**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**




**FORM
      10-Q**





**Quarterly
      Report Pursuant to Section 13 or 15 (d)** **of
      the Securities Exchange Act of 1934**





For
      Quarterly Period Ended March 31, 2007





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
              (I.R.S.
                  Employer Identification No.)Incorporation
                  or Organization)


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. Yes x No
o




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer.




Large
                  accelerated filer o
              Accelerated
                  filer o
              Non-accelerated
                  filer x





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




The
      registrant had 17,928,800 shares of its common stock outstanding as of May
      11,
      2007.


1


**AFP
      Imaging Corporation**





Table
      of Contents




Page**Part
                    I.**
                **Financial
                    Information**Item
                    1.
                Financial
                    StatementsCondensed
                    Consolidated
                    Balance
                    Sheets
                    as
                    of March 31, 2007 (unaudited) and June 30, 2006
                4Condensed
                    Consolidated Statements of
                    Operations for the nine months ended March 31, 2007 and 2006
                    (unaudited)5Condensed
                    Consolidated Statements of
                    Shareholders’ Equity for the nine months ended March 31, 2007 and 2006
                    (unaudited)
                6Condensed
                    Consolidated
                    Statements
                    of Cash Flows for the nine months ended March 31, 2007 and2006
                    (unaudited)
                7Notes
                    toConsolidated
                    Interim Financial Statements
                8-12Item
                    2.
                Management’sDiscussion
                    and Analysis of Financial Condition and Results of
                    Operations
                13-18Item
                    3.
                Quantitative
                    andQualitative Disclosures About Market Risk
                18Item
                    4.
                Controlsand
                    Procedures
                18**Part
                    II.**
                **Other
                    Information**Item
                    1
                Legal
                    Proceedings
                19Item
                    2
                Unregistered
                    Sales of Equity Securities and Use of
                    Proceeds
                19Item
                    6.
                Exhibits
                19-20Signatures
                21-27
  2




This
      Quarterly Report on Form 10-Q contains certain forward-looking statements within
      the meaning of the Private Securities 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 “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 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,


·
            maintaining
                operating efficiencies,


·
            pricing
                pressures,


·
            risks
                associated with foreign sales,


·
            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, 2006, 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, 2006 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, 2006.





In
      the
      opinion of the Company, all adjustments necessary to present fairly the
      Company’s consolidated financial position as of March 31, 2007, and its results
      of operations for the nine and three-month periods ended March 31, 2007 and
      2006, and its cash flows for the nine-month periods ended March 31, 2007 and
      2006, 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 - March 31, 2007 and June 30,
        2006**




**Assets**
              
              
              **March
                  31,**
              
              
              **June
                  30,**
              
              
              **Liabilities
                  and Shareholders' Equity**
              
              
              **March
                  31, 2007**
              
              
              **June
                  30,****2007**
              
              
              **2006**
              
              
              
              
              
              **2007**
              
              
              **2006**(Unaudited)
              
              
              
              
              
              
              
              
              (Unaudited)Current
                  Assets:
              
              
              
              
              
              
              
              
              Current
                  Liabilities:Cash
                  and cash equivalents
              
              $
              4,057,813
              
              $
              5,213,289
              
              
              Current
                  portion of long-term debt
              
              $
              385,618
              
              $
              -Accounts
                  receivable, less allowance for
              
              
              
              
              
              
              
              
              Accounts
                  payable
              
              
              2,431,473
              
              
              2,035,117doubtful
                      accounts of $110,000 and
              
              
              
              
              
              
              
              
              Accrued
                  expenses
              
              
              1,640,545
              
              
              1,565,174$90,000,
                  respectively
              
              
              2,928,864
              
              
              2,757,114
              
              
              **Total
                  current liabilities**
              
              
              4,457,636
              
              
              3,600,291Inventories
              
              
              4,907,598
              
              
              4,834,510Prepaid
                  expenses and other current assetsassets
              
              
              220,275
              
              
              97,189
              
              
              Deferred
                  Liabilities
              
              
              218,949
              
              
              71,204Deferred
                  income taxes
              
              
              680,000
              
              
              680,000**Total
                  liabilities**
              
              
              4,676,585
              
              
              3,671,495**Total
                  current assets**
              
              
              12,794,550
              
              
              13,582,102Common
                  Stock subject to registration
                rights
              
              
              ---
              
              
              4,744,323Property
                  and EquipmentAt
                  cost
              
              
              1,946,765
              
              
              1,828,149
              
              
              Shareholders’
                  Equity:Less
                  accumulated depreciation
              
              
              (1,620,958)
              
              
              (1,450,484)
              
              
              Preferred
                  stock -$.01
                  par value; authorized325,807
              
              
              377,665
              
              
              5,000,000shares,
                  none issued
              
              
              -
              
              
              -Common
                  stock,$.01
                  par value; authorized
                30,000,000
                  shares, issued and outstanding
                12,428,800
                  and 12,345,994 (including
                2,777,777
                  shares subject to registration
                rights)
                  shares at March 31, 2007, and June
                30,
                  2006, respectively
              
              
              124,288
              
              
              95,682Other
                  Assets
              
              
              1,913,916
              
              
              380,797
              
              
              Common stock
                  warrants
              
              
              91,131
              
              
              110,931Paid-in
                  capital in excess of par
              
              
              16,571,129
              
              
              11,805,852Accumulated
                  deficit
              
              
              (6,428,860
              )
              
              (6,087,719
              )**Total
                  shareholders' equity**
              
              
              10,357,688
              
              
              5,924,746**Total
                  Liabilities and Shareholders'****Total
                  Assets**
              
              **$**
              **15,034,273**
              
              **$**
              **14,340,564**
              
              
              **Equity**
              
              **$**
              **15,034,273**
              
              **$**
              **14,340,564**






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**
                **March
                  31,**
              
              **Nine
                  Months Ended**
                **March
                  31,****2007**
              
              **2006**
              
              **2007**
              
              **2006****Net
                  sales**
              
              **$**
              **7,126,326**
              
              **$**
              **7,173,942**
              
              **$**
              **20,503,091**
              
              **$**
              **18,663,935**Cost
                  of sales
              
              
              4,680,120
              
              
              4,481,436
              
              
              13,164,432
              
              
              11,571,521Gross
                  profit
              
              
              2,446,206
              
              
              2,692,506
              
              
              7,338,659
              
              
              7,092,414Selling,
                  general and administrative expenses
              
              
              2,651,343
              
              
              2,011,530
              
              
              7,174,740
              
              
              5,811,177Research
                  and development expenses
              
              
              167,554
              
              
              183,014
              
              
              541,090
              
              
              527,5932,818,897
              
              
              2,194,544
              
              
              7,715,830
              
              
              6,338,770Operating
                  income/(loss)
              
              
              (372,691
              )
              
              497,962
              
              
              (377,171
              )
              
              753,644Interest
                  income, net of (interest expense)
              
              
              13,530
              
              
              (8,851
              )
              
              70,442
              
              
              (64,173
              )Income/(loss)
                  before provision for income taxes
              
              
              (359,161
              )
              
              489,111
              
              
              ($306,729
              )
              
              689,471Provision
                  for income taxes
              
              
              19,768
              
              
              (1,510
              )
              
