments, have been included.  The accompanying unaudited interim
consolidated financial statements include all adjustments (consisting only of
those of a normal recurring nature) necessary for a fair statement of the
results of the interim periods.






3




Item 1:  FINANCIAL STATEMENTS
  AFP
Imaging Corporation and Subsidiaries
 Condensed Consolidated
Balance Sheets – September 30, 2008 and June 30, 2008
  
 Assets
                
                September
      30,
                  2008
                
                June
      30,
                  2008
                
                
                Liabilities
      and Shareholders' Equity
                
                September
      30,
                  2008
                
                June
      30,
                  2008(Unaudited)
                
                
                
                
                
                
                (Unaudited)Current
      Assets:
                
                
                
                
                
                
                Current
      Liabilities:Cash
      and cash equivalents
                
                $
                469,495
                
                
                $
                819,444
                
                
                
                Current
      portion of long-term debt
                
                $
                9,678,116
                
                
                $
                8,578,056Accounts
      receivable, less allowance for doubtful accounts of $870,049 and $919,483,
      respectively
                
                
                2,812,008
                
                
                
                4,281,796
                
                
                
                Accounts
      payable
                
                
                3,676,746
                
                
                
                3,557,357Accrued
      expenses and other current liabilities
                
                
                2,579,715
                
                
                
                3,525,308Deferred
      revenue
                
                
                330,000
                
                
                
                822,000Total
      current liabilities
                
                
                16,264,577
                
                
                
                16,482,721Inventories
                
                
                6,964,684
                
                
                
                6,950,129Prepaid
      expenses and other current assets
                
                
                311,019
                
                
                
                557,947
                
                
                
                Deferred
      liabilities
                
                
                278,595
                
                
                
                718,358Deferred
      income taxes
                
                
                51,108
                
                
                
                76,921
                
                
                
                Long-term
      debt
                
                
                20,809
                
                
                
                22,957Total
      current assets
                
                
                10,608,314
                
                
                
                12,686,237
                
                
                
                Total
      liabilities
                
                
                16,563,981
                
                
                
                17,224,036Commitments
      and Contingencies (Note 9)Property
      and equipment
                
                
                
                
                
                
                Shareholders’
      Equity:At cost
                
                
                2,264,890
                
                
                
                2,252,099
                
                
                
                Preferred
      stock - $.01 par value; authorizedLess
      accumulated depreciation
                
                
                (1,835,315
                )
                
                
                (1,778,510
                )
                
                
                5,000,000 shares, none issued
                
                
                -
                
                
                
                -429,575
                
                
                
                473,589
                
                
                
                Common
      stock, $.01 par value; authorized30,000,000 shares, issued and outstanding17,928,800 shares at September 30, 2008,and June 30, 2008
                
                
                179,288
                
                
                
                179,288Deferred
      income taxes
                
                
                485,761
                
                
                
                466,022
                
                
                
                Common
      stock warrants
                
                
                91,131
                
                
                
                91,131Other
      assets
                
                
                161,425
                
                
                
                323,813
                
                
                
                Paid-in
      capital
                
                
                25,444,176
                
                
                
                25,444,176Goodwill
                
                
                3,981,878
                
                
                
                4,453,627
                
                
                
                Accumulated
      deficit
                
                
                (25,142,136
                )
                
                
                (21,809,709
                )Other
      intangibles, net
                
                
                2,568,612
                
                
                
                2,997,551
                
                
                
                Cumulative
      translation adjustment
                
                
                1,099,125
                
                
                
                271,917Total
      shareholders’ equity
                
                
                1,671,584
                
                
                
                4,176,803Total
      Liabilities and Shareholders’Total
      Assets
                
                $
                18,235,565
                
                
                $
                21,400,839
                
                
                
                Equity
                
                $
                18,235,565
                
                
                $
                21,400,839
 The
accompanying notes to condensed consolidated financial statements are an
integral part of these statements.




4




AFP Imaging Corporation and Subsidiaries
 Condensed Consolidated
Statements of Operations
 (Unaudited)
 
 
 Three
      Months Ended
                September
      30,2008
              
              
              2007Net
      sales
              
              $
              6,648,264
              
              
              $
              7,448,055Cost
      of sales
              
              
              3,846,432
              
              
              
              4,355,416Gross
      profit
              
              
              2,801,832
              
              
              
              3,092,639Selling,
      general and administrative expenses
              
              
              3,571,353
              
              
              
              3,111,501Amortization
      of intangibles
              
              
              118,854
              
              
              
              288,454Research
      and development expenses
              
              
              480,465
              
              
              
              433,9974,170,672
              
              
              
              3,833,952Operating
      loss
              
              
              (1,368,840
              )
              
              
              (741,313
              )Foreign
      currency (loss)/gain on intercompany note
              
              
              (1,362,375
              )
              
              
              577,123Interest
      expense, net
              
              
              1,057,637
              
              
              
              253,659Loss
      before provision for income taxes
              
              
              (3,788,852
              )
              
              
              (417,849
              )(Benefit)/provision
      for income taxes
              
              
              (456,425
              )
              
              
              295,662Net
      loss
              
              $
              (3,332,427
              )
              
              $
              (713,511
              )Net
      loss per common share:Basic
              
              $
              (.19
              )
              
              $
              (.04
              )Diluted
              
              $
              (.19
              )
              
              $
              (.04
              )Weighted
      average shares outstanding common stock:Basic
              
              
              17,928,800
              
              
              
              17,928,800Diluted
              
              
              17,928,800
              
              
              
              17,928,800
 
 
 
 The
accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
 
 5




AFP Imaging Corporation and Subsidiaries
                Condensed
      Consolidated Statements of Shareholders’ Equity
                For
      the Three Months Ended September 30, 2008 and 2007
                (Unaudited)Comprehensive
                Loss
              
              
              Common
      Stock
              
              
              Common
      Stock
                Warrants
              
              
              Paid-in-Capital
              
              
              Accumulated
                Deficit
              
              
              Foreign
                Currency
                Translation
                Adjustment
              
              
              TotalBalance
      June 30, 2007
              
              $
              --
              
              
              $
              179,288
              
              
              $
              91,131
              
              
              $
              25,404,045
              
              
              $
              (10,760,543
              )
              
              $
              (38,488
              )
              
              $
              14,875,433Foreign
      currency translation gain
              
              
              187,872
              
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              187,872
              
              
              
              187,872Net
      loss for three months ended September 30, 2007
              
              
              (713,511
              )
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              (713,511
              )
              
              
              --
              
              
              
              (713,511
              )Comprehensive
      loss
              
              
              (525,639
              )
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --Balance
      September 30, 2007
              
              $
              --
              
              
              $
              179,288
              
              
              $
              91,131
              
              
              $
              25,404,045
              
              
              $
              (11,474,054
              )
              
              $
              149,384
              
              
              $
              14,349,794Balance
      June 30, 2008
              
              $
              --
              
              
              $
              179,288
              
              
              $
              91,131
              
              
              $
              25,444,176
              
              
              $
              (21,809,709
              )
              
              $
              271,917
              
              
              $
              4,176,803Foreign
      currency translation gain
              
              
              827,208
              
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              827,208
              
              
              
              827,208Net
      loss for three months ended September 30, 2008
              
              
              (3,332,427
              )
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              (3,332,427
              )
              
              
              --
              
              
              
              (3,332,427
              )Comprehensive
      loss
              
              
              (2,505,219
              )
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --Balance
      September 30, 2008
              
              $
              --
              
              
              $
              179,288
              
              
              $
              91,131
              
              
              $
              25,444,176
              
              
              $
              (25,142,136
              )
              
              $
              1,099,125
              
              
              $
              1,671,584
 
 
 
 The
accompanying notes to condensed consolidated financial statements are an
integral part of these statements.




