UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549




FORM
10-Q





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




FOR
THE QUARTERLY PERIOD ENDED MARCH 31, 2008




OR




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




FOR
THE TRANSITION PERIOD FROM 
TO








Commission
File Number 0-10832








AFP
Imaging Corporation


(Exact
Name of Registrant as Specified in Its Charter)





New
      York
            13-2956272(State
      or Other Jurisdiction of
            (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_____





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





Large
accelerated filer
_____                                                                            
Accelerated filer
_____                                                                                 
Non-accelerated filer _____




(Do not check if a smaller reporting company)


Smaller
reporting company __X__




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





The
registrant had 17,928,800 shares of its common stock outstanding as of May 12,
2008.











AFP
Imaging Corporation





Table of
Contents





PagePart
      I.
              Financial
      InformationItem
      1.
              Financial
      StatementsCondensed Consolidated Balance Sheets as of March
      31, 2008 (unaudited) and June 30, 2007
              4Condensed Consolidated Statements of Operations for the
      three and nine months ended March 31, 2008 and 2007
      (unaudited)
              5Condensed Consolidated Statements of Shareholders’ Equity
      for the nine months ended March 31, 2008 and 2007
      (unaudited)
              6Condensed Consolidated Statements of Cash Flows for the
      nine months ended March 31, 2008 and 2007 (unaudited)
              7Notes to Consolidated Interim Financial
      Statements
              8-15Item
      2.
              Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
              16-22Item
      3.
              Quantitative and Qualitative Disclosures About Market
      Risk
              22-23Item
      4.
              Controls and Procedures
              23Part
      II.
              Other
      InformationItem
      1.
              Legal Proceedings
              24Item
      6.
              Exhibits
              24Signatures
              25-31
  2





This
Quarterly Report on Form 10-Q contains certain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of
1995.  Forward-looking statements involve known and unknown risks and
uncertainties and other factors that could cause the actual results of AFP
Imaging Corporation (collectively with its subsidiaries, the “Company”) or
achievements expressed or implied by such forward-looking statements to not
occur, not be realized or differ materially from that stated in such
forward-looking statements.  Forward-looking statements may be
identified by terminology such as “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,


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


·
            maintaining
      operating efficiencies,


·
            pricing
      pressures,


·
            risks
      associated with foreign sales,


·
            risks
      associated with the implementation of the new direct sales
      program,


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


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


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


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


·
            determinations
      in various outstanding legal
matters,


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


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


·
            changes
      in currency exchange rates and regulations,
and


·
            other
      factors set forth in this Quarterly Report on Form 10-Q, and the Company’s
      Annual Report on Form 10-K for the year ended June 30, 2007, 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, 2007, and the Company’s other filings with
the SEC.  These reports attempt to advise interested parties of the
risks and factors that may affect the Company’s business, financial condition
and results of operations and prospects.  The forward-looking
statements made in this 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, 2007.





In the
opinion of the Company, all adjustments necessary to present fairly the
Company’s consolidated financial position as of March 31, 2008, and its results
of operations for the nine and three-month periods ended March 31, 2008 and
2007, and its cash flows for the nine-month periods ended March 31, 2008 and
2007, consisting of normal recurring adjustments, have been
included.  The accompanying unaudited interim consolidated financial
statements include all adjustments (consisting only of those of a normal
recurring nature) necessary for a fair statement of the results of the interim
periods.




3




Item
1:  FINANCIAL STATEMENTS




AFP Imaging Corporation and
Subsidiaries


Condensed Consolidated Balance Sheets - March 31, 2008 and
June 30, 2007




Assets
              
              March 31,
                2008
              
              June
      30,
                2007
              
              Liabilities and
      Shareholders' Equity
              March
      31,
                2008
              
              June
      30,
                2007(Unaudited)
              
              
              
              
              
              (Unaudited)Current
    Assets:
              
              
              
              
              
              
              Current
      Liabilities:Cash and cash
      equivalents
              
              $
              659,671
              
              $
              921,632
              
              Current portion of long-term
      debt
              
              $
              2,359,364
              
              $
              536,727Accounts receivable,less
      allowance for
                doubtful
      accounts of $837,940 and $130,000, respectively
              
              
              
              
              
              
              
              Accounts
      payable
              
              
              3,256,524
              
              
              2,834,875Accrued expenses and other current
      liabilities
              
              
              2,799,176
              
              
              2,887,5843,452,793
              
              
              5,030,579
              
              Total current
      liabilities
              
              
              8,415,064
              
              
              6,259,186Inventories
              
              
              6,091,080
              
              
              6,395,052Prepaid expenses and other current
      assets
              
              
              389,067
              
              
              179,771
              
              Deferred
      liabilities
              
              
              118,505
              
              
              213,860Deferred income
      taxes
              
              
              552,756
              
              
              926,603
              
              Long-term
    debt
              
              
              5,252,253
              
              
              5,822,347Total current
      assets
              
              
              11,145,367
              
              
              13,453,637
              
              Deferred income
      taxes
              
              
              642,827
              
              
              -Total
      liabilities
              
              
              14,428,649
              
              
              12,295,393Commitments
      and Contingencies (Note 9)Property and
      equipment
              
              
              
              
              
              
              
              Shareholders’
      Equity:
                Preferred stock -$.01 par
      value; authorized
                5,000,000
      shares, none issued
                Common stock,$.01 par
      value; authorized
                30,000,000
      shares, issued and outstanding
                17,928,800
      shares at March 31, 2008, and
                June
      30, 2007At cost
              
              
              2,328,010
              
              
              2,141,123
              
              
              
              -
              
              
              -Less accumulated
      depreciation
              
              
              (1,828,617
              )
              
              (1,602,121
              )499,393
              
              
              539,002179,288
              
              
              179,288Deferred income
      taxes
              
              
              281,507
              
              
              369,115
              
              Common stock
      warrants
              
              
              91,131
              
              
              91,131Other
assets
              
              
              327,923
              
              
              381,905
              
              Paid-in capital in excess of
      par
              
              
              25,444,176
              
              
              25,404,045Goodwill
              
              
              4,469,183
              
              
              3,846,405
              
              Accumulated
      deficit
              
              
              (14,570,257
              )
              