              34,412
              
              
              (1,510
              )**Net
                  income/(loss)**
              
              
              **($378,929**
              **)**
              **$**
              **490,621**
              
              
              **($341,141**
              **)**
              **$**
              **690,981**Net
                  income/(loss) per common share:Basic
              
              
              ($.03
              )
              $
              .05
              
              
              ($.03
              )
              $
              .07Diluted
              
              $
              ---
              
              $
              .05
              
              $
              ---
              
              $
              .07Weighted
                  average outstanding common stock:Basic
              
              
              12,428,800
              
              
              9,568,217
              
              
              12,410,604
              
              
              9,558,533Diluted
              
              
              ---
              
              
              10,050,532
              
              
              ---
              
              
              10,053,422
 
  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 Nine Months Ended March 31, 2007 and 2006**(Unaudited)**Common**
                **Stock**
              
              **Common**
                **Stock**
                **Warrants**
              
              **Paid-in**
                **Capital
                  In**
                **Excess
                  of Par**
              
              **Accumulated**
                **Deficit**
              
              **Total****Balance
                  June 30, 2005**
              
              **$**
              **94,077**
              
              **$**
              **19,800**
              
              **$**
              **11,641,821**
              
              **$**
              **(7,093,067**
              **)**
              **$**
              **4,662,631**Issuance
                  of 160,500 shares of common stock in
                connection
                  with the exercise of stock ptions
              
              
              1,605
              
              
              ---
              
              
              81,633
              
              
              ---
              
              
              83,238Stock-based
                  compensation expense
              
              
              ---
              
              
              ---
              
              
              60,196
              
              
              ---
              
              
              60,196Issuance
                  of common stock warrants
              
              
              ---
              
              
              91,131
              
              
              ---
              
              
              ---
              
              
              91,131Net
                  income for nine monthsended
                  March 31, 2006
              
              
              ---
              
              
              ---
              
              
              ---
              
              
              690,981
              
              
              690,981**Balance
                  March 31, 2006**
              
              **$**
              **95,682**
              
              **$**
              **110,931**
              
              **$**
              **11,783,650**
              
              **$**
              **(6,402,086**
              **)**
              **$**
              **5,588,177****Balance
                  June 30, 2006**
              
              **$**
              **95,682**
              
              **$**
              **110,931**
              
              **$**
              **11,805,852**
              
              **$**
              **(6,087,719**
              **)**
              **$**
              **5,924,746**
 
 Issuance
                  of 82,800 shares of common stock in
                connection
                  with the exercise of common stock warrants
              
              
              828
              
              
              (19,800
              )
              
              18,972
              
              
              ---
              
              
              ---Cumulative
                  effect adjustment to reclassify
                common
                  stock subject to registration rights from temporary equity
              
              
              27,778
              
              
              ---
              
              
              4,716,545
              
              
              ---
              
              
              4,744,323Stock-based
                  compensation expense
              
              
              ---
              
              
              ---
              
              
              42,329
              
              
              ---
              
              
              42,329Additional
                  fees associated with issuance of common stock in May 2006
              
              
              ---
              
              
              ---
              
              
              (12,569
              )
              
              ---
              
              
              (12,569
              )Net
                  loss for nine months endedMarch
                  31, 2007
              
              
              ---
              
              
              ---
              
              
              ---
              
              
              (341,141
              )
              
              (341,141
              )**Balance
                  March 31, 2007**
              
              **$**
              **124,288**
              
              **$**
              **91,131**
              
              **$**
              **16,571,129**
              
              **$**
              **(6,428,860**
              **)**
              **$**
              **10,357,688**
   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)
 
 Nine
                  months ended
                March
                  31,2007
              
              2006Cash
                  flows from operating activities:Net
                  income/(loss)
              
              
              ($341,141
              )
              $
              690,981Adjustments
                  to reconcile net income/(loss) to net cash provided by operating
                  activities-Depreciation
                  and amortization
              
              
              177,044
              
              
              171,170Non-cash
                  compensation expense
              
              
              42,329
              
              
              60,196Write-off
                  of deferred financing costs
              
              
              75,000
              
              
              ---Marked
                  to market gain on Euro hedge contract
              
              
              (137,237
              )
              
              ---Change
                  in assets and liabilities:(Increase)
                  in accounts receivable
              
              
              (171,750
              )
              
              (319,842
              )(Increase)/decrease
                  in inventories
              
              
              (73,088
              )
              
              139,265Decrease/(increase)
                  in prepaid expenses and other assets
              
              
              4,951
              
              
              (31,738
              )Increase
                  in accounts payable
              
              
              396,356
              
              
              498,996Increase/(decrease)
                  in accrued expenses
              
              
              75,371
              
              
              (48,929
              )Increase/(decrease)
                  in deferred liabilities
              
              
              147,745
              
              
              (33,165
              )Total
                  adjustments
              
              
              536,721
              
              
              435,953**Net
                  cash provided by operating activities**
              
              
              195,580
              
              
              1,126,934Cash
                  flows from investing activities:Purchases
                  of property and equipment
              
              
              (118,616
              )
              
              (192,063
              )Costs
                  related to a proposed acquisition
              
              
              (1,605,489
              )
              
              ---**Net
                  cash used in investing activities**
              
              
              (1,724,105
              )
              
              (192,063
              )Cash
                  flows from financing activities:Borrowing
                  of debt
              
              
              385,618
              
              
              ---Repayment
                  of debt
              
              
              ---
              
              
              (652,363
              )Proceeds
                  from exercise of common stock options
              
              
              ---
              
              
              83,238Payment
                  of fees associated with issuance of common stock in May
                  2006
              
              
              (12,569
              )
              
              ---**Net
                  cash provided/(used by) by financing activities**
              
              
              373,049
              
              
              (569,125
              )Net
                  (decrease)/increase in cash and cash equivalents
              
              
              (1,155,476
              )
              
              365,746Cash
                  and cash equivalents, at beginning of period
              
              
              5,213,289
              
              
              331,009Cash
                  and cash equivalents, at end of period
              
              $
              4,057,813
              
              $
              696,755**Supplemental
                  cash flow disclosures:**
                Cash
                  paid during the periods for-Interest
              
              $
              96,508
              
              $
              74,057Income
                  taxes, net of refunds
              
              $
              27,482
              
              
              4,563**Supplemental
                  Schedule of Non Cash Activity:**Cashless
                  exercise of common stock warrants
              
              $
              19,800
              
              
              ---
   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**


**March
      31, 2007**


(Unaudited)





**(1)** **Genera** **l:**


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, capturing,
      producing and recording medical, veterinary and dental images through digital
      technology, as well as the chemical processing of photosensitive materials.
      Medical, dental, veterinary and industrial professionals use these products.
      The
      Company’s products are distributed to worldwide markets under various brand
      names to the diagnostic professionals and through a network of independent
      and
      unaffiliated dealers. The Company has only one business segment -
      medical/dental.