6




AFP Imaging Corporation and Subsidiaries
 Condensed Consolidated
Statements of Cash Flows
 (Unaudited)
  Three
      Months Ended
                September
      30,2008
              
              
              2007Cash
      flows from operating activities:Net
      loss
              
              $
              (3,332,427
              )
              
              $
              (713,511
              )Adjustments
      to reconcile net loss to net cash used by operating
      activities-Depreciation
      and amortization
              
              
              342,516
              
              
              
              372,133Amortization
      of discount on term loan
              
              
              861,626
              
              
              
              50,316Provision
      for bad debts on accounts receivable
              
              
              (5,000
              )
              
              
              ---Exchange
      rate effect on intercompany note
              
              
              1,362,375
              
              
              
              (554,120
              )Deferred
      income taxes
              
              
              (482,651
              )
              
              
              ---Change
      in assets and liabilities:Decrease
      in accounts receivable
              
              
              1,315,856
              
              
              
              876,387Increase
      in inventories
              
              
              (205,641
              )
              
              
              (615,505
              )Decrease/(increase)
      in prepaid expenses and other assets
              
              
              9,108
              
              
              
              (13,300
              )Increase
      in accounts payable
              
              
              326,675
              
              
              
              249,302(Decrease)
      in accrued expenses and other current liabilities
              
              
              (551,203
              )
              
              
              (325,169
              )(Decrease)
      in deferred liabilities
              
              
              (502,339
              )
              
              
              (11,833
              )Total
      adjustments
              
              
              2,471,322
              
              
              
              28,211Net
      cash used by operating activities
              
              
              (861,105
              )
              
              
              (685,300
              )Cash
      flows from investing activities:Purchases
      of property and equipment
              
              
              (19,402
              )
              
              
              (37,077
              )Net
      cash used in investing activities
              
              
              (19,402
              )
              
              
              (37,077
              )Cash
      flows from financing activities:Borrowing
      of debt
              
              
              626,748
              
              
              
              355,345Repayment
      of debt
              
              
              (94,486
              )
              
              
              ---Net
      cash provided by financing activities
              
              
              532,262
              
              
              
              355,345Exchange
      rate effect on cash and cash equivalents
              
              
              (1,704
              )
              
              
              187,872Net
      decrease in cash and cash equivalents
              
              
              (349,949
              )
              
              
              (179,160
              )Cash
      and cash equivalents, at beginning of period
              
              
              819,444
              
              
              
              921,632Cash
      and cash equivalents, at end of period
              
              $
              469,495
              
              
              $
              742,472Supplemental
      cash flow disclosures:
                Cash
      paid during the periods for-Interest
              
              $
              185,567
              
              
              $
              247,038Income
      taxes, net of refunds
              
              $
              226,648
              
              
              $
              466,762
   The
accompanying notes to condensed consolidated financial statements are an
integral part of these statements.




7




AFP Imaging Corporation and Subsidiaries


Notes
to Consolidated Financial Statements


September 30,
2008


(Unaudited)





(1)
General:




AFP
Imaging Corporation (together with its subsidiaries, the “Company”) was
organized on September 20, 1978 under the laws of the State of New
York.  Since such date, 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.  Medical, dental, veterinary and industrial
professionals use these products.  The Company’s products are sold and
distributed to worldwide markets under various brand names and trademarks
through a network of independent and unaffiliated dealers and independent sales
representatives.   The Company has one business segment – medical
and dental x-ray imaging.





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 its product offerings in the transition from x-ray film to
      electronic imaging,


●
            enhancing
      both its domestic and international distribution channels,
    and


●
            expanding
      its worldwide market presence in the diagnostic dental and medical imaging
      fields.





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 its shareholders.  QR is a global supplier of
state-of-the-art, in-office three-dimensional dental and medical 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.




The
Company presently believes that its senior secured credit facility and foreign
lines of credit will not be sufficient to finance the Company’s ongoing
worldwide working capital requirements for the next twelve months.  As
previously disclosed, the Senior Secured Lender agreed to lend to 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 (“Revolver”).  The Company’s aggregate
outstanding advances under the Revolver exceed the maximum revolving credit
commitment permissible under the Loan Agreement as a direct result of additional
borrowings made by the Company under the Revolver to pay the term loan principal
and interest charges and revolver interest charges for August, September and
October 2008.  The Company is in default under the Revolving Credit and
Term Loan Agreement with respect to the Company’s obligation to repay the
outstanding advances in excess of the permissible maximum.  The Senior
Secured Lender has not accelerated the Revolver.Additionally,
the Company’s foreign subsidiary, QR, has failed to make payment with respect to
certain invoices payable to one of its financial institutions pursuant to a line
of credit agreement.  The lender has notified QR that such invoices are
past due, but has taken no further action at the present time in respect
thereof.All of
the Company’s debt, except for the capitalized lease, has been classified as a
current liability in the accompanying consolidated financial
statements.




The
Company has instituted cost cutting measures to reduce its cash
requirements.  The Company is also currently in the process of seeking out
additional financing alternatives, including potential private equity sales of
its securities, or seeking out a domestic or foreign strategic and/or financial
partner to negotiate a transaction to best serve their long-term goals and
needs.  There can be no assurance that the Company will be able to
obtain any such financing upon favorable terms to the Company, or at all. 
In the event that the Company is unable to secure sufficient financing to
maintain its operations, its business and financial condition would be
materially adversely affected.  These factors raise substantial doubt about
the Company’s ability to continue as a going concern.  The consolidated
financial statements do not include any adjustments regarding this
uncertainty.





The
consolidated financial statements include AFP Imaging Corporation and its
wholly-owned subsidiaries.  All significant intercompany transactions
have been eliminated in consolidation.





The
accounting policies followed during the interim periods reported on herein are
in conformity with accounting principles generally accepted in the United States
and are consistent with those applied for annual periods, as described in the
Company's consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended June 30, 2008.  The Condensed
Consolidated Balance Sheet at June 30, 2008 has been derived from the audited
financial statements.




8





Certain
prior-period amounts have been reclassified to conform to the current-period
presentation.





(2)
Stock Option
Plans:





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
123R”), using the modified prospective method without restatement of the interim
periods prior to the adoption date, as described in SFAS 123R.  As a
result, the Company began 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 three months ended September 30, 2008 and
September 30, 2007, no incentive stock options were granted, and therefore,
there was no non-cash stock based compensation expense related to stock option
awards.





When
granting incentive stock options, the fair value of each option granted under
the Company’s incentive stock plans is 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
period’s 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.