              (10,760,543
              )Other
      intangibles
              
              
              8,974,921
              
              
              8,580,762
              
              Cumulative translation
      adjustment
              
              
              125,307
              
              
              (38,488
              )Total
      shareholders’ equity
              
              
              11,269,645
              
              
              14,875,433Total
      Assets
              
              $
              25,698,294
              
              $
              27,170,826
              
              Total
      Liabilities and Shareholders’
                Equity
              
              $
              25,698,294
              
              $
              27,170,826


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
      31,2008
              
              
              2007
              
              
              2008
              
              
              2007Net
      sales
              
              $
              8,562,300
              
              
              $
              7,126,326
              
              
              $
              24,669,738
              
              
              $
              20,503,091Cost
      of sales
              
              
              5,044,692
              
              
              
              4,680,120
              
              
              
              14,505,785
              
              
              
              13,164,432Gross
      profit
              
              
              3,517,608
              
              
              
              2,446,206
              
              
              
              10,163,953
              
              
              
              7,338,659Selling,
      general and administrative expenses
              
              
              4,543,187
              
              
              
              2,651,343
              
              
              
              11,334,969
              
              
              
              7,174,740Amortization
      of intangibles
              
              
              314,482
              
              
              
              ---
              
              
              
              906,764
              
              
              
              ---Research
      and development expenses
              
              
              495,855
              
              
              
              167,554
              
              
              
              1,498,859
              
              
              
              541,0905,353,524
              
              
              
              2,818,897
              
              
              
              13,740,592
              
              
              
              7,715,830Operating
      loss
              
              
              (1,835,916
              )
              
              
              (372,961
              )
              
              
              (3,576,639
              )
              
              
              (377,171
              )Foreign
      currency gain on intercompany note
              
              
              992,678
              
              
              
              ---
              
              
              
              2,088,024
              
              
              
              ---Interest
      expense, net of (interest income)
              
              
              220,613
              
              
              
              (13,530
              )
              
              
              714,077
              
              
              
              (70,442
              )Loss
      before provision for income taxes
              
              
              (1,063,851
              )
              
              
              (359,161
              )
              
              
              (2,202,692
              )
              
              
              (306,729
              )Provision
      for income taxes
              
              
              307,644
              
              
              
              19,768
              
              
              
              1,607,022
              
              
              
              34,412Net
      loss
              
              $
              (1,371,495
              )
              
              $
              (378,929
              )
              
              $
              (3,809,714
              )
              
              $
              (341,141
              )Net
      loss per common share:Basic
              
              $
              (.08
              )
              
              $
              (.03
              )
              
              $
              (.21
              )
              
              $
              (.03
              )Diluted
              
              $
              (.08
              )
              
              $
              (.03
              )
              
              $
              (.21
              )
              
              $
              (.03
              )Weighted
      average outstanding common stock:Basic
              
              
              17,928,800
              
              
              
              12,428,800
              
              
              
              17,928,800
              
              
              
              12,410,604Diluted
              
              
              17,928,800
              
              
              
              12,428,800
              
              
              
              17,928,800
              
              
              
              12,410,604
  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, 2008 and 2007
 (Unaudited)


Comprehensive
                Loss
              
              Common
      Stock
              
              Common
      Stock
                Warrants
              
              Paid-in-Capital
              
              Accumulated
                Deficit
              
              Foreign
                Currency
                Translation
                Adjustment
              
              TotalBalance
      June 30, 2006
              
              $
              --
              
              $
              95,682
              
              $
              110,931
              
              $
              11,805,852
              
              $
              (6,087,719
              )
              $
              --
              
              $
              5,924,746Issuance
      of 82,806 shares of common stock in connectionwith the exercise of common stock warrants
              
              
              --
              
              
              828
              
              
              (19,800
              )
              
              18,972
              
              
              --
              
              
              --
              
              
              --Adjustment
      to reclassify common stock subject toregistration 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 stockin May 2006
              
              
              --
              
              
              --
              
              
              --
              
              
              (12,569
              )
              
              --
              
              
              --
              
              
              (12,569
              )Net
      loss for nine months ended March 31, 2007
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              (341,141
              )
              
              --
              
              
              (341,141
              )Balance
      March 31, 2007
              
              
              --
              
              $
              124,288
              
              $
              91,131
              
              $
              16,571,129
              
              $
              (6,428,860
              )
              
              --
              
              $
              10,357,688Balance
      June 30, 2007
              
              $
              --
              
              $
              179,288
              
              $
              91,131
              
              $
              25,404,045
              
              $
              (10,760,543
              )
              $
              (38,488
              )
              $
              14,875,433Foreign
      currency translation gain
              
              
              163,795
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              163,795
              
              
              163,795Stock
      based compensation expense
              
              
              --
              
              
              --
              
              
              --
              
              
              40,131
              
              
              --
              
              
              
              
              
              40,131Net
      loss for nine months ended March 31, 2008
              
              
              (3,809,714
              )
              
              --
              
              
              --
              
              
              --
              
              
              (3,809,714
              )
              
              --
              
              
              (3,809,714
              )Comprehensive
      loss
              
              
              (3,645,919
              )
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              --
              
              
              --Balance
      March 31, 2008
              
              $
              --
              
              $
              179,288
              
              $
              91,131
              
              $
              25,444,176
              
              $
              (14,570,257
              )
              $
              125,307
              
              $
              11,269,645
  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
      31,2008
              
              
              2007Cash
      flows from operating activities:Net
      loss
              
              $
              (3,809,714
              )
              
              $
              (341,141
              )Adjustments
      to reconcile net (loss)/income to net cash used by operating
      activities-Depreciation
      and amortization
              
              
              1,166,085
              
              
              
              177,044Amortization
      of discount on term loan
              
              
              152,321
              
              
              
              ---Non-cash
      compensation expense
              
              
              40,131
              
              
              
              42,329Provision
      for losses on accounts receivable
              
              
              683,494
              
              
              