On
      April
      19, 2007, the Company completed the acquisition of Quantitative Radiology srl,
      an Italian corporation (“QR”), by acquiring all of the outstanding share capital
      of QR from the shareholders. QR is a global supplier of state-of-the-art,
      in-office 3D dental computed tomography (CT). QR uses an imaging technology
      that
      features a cone shaped beam of x-rays (a CBCT scanner). The Company, prior
      to
      April 19, 2007, had acted as QR’s exclusive distributor in North and South
      America, excluding Brazil. Funding for the acquisition was principally derived
      from two sources, the first was the proceeds raised from a private offering
      of
      the Company’s common stock to equity investors and the second was the loan
      proceeds from ComVest Capital, LLC in connection with a term loan and revolving
      credit facility. In connection with the acquisition, the Company, entered into
      employment agreements with each of the former shareholders’ of QR. Each
      agreement contains a non-compete clause which prohibits the employee from
      engaging in activities competitive with the business of QR for a period of
      five
      years from the date of termination of employment.





On
      April
      12, 2007, the Company completed the sale of an aggregate of 5,500,000 shares
      of
      its common stock to certain accredited investors for an aggregate consideration
      of $8,140,000 pursuant to previously executed subscription agreements. The
      Company has granted the investors certain registration rights with respect
      to
      the resale of the shares acquired. The common stock was issued and sold pursuant
      to the exemption from registration afforded by Regulation D of the Securities
      Act of 1933, as amended. In connection with the transaction, the Company paid
      the placement agent for the offering $407,000, or five percent of the gross
      proceeds of the offering.





On
      April
      13, 2007, the Company entered into a Revolving Credit and Term Loan Agreement
      with ComVest Capital, LLC (“ComVest”) whereby ComVest agreed to lend the Company
      an aggregate of up to $8 million in the form of a $5 million term loan and
      a $3
      million revolving loan facility. The term loan bears interest at a rate of
      ten
      percent (10%) per annum and provides for repayment over five years commencing
      in
      November 2007; and the revolving loans bear interest a rate per annum of two
      percent (2%) plus the prime rate and is payable in full on April 30, 2012.
      The
      Company and each of its wholly-owned subsidiaries executed a Collateral
      Agreement pursuant to which each such party agreed to grant a security interest
      in all of its respective assets to ComVest as collateral security for repayment
      of the loans. This new senior secured Revolving Credit and Term Loan Agreement
      replaced the Company’s previous $2.5 million senior secured credit facility,
      which was due to expire on September 21, 2007. See footnote 4, Long and Short
      Term Debt for a further discussion of this transaction.





Included
      in other assets at March 31, 2007 and June 30, 2006 is $1,880,985 and $350,496,
      respectively, relating to deferred costs in connection with the acquisition
      of
      QR, which was completed on April 19, 2007. QR’s financial results will be fully
      consolidated with those of the Company from April 19, 2007 onwards. These costs
      will be recorded as an addition to the purchase price of QR srl.





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, 2006. The Condensed Consolidated
      Balance Sheet at June 30, 2006 has been derived from the audited financial
      statements.




**(2)** **Stock
      Option Plans:**


The
      Company currently has in effect two employee incentive stock plans, under which
      approximately 1,100,000 shares of Company common stock were originally
      authorized and available for issuance. Options that are granted under the plans
      generally are either fully vested when granted or vest upon completion of
      specific length of employment. Under the terms of these plans, options to
      purchase common stock of the Company may be granted at not less than 85% of
      the
      fair market value of the stock on the date of grant (100% in the case of
      incentive stock options qualifying under Section 422A of the Internal Revenue
      Code (“ISOs”) or 110% in the case of ISOs granted to persons owning more than
      10% of the outstanding stock of the Company).





8




Effective
      July 1, 2005, the Company adopted the fair value based method of accounting
      for
      stock-based employee compensation under the provisions of Statement of Financial
      Accounting Standards No. 123 (Revised 2004), *Share
      Based Payment* (“SFAS
      No. 123R”), using the modified prospective method without restatement of the
      interim periods prior to the adoption date, as described in SFAS 123R. As a
      result, the Company has begun recognizing expense in an amount equal to the
      fair
      value of share-based payments (including stock option awards) on their date
      of
      grant over the vesting period of the awards. Under SFAS 123R, the Company must
      recognize compensation expense for (1) all share-based payments granted on
      or
      after July 1, 2005 and (2) any partially vested options as of July 1, 2005.
      Prior to the adoption of SFAS 123R, the Company accounted for these plans
      pursuant to Accounting Principles Board Opinion No. 25 *Accounting
      for Stock Issued to Employees* .
      Therefore, compensation expense related to stock option awards was not reflected
      in operating expenses in any period prior to July 2005 (first quarter of Fiscal
      Year 2006), and prior period results have not been restated. For the three
      and
      nine months ended March 31, 2007, non-cash stock based compensation expense
      related to stock option awards was $0 and $42,329 respectively, and for the
      three and nine months ended March 31, 2006, non-cash stock based compensation
      expense related to stock option awards was $34,346 and $60,196, respectively.
      These charges have all been included in operating expenses.





The
      fair
      value of each option granted under the Company’s incentive stock plans during
      the three and nine months ended March 31, 2007 and 2006 was estimated on the
      date of grant using the Black-Scholes option pricing method. Using this model,
      fair value is calculated based on assumptions with respect to (a) expected
      volatility of the market price of Company common stock, (b) the periods of
      time
      over which employees, directors and other option holders are expected to hold
      their options prior to exercise (expected lives), (c) expected dividend yield
      on
      Company common stock and (d) risk-free interest rates which are based on quoted
      US Treasury rates for securities with maturities approximating the options’
expected lives. Expected volatility has been estimated based on actual movements
      in the Company’s stock price over the most recent historical periods equivalent
      to the options’ expected lives. Expected lives are principally based on the
      Company’s limited historical exercise experience with option grants with similar
      prices. The expected dividend yield is zero as the Company has never paid
      dividends, does not currently anticipate paying any dividends in the foreseeable
      future and is restricted from paying dividends under the terms of its new senior
      secured debt. The weighted-average of the fair value of the options granted
      during the three and nine months ended March 31, 2007 was $0 and $2.15 per
      option, respectively, and the weighted-average of the fair value of the options
      granted during the three and nine months ended March 31, 2006 was $2.40 and
      $2.10 per option, respectively.





Stock
      options to purchase an aggregate of 20,000 shares of Company common stock were
      granted to the Company’s non-employee Board of Director members in the
      nine-month period ended March 31, 2007; no stock options were granted during
      the
      three-month period ended March 31, 2007, in accordance with the Company’s policy
      for non-employee director compensation. Stock options to purchase an aggregate
      of 10,000 shares of Company common stock were granted to the Company’s
      non-employee Board of Director members in each of the three-month periods ended
      September 30, 2005, December 31, 2005, and March 31, 2006 in accordance with
      the
      Company’s policy for non-employee director compensation. All of these stock
      options were issued with a ten-year useful life.





**(** **3)
      Per Share Data** **:**


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





On
      March
      28, 2006, the Company issued an aggregate of 50,000 warrants to designees of
      an
      investment banking firm. Each warrant entitles the holder to purchase one share
      of Company common stock at a purchase price of $1.98, the closing stock price
      on
      March 28, 2006. The warrants are for five years and the Black-Scholes method
      was
      used to value these warrants.