In April
2007, the Company granted an aggregate of 50,000 shares of Company common stock
to an employee, half of which vested immediately and the remainder of which
vested in April 2008.  These options were issued with a ten-year
useful life.





(3)Per Share Data and
Significant Capital Transactions:





The
Company’s basic net loss per share amounts are calculated by dividing net loss
by the weighted average number of common shares outstanding during the
period.  Diluted net loss per share is based upon the weighted average
number of common shares and common share equivalents outstanding, when
dilutive.  Common stock equivalents include (1) outstanding stock
options and (2) outstanding warrants.





The
following is a reconciliation from basic to diluted shares for the three months
ended September 30, 2008 and 2007:





Three
      months ended September 30,2008
            
            
            2007Basic
      Shares
            
            
            17,928,800
            
            
            
            17,928,800Dilutive:Options
            
            
            ---
            
            
            
            ---Warrants
            
            
            ---
            
            
            
            ---Diluted
      Shares
            
            
            17,928,800
            
            
            
            17,928,800





The
diluted weighted average number of shares outstanding for the three months ended
September 30, 2008 and 2007 does not include the potential exercise of the
following stock options and warrants as such amounts were
anti-dilutive.





Three
      months ended September 30,2008
            
            
            2007Options
            
            
            862,400
            
            
            
            868,900Warrants
            
            
            850,000
            
            
            
            850,000Diluted
      Shares
            
            
            1,712,400
            
            
            
            1,718,900




9





(4)
Long and Short Term
Debt:





On April
13, 2007, the Company entered into a new senior secured facility (“Revolving
Credit and Term Loan”) with a new lender (“Senior Secured Lender”) 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 (10%) 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, 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 to the lender.  The convertible term note, in
addition to being convertible by the Company upon the satisfaction of certain
conditions, 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 the Senior Secured Lender as collateral
security for repayment of the loans.  The Revolving Credit and Term
Loan is secured by all of the Company’s and its wholly-owned subsidiaries’
inventory, accounts receivable, equipment, officer life insurance policies and
proceeds thereof, trademarks, licenses, patents and general
intangibles.





The
Company’s aggregate outstanding advances under the Revolver exceed the maximum
revolving credit commitment permissible under the Loan Agreement as a direct
result of additional borrowings made by the Company under the Revolver to pay
the term loan principal and interest charges and revolver interest charges for
August, September and October 2008.  The Company is in default under
the Revolving Credit and Term Loan Agreement with respect to the Company’s
obligation to repay the outstanding advances in excess of the permissible
maximum borrowings. The Senior Secured Lender has not accelerated the
Revolver.  As described in Note 1, factors exist that result in doubt
as to the Company’s ability to continue as a going concern.  The Company’s
Revolving Credit and Term Loan Agreement contains a subjective acceleration
clause and accordingly, all such debt has been classified as a current liability
as of September 30, 2008 and June 30, 2008 in accordance with FASB Technical
Bulletin No. 79-3 “Subjective Acceleration Clauses in Long-Term Debt
Agreements”.  As of September 30, 2008, the Company wrote-off the balance
of the deferred financing costs related to this debt, approximately $152,250,
which has been recorded as selling, general and administrative costs in the
accompanying consolidated statements of operations, as the Company has not been
able to successfully negotiate a waiver, a forbearance agreement or renegotiate
this debt.  The Company was in compliance with all other terms and
conditions of the Revolving Credit and Term Loan Agreements as of June 30,
2008.





As part of
the original transaction, the Company granted to the Senior Secured Lender 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 classified the
warrants as equity, using the Black-Scholes Method to value these detachable
warrants.  They have been recorded in the accompanying Consolidated
Balance Sheets at $1,114,784.





The fair
value of the warrants issued to the Senior Secured Lender is being treated as
debt discount, and was originally accreted as interest expense utilizing the
interest method over the 60-month term of the Term Loan.  As the
Company has reclassified this debt as a current liability and has not been able
to successfully negotiate a waiver, a forbearance agreement or renegotiate this
debt, the balance of the debt discount, approximately $808,701, has been
completely accreted as interest expense in the accompanying consolidated
statements of operations.  The original assumptions used for the
Black-Scholes option pricing model were as follows:  a risk-free
interest rate of 4.66%, an expected volatility of 123%, an expected life of five
years, and no expected dividends.  A summary of the balances of the
Term Loan are as follows:





September 30,
      2008
            
            
            June 30,
      2008Term
      Loan
            
            $
            5,000,000
            
            
            $
            5,000,000Fair
      value of warrants (recorded as capital in excess of par)
            
            
            (1,114,784
            )
            
            
            (1,114,784
            )Principal
      payments
            
            
            (833,334
            )
            
            
            (740,741
            )Accretion
      of debt discount (recorded as interest expense)
            
            
            1,114,784
            
            
            
            253,158Recorded
      value of Term Loan
            
            $
            4,166,666
            
            
            $
            3,397,633




10




QR has the
ability to borrow up to 2,000,000 Euros under various lines of credit with two
different financial institutions, and all such borrowings are classified as
short term debt.  Most of these lines are guaranteed by its accounts
receivables and inventory.  These lines of credit were granted in
August 2007 and increased from 1,750,000 Euros to 2,000,000 Euros in April
2008.  There were 1,868,948 Euros outstanding as of September 30, 2008
and 1,652,712 Euros outstanding as of June 30, 2008.  The funds
borrowed in Italy are guaranteed by specific outstanding accounts receivable and
inventory, and the current rate of borrowing is a function of Euribor plus .75%
to 1.5%.  QR has failed to make payment with respect to certain
invoices payable to one of its financial institutions pursuant to one of its
line of credit agreements.  The lender has notified QR that such
invoices are past due, but has taken no further action at the present time in
respect thereof.





As of
September 30, 2008 and June 30, 2008, debt consisted of the
following:




September
      30, 2008
            
            
            June
      30, 2008Senior
      Secured Lender Term Loan, net of debt discount, where
      applicable
            
            $
            4,166,666
            
            
            $
            3,397,633$3.0
      Million Revolving Senior Credit Facility
            
            
            2,871,957
            
            
            
            2,569,952Capitalized
      lease
            
            
            29,010
            
            
            
            30,903Foreign
      line of credit borrowings
            
            
            2,631,292
            
            
            
            2,602,5259,698,925
            
            
            
            8,601,013Less
      current portion
            
            
            9,678,116
            
            
            
            8,578,056Total
      long-term debt
            
            $
            20,809
            
            
            $
            22,957





At
September 30, 2008, the Company had no unused lines of credit
available.