              20,000Exchange
      rate effect on intercompany note
              
              
              (2,088,024
              )
              
              
              ---Write-off
      of deferred financing costs
              
              
              ---
              
              
              
              75,000Marked
      to market gain on Euro Hedge contract
              
              
              ---
              
              
              
              (137,237
              )Deferred
      income taxes
              
              
              1,161,841
              
              
              
              ---Change
      in assets and liabilities:Decrease/(increase)in
      accounts receivable
              
              
              1,093,691
              
              
              
              (191,750
              )Decrease/(increase)
      in inventories
              
              
              608,173
              
              
              
              (73,088
              )(Increase)/decrease
      in prepaid expenses and other assets
              
              
              (135,249
              )
              
              
              4,951Increase
      in accounts payable
              
              
              21,219
              
              
              
              396,356(Decrease)/increase
      in accrued expenses and other current liabilities
              
              
              (391,992
              )
              
              
              75,371(Decrease)/increase
      in deferred liabilities
              
              
              (95,355
              )
              
              
              147,745Total
      adjustments
              
              
              2,216,335
              
              
              
              536,721Net
      cash (used in)/provided by operating activities
              
              
              (1,593,379
              )
              
              
              195,580Cash
      flows from investing activities:Purchases
      of property and equipment
              
              
              (141,213
              )
              
              
              (118,616
              )Costs
      related to acquisition of QR
              
              
              ---
              
              
              
              (1,605,489
              )Net
      cash used in investing activities
              
              
              (141,213
              )
              
              
              (1,724,105
              )Cash
      flows from financing activities:Borrowing
      of debt
              
              
              1,399,601
              
              
              
              385,618Repayment
      of debt
              
              
              (462,963
              )
              
              
              ---Payment
      of fees associated with issuance of common stock in May
    2006
              
              
              ---
              
              
              
              (12,569
              )Net
      cash provided by financing activities
              
              
              936,638
              
              
              
              373,049Exchange
      rate effect on cash and cash equivalents
              
              
              535,993
              
              
              
              ---Net
      decrease in cash and cash equivalents
              
              
              (261,961
              )
              
              
              (1,155,476
              )Cash
      and cash equivalents, at beginning of period
              
              
              921,632
              
              
              
              5,213,289Cash
      and cash equivalents, at end of period
              
              $
              659,671
              
              
              $
              4,057,813Supplemental
      cash flow disclosures:Cash
      paid during the periods for-Interest
              
              $
              587,962
              
              
              $
              96,508Income
      taxes, net of refunds
              
              $
              750,447
              
              
              $
              27,482Supplemental
      schedule of non cash activity:Cashless
      exercise of common stock warrants
              
              
              ---
              
              
              $
              19,800Equipment
      under capital lease
              
              $
              35,872
              
              
              
              ---
  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,
2008


(Unaudited)





(1)
General :


AFP
Imaging Corporation (together with its subsidiaries, the “Company”) was
organized on September 20, 1978 under the laws of the State of New
York.  Since such date, the Company has been engaged in the business
of designing, developing, manufacturing and distributing equipment for
generating and/or capturing medical and dental diagnostic images.  The
products utilize electronic and radiographic technologies, as well as the
chemical processing of photosensitive materials.  The Company is ISO
9001 certified.  Medical, dental, veterinary and industrial
professionals use these products.  The Company’s products are
distributed to worldwide markets under various brand names and trademarks
through a network of independent and unaffiliated dealers.  Certain
digital imaging products are also sold and distributed by the Company directly
to dental professional end users.  The Company has one business
segment - medical/dental.





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


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


·
            enhancing
      both its domestic and international distribution channels,
    and


·
            expanding its world-wide market
      presence in the diagnostic dental and medical imaging fields.





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





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





The
accounting policies followed during the interim periods reported on herein are
in conformity with accounting principles generally accepted in the United States
and are consistent with those applied for annual periods, as described in the
Company's consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended June 30, 2007.  The Condensed
Consolidated Balance Sheet at June 30, 2007 has been derived from the audited
financial statements.





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





(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).





Effective
July 1, 2005, the Company adopted the fair value based method of accounting for
stock-based employee compensation under the provisions of Statement of Financial
Accounting Standards No. 123 (Revised 2004), Share Based Payment (“SFAS
123R”), using the modified prospective method without restatement of the interim
periods prior to the adoption date, as described in SFAS 123R.  As a
result, the Company began recognizing expense in an amount equal to the fair
value of share-based payments (including stock option awards) on their date of
grant over the vesting period of the awards.  Under SFAS 123R, the
Company must recognize compensation expense for (1) all share-based payments
granted on or after July 1, 2005 and (2) any partially vested options as of July
1, 2005.  Prior to the adoption of SFAS 123R, the Company accounted
for these plans pursuant to Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to
Employees.   Therefore, compensation expense related to
stock option awards was not reflected in operating expenses in any period prior
to July 2005 (first quarter of Fiscal Year 2006), and prior period results have
not been restated.  For the three and nine months ended March 31,
2008, non-cash stock based compensation expense related to stock option awards
was $40,131 and $40,131 respectively.  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.  These charges have all
been included in operating expenses.





8




The fair
value of each option granted under the Company’s incentive stock plans during
the three and nine months ended March 31, 2008 and 2007 was estimated on the
date of grant using the Black-Scholes option pricing method.  Using
this model, fair value is calculated based on assumptions with respect to (a)
expected volatility of the market price of Company common stock, (b) the periods
of time over which employees, directors and other option holders are expected to
hold their options prior to exercise (expected lives), (c) expected dividend
yield on Company common stock and (d) risk-free interest rates which are based
on quoted US Treasury rates for securities with maturities approximating the
options’ expected lives.  Expected volatility has been estimated based
on actual movements in the Company’s stock price over the most recent historical
periods equivalent to the options’ expected lives.  Expected lives are
principally based on the Company’s limited historical exercise experience with
option grants with similar prices.  The expected dividend yield is
zero as the Company has never paid dividends and does not currently anticipate
paying any dividends in the foreseeable future.  There were no options
granted during the three and nine months ended March 31, 2008.  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.