On
      May 2,
      2006, the Company issued 2,777,777 shares of its common stock in a private
      placement to selected institutional and other accredited investors. The offering
      price was at $1.80 per share. In conjunction with the private placement, the
      Company has granted the investors certain registration rights with respect
      to
      the resale of the shares acquired. No warrants were issued to the investors
      in
      this private placement. The Company incurred fees of approximately $256,000
      including all placement fees and related legal and accounting expenses. The
      Company used the entire net proceeds for the acquisition of QR on April 19,
      2007.





With
      respect to the above described financing, the Company filed a registration
      statement which was declared effective on July 14, 2006. If this registration
      statement is subsequently suspended for a specified period of time, the Company
      could be required to pay a penalty of 1% of the financing per month to the
      investors. Additionally, the Company is required to file amendments to the
      registration statement as necessary to keep the registration effective for
      24
      months from the closing date. In accordance with the provisions of FSP EITF
      00-19-2, the Company has reclassified this private placement from temporary
      equity to shareholders’ equity on the accompanying balance sheet as of March 31,
      2007. At June 30, 2006, the net proceeds were classified as temporary equity
      in
      accordance with the provisions of EITF Topic D-98. The Company has maintained
      this registration statement since it was declared effective and believes that
      any future payments related to this registration statement are remote.
      Therefore, in accordance with SFAS 5, *Accounting
      for Contingencies,* no
      corresponding contingent liability has been recorded.





9




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





On
      April
      12, 2007, the Company completed the sale of an aggregate of 5,500,000 shares
      of
      its common stock to certain accredited investors for an aggregate consideration
      of $8,140,000 pursuant to previously executed subscription agreements. The
      Company has granted the investors certain registration rights with respect
      to
      the resale of the shares acquired. The common stock was issued and sold pursuant
      to the exemption from registration afforded by Regulation D of the Securities
      Act of 1933, as amended. In connection with the transaction, the Company paid
      the placement agent for the offering $407,000, or five percent of the gross
      proceeds of the offering.





The
      following is a reconciliation from basic to diluted shares for the three and
      nine months ended March 31, 2007 and 2006:





Three
                months ended March 31,
            
            Nine
                months ended March 31,2007
            
            2006
            
            2007
            
            2006Basic
                Shares
            
            
            12,428,800
            
            
            9,568,217
            
            
            12,410,604
            
            
            9,558,533Dilutive:Options
            
            
            ---
            
            
            398,235
            
            
            ---
            
            
            410,176Warrants
            
            
            ---
            
            
            84,080
            
            
            ---
            
            
            84,713Diluted
                Shares
            
            
            12,428,800
            
            
            10,050,532
            
            
            12,410,604
            
            
            10,053,422





The
      diluted weighted average number of shares outstanding for the nine months ended
      March 31, 2007 and 2006 does not include the potential exercise of the following
      stock options and warrants, as such amount were antidilutive,





Nine
                months ended March 31,2007
            
            2006Options
            
            
            843,900
            
            
            25,000Warrants
            
            
            50,000
            
            
            ---Diluted
                Shares
            
            
            893,900
            
            
            25,000





**(4)
      Short Term Debt** **:**


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





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






10




As
      part of
      the transaction, the Company granted to ComVest an aggregate of 800,000 warrants
      to purchase shares of the Company’s common stock at exercise prices per share
      equal to $1.85 with respect to 266,666 warrants, $2.02 with respect to an
      additional 266,666 warrants, and $2.19 with respect to the remaining 266,668
      warrants. The Company entered into a Registration Rights Agreement pursuant
      to
      which it has agreed to register the shares of common stock issuable upon
      exercise of the warrants and conversion of the term note .





**(5)** **Inventory** **:**


Inventories,
      which include material and a small component of labor and manufacturing
      overhead, are stated at the lower of cost (first-in, first-out) or market (net
      realizable value). Production materials represent a small component of inventory
      at month-end due to the manufacturing cycle. The Company uses a standard cost
      accounting system in conjunction with an actual perpetual inventory system
      to
      properly account for, control, and maintain the movement of all inventory
      components. All standard costs are reviewed periodically and updated accordingly
      to verify that the standard costs approximate the actual costs. At March 31,
      2007 and June 30, 2006, inventories, net of reserves, consisted of the
      following:





March
                31, 2007
            
            June
                30, 2006(Unaudited)Raw
                materials and sub-component parts
            
            $
            2,155,515
            
            $
            1,984,979Work-in-process
                and finished goods
            
            
            2,752,083
            
            
            2,849,531$
            4,907,598
            
            $
            4,834,510




**(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 March 31, 2007, the Company has recorded a deferred tax asset
      of
      $680,000, which primarily relates to losses recorded in prior years, and which
      the Company believes it is likely that the Company will utilize these prior
      year
      net operating loss carry forwards. Should circumstance change and the Company
      determine that it will not be able to utilize its net operating loss
      carryforward, such as a continuous decline in future taxable income, the Company
      will reevaluate its valuation allowance. As of March 31, 2007, the Company
      had
      approximately $7.24 million in federal net operating loss carryforwards, and
      approximately $12.0 million in state net operating loss
      carryforwards.





The
      Company made several small state and federal tax payments in the nine months
      ended March 31, 2007, based on payments previously made during its fiscal year
      ended June 30, 2006.





**(7)**  **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 State of New Jersey, citing
      several hundred other third-party defendants. The Company (through its former
      subsidiary, Kenro Corporation) was added, along with many other defendants,
      to
      the suit. The Company's claimed liability was potentially assessed by the
      plaintiff at $150,000. The Company has joined, along with other involved
      defendants, in an alternative dispute resolution (ADR) process for smaller
      claims. An initial settlement amount was offered by this group, however, to
      date, no settlement has been reached. The potential cost to the Company based
      on
      this settlement offer has been assessed at $23,100. The Company accrued $11,550
      as of June 2006, which represents the Company’s estimate of its potential
      liability, net of the Company’s insurance carrier’s agreed-upon contribution
      towards a potential settlement. The Company does not expect to receive any
      further information until after a mediation session is held, which has been
      scheduled for mid 2007. The Company cannot currently assess the amount of
      liability that could result from any adverse final outcome of this environmental
      complaint. The Company's insurance carrier has agreed to equally share with
      the
      Company the defense costs incurred in connection with this environmental
      claim.





The
      Company is a defendant (with several other parties) in a product liability
      insurance action, which was filed in May 2005 in the Superior Court in Hartford,
      Connecticut and later transferred to the United States District Court, District
      of Connecticut. The plaintiff, through its insurance company, claims that the
      Company’s equipment caused a fire on the plaintiff’s premises in May 2003. The
      complaint seeks approximately $200,000 in compensatory damages, and there were
      no reported injuries or such claims. Two additional suits seeking approximately
      $113,000 in damages were filed in May 2006 in the Superior Court in Hartford,
      Connecticut as subrogation claims relating to the same incident. The Company
      maintains that its equipment was not the cause of the incident or the resultant
      damage. The Company’s insurance carriers and their attorneys are assisting in
      the Company’s defense of this matter. The Company does not believe that the
      final outcome of this matter will have a material adverse effect on the
      Company .





11




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.