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)
Inventories:





Inventories,
which include material, labor and manufacturing overhead, are stated at the
lower of cost (first-in, first-out) or market (net realizable
value).  Inventory reserves are provided for risks relating to slow
moving items.  Demonstration equipment which is on consignment with
customers is valued at cost, reduced for reductions in value due to technical
obsolescence and/or wear and tear over periods up to five years.  At
September 30, 2008 and June 30, 2008, inventories, consisted of the
following:





September 30,
      2008
            
            
            June 30,
    2008Raw
      materials and sub-component parts
            
            $
            4,694,685
            
            
            $
            3,675,763Work-in-process
      and finished goods
            
            
            2,269,999
            
            
            
            3,274,366$
            6,964,684
            
            
            $
            6,950,129





(6)
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 September 30, 2008, the Company has recorded net
deferred tax assets of approximately $329,000 and as of June 30, 2008, net
deferred tax liabilities of approximately $155,000, all of which relates to its
foreign operations.  The September 30, 2008 net deferred tax assets
are comprised of approximately $537,000 of deferred tax assets and $208,000 of
deferred tax liabilities.  The June 30, 2008 net deferred tax
liabilities are comprised of approximately $698,000 of deferred tax liabilities
and $543,000 of deferred tax assets.  The deferred tax liabilities are
related to the previously recorded net unrealized exchange gain on the
intercompany note denominated in  U.S. dollars, as it will only be
taxed when realized and when repayment is made; and the deferred tax assets are
mainly related to the temporary differences on the intangible assets
amortization.





The
net tax benefit recorded for the period ended September 30, 2008 and net tax
expense for the period ended September 30, 2007 include foreign taxes at the
statutory rates on the Company’s foreign operations, changes to the deferred tax
accounts, and state income and capital taxes generated in the United
States.  As of September 30, 2008, the Company had approximately $12.0
million in federal net operating loss carry forwards, and approximately $16.4
million in state net operating loss carry forwards.  These NOL’s will
begin to expire in 2010 and are subject to review by the Internal Revenue
Service.  Past and future changes in ownership of the Company as
defined in Section 382 of the Internal Revenue Code, may limit the amount of
NOL’s available for use in any one year.




11





Effective
July 1, 2007, the Company adopted the provisions of the Financial Accounting
Standards Board (“FASB”) Interpretation No. 48 (“FIN 48”), Accounting for Uncertainties in
Income Taxes – an interpretation of FASB Statement No. 109.In
accordance with FIN 48, the Company classifies interest as a component of income
tax expense.  The implementation of FIN 48 had no impact on the
Company’s financial statements, and no interest and penalties related to
uncertain tax positions were accrued at September 30, 2008 and June 30,
2008.





(7)
Intangible Assets and
Goodwill:





On April
19, 2007 the Company acquired QR, an Italian corporation located in Verona,
Italy.  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 goodwill and intangible amounts are maintained in
Euros on the subsidiary’s books and converted into US dollars at the respective
exchange rate.





The
Company performed the required annual impairment tests as of June 30, 2008, in
accordance with FASB Statements No. 142, Goodwill and Other Intangibles,and No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. The Company
expressly tested the developed technologies and customer relationships for
impairment and determined that there had been impairment of $5,615,880 in their
respective values.  The impairment was calculated by a comparison of
the fair values of the assets, using discounted cash flows.  The
impairment charge was booked in the fourth quarter of Fiscal Year
2008.





The
Company tested goodwill for impairment by a comparison of the fair value of the
reporting unit to its respective carrying value and determined that there was no
impairment to the carrying value as of June 30, 2008.





The
following is a summary of the intangible assets subject to
amortization:





June
      30, 2008
            
            Gross
              carrying
              amount
            
            
            Impairment
            
            
            Adjusted
              carrying
      amount
            
            
            Accumulated
              amortization
            
            
            NetDeveloped
      technologies
            
            $
            6,159,856
            
            
            $
            4,006,292
            
            
            $
            2,153,564
            
            
            $
            1,053,564
            
            
            $
            1,100,000Customer
      relationships
            
            
            3,646,125
            
            
            
            1,609,588
            
            
            
            2,036,537
            
            
            
            436,537
            
            
            
            1,600,000Non-compete
      contracts and other
            
            
            389,044
            
            
            
            ---
            
            
            
            389,044
            
            
            
            91,493
            
            
            
            297,551Total
            
            $
            10,195,025
            
            
            $
            5,615,880
            
            
            $
            4,579,145
            
            
            $
            1,581,594
            
            
            $
            2,997,551





September
      30, 2008
            
            Gross
      carrying
              amount
            
            
            Accumulated
      amortization
            
            
            NetDeveloped
      technologies
            
            $
            1,925,448
            
            
            $
            984,317
            
            
            $
            941,131Customer
      relationships
            
            
            1,820,816
            
            
            
            441,976
            
            
            
            1,378,840Non-compete
      contracts and other
            
            
            347,835
            
            
            
            99,194
            
            
            
            248,641Total
            
            $
            4,094,099
            
            
            $
            1,525,487
            
            
            $
            2,568,612





Amortization
for the three months ended September 30, 2008 and 2007 were $118,854 and
$288,454, respectively.





The change
in the value of the other intangibles from the date of acquisition to September
30, 2008, and the change in accumulated amortization include changes in the US
Dollar/Euro exchange rates, which fluctuated during the periods.  For
the three months ended September 30, 2008 the impact was approximately $310,085
on the long-lived intangibles subject to amortization.





The
changes in the carrying amount of goodwill are as follows:





For
      the period ended
            
            Fiscal
      Year 2008
            
            
            Three
      Months September 30, 2008Balance
      as of July 1,
            
            $
            3,846,405
            
            
            $
            4,453,627Foreign
      currency translation difference
            
            
            607,222
            
            
            
            (471,749
            )Balance
      as of September 30, 2008
            
            
            ---
            
            
            $
            3,981,878Balance
      as of June 30, 2008
            
            $
            4,453,627
            
            
            
            ---




12




(8)
Segment
Information:





As of September 30, 2008 and 2007, and
June 30, 2008, the Company had one business segment, medical and dental x-ray
imaging.  The medical and 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
x-ray imaging systems and all related accessories.  The amortization
and impairment of the intangibles associated with the acquisition of QR has been
attributed to the Italian operations.  Geographical financial
information is as follows:








Three
      months ended September 30,2008
            
            
            2007Net
      sales:United
      States
            
            $
            3,665,634
            
            
            $
            3,674,784Europe
            
            
            1,918,879
            
            
            
            1,821,114Other
            
            
            1,063,751
            
            
            
            1,952,157$
            6,648,264
            
            
            $
            7,448,055Net
      (loss)/incomeUnited
      States
            
            $
            (2,302,877
            )
            
            $
            (1,311,202
            )Europe
            
            
            (1,029,550
            )
            
            
            597,691$
            (3,332,427
            )
            
            $
            (713,511
            )September
      30, 2008
            
            
            June
      30, 2008Identifiable
      assets:United
      States
            
            $
            6,549,027
            
            
            $
            8,282,539Europe
            
            
            11,686,538
            
            
            
            13,118,300Total
            
            $
            18,235,565
            
            
            $
            21,400,839





(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 for the District of New Jersey, Newark Vicinage, 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 joined, along with other
involved defendants in an alternative dispute resolution (ADR) process for
smaller claims.  On May 7, 2008, a tentative mediated settlement was
reached by all parties, and the Consent Decree memorializing the settlement is
being negotiated by the governments and each group’s liaison counsel and is
presently scheduled to be finalized by December 2008.  The Company’s
share is $82,880 of which the Company’s insurance carrier has agreed to pay 50%
of the settlement offer.  In October 2008, the Company and its
insurance carrier each contributed $41,440 to the escrow account to settle this
outstanding environment claim.  The Company cannot, at this time,
assess the amount of liability that could result if this settlement is not
finalized.  The Company's insurance carrier has agreed to equally
share with the Company the defense costs incurred in this environmental
claim.