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
three-month period ended September 30, 2006 in accordance with the Company’s
policy for non-employee director compensation.  All of these stock
options were issued with a ten-year life.





In April
2007, the Company granted an aggregate of 50,000 shares of Company common stock
to an employee, half of which vested immediately.  Compensation
expense amounting to $40,131 was recognized in the current quarter upon the
vesting of these options.  These options were issued with a ten-year
useful life.





(3)Per Share Data and
Significant Capital Transactions :




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 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.





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 common stock was issued and sold pursuant to the
exemption from registration pursuant to Regulation D of the Securities Act of
1933.  In connection with the transaction, the Company paid the
placement agent for the offering $407,000, or five percent of the gross proceeds
of the offering.  The proceeds were used for the purchase of
QR.  The Company granted the investors certain registration rights
with respect to the resale of the shares acquired and has registered these
shares of common stock for resale.





9




The
following is a reconciliation from basic to diluted shares for the three and
nine months ended March 31, 2008 and 2007:





Three
      months ended March 31,
            Nine
      months ended March 31,2008
            2007
            2008
            2007Basic
      Shares
            17,928,800
            12,428,800
            17,928,800
            12,410,604Dilutive:Options
            ---
            ---
            ---
            ---Warrants
            ---
            ---
            ---
            ---Diluted
      Shares
            17,928,800
            12,428,800
            17,928,800
            12,410,604





The
diluted weighted average number of shares outstanding for the three and nine
months ended March 31, 2008 and 2007 does not include the potential exercise of
the following stock options and warrants as such amounts were
anti-dilutive.




Three
      and nine months ended March 31,2008
            2007Options
            889,900
            843,900Warrants
            850,000
            50,000Diluted
      Shares
            1,739,900
            893,900





(4)
Long and Short Term
Debt:





On April
13, 2007, the Company entered into a new senior secured facility (“Revolving
Credit and Term Loan”) with a new lender (“Senior Secured Lender”) that replaced
the Company’s existing $2.5 million revolving line of credit  that was
due to expire on September 21, 2007.  The Revolving Credit and Term
Loan consists of a $5 million convertible term note and a $3 million revolving
loan facility.  The convertible term note bears interest at a rate of
ten percent (10%) per annum and provides for repayment over five years
commencing in November 2007 with a final balloon payment of all remaining
amounts due there-under on April 30, 2012.  The revolving loan bears
interest at a rate of two percent plus prime rate per annum, has a specific
formula to calculate available funds based on eligible accounts receivable and
inventory, is subject to maximum “borrowing base” limitations, and hascertain
reporting requirements to the lender.  The convertible term note, in
addition to being convertible by the Company upon the satisfaction of certain
conditions, including a trading price equal to 175% of the conversion price of
the Company’s common stock being traded on Nasdaq, is convertible by the lender
at any time into shares of common stock at a conversion price of $2.37 per share
or 2,109,705 shares based on the initial principal amount of the convertible
term note.





The
Company and each of its wholly-owned subsidiaries executed a collateral
agreement pursuant to which each such party agreed to grant a security interest
in all of its respective assets to the Senior Secured Lender as collateral
security for repayment of the loans.  The Revolving Credit and Term
Loan is secured by all of the Company’s and its wholly-owned subsidiaries’
inventory, accounts receivable, equipment, officer life insurance policies and
proceeds thereof, trademarks, licenses, patents and general
intangibles.  It is believed that the Revolving Credit and Term Loan
is sufficient to finance the Company’s ongoing working capital requirements for
the foreseeable future, based on existing sales levels.





As part of
the transaction, the Company granted to the Senior Secured Lender an aggregate
of 800,000 five-year warrants to purchase shares of the Company’s common stock
at exercise prices per share equal to $1.85 with respect to 266,666 warrants,
$2.02 with respect to an additional 266,666 warrants, and $2.19 with respect to
the remaining 266,668 warrants. The Company registered the shares of common
stock issuable upon exercise of the warrants and conversion of the term note and
must use its best efforts to keep the registration statement effective during
the applicable registration period.





The
Company has assessed whether the warrants granted to the Senior Secured Lender
should be classified as either a liability or equity in accordance with EITF
00-19, “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in a
Company’s Own Stock” and concluded that these warrants should be
classified as equity.  The Black-Scholes Method was used to value
these detachable warrants, and they have been recorded in the accompanying
Consolidated Balance Sheets at $1,114,784.  In accordance with
Accounting Principles Board Opinion No. 14, “Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants”, proceeds received from the
sale of debt with detachable stock purchase warrants are allocated to both the
debt and the warrants.  The portion allocable to warrants is accounted
for as additional paid in capital, and the remaining portion is classified as
debt.  The fair value of the warrants issued to the Senior Secured
Lender is being treated as debt discount, which will be accreted as interest
expense utilizing the interest method over the 60-month term of the Term
Loan.  The assumptions used for the Black-Scholes option pricing model
were as follows:  risk-free interest rate of 4.66%, expected
volatility of 123%, an expected life of five years, and no expected
dividends.  A summary of such follows:





10


March 31,
      2008
            June 30,
      2007Term
      Loan
            $5,000,000
            $5,000,000Fair
      value of warrants (recorded as capital in excess of par)
            (1,114,784)
            (1,114,784)Principal
      payments
            (462,963)
            ---Accretion
      of debt discount (recorded as interest expense)
            201,465
            49,144Recorded
      value of Term Loan
            $3,623,718
            $3,934,360





As of
March 31, 2008, the Company was in compliance with all terms and conditions of
the Revolving Credit and Term Loan Agreement.




QR has the
ability to borrow up to 2,000,000 Euros under various lines of credit with two
different financial institutions.  Most of these lines are guaranteed
by its accounts receivables and inventory.  These lines of credit were
granted in August 2007 and increased from 1,750,000 Euros to 2,000,000 Euros in
April 2008.  As of March 31, 2008, 918,790 Euros were outstanding and
no Euros were outstanding as of June 30, 2007.  The funds borrowed in
Italy are guaranteed by specific outstanding accounts receivable and inventory,
and the current rate of borrowing is a function of Euribor plus .75% to
1.5%.