**(8)** **** **New
      Accounting Standards:**


In
      June
      2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
      Income Taxes- an Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48
      clarifies the accounting for uncertainty in income taxes recognized in a
      company’s financial statements in accordance with SFAS No. 109, “Accounting for
      Income Taxes.” FIN 48 prescribes a recognition threshold and measurement
      attribute for the financial statement recognition and measurement of a tax
      position taken or expected to be taken in a tax return. FIN 48 is effective
      for
      fiscal years beginning after December 15, 2006. The Company is still evaluating
      the effects, if any; the adoption of FIN 48 will have on its results of
      operations and financial position.





In
      September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
      No. 157, *Fair
      Value Measurements* (“SFAS
      No.
      157”). SFAS No. 157 establishes a framework for measuring fair value in
      generally accepted accounting principles and expands disclosures about fair
      value measurements. SFAS No. 157 emphasizes that fair value is a market-based
      measurement, not an entity-specific measurement. SFAS No. 157 also expands
      disclosures about the use of fair value to measure assets and liabilities in
      interim and annual periods subsequent to initial recognition. The Company is
      required to adopt SFAS No. 157, as applicable, beginning in July 2008. The
      Company is evaluating the effect of SFAS No. 157, but does not believe that
      there will be any material effect on the Company’s financial
      statements.





In
      September 2006, the FASB also issued SFAS No. 158, *Employers’
      Accounting for Defined Benefit Pension and Other Postretirement Plans-an
      Amendment of FASB Statements No. 87, 88, 106 and 132R* (“SFAS
      No.
      158”). SFAS No. 158 improves financial reporting by requiring an employer to
      recognize the overfunded or underfunded status of a defined benefit
      postretirement plan as an asset or liability in its statement of financial
      position and to recognize changes in that funded status in the year in which
      the
      changes occur through comprehensive income of a business entity or changes
      in
      unrestricted net assets of a not-for-profit organization. SFAS No. 158 also
      improves financial reporting by requiring an employer to measure the funded
      status of a plan as of the date of its year-end financial position. The Company
      is required to adopt SFAS No. 158, as applicable, as follows. The Company must
      recognize the funded status of its defined benefit postretirement plans and
      provide the required disclosures as of June 30, 2007, and the Company must
      measure the plan assets and benefit obligations for the fiscal year ended June
      30, 2009. The Company does not believe that there will be any material effect
      on
      the Company’s financial statements.





In
      December 2006, the FASB issued FSP EITF 00-19-2, *Accounting
      for Registration Payment Arrangements* (“FSP
      EITF
      00-19-2”). FSP EITF 00-19-2 addresses an issuer’s accounting for registration
      payment arrangements, and specifies that the contingent obligation to make
      future payments or otherwise transfer consideration under a registration payment
      arrangement should be separately recognized and measured in accordance with
      SFAS
      No. 5, *Accounting
      for Contingencies.* The
      Company adopted FSP EITF 00-19-2 effective January 1, 2007.





In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities - Including
      an
      Amendment of FASB Statement No. 115* (“SFAS
      No.
      159”) *.* SFAS
      159
      permits entities to choose to measure many financial instruments and certain
      other items at fair value, so as to improve financial reporting by providing
      entities with the opportunity to alleviate volatility in reported earnings.
      This
      Statement should expand the use of fair value measurement and permits all
      entities to choose to measure eligible items at fair value at specified election
      dates. The resulting unrealized gains or losses on items which the fair value
      option has been elected are to be reported in earnings. The Company is required
      to adopt SFAS No. 159, as applicable, beginning in July 2008. The Company is
      evaluating the effect of SFAS No. 159, but does not believe that there will
      be
      any material effect on the Company’s financial statements.





12


**Item
      2: Management's Discussion and Analysis of Financial Condition and Results
      of
      Operation**





**Capital
      Resources and Liquidity**





The
      Company’s working capital at March 31, 2007 decreased by approximately $1.64
      million from June 30, 2006. This decrease is principally due to the payment
      of
      approximately $1.60 million in the current nine-month period related to the
      acquisition of QR srl that was completed on April 19, 2007. Such costs included
      a non-refundable down payment of $1.32 million in February 2007 (credited to
      the
      purchase price) and various legal and accounting charges, and were classified
      as
      deferred charges as of March 31, 2007. The decrease in working capital is also
      attributable to increases in the Company’s senior secured debt, accounts payable
      and accrued expenses, all offset by moderate increases in accounts receivables
      and inventory.





Operating
      cash flows were significantly lower in the current nine-month period principally
      due to the loss from operations. This loss is mainly attributable to lower
      gross
      margins based on the product mix towards more distributor goods, the strong
      Euro
      in relation to the US dollar, increased competition in the marketplace, as
      well
      as significantly higher marketing, sales distribution and administrative
      expenses. These expenses related to new and existing products and the
      development and growth of various new distribution channels to advance sales
      growth. These factors caused the Company to utilize its cash resources,
      resulting in increased borrowings on the senior secured debt. The Company is
      requiring advance deposits from its customers on the new-high dollar valued
      equipment, which is consistent with the vendor’s terms of sale. Otherwise, the
      Company has neither changed its payment policies to its vendors nor revised
      its
      payment terms with its customers.





On
      April
      12, 2007, the Company completed the sale of an aggregate of 5,500,000 shares
      of
      its common stock to certain accredited investors for an aggregate consideration
      of $8,140,000 pursuant to previously executed subscription agreements. The
      Company has granted the investors certain registration rights with respect
      to
      the resale of the shares acquired. The common stock was issued and sold pursuant
      to the exemption from registration afforded by Regulation D of the Securities
      Act of 1933, as amended. In connection with the transaction, the Company paid
      the placement agent for the offering $407,000, or five percent of the gross
      proceeds of the offering. The net proceeds were used to fund a portion of the
      purchase price of QR srl, which was completed on April 19, 2007.





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





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





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





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





13




As
      part of
      the transaction, the Company granted to ComVest an aggregate of 800,000 warrants
      to purchase shares of the Company’s common stock at exercise prices per share
      equal to $1.85 with respect to 266,666 warrants, $2.02 with respect to an
      additional 266,666 warrants, and $2.19 with respect to the remaining 266,668
      warrants. The Company entered into a Registration Rights Agreement pursuant
      to
      which it has agreed to register the shares of common stock issuable upon
      exercise of the warrants and conversion of the term note .





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





Capital
      expenditures for the first nine months of fiscal 2007 were approximately
      $118,600, consisting of the purchase of several new high-end sales demonstration
      computers, an additional module for the Customer Relationship Management system,
      a sales tax module, improvements to the Company’s existing network, and tooling
      expenditures related to the redesign, development and production of new imaging
      products.





The
      Company’s historical operating cash flows generally have been positive; however,
      the Company is dependent upon its Revolving Credit and Term Loan Agreement
      with
      ComVest to finance its ongoing operations. The Company expects its worldwide
      working capital requirements will continue to be financed by operations, both
      in
      the United States and Italy, with the completion of the acquisition of QR srl,
      and from borrowings on the Revolving Credit and Term Loan Agreement. It is
      believed that the Revolving Credit and Term Loan Agreement is sufficient to
      finance the Company’s ongoing worldwide working capital requirements for the
      foreseeable future. The Company currently believes that there are no significant
      trends, demands, commitments or contingencies, other than an unexpected material
      adverse conclusion to an ongoing environmental litigation case, which are
      reasonably likely to result in a significant increase or decrease in its
      liquidity or capital resources within the foreseeable near-term future. As
      of
      May 1, 2007, the Company had available approximately $999,300 of unused credit
      under the Revolving Credit and Term Loan Agreement. No assurances can be given
      that the Company will have sufficient cash flow in the long term.