On May 5,
2008, the Company and Dent-X International, Inc. commenced litigation in the
United States District Court, Southern District of New York, against Genexa
Medical, Inc. (“Genexa”) to recover $394,610 for goods sold and delivered to
Genexa during the period from December 11, 2007 through March 13, 2008, after
Genexa failed and refused to pay the amount due.  On June 27, 2008,
Genexa filed an Answer and Counterclaims alleging several causes of action which
are potentially material.  Although the Company intends to vigorously
defend all such counterclaims, a determination as to the likelihood of Genexa
prevailing on the merits with respect to such counterclaims is premature as of
the date hereof.  The case was scheduled for an initial conference
before Judge Charles L. Brieant on July 25, 2008, but Judge Brieant passed away
and the case was reassigned.   In November 2008, both parties
were instructed by the court to attempt to negotiate through a court appointed
mediator.  The next court date has been set for January 9,
2009.   The Company intends to vigorously defend all
counterclaims, however the Company cannot, at this time, assess the amount of
liability that could result if there is an adverse decision.




13





The
Company is involved in two other product liability claims; 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 has received notification of a customer complaint filed in the Superior
Court of California, County of Placer, on December 19, 2007.  The
Complaint seeks damages in excess of $25,000.  The Company has not yet
been formally served with this Complaint.  The Company, through its
attorneys, has repeatedly agreed to a settlement, but to date, no settlement has
been reached.





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.





As part of
the acquisition of QR, 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 (April 2008), in which event, any employee so
terminated is entitled to one-half of the salary for the remaining
term.  Effective July 2008, two of these employment agreements were
modified so that the total yearly commitment is 420,000 Euros.





(10)
New Accounting
Standards:





Management
does not believe that there were any recently issued, but not yet effective,
accounting standards, if currently adopted, would have a material effect on the
accompanying consolidated financial statements.




14




Item 2.   Management's Discussion and Analysis of
Financial Condition and Results of Operations.





The
following should be read in conjunction with the Company’s Consolidated
Financial Statements and notes thereto included elsewhere in this Quarterly
Report on Form 10-Q.  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
U.S. dollars ($).





Capital Resources and
Liquidity





The
Company believes that its senior secured credit facility and foreign lines of
credit will not be sufficient to finance the Company’s ongoing worldwide working
capital requirements for the next twelve months.  As previously
disclosed, the Senior Secured Lender agreed to lend to 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 (“Revolver”).  The Company’s aggregate
outstanding advances under the Revolver exceed the maximum revolving credit
commitment permissible under the Loan Agreement as a direct result of additional
borrowings made by the Company under the Revolver to pay the term loan principal
and interest charges and revolver interest charges for August, September and
October 2008.  The Company is in default under the Revolving Credit and
Term Loan Agreement with respect to the Company’s obligation to repay the
outstanding advances in excess of the permissible maximum. The Senior
Secured Lender has not accelerated the Revolver.  Additionally,
the Company’s foreign subsidiary, QR, has failed to make payment with respect to
certain invoices payable to one of its financial institutions pursuant to a line
of credit agreement.  The lender has notified QR that such invoices are
past due, but has taken no further action at the present time in respect
thereof.All of the
Company’s debt, except for the capitalized lease, has been classified as a
current liability in the accompanying consolidated financial statements. 
The Company has instituted cost cutting measures to reduce its cash
requirements.





The
Company is also currently in the process of seeking out additional financing
alternatives, including potential private equity sales of its securities, or
seeking out a domestic or foreign strategic and/or financial partner to
negotiate a transaction to best serve the Company’s long-term goal and
needs.  There can be no assurance that the Company will be able to
obtain any such financing upon favorable terms to the Company, or at all. 
In the event that the Company is unable to secure sufficient financing to
maintain its operations, its business and financial condition would be
materially adversely affected.  These factors raise substantial doubt about
the Company’s ability to continue as a going concern.  The consolidated
financial statements do not include any adjustments regarding this
uncertainty.





The
Company’s working capital at September 30, 2008 decreased by approximately $1.86
million from June 30, 2008.  This decrease is principally due to a
decrease in accounts receivable due to lower sales in the current quarter. These
lower sales are attributable to the current worldwide economic liquidity crisis
which has, in turn, delayed the purchasing decisions for the Company’s high
technology products and reduced the ability for potential customers to obtain
financing for these products.  There was an increase in the current
portion of the outstanding debt due to the acceleration and write-off of the
balance of the imputed debt discount related to the warrants issued to the
Senior Secured Lender of approximately $808,701, as the Company has currently
not been able to successfully negotiate a waiver, a forbearance agreement or
renegotiate the debt.  The Company also utilized a significant portion
of its cash to satisfy previously contracted obligations.





Operating
cash flows were negatively impacted in the three months ended September 30, 2008
principally due to the loss from operations.  This loss is mainly
attributable to lower sales in this first quarter, increased worldwide
marketing, sales and administrative costs related to the support and
distribution of the Company’s high-tech products, the acceleration and write-off
the deferred financing costs and the write-off of the imputed debt discount on
the Term Note.  These factors caused the Company to utilize all of its
cash resources.  The Company requires advance deposits from its
customers on its high dollar valued equipment prior to shipment.  The
Company has neither changed its payment policies to its vendors nor revised its
payment terms with its customers; however, the Company has had to delay payments
to vendors based on available cash resources, as the Company does not have any
access to additional funds for working capital requirements.  The
Company does not have the capacity to borrow on either its senior secured debt
in the United States or its lines of credit in Europe.





Capital
expenditures for the first three months of Fiscal Year 2009 were $19,402,
consisting mainly of small tooling expenditures related to the redesign,
development and production of new imaging equipment, and some new computer
equipment.  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
Revolving Credit and Term Loan Agreement; however, the Company has significantly
reduced or delayed its capital purchases in the current period due to the
existing cash flow situation.




15





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.  The Company has registered these shares for
resale.  The common stock was issued and sold pursuant to the
exemption from registration pursuant to Regulation D of the Securities
Act.  In connection with the transaction, the Company paid the
placement agent a five percent fee.  The net proceeds were used to
fund a portion of the purchase price of QR, which was completed on April 19,
2007.





On April
13, 2007, the Company entered into a Revolving Credit and Term Loan Agreement
with the Senior Secured Lender, whereby the Senior Secured Lender 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
$92,593 with a final balloon payment of all remaining amounts due there under on
April 30, 2012. The Company has not made any of the required term loan principal
payments since July 2008 due to continuing cash flow problems.  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 at a rate per annum of
two percent (2%) plus the prime rate and are payable in full on April 30, 2012,
have a specific formula to calculate available funds based on eligible accounts
receivable and inventory, are subject to maximum “borrowing base” limitations,
and has certain reporting requirements.  This 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, and for ongoing working capital requirements.