In
November 2007, the Company purchased a new telephone system to integrate its US
locations.  This equipment was leased with a bargain purchase option,
and accounted for as a capital lease.  The value of this equipment has
been recorded as capital equipment and the resulting liability
recorded.





As of
March 31, 2008 and June 30, 2007, debt consisted of the following:




March 31,
      2008
            June 30,
      2007Senior
      Secured Lender Term Loan, net of debt discount
            $3,623,718
            $3,934,360$3.0
      Million Revolving Senior Credit Facility
            2,503,289
            2,424,714Capitalized
      lease
            32,738
            ---Foreign
      line of credit borrowings
            1,451,872
            ---7,611,617
            6,359,074Less
      current portion
            2,359,364
            536,727Total
      long-term debt
            $5,252,253
            $5,822,347





At March
31, 2008, the Company had available $496,712 of unused lines of credit under the
Revolving Senior Credit Facility, as well as the unused lines of credit
available to QR.





Due to the
short-term nature of all of the debt as well as borrowing rates currently
available to the Company, the fair market value of all of the Company's debt
approximated its carrying value.





(5)
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). The Company’s US operations uses a standard cost accounting
system in conjunction with an actual perpetual inventory system to properly
account for, control, and maintain the movement of all inventory
components.  All standard costs are reviewed periodically and updated
accordingly to verify that the standard costs approximate the actual costs. The
Company’s foreign operations implemented an inventory control system in early
fiscal year 2008.  Provision has been made for any potential losses on
obsolete or slow-moving inventory items.  At March 31, 2008 and June
30, 2007, inventories, consisted of the following:





March 31,
      2008
            
            June 30,
      2007Raw
      materials and sub-component parts
            $3,487,074
            
            $2,856,813Work-in-process
      and finished goods
            2,604,006
            
            3,538,239$6,091,080
            
            $6,395,052





11




(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, 2008, the Company has recorded a deferred
tax asset of approximately $834,000, all of which relates to its foreign
operations. In December 2007, the Company increased its valuation allowance on
the US portion of its deferred tax asset  by approximately $680,000 as
it does not believe that it is more likely than not that it will be able to
utilize these prior year operating loss carry forwards based on the recent
losses and anticipated market conditions.  However, should
circumstance change and the Company determine that it will be able to utilize
its net operating loss carry forward, such as the generation of consolidated
future taxable income, the Company will reevaluate its valuation
allowance.  In December 2007, the Company decreased its foreign
deferred tax asset by approximately $100,000 to reflect the newly enacted
Italian Finance Bill of 2008 which reduced the overall tax rate from 37.25% to
31.4%.  This decrease in the deferred tax asset as well as the
increase in the valuation allowance has been reflected as part of the tax
provision in the accompanying financial statements. The Company’s foreign
operations recorded a deferred tax liability of approximately $643,000 related
to the unrealized exchange gain on the intercompany note denominated in US
dollars, as it will only be taxed when realized and when repayment is made. The
net tax expense recorded for the three and nine months ended March 31, 2008
includes foreign taxes at the statutory rates on the Company’s foreign
operations, state income and capital taxes required in the United States and the
changes to the deferred tax accounts.





As of
March 31, 2008, the Company had approximately $7.7 million in federal net
operating loss carry forwards, and approximately $12.4 million in state net
operating loss carryforwards.  These NOL’s will begin to expire in
2010 and are subject to review by the Internal Revenue
Service.  Changes in ownership of the Company as defined in Section
382 of the Internal Revenue Code, will limit the amount of NOL’s available in
any one year.





Effective
July 1, 2007, the Company adopted the provisions of the Financial Accounting
Standards Board (“FASB”) Interpretation No. 48 (“FIN 48”), Accounting for Uncertainties in
Income Taxes – an interpretation of FASB Statement No.
109.The implementation of FIN 48 had no impact on the
Company’s financial statements.





(7)
Intangible Assets and
Goodwill :


On April
19, 2007 the Company acquired QR, an Italian corporation located in Verona,
Italy.  The purchase price was 13 million Euros and was funded through
the issuance of stock and assumption of new debt.  The results of QR’s
operations have been combined with those of the Company since the date of
acquisition.  The acquisition was accounted for under the purchase
method of accounting in accordance with FASB Statement No. 141, Business Combinations (“SFAS
141”).  The carrying values of QR’s assets and liabilities were
adjusted to their fair values on April 19, 2007 and the difference between the
purchase price and the fair value of the net assets and liabilities was recorded
as goodwill.  The goodwill and intangible amounts are maintained in
Euros on the subsidiary’s books and converted into US dollars at the respective
exchange rate.





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





June
      30, 2007
            Gross
      carrying
              amount
            Accumulated
              amortization
            NetDeveloped
      technologies
            $5,320,000
            $149,918
            $5,170,898Customer
      relationships
            3,149,000
            62,117
            3,086,883Non-compete
      contracts and other
            336,000
            13,019
            322,9818,805,000
            225,054
            8,580,762Goodwill
            3,846,405
            ---
            3,846,405Total
      intangible assets
            $12,651,405
            $225,054
            $12,427,167





March
      31, 2008
            Gross
      carrying
              amount
            Accumulated
              amortization
            NetDeveloped
      technologies
            $6,181,371
            $836,481
            $5,344,890Customer
      relationships
            3,658,860
            346,590
            3,312,270Non-compete
      contracts and other
            390,403
            72,642
            317,76110,230,634
            1,255,713
            8,974,921Goodwill
            4,469,183
            ---
            4,469,183Total
      intangible assets
            $14,699,817
            $1,255,713
            $13,444,104





12




The change
in the value of goodwill and other intangibles from the date of acquisition to
March 31, 2008, and the change in accumulated amortization are due to changes in
exchange rates, as there was a significant change in value between the US dollar
and the Euro during this time period.