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





Included
      in other assets at March 31, 2007 and June 30, 2006 is $1,880,985 and $350,496,
      respectively, relating to deferred costs in connection with the acquisition
      of
      QR, which was completed on April 19, 2007. QR’s financial results will be fully
      consolidated with those of the Company from April 19, 2007 onwards.





**Results
      of Operations**





**Fluctuations
      in Operating Results**


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 out of the Company’s control, and include the
      following:




§
            changes
                in technology,


§
            changes
                in product mix,


§
            the
                timing of industry trade shows,


§
            the
                timing of new product introductions by the Company as well as by
                its
                competitors, and


§
            currency
                fluctuations.





**Nine
      Months Fiscal 2007 Versus Nine Months Fiscal 2006**





Sales
      increased approximately $1,839,100, or 9.9%, between the Fiscal 2006 and Fiscal
      2007 nine-month periods. The Company’s veterinary products business increased
      31%, mainly due to the introduction in mid-Fiscal Year 2006 of a digital imaging
      system for equine patients and general purpose x-ray systems (analog and
      digital) specifically designed for all veterinary applications. In addition,
      there is continuing demand for our filmless digital dental radiography system
      which showed a 16% increase in human and veterinary sales in the current
      nine-month period. In June 2006, the Company became the exclusive distributor
      in
      the United States, Canada and Latin America (excluding Brazil) for a
      three-dimensional dental x-ray imaging system manufactured in Italy by QR srl
      (which the Company acquired on April 19, 2007). It produces computer generated
      three-dimensional images which are a significant improvement over conventional
      two-dimensional x-ray images. The Company sells this product into both the
      dental and the medical ENT market and experienced new sales growth with this
      product. The Company’s analog film processor business showed a decline of
      approximately 19% in the current nine-month period as health-care professionals
      continue to migrate to digital imaging equipment, much of which the Company
      also
      supplies. The Company has continued its efforts to increase worldwide
      distribution and expand and develop new international markets for its digital
      products, resulting in a 30.5% increase in international sales between the
      periods.





14




Gross
      profit as a percent of sales decreased 2.2 percentage points between the Fiscal
      2006 and Fiscal 2007 nine-month comparable periods. Material costs as a percent
      of sales increased 3.7 percentage points, as the Company is selling more high
      dollar value distributor goods, which tend to have lower gross margins. Many
      of
      the distributor goods are imported, and the Company has realized additional
      costs with the strong Euro to the US dollar. Labor and overhead costs, while
      the
      dollar values decreased slightly between the periods, decreased 1.5 percentage
      points due to much higher sales in the current nine-month period.





Selling,
      general, and administrative costs increased approximately $1,363,600 or 23.5%,
      between the Fiscal 2006 and Fiscal 2007 nine-month comparable periods. This
      increase is due to several factors, including: (1) the write-off of certain
      deferred financing costs incurred in the previous fiscal year as the Company
      chose not to utilize that lender; (2) an approximate 7% increase in general
      and
      administrative costs associated with the increase in sales; (3) approximately
      a
      $90,000 increase in technical support costs related to the new digital equipment
      the Company is selling, that require a devoted infrastructure support system;
      (4) an increase in marketing and sales costs of approximately $560,000 in the
      current nine-month period due to (a) the Company’s aggressive launch into the
      dental and medical marketplaces for the new three dimensional x-ray imaging
      equipment, including attendance at two large international tradeshows,
      development of new brochures and advertising materials, and the related travel
      and entertainment expenses, (b) pursuing various sales opportunities in both
      the
      domestic and international markets, with specific emphasis in the growing
      veterinary markets, (c) attendance and exhibition at two other large
      international trade shows in Europe and (d) an increase in general operating
      expenses, based on increased sales levels; and (5) approximately $500,000
      related to the acquisition in mid-December 2006 of a new distinct distribution
      channel to implement various methods to increase sales levels. Included in
      selling, general and administrative costs in Fiscal 2007 is $137,237 of income
      related to the marked to market gain on a Euro hedge contract purchased in
      March
      2007 associated with the purchase of QR srl on April 19, 2007, as the purchase
      price was in Euro.





Research
      and development costs increased approximately $13,500, or 2.6%, between the
      Fiscal 2006 and Fiscal 2007 nine-month comparable periods. The Company continues
      to invest in the design, development and refinement of its existing digital
      imaging products, as well as the design and development of new digital imaging
      products for the human dental and broad veterinary applications, including
      both
      hardware and software enhancements. Research and development costs may fluctuate
      between reporting periods, due to changing research and development consulting
      agreements, initiation or completion of certain project tasks, and market
      demands. Research and development costs are generally expected to continue
      to
      increase over the next several years as part of the Company’s strategy to
      develop and market additional high tech digital products.





For
      the
      nine-month period ended March 31, 2007 (FY 2007), net interest income was
      $70,442. For the nine-month period ended March 31, 2006 (FY 2006), net interest
      expense was $64,173. There was approximately $176,800 of interest income in
      Fiscal Year 2007 compared to approximately $6,000 in Fiscal year 2006. The
      increase in interest income is due to the private placement the Company
      completed in May 2006, whereby all the proceeds have been invested in a
      diversified US Treasury Money Market Fund. There was approximately $106,400
      of
      interest expense in the current nine-month period, compared to approximately
      $70,100 in the comparable period in the prior year. The current nine-month
      period had approximately $400,000 more in average borrowings on the senior
      secured debt and had a slightly higher average interest rate, which is based
      on
      the prime rate of borrowing.




The
      Company made several small state and federal tax payments in the nine-months
      ended March 31, 2007, based on payments previously made during its fiscal year
      ended June 30, 2006. The Company has recorded a deferred tax asset of $680,000,
      which primarily relates to losses recorded in prior years; the Company believes
      it is likely that it will utilize these prior year net operating loss carry
      forwards. As of March 31, 2007, the Company had approximately $7.24 million
      in
      federal net operating loss carryforwards, and approximately $12.0 million in
      state net operating loss carryforwards.





15





**Third
      Quarter Fiscal 2007 Versus Third Quarter Fiscal 2006**





Sales
      for
      the third quarter fiscal year 2007 were $7.13M, a slight decrease of $47,600
      or
      .7% compared to the third quarter fiscal 2006. In June 2006, the Company became
      the exclusive distributor in the United States, Canada and Latin America
      (excluding Brazil) for a three-dimensional dental x-ray imaging machine
      manufactured in Italy, by QR srl (which the Company acquired on April 19, 2007).
      It produces computer generated images that are a significant improvement over
      conventional two-dimensional x-ray images. The Company sells this product into
      both the dental and the medical ENT market and continues to experience
      significant growth with this product. There is continuing demand for our
      filmless digital dental radiography system in both the human and veterinary
      marketplaces. These increases in sales were offset by decreases in (a) the
      Company’s veterinary products business which decreased approximately 5.8%,
      mainly due to vendor production issues which have now been resolved and (b)
      a
      decline of approximately 19% for analog film processors, as health-care
      professionals continue to choose to upgrade to digital imaging equipment, much
      of which the Company also supplies. The Company has continued its efforts to
      increase worldwide distribution and expand and develop new international markets
      for its digital products.