Both loans
are subject to mandatory prepayment in full in the event of certain events
deemed to be a “sale,” including, but not limited to, a merger, sale of assets
or change in control.  The term loan is convertible by the Senior
Secured Lender at any time into shares of 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 the Senior Secured Lender as collateral
security for repayment of the loans.  Further, each subsidiary agreed
to guaranty performance of all of the Company’s obligations to the Senior
Secured Lender.





As part of
the transaction, the Company granted to the Senior Secured Lender an aggregate
of 800,000 warrants to purchase shares of 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 registered the shares of common stock issuable
upon the exercise of the warrants and conversion of the term note and must use
its best efforts to keep the registration statement effective during the
applicable registration period.





The
Company’s foreign subsidiary maintains various lines of credit with two separate
financial institutions.  In April 2008, these lines were increased
from 1,750,000 to 2,000,000 Euros.  The borrowings under most of these
lines of credit are guaranteed by specific foreign accounts receivable and
inventory.  These lines of credit were granted in August 2007 and
there are no restrictive covenants, subordination clauses or corporate
guarantees.  As of September 30, 2008, there was 1,868,948 Euros
outstanding in connection therewith.  The Company’s foreign subsidiary
has failed to make payment with respect to certain invoices payable to one of
these financial institutions pursuant to a line of credit
agreement.  The lender has notified QR that such invoices are past
due, but has taken no further action at the present time in respect
thereof.





The
Company is dependent upon its Revolving Credit and Term Loan Agreement with the
Senior Secured Lender, its foreign lines of credit, and continued minimum sales
levels to finance its ongoing operations.  As of September 30, 2008,
and the current date, the Company did not have any unused credit under the
Revolving Credit and Term Loan Agreement as described above.





The
Company is continuing to investigate various strategic alliances to increase its
market share.  Some of these strategies could involve the acquisition
or joint venturing of one or more businesses or product line
distributions.  There are no assurances that the Company will be able
to identify any suitable 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.




16





Results of
Operations





Fluctuations in Operating
Results





The
results of operations for the Company have changed significantly as a result of
the acquisition of QR.  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 affected by the amortization costs associated with
these other intangibles and any impairment charges.





The U.S.
dollar is the Company’s reporting currency; however, a significant portion of
the consolidated operating results are denominated in Euros.  Since
the acquisition in April 2007, the U.S. dollar/Euro exchange rate has fluctuated
significantly, thereby impacting the Company’s financial
results.  Between April 2007 and September 2008, the U.S. dollar/Euro
exchange rate ranged from as low as $1.35 to as high as $1.57.  In the
current quarter ended September 30, 2008, the U.S. dollar/Euro exchange rate
varied from $1.57 to $1.40, based on the current worldwide economic conditions
and marketplace uncertainty.  The Company does not usually use foreign
exchange contracts to manage foreign currency exposure.  As of
September 30, 2008, there were no outstanding foreign exchange
contracts.





Based on
the recent losses, the Company has instituted significant cost cutting measures
in the first quarter of Fiscal 2009, which should begin to take effect in the
second quarter Fiscal 2009.  These measures include reductions in
operating costs and worldwide marketing and distribution costs, including
payroll, employee benefits and operating overhead charges.





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 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 affect 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,


●
            Changes
      in federal and foreign tax laws,


●
            The
      timing of new product introductions by the Company as well as by its
      competitors,


●
            Worldwide
      economic events which have negatively impacted potential customers’
      purchasing decisions, and


●
            Worldwide
      economic events which have negatively impacted the ability of customers to
      obtain financing.





Three Months Fiscal 2009
Versus Three Months Fiscal 2008





Sales
decreased approximately $800,000 or 10.7% between the Fiscal 2008 and Fiscal
2009 three-month comparable periods.  The Company experienced lower
sales in the current quarter, which can be attributable to the current worldwide
economic liquidity crises which has negatively impacted the potential purchasing
decisions for the Company’s high technology products and reduced the ability for
customers to obtain financing for these products.  Many customers
continue to reconsider their purchases for the Company’s equipment, based on
their own economic circumstances and evolving worldwide market
conditions.  There was an increase of approximately $540,000 related
to sales of the three-dimensional dental x-ray imaging systems, most of which
related to the reclassification from deferred revenue to revenue, based on
completion of certain contractual obligations.  The Company’s
veterinary products business increased approximately $100,000 mainly due to
increased sales of general purpose digital x-ray systems designed for general
veterinary applications.  Demand for the Company’s two-dimensional
filmless digital dental radiography system for veterinary applications remained
strong in the current quarter.  The Company’s two-dimensional filmless
digital dental radiography system for human sales decreased approximately
$240,000 due to the loss of the Company’s Canadian distributor and lower sales
in the United States as dentists continue to delay their purchasing
decisions.  The Company’s other dental x-ray systems showed a decrease
of approximately $150,000 in the current three-month period as intra-oral x-rays
have become a commodity product.  The Company’s analog film processor
business including spare parts and chemistry showed a decrease of approximately
$1.06 million in the current three-month period, due to the continuing
transition from analog to digital imaging processing as U.S. healthcare
professionals continue to migrate to digital imaging equipment, which the
Company also supplies, and the postponement of a large international order until
the third quarter of the current year.  The Company has continued its
efforts to increase worldwide distribution and expand and develop new
international markets for its digital products.




17





Gross
profit as a percent of sales stayed relatively constant between the Fiscal 2008
and Fiscal 2009 three-month comparable periods.





Selling,
general, and administrative costs increased approximately $460,000 or 14.8%,
between the Fiscal 2008 and Fiscal 2009 three-month comparable
periods.  Approximately $380,000 of this increase is due to increased
operating costs in Italy, and the balance relates to operations in the United
States.  During the second half of Fiscal Year 2008, the Company
increased administrative and sales personnel in Italy to properly produce,
position, market and distribute the three-dimensional products worldwide, and a
senior executive relocated to Italy from the US.  The Company also
leased additional R & D space in Italy in January 2008, to allow for a
realignment of factory production and distribution demands.  The
Company sponsored “NewTom” day in July 2008, for its existing dealers and
potential new customers to promote awareness of the Company’s three-dimensional
imaging products and product improvements; this event is held every other
year.  The increase in the United States is due to the write-off of
approximately $152,250 related to the deferred financing costs which had been
capitalized in April 2007, as the Company has not currently been able to
successfully negotiate a waiver, a forbearance agreement or renegotiate its
senior secured debt.  There was a net decrease of approximately
$70,000 related to the Company’s administrative, marketing/sales and technical
support costs.  The Company reduced the number of exhibitions it
attended in the current three-month period and reduced its outside consultants
due to the current restraints on available funding.  The Company
continued to increase its technical support costs related to the new digital
equipment, as the installed base increased in the United States in the past
year.  The three-dimensional imaging systems require a devoted
infrastructure support system, including installation, training and related
costs to assist users.





Amortization
of intangibles decreased approximately $169,600 or 58.8% due to the impairment
charge of $5.6 million recorded in Fiscal Year 2008, which lowered the gross
value of the other intangibles being amortized.