(8)
Segment
Information :


As of
March 31, 2008 and June 30, 2007, the Company had one business segment,
medical/dental imaging. The
medical/dental segment operations are conducted under the Dent-X, EVA, NewTom
and AFP trade names and consist of the design, development, manufacturing,
marketing and distribution of medical and dental imaging systems and all related
accessories.  The amortization of the intangibles associated with the
acquisition of QR has been attributed to the Italian
operations.  Geographical financial information is as
follows:





Three
      months ended March 31,
            Nine
      months ended March 31,2008
            2007
            2008
            2007Net
      sales:United
      States
            $4,727,010
            $5,688,087
            $13,033,641
            $15,214,057Europe
            2,056,216
            ---
            5,321,356
            ---US
      Export Sales
            1,779,074
            1,438,239
            6,314,741
            5,289,034$8,562,300
            $7,126,326
            $24,669,738
            $20,503,091Net
      income (loss)United
      States
            $(1,772,229)
            $(378,929)
            $(4,807,361)
            $(341,141)Europe
            400,734
            ---
            997,647
            ---$(1,371,495)
            $(378,929)
            $(3,809,714)
            $(341,141)March
      31, 2008
            June
      30, 2007Identifiable
      assets:United
      States
            $6,987,247
            $9,942,023Europe
            18,711,047
            17,228,803Total
            $25,698,294
            $27,170,826





(9) Commitments
and Contingencies :


The
Company is a defendant in an environmental claim relating to a property in New
Jersey owned by the Company between August 1984 and June 1985.  This
claim relates to the offsite commercial disposition of trash and waste in a
landfill in New Jersey.  The Company maintains that its waste
materials were of a general commercial nature.  This claim was
originally filed in 1998 by the federal government in United States District
Court for the 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 many other
involved defendants, in an alternative dispute resolution (ADR) process for
smaller claims.  A recent settlement amount was offered by this group,
however, to date, no settlement has been reached.  The Company’s
insurance carrier has agreed to equally share in the proposed
settlement.  The Company has accrued $35,370 as of March 31, 2008,
based on the most recent settlement offer.  The Company does not
expect to receive any further information until after a settlement conference is
held in mid May 2008.  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 filed a complaint on May 5, 2008 in United States District Court,
Southern District of New York, against Genexa Medical, Inc., a Canadian
distributor that is past due on amounts owed to the Company.  The
complaint seeks damages for unpaid principal, interest and fees.  The
Company has recorded a reserve of $395,000, which represents the entire
principal balance.





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





13




The
Company has received notification of a complaint filed in the Superior Court of
California, County of Placer, on December 19, 2007.  The Complaint
seeks damages in excess of $25,000.  The Company has not yet been
formally served with this Complaint.  The Company, through its
attorneys, has repeatedly agreed to a settlement, but has not received any
further communication.





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





As part of
the acquisition of QR, the Company granted employment agreements to each of the
four former owners, for a total yearly commitment of 500,000
Euros.  Each agreement is for a period of five years and contains a
non-compete clause.  The Company can terminate each agreement after
the first year of employment (April 2008), in which event, any employee so
terminated is entitled to one-half of the salary for the remaining
term.





In October
2007, QR signed a non-cancelable operating lease for additional office space in
Verona, Italy.  The leasing agent is owned by three of the four former
owners of QR.  The annual rental is 39,000 Euro per year.





(10)
New Accounting
Standards :


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.  In February 2008, the FASB decided
to defer the effective date of SFAS No. 157 for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value on a recurring basis.  Therefore, the Company is required to
adopt SFAS No. 157, as applicable, beginning in July 2009.  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
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 No. 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.





In
December 2007, the FASB issued SFAS No. 141R, Business Combinations(“SFAS
No. 141R”) to replace SFAS No. 141 Business Combinations.  The
objective of this statement is to improve the relevance, representation and
comparability of financial information provided about a business combination and
its effects and establishes principles and requirements for (1) recognizing and
measuring the assets and liabilities assumed, (2) recognizing and measuring the
goodwill or bargain purchase, and (3) determining the information required to be
disclosed in the financial reports.    This statement
applies to business combinations where the acquisition date is on or after
December 15, 2008.  The Company will adopt SFAS 141R for any business
combinations completed on or after December 15, 2008.





In
December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in
Consolidated Statements-an Amendment of ARB No. 51 (“SFAS No.
160”).  The objective of SFAS No. 160 is to improve financial
information related to entities that have an outstanding non-controlling
interest in one or more subsidiaries.  The non-controlling interest in
the subsidiary is an ownership interest in the consolidated entity that should
be reported as equity in the consolidated financial statements and consolidated
net income should include (and separately disclose) the amounts of the parent
and the non-controlling interest on the income statement.  This
statement requires additional financial statement disclosures related to the
parent and the non-controlling owners of the subsidiary.  Earnings per
share amounts will be based on the amounts attributable to the
parent.  The Company is required to adopt SFAS No. 160 beginning in
July 2009.  The Company is evaluating the effect of SFAS No. 160, but
does not believe that there will be any material effect on the Company’s
financial statements.





14





In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities-an Amendment of FASB Statement No. 133
(“SFAS No. 161”).  The objective of
SFAS No. 161 is to improve financial reporting on derivative instruments and
hedging activities with enhanced disclosures.  This statement requires
disclosure of the fair values of derivative instruments and their gains and
losses in a tabular format, and provides more information about an entity’s
liquidity by requiring disclosure of derivative features that are credit–risk
related. The Company is required to adopt SFAS No. 161 beginning in January
2009.  The Company is evaluating the effect of SFAS No. 161, but does
not believe that there will be any material effect on the Company’s financial
statements.





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








15




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





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





Capital Resources and
Liquidity





The
Company’s working capital at March 31, 2008 decreased by approximately $4.46
million from June 30, 2007.  This decrease is principally due to an
increase in the current portion of the outstanding debt, based on scheduled
principal payments and increased borrowings on foreign credit lines, a decrease
in inventory, and a decrease in accounts receivable resulting from an increase
in the allowance for doubtful accounts, when compared to June 30,
2007.