Gross
      profit as a percent of sales decreased 3.2 percentage points between the third
      quarter Fiscal 2006 and the third quarter Fiscal 2007 comparable periods.
      Material costs as a percent of sales increased 3.8 percentage points, as the
      Company is selling more high dollar value distributor goods, which tend to
      have
      lower gross margins. Many of the distributor goods are imported, and the Company
      has realized additional costs with the strong Euro to the US dollar. Labor
      and
      overhead costs decreased approximately $52,000 as well as decreased .6
      percentage points.





Selling,
      general, and administrative costs increased approximately $640,000 or 31.8%,
      between the third quarter Fiscal 2006 and the third quarter Fiscal 2007. This
      increase is due to several factors, including: (1) approximately $430,000
      related to the acquisition in mid-December 2006 of a new distinct distribution
      channel to implement various methods to increase sales levels; (2) a 6.5%
      increase in general and administrative costs associated with the increase in
      sales; (3) an approximately $70,000 increase in technical support costs related
      to the new digital equipment the Company is selling, which require a devoted
      infrastructure support system; and (4) an increase in marketing and sales costs
      of approximately $160,000 in the current third quarter Fiscal 2007 due to (a)
      the Company’s continued aggressive launch into the dental and medical
      marketplaces for the new three dimensional x-ray imaging equipment and the
      associated travel and entertainment expenses, (b) pursuing various sales
      opportunities in both the domestic and international markets, with specific
      emphasis in the growing veterinary markets, (c) attendance and exhibition at
      two
      large international trade shows in Europe and (d) an increase in general
      operating expenses, based on increased sales levels. Included in selling,
      general and administrative costs in the third quarter Fiscal 2007 is $137,237
      of
      income related to the marked to market gain on a Euro hedge contract purchased
      in March 2007 associated with the purchase of QR srl on April 19, 2007, as
      the
      purchase price was in Euro.





Research
      and development costs decreased slightly by approximately $15,400, or 8.4 %,
      between the third quarter Fiscal 2006 and third quarter Fiscal 2007, mainly
      due
      to the timing of the completion of certain software projects in the prior year.
      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 are generally expected to continue to increase over the next several
      years
      as part of the Company’s strategy to develop and market additional digital
      products.





For
      the
      three-month period ended March 31, 2007, net interest income was $13,530. For
      the three-month period ended March 31, 2006, net interest expense was $8,851.
      There was approximately $53,000 of interest income in the third quarter Fiscal
      Year 2007 compared to approximately $1,500 in the third quarter Fiscal Year
      2006. The increase in interest income is due to the private placement the
      Company completed in May 2006, whereby all the proceeds have been invested
      in a
      diversified US Treasury Money Market Fund. There was approximately $39,500
      of
      interest expense in the current third quarter, compared to approximately $10,300
      in the comparable period in the prior year. The current third quarter period
      had
      approximately $1.03 million more in average borrowings on the senior secured
      debt and had a slightly higher average interest rate, which is based on the
      prime rate of borrowing.




The
      Company made several small state and federal tax payments in the third quarter
      ended March 31, 2007, based on payments previously made during its fiscal year
      ended June 30, 2006. The Company has recorded a deferred tax asset of $680,000,
      which primarily relates to losses recorded in prior years, and which the Company
      believes it is likely that it will utilize these prior year net operating loss
      carry forwards. As of March 31, 2007, the Company had approximately $7.24
      million in federal net operating loss carryforwards, and approximately $12.0
      million in state net operating loss carryforwards.








16





**Critical
      Accounting Policies and Estimates**





The
      preparation of financial statements in conformity with United States generally
      accepted accounting principles requires management to make estimates and
      assumptions that affect the reported amounts of assets and liabilities and
      the
      reported amounts of revenues and expenses. These estimates and assumptions
      are
      evaluated on an ongoing basis focusing 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 assurance that actual results of operations will be consistent
      with management’s estimates and assumptions, and that reported results of
      operations will not be adversely affected by the requirement to make accounting
      adjustments to reflect changes in these estimates from time to time. The
      following policies are those that management believes to be the most sensitive
      to estimates and judgments.





Revenue
      Recognition


The
      Company recognizes revenue for both its domestic and international sales when
      products are shipped and title passes to the customer. The Company includes
      shipping and handling costs as a component of cost of sales. The Company has
      begun to sell extended service contracts on its three-dimensional dental x-ray
      imaging machines. Such revenue has been deferred and will be recorded on a
      straight-line basis over the period of the extended service
      contract.





Accounts
      Receivable


The
      Company reports accounts receivable net of reserves for doubtful accounts.
      Credit is extended to worldwide distributors on varying terms from letters
      of
      credit to between 30 and 90 days. 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 are determined by management to be uncollectible. There
      have been no significant changes in the computation methodology of the reserve
      for doubtful accounts in the past three years and the Company has not had
      significant bad debt write-offs in the past few years. The allowance for
      doubtful accounts is based on the Company’s analysis of aged accounts
      receivable. Management believes that any potential risk associated with the
      estimate of reserve for doubtful accounts is therefore limited.





Inventories


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





Warranties


The
      Company records a liability for an estimate of costs that it expects to incur
      under the Company’s limited warranties issued to its customers. 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. Management believes that the current warranty
      provisions are sufficient based on the warranty information available to the
      Company.





The
      Company offers extended warranties in connection with sales of its digital
      sensors. The Company is continuing to monitor the rate and costs of claims
      and
      review the adequacy of its warranty liability and make any changes as, and
      if,
      necessary. If the Company experiences significant increased warranty claims
      or
      activity, or the warranty claims exceed the currently reserved amount, the
      warranty reserve will be increased, resulting in decreased gross profit during
      the period(s) in which the warranty reserve is increased.





Stock-based
      Compensation


Stock
      based compensation is accounted for in accordance with SFAS No. 123R. The
      Company determines the fair value of options based on the Black-Scholes model,
      which is based on specific assumptions including (1) the 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 reflect the tax rates expected to be in effect in the period in which
      the
      differences are expected to reverse. The Company records a valuation allowance
      to reduce its tax asset when it is more likely than not that a portion of the
      amount may not be realized. The Company estimates its valuation allowance based
      on an estimated forecast of its future profitability. Any significant changes in
      future profitability resulting from variations in future revenues or expenses
      could affect the valuation allowance on its deferred tax asset and operating
      results could be 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.





17




Litigation
      and Contingencies


The
      Company is party to lawsuits arising out of its operations. The Company records
      a liability when it is probable and can be reasonably estimated. The Company
      believes it has properly estimated its potential litigation liability 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**





The
      Company’s earnings and cash flows are subject to changes in interest rates
      (i.e., short-term, prime-based interest rates) from its borrowings under its
      senior secured debt. The Company does not believe that it is materially exposed
      to changes in interest rates; as at March 31, 2007, there was approximately
      $385,600 in total debt outstanding. The Company currently does not use interest
      rate derivative instruments to manage exposure to interest rate
      changes.