Research
and development costs increased approximately $46,500, or 10.7%, between the
Fiscal 2008 and Fiscal 2009 three-month comparable periods.  The
Company’s research and development efforts and technologies were significantly
enhanced by the acquisition of QR.  All 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 may continue to
increase over the next several years as the Company evaluates its strategy to
develop and market additional high-tech digital products.





For the
three-month period ended September 30, 2008, the loss on foreign currency
transactions amounted to $1,362,375 due to the significant decrease in the value
of the Euro in relation to the U.S. dollar during this time period.  A
deferred tax asset has been recorded in Italy for this unrealized loss, in
accordance with local laws.  For the three-month period ended
September 30, 2007, the gain on foreign currency transactions amounted to
$577,123 due to the increase in the value of the Euro in relation to the U.S.
dollar during this time period.  A deferred tax liability was recorded
in Italy for this unrealized gain.  This is an unrealized non-cash
foreign currency transaction related to the US dollar denominated intercompany
note and recorded by QR in Euros.





For the
three-month period ended September 30, 2008, net interest expense was
approximately $1.058 million.  For the three-month period ended
September 30, 2007, net interest expense was approximately
$253,700.  This increase of approximately $804,000 is mainly
attributable to the acceleration and write-off of the balance of the Term Note
imputed  debt discount of $808,701, as the Company has not been able
to successfully negotiate a waiver, a forbearance agreement or renegotiate its
senior secured debt.  There was also approximately $1.7 million more
in average borrowings during the current three-month period offset by a lower
rate of borrowing on the Revolver, due to recent decreases in the prime rate of
borrowing.




18





The net
tax benefit recorded for the period ended September 30, 2008 and net tax expense
for the period ended September 30, 2007, include foreign taxes at the statutory
rates on the Company’s foreign operations, changes to the deferred tax accounts,
and state income and capital taxes generated in the United States.  As
of September 30, 2008, the Company had approximately $12.0 million in federal
net operating loss carry forwards, and approximately $16.4 million in state net
operating loss carry forwards.  These NOL’s will begin to expire in
2010 and are subject to review by the Internal Revenue Service.  Past
and future changes in ownership of the Company as defined in Section 382 of the
Internal Revenue Code, may limit the amount of NOL’s available for use in any
one year.





As
of September 30, 2008, the Company has recorded net deferred tax assets of
approximately $329,000 and as of June 30, 2008, net deferred tax liabilities of
approximately $155,000, all of which relates to its foreign
operations.  The September 30, 2008 net deferred tax assets are
comprised of approximately $537,000 of deferred tax assets and $208,000 of
deferred tax liabilities.  The June 30, 2008 net deferred tax
liabilities are comprised of approximately $698,000 of deferred tax liabilities
and $543,000 of deferred tax assets. The deferred tax liabilities are related to
the previously recorded net unrealized exchange gain on the intercompany note
denominated in US dollars, as it will only be taxed when realized and when
repayment is made; and the deferred tax assets are mainly related to the
temporary differences on the intangible assets amortization.








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 net of related discounts and allowances for its
consolidated operations when persuasive evidence of the arrangement exists, the
price is fixed or determinable, collectability is reasonably assured, and
delivery or title and risk of loss has passed to the customer, based on the
specific shipping terms.   The Company includes shipping and
handling costs as a component of cost of sales.  Revenue related to
equipment orders that contain one or more elements to be delivered at a future
date is recognized in accordance with EITF 00-21 “Accounting for Revenue Arrangements
with Multiple Deliverables”.The Company allocates revenue
between the various elements using the relative fair value method, based on
evidence of fair value for the respective elements.    The
revenue allocated to deferred service contracts, installation and training for
the three-dimensional imaging equipment is deferred until service is
provided.  Amounts received from customers in advance of equipment
deliveries are recorded as deferred income until the revenue can be recognized
in accordance with the Company’s revenue recognition policy.





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. The Company has not had significant
bad debt write-offs in the past few years, except for Fiscal Year 2008, when the
company recorded certain write-offs related to the receivables associated with
the acquisition of QR srl and the write-off related to an exclusive Canadian
distributor. 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 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
two years.




19





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, and (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 based upon the number of units sold, the
actual amount of warranty claims processed, and the specific warranty
period.  The increase in the warranty reserve has resulted in
decreased gross profit.





In Fiscal
2008, the Company’s Italian subsidiary began to separately account for warranty
costs related to its three-dimensional digital imaging equipment and has
recorded a warranty reserve as of June 30, 2008 and September 30,
2008.





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.





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 and liabilities reflect the tax
rates expected to be in effect in the period in which the differences are
expected to reverse.  Any changes in tax laws which affect the
effective tax rates will affect the deferred tax asset and will be reflected in
the accompanying current tax provision.  The Company records a
valuation allowance to reduce its deferred 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 the deferred tax asset and operating results could be
affected.  In reviewing the valuation allowance, the Company considers
future taxable income and determines whether 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-determination of the valuation
allowance.  In Fiscal Year 2008, the Company increased its valuation
allowance on the U.S. portion of its deferred tax asset by approximately
$4,398,000, as it does not believe that it is more likely than not that it will
be able to utilize the net operating loss carry forwards based on recent losses
and anticipated market conditions.





The
Company has recorded deferred tax assets and liabilities associated with its
foreign operations.  Certain tax assets 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.





The
Company has recorded NOLs amounting to approximately $12.0 million in federal
NOLs and $16.4 million in state NOLs at September 30, 2008.  The NOLs
are subject to review by the Internal Revenue Service.  Past and
future changes in ownership of the Company, as defined in Section 382 of the
Internal Revenue Code, may limit the amount of NOLs available for use in any one
year.





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, at which time, the
Company will perform an impairment analysis primarily related to technology and
customer relationships.  Determination of whether impairment exists
will be based upon comparison of the fair value of the assets to the carrying
values of the respective assets. This could result in a material charge to
earnings.  The Company considers factors such as operating results,
market trends, technological developments, competition, other economic factors,
and the effects of obsolescence for this assessment.





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.  These events include a significant change in the
business climate, operating performance indicators, legal factors, competition
or a significant change in the business entity.  The first step of the
goodwill impairment tests will be based upon a comparison of the fair value of
the reporting unit to the respective carrying value.  If the fair
value of the reporting unit exceeds its carrying amount, no impairment
exists.  If, however, the carrying amount of a reporting unit exceeds
its fair value, the second step of the goodwill impairment test will be
performed to measure the amount of impairment loss, if any.  The
implied fair value requires a fair value process similar to a business
combination, where the individual assets and liabilities are valued at fair
value with the difference between the fair value of the reporting unit being the
implied fair value of goodwill.  If the carrying amount of the
reporting unit exceeds its fair value, the goodwill impairment loss is measured
as the excess of the carrying amount of goodwill over its implied fair
value.  Any identified impairment will result in a charge to reduce
the carrying value of the associated goodwill.  This could result in a
material charge to earnings.




20





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 3.   Quantitative and Qualitative Disclosures
About Market Risk.




Not
Applicable.