Operating
cash flows were negatively impacted by the loss from operations in the current
nine month period; however, cash receipts were above average which reduced the
Company’s accounts receivable balance and provided working capital funds for the
increase in sales.  This loss is mainly attributable to lower gross
margins in the US 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
promote sales growth.  The allowance for doubtful accounts was
increased approximately $700,000 to include a Canadian distributor in arrears,
and foreign accounts receivable acquired in April 2007 as part of the
acquisition of QR, which have now been deemed uncollectable.  These
factors caused the Company to utilize its cash resources, resulting in increased
borrowings on the Company’s various credit facilities.  The Company is
continuing its policy to require advance deposits from its customers on the new,
high dollar valued equipment.  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.  The Company has registered these shares for
resale.  The common stock was issued and sold pursuant to the
exemption from registration pursuant to Regulation D of the Securities Act of
1933.  In connection with the transaction, the Company paid the
placement agent a five percent fee.  The net proceeds were used to
fund a portion of the purchase price of QR, which was completed on April 19,
2007.





On April
13, 2007, the Company entered into a Revolving Credit and Term Loan Agreement
with the Senior Secured Lender whereby the Senior Secured Lender agreed to lend
the Company an aggregate of up to $8 million in the form of a $5 million
Convertible Term Note 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 thereunder 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 loan bears interest at a
rate per annum of two percent (2%) plus the prime rate and is payable in full on
April 30, 2012, has a specific formula to calculate available funds based on
eligible accounts receivable and inventory, is subject to maximum “borrowing
base” limitations, and hascertain
reporting requirements.  This new senior secured Revolving Credit and
Term Loan Agreement replaced the Company’s previous $2.5 million senior secured
credit facility, which was due to expire on September 21, 2007.  The
proceeds were used to fund a portion of the purchase price of QR and for ongoing
working capital requirements.





As of
March 31, 2008, the Company was in compliance with all the terms and conditions
of the Revolving Credit and Term Loan Agreement.





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 the Senior Secured Lender at any time into shares of
the Company’s common stock at a fixed conversion price of $2.37 per
share.  The term loan is convertible at the Company’s option upon the
satisfaction of certain conditions, including a reported trading price equal to
175% of the conversion price, the common stock being traded on NASDAQ, and a
certain minimum trading volume, among others.  In addition, the
Company and each of its wholly-owned subsidiaries executed a collateral
agreement pursuant to which each such party agreed to grant a security interest
in all of its respective assets to the Senior Secured Lender as collateral
security for repayment of the loans.  Further, each subsidiary agreed
to guaranty performance of all of the Company’s obligations to the Senior
Secured Lender.





16




As part of
the transaction, the Company granted to the 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 with respect to 266,666 warrants, $2.02 with
respect to an additional 266,666 warrants, and $2.19 with respect to the
remaining 266,668 warrants.  The Company registered the shares of
common stock issuable upon exercise of the warrants and conversion of the term
note and must use its best efforts to keep the registration statement effective
during the applicable registration period.





The
Company’s foreign subsidiary maintains various lines of credit with two separate
financial institutions.  In April 2008, these lines were increased
from 1,750,000 Euros to 2,000,000 Euros.  The borrowings under most of
these lines of credit are guaranteed by specific foreign accounts receivable and
inventory.  These lines of credit were granted in August 2007 and
there are no restrictive covenants or subordination clauses.  As of
March 31, 2008 there was outstanding 918,790 Euros and no funds were outstanding
as of June 30, 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 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.





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 Year 2008 were approximately
$141,200, consisting mainly of tooling expenditures related to the redesign,
development and production of new imaging products.  The Company
expects to continue to finance any future capital requirements principally from
internally generated funds.  The total amount of capital expenditures
is not limited under the Company’s new Revolving Credit and Term Loan
Agreement.





The
Company’s operating cash flows in previous fiscal years generally have been
positive; however, the Company is dependent upon its Revolving Credit and Term
Loan Agreement and its foreign lines of credit to continue to finance its
ongoing operations.  The Company expects its worldwide working capital
requirements will continue to be financed by operations, both in the United
States and Italy, and from borrowings on the Revolving Credit and Term Loan
Agreement and the foreign lines of credit.  It is believed that the
Revolving Credit and Term Loan Agreement and foreign lines of credit are
sufficient to finance the Company’s ongoing worldwide working capital
requirements for the foreseeable future, based upon existing sales
levels.  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, the dispute with
its Canadian distributor, or any other pending litigation, which are reasonably
likely to result in a significant increase or decrease in its liquidity or
capital resources within the foreseeable near-term future.  As of
March 31, 2008, the Company had available $496,712 of unused credit under the
Revolving Credit and Term Loan Agreement.  As of May 2, 2008, the
Company had available $620,804 of unused credit under the Revolving Credit and
Term Loan Agreement.  The Company also had the ability to borrow on
its foreign lines of credit from the generation of any new sales and inventory
purchases.  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, product lines, or product line
distributors.  There are no assurances that the Company will be able
to identify any suitable acquisition candidate(s), or, if so identified, be able
to enter into a definitive agreement with such candidates on terms favorable to
the Company.


Off-Balance
Sheet Arrangements


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




17





Results of
Operations





Fluctuations in Operating
Results





The
results of operations for the Company have changed significantly as a result of
the acquisition of QR on April 19, 2007.  The carrying values of QR’s
assets and liabilities were adjusted to their fair values and the difference
between the purchase price and the fair value of the net assets was recorded as
goodwill and other intangibles, and is subject to periodic impairment
testing.  The goodwill and intangibles is based on the Euro cost of
the acquisition at April 19, 2007 and is maintained in Euros and is therefore
subject to fluctuations in currency between the US dollar and the Euro. The
Company’s results of operations have been and will continue to be materially
effected by the amortization costs associated with these other
intangibles.