The
      Company’s earnings and cash flows are subject to changes in interest rates
      associated with U.S. Treasury Notes and U.S. Treasury Bills, primarily from
      its
      investments of excess cash. The Company invests this cash in an open-end,
      diversified U.S. Treasury Money Market Fund, whose investment objective is
      high
      current income consistent with the preservation of principal and liquidity.
      All
      investments are exclusively in U.S. Treasury obligations which have remaining
      maturities of 397 days or less and repurchase agreements collateralized by
      U.S.
      Treasury obligations. The Company does not believe that such investments are
      materially exposed to market rate volatility.





The
      Company’s earnings and cash flows are subject to foreign currency exchange rate
      risk, specifically the Euro/Dollar and the Yen/Dollar. The Company does not
      believe that it is materially exposed to foreign currency exchange rate risk
      due
      to the volume of purchases in foreign currency relative to purchases in US
      dollars; however, the relative strength/weakness of the Dollar to the Euro
      or to
      the Yen does affect the Company’s gross profit. The Company regularly monitors
      all changes in foreign currency and may adjust its pricing to customers to
      reflect these changes. The Company purchased a Euro hedge contract in March
      2007
      to limit the Company’s foreign currency exchange rate risk associated with the
      purchase of QR srl on April 19, 2007, as the purchase price was in
      Euro.








**Item
      4: Controls and Procedures.**





a) Evaluation
      of disclosure controls and procedures





Our
      Co-Chief Executive Officers and Chief Financial Officer have reviewed and
      evaluated the effectiveness of the Company’s disclosure controls and procedures
      (as defined in Rule 13a - 15 (e) of the Securities Exchange Act of 1934 (the
      “Act”)). Based on their review and evaluation, the Co-Chief Executive Officers
      and Chief Financial Officer have concluded that, as of March 31, 2007, the
      Company’s disclosure controls and procedures were adequate and effective to
      ensure that information required to be disclosed by the Company in the reports
      that it files or submits under the Act is recorded, processed, summarized and
      reported, within the time periods specified in the rules and forms of the
      Securities and Exchange Commission.





(b) Changes
      in internal controls





During
      the
      quarter ended March 31, 2007, there were no significant changes in the Company’s
      internal controls over financial reporting or in other factors that could
      materially affect, or would be reasonably likely to materially affect, these
      internal controls, nor were there any significant deficiencies or material
      weaknesses in these internal controls requiring corrective actions. As a result,
      no corrective actions were necessary.







18


**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, 2006, and to the references therein, for a discussion of
      all
      material pending legal proceedings to which the Company and its subsidiaries
      are
      parties.





A
      status
      conference was held in November 2006 relating to the environmental claim
      involving a property in New Jersey owned by the Company between August 1984
      and
      June 1985. A mediation session has been scheduled for mid 2007, when a new
      settlement offer is expected to be submitted.





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
      2: Unregistered Sales of Equity Securities and Use of
      Proceeds**





On
      April
      12, 2007, the Company completed the sale of an aggregate of 5,500,000 shares
      of
      its common stock to certain investors for an aggregate consideration of
      $8,140,000 pursuant to previously executed subscription agreements. The Company
      has granted the investors certain registration rights with respect to the resale
      of the shares acquired. The common stock was issued and sold pursuant to the
      exemption from registration afforded by Regulation D of the Securities Act
      of
      1933, as amended. In connection with the transaction, the Company paid the
      placement agent for the offering $407,000, or five percent of the gross proceeds
      of the offering.





On
      April
      13, 2007, the Company granted to ComVest Capital LLC, its new senior secured
      lender, an aggregate of 800,000 warrants to purchase shares of the Company’s
      common stock at exercise prices per share equal to $1.85 in respect of 266,666
      warrants, $2.02 in respect of an additional 266,666 warrants, and $2.19 in
      respect of the remaining 266,668 warrants. The Company entered into a
      Registration Rights Agreement pursuant to which it has agreed to register the
      shares of common stock issuable upon exercise of the warrants and conversion
      of
      the term note .





**Item
      6:****Exhibits****.**




4.1
              -
              Form
                of Subscription Agreement utilized in a private placement of common
                stock,
                effective April 12, 2007.4.2
              -
              Common
                Stock Purchase Warrant issued to ComVest Capital, LLC, dated April
                13,
                2007.4.3
              -
              Common
                Stock Purchase Warrant issued to ComVest Capital, LLC, dated April
                13,
                2007.4.4
              -
              Common
                Stock Purchase Warrant issued to ComVest Capital, LLC, dated April
                13,
                2007.10.1
              -
              Preliminary
                  Contract for Share transfer by and between QR Imaging S.r.l., NIM
                  S.R.L.,
                  Gianmaria Tommasi, Mara Tacconi, Attilio Tacconi and Mozzo Pierluigi,
                  dated February22,
                  2007.10.2
              -
              Revolving
                Credit and Term Loan Agreement by and between ComVest Capital, LLC
                and AFP
                Imaging Corporation, dated April 13, 2007.10.3
              -
              Guaranty
                Agreement made by Dent-X International Inc., QR Imaging USA Inc.
                and
                Visiplex Instruments Corporation in favor of ComVest Capital, LLC,
                dated
                April 13, 2007.10.4
              -
              Collateral
                Agreement by and among AFP Imaging Corporation, Dent-X International
                Inc.,
                QR Imaging USA, Inc., Visiplex Instruments Corporation and ComVest
                Capital, LLC, dated April 13, 2007.10.5
              -
              Registration
                Rights Agreement by AFP Imaging Corporation, made as of April 13,
                2007.10.6
              -
              Convertible
                Term Note issued by AFP Imaging Corporation to ComVest Capital, LLC,
                dated
                April 13, 2007.10.7
              -
              Revolving
                Credit Note issued by AFP Imaging Corporation to ComVest Capital,
                LLC,
                dated April 13, 2007.10.8
              -
              Notice
                of Patent Security Agreement, dated April 13, 2007.10.9
              -
              Notice
                of Trademark Security Agreement, dated April 13, 2007.10.10
              -
              Cooperation
                Agreement between QR S.r.l. and Gianmaria Tommasi, effective April
                19,
                2007.10.11
              -
              Contract
                among QR S.r.l., Attilio Tacconi and Mozzo Pierluigi, effective April
                19,
                2007.10.12
              -
              Contract
                between QR S.r.l. and Mara Tacconi, effective April 19,
                2007.31.1
              -
              Certification
                of Co-Chief Executive Officer pursuant to Exchange Act Rule 13a -
                14
                (a).31.2
              -
              Certification
                of Co-Chief Executive Officer pursuant to Exchange Act Rule 13a -
                14
                (a).31.3
              -
              Certification
                of Chief Financial Officer pursuant to Exchange Act Rule 13a - 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.





19





**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** **)**





/s/ David
              Vozick**David
              Vozick**Chairman
                of the Board,
              (Co-Chief
                  Executive Officer)
                Secretary,
                  Treasurer
                Date:
                  May 15, 2007






/s/ Donald
              Rabinovitch**Donald
                Rabinovitch**President
              (Co-Chief
                Executive Officer)
              Date:
                May 15, 2007





/s/
              Elise Nissen**Elise
              Nissen**Chief
                Financial Officer
              (Principal
                Financial and Accounting Officer)
              Date:
                May 15, 2007


20