Item 4T.  Controls and Procedures.





a) Evaluation of disclosure
controls and procedures





The
Company conducted an evaluation of the effectiveness of the design and operation
of the Company’s disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”)) as of the end of September 30, 2008.  The
controls evaluation was conducted under the supervision and with the
participation of our management, including our Co-Chief Executive Officers and
Chief Financial Officer.  Based upon that evaluation, the Co-Chief
Executive Officers and Chief Financial Officer have concluded that, as a result
of the identification of the material weaknesses identified below, as of the end
of the period covered by this report, our disclosure controls and procedures
were not effective.





In its
assessment of the effectiveness of internal control over financial reporting as
of September 30, 2008, management concluded that the Company's internal controls
over financial reporting were not operating effectively.  It was
determined that there were control deficiencies that when aggregated, may
possibly be viewed as a material weakness in our internal control over financial
reporting as of September 30, 2008.  Those deficiencies were as
follows:




1.
            We
      do not employ an Audit Committee as defined by Section 3(a)(58) of the
      Exchange Act and none of the Company’s directors are
      independent.  While not being legally obligated to have an audit
      committee, it is the Company's view that such a committee, including a
      financial expert, is an utmost important entity level control over the
      Company's financial statements.  Currently, the full Board of
      Directors acts in the capacity of the Audit
  Committee.





2.
            The
      Company does not have an individual who meets the criteria to be defined
      as a financial expert on its Board of Directors.  The financial
      expert could lead the Audit Committee to provide additional oversight of
      the Company’s Chief Financial Officer, as well as provide the Company’s
      financial management with enhanced segregation of duties and controls
      which would minimize the risk of a material
  misstatement.





3.
            There
      are no processes in place for someone to review and determine financial
      impacts of contracts and agreements.  The financial expert could
      assist in this review prior to the legal review and minimize any potential
      financial exposures.





In light
of this identified material weakness, the Company’s Board interacts with
management frequently and management performed (1) significant additional
substantive review of the financial information, (2) performed additional
analyses, including but not limited to a substantive analytical review that
compared changes from the prior period's financial statements and analyzed all
significant amounts that deviated from expectations, and (3) utilized an outside
consultant to provide assistance with technical accounting and reporting
matters.  These enhanced procedures were completed to mitigate the
entity level control deficiencies noted above.





21





Remediation of Material
Weaknesses


Management
concluded that the above identified material weakness did not result in material
audit adjustments to our 2008 financial statements. However, it is reasonably
possible that, if not remediated, one or more of the identified deficiencies
noted above could result in a material misstatement in our financial statements
that might result in a material misstatement in a future annual or interim
period.





In an
effort to remediate the identified material weaknesses, the recommendations are
as follows:





1.
Management will consider seeking candidates to expand the Board of Directors in
order to ensure a majority of the Board is independent.





2. Once
the expansion of the Board is completed, the Company’s Board of Directors will
nominate an Audit Committee, which includes a financial expert that has an
understanding of U.S. generally accepted accounting principles and financial
statements; the ability to assess the general application of such principles in
connection with the accounting for estimates, accruals and reserves; experience
in preparing, auditing, analyzing or evaluating financial statements that
present a breadth and level of complexity of accounting issues that are
generally comparable to the breadth and complexity of issues that can reasonably
be expected to be raised by the registrant's financial statements, or experience
actively supervising one or more persons engaged in such activities; an
understanding of internal controls and procedures for financial reporting; and
an understanding of audit committee functions.





This
person will have acquired such attributes through any one or more of the
following:





●
            Education
      and experience as a principal financial officer, principal accounting
      officer, controller, public accountant or auditor or experience in one or
      more positions that involve the performance of similar
      functions;


●
            Experience
      actively supervising a principal financial officer, principal accounting
      officer, controller, public accountant, auditor or person performing
      similar functions;


●
            Experience
      overseeing or assessing the performance of companies or public accountants
      with respect to the preparation, auditing or evaluation of financial
      statements; or


●
            Other
      relevant experience.





Limitations of Effectiveness
of Controls


As of the
date of this filing, the Company is satisfied that actions implemented to date
and those in progress will remediate the material weaknesses and deficiencies in
the internal controls that have been identified.   The Company
notes that, like other companies, any system of internal controls, however well
designed and operated, can provide only reasonable assurance, and not absolute
assurance, that the objectives of the internal control system will be
met.   The design of any control system is based, in part, upon
the benefits of the control system relative to its costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected.  These inherent
limitations include the realities that judgments in decision making can be
faulty, and that controls can be circumvented by the individual acts of some
persons, by collusion of two or more people or by management override of
control. In addition, over time, controls may become inadequate because of
changes in conditions, or the degree of compliance with the policies or
procedures may deteriorate.  In addition, the design of any control
system is based in part upon certain assumptions about the likelihood of future
events. Because of the limitations inherent in a cost-effective control system,
misstatements due to error or fraud may occur and may not be
detected.





(b) Changes in internal
controls





During the
quarter ended September 30, 2008, there were no significant changes in the
Company’s internal controls over financial reporting or in other factors that
have materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.




22




PART II


OTHER
INFORMATION





Item 1.   Legal Proceedings.





Reference
is made to Item 3 in the Company’s Annual Report on Form 10-K for the fiscal
year ended June 30, 2008, and to the references therein, for a discussion of all
material pending legal proceedings to which the Company and its subsidiaries are
parties.





In October
2008, the Company and its insurance carrier each contributed $41,440 to the
escrow account to settle the outstanding environment claim relating to property
owned by the Company in New Jersey between August 1984  and June
1985.  The Consent Decree memorializing the settlement is presently
scheduled to be finalized by December 2008.





In
November 2008, the Company and Genexa Medical, Inc., were instructed by the
court to attempt to negotiate through a court appointed mediator the outstanding
litigation which had originally been filed on May 5, 2008 in the United States
District Court, Southern District of New York.  The next court date
has been set for January 9, 2009.





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 6.   Exhibits.




31.1 -Certification of
      Co-Chief Executive Officer pursuant to Exchange Act Rule 13a – 14 (a) or
      Rule 15d-14(a).*31.2 -Certification
      of Co-Chief Executive Officer pursuant to Exchange Act Rule 13a – 14 (a)
      or Rule 15d-14(a).*31.3 -Certification of
      Chief Financial Officer pursuant to Exchange Act Rule 13a – 14 (a) or Rule
      15d-14(a).*32.1
      - Certification of Co-Chief Executive Officer pursuant to 18 U.S.C.
      Section 1350 of the Sarbanes – Oxley Act of 2002.*32.2
      - Certification of Co-Chief Executive Officer pursuant to 18 U.S.C.
      Section 1350 of the Sarbanes – Oxley Act of 2002.*32.3
      - Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
      1350 of the Sarbanes – Oxley Act of
    2002.**Filed
      herewith.





23




SIGNATURES








Pursuant
to the requirements 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(Registrant)By:
              /s/David
      VozickDavid
      VozickChairman
      of the Board,(Co-Chief
      Executive Officer)Secretary,
      TreasurerDate:  November
      19, 2008By:
              /s/Donald
      RabinovitchDonald
      RabinovitchPresident(Co-Chief
      Executive Officer)Date:  November
      19, 2008By:
              /s/Elise
      NissenElise
      NissenChief Financial
      Officer(Principal Financial
      and Accounting Officer)Date:  November
      19, 2008








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