The
Company’s operating results have varied in the past and are likely to fluctuate
in the future.  Due to historic changes 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, specifically imaging
modalities,


§
            demand
      for products and services,


§
            the
      level of product, price  and service
  competition,


§
            changes
      in product mix, which could effect profit
  margins,


§
            Federal,
      state, local or international
regulations,


§
            the
      timing of industry trade shows,


§
            currency
      fluctuations,


§
            capital
      spending budgets of customers,


§
            general
      economic trends and conditions specific to the Company’s
      industry,


§
            changes
      in the prime rate of borrowing in the United
  States,


§
            changes
      in the federal and foreign tax laws,
and


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





Nine Months Fiscal 2008
Versus Nine Months Fiscal 2007





Sales
increased approximately $4.2 million or 20.3%, between the Fiscal 2007 and
Fiscal 2008 nine-month comparable periods, principally due to increases in
volume.  Approximately $6.5 million of this increase can be attributed
to the worldwide sales of the three-dimensional dental x-ray imaging systems
manufactured by QR in Italy.  Prior to the purchase of QR, the Company
was the exclusive distributor in the United States, Canada and Latin America
(excluding Brazil) for QR’s three-dimensional x-ray imaging
system.  The Company sells this product into both the dental and
medical ENT markets.  The Company’s veterinary products business
decreased approximately 44%, mainly due to lower than anticipated demand for the
very specialized digital equine systems and general purpose analog x-ray systems
designed for general veterinary applications.  There is a continuing
strong demand for the Company’s two-dimensional filmless digital dental
radiography system and veterinary and human sales remained relatively constant
in the current nine-month period compared to the previous year.  The
Company’s other dental x-ray systems showed a decrease of 8% in the current
nine-month period as intra-oral x-rays have become a commodity
product.  The Company’s analog film processor business showed a slight
decrease of approximately 4% in the current nine-month period, due to the
transition from analog to digital imaging processing.  US health-care
professionals continue to migrate to digital imaging equipment 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 19% increase in international sales, generated
from the United States, between the periods.





Gross
profit as a percent of sales increased 5.4 percentage points between the Fiscal
2007 and Fiscal 2008 nine-month comparable periods.  This increase can
mainly be attributed to the profit margins realized from QR, offset by increases
in freight charges due to the increase in fuel costs.





Selling,
general, and administrative costs increased approximately $4.16 million or 58%,
between the Fiscal 2007 and Fiscal 2008 nine-month comparable
periods.  Approximately $2.7 million of this increase is due to
operating costs in Italy associated with the acquisition of
QR.  Included in the Italian operation’s costs is approximately
$300,000 to increase the allowance for doubtful accounts related to receivables
acquired as part of the acquisition. The balance of this increase is
attributable to the US operations, including:  (1) an approximate
$775,000 increase in general and administrative costs, which includes (a) costs
associated with the Company’s initial compliance with Section 404 of the
Sarbanes-Oxley Act of 2002, (b) increased professional fees related to the legal
and tax consolidation of the European operations, and (c) approximately $400,000
to increase the US allowance for doubtful accounts due to a delinquent Canadian
distributor; (2) approximately a $256,000 increase in technical support costs
related to the new digital equipment the Company is selling that require a
devoted infrastructure support system including installation and hardware and
software training;  (3) an increase in marketing and sales costs of
approximately $440,000 in the current nine-month period due to (a) the Company’s
continued aggressive launch into the dental and medical marketplaces for the new
three dimensional x-ray imaging equipment, including attendance at several large
international trade shows, development of new marketing and advertising
materials including a redesigned website, and the related travel expenses, (b)
the worldwide introduction of the Company’s new vertical three-dimensional CBCT
scanner, (c) pursuing various sales opportunities in both the domestic and
international markets, with specific emphasis in the growing veterinary markets,
(d) an increase in general operating expenses based on increased sales levels;
and  (4) costs associated with the development and growth of a new
distinct distribution channel to implement various methods to increase sales
levels.  Included in the Fiscal Year 2007 nine-month period is the
write-off of certain deferred financing costs incurred in the previous fiscal
year as the Company chose not to utilize that lender.





18




Amortization
of intangibles increased $714,077 or 100% and resulted from the amortization of
the other intangibles created from the acquisition of QR.  Prior to
April 2007, the Company did not have any such intangibles.





Research
and development costs increased approximately $957,800, or 177%, between the
Fiscal 2007 and Fiscal 2008 nine-month comparable periods.  The
Company’s research and development efforts and technologies were significantly
enhanced by the acquisition of QR.  Most of this increase is due to
research and development efforts in Italy.  The Company continues to
invest in the design, development and refinement of its existing digital imaging
products, as well as the design and development of new digital imaging products
for the human dental and broad veterinary applications, including both hardware
and software enhancements.  Research and development costs may
fluctuate between reporting periods, due to changing research and development
consulting agreements, initiation or completion of certain project tasks, and
market demands.  Research and development costs may increase over the
next several years as the Company evaluates its strategy to develop and market
additional high tech digital products.  The Company has integrated its
research and development between both locations.





For the
nine-month period ended March 31, 2008, the gain on foreign currency
transactions amounted to $2,088,024.  This gain is an unrealized
non-cash foreign currency gain on the US dollar denominated intercompany note
and recorded by QR.  A deferred tax liability has been recorded in
Italy for this unrealized gain, in accordance with local laws.  There
was no foreign currency gain or loss recorded in the nine- month period ended
March 31, 2007.





For the
nine-month period ended March 31, 2008, net interest expense was
approximately  $714,000.  For the nine-month period ended
March 31, 2008, net interest income was approximately $70,400.  There
was minimal interest income in Fiscal Year 2008.  The decrease in
interest income is due to the utilization of all cash raised from the private
placements in Fiscal Years 2007 and 2006 for the acquisition of QR in April
2007.  There was approximately $734,000 of interest expense in the
current nine-month period, compared to approximately $106,000 in the comparable
period in the prior year.  The current nine-month period had
approximately $6.5 million more in average borrowings on the senior secured debt
and foreign lines of credit, and had a slightly higher average interest
rate.  The significant increase in borrowings was used to fund a
portion of the purchase price of QR and to provide continued working capital for
the growth of the new digital imaging product lines.





The
Company made several small state tax payments in the US in the nine-months ended
March 31, 2008, based on the consolidated loss from operations and made the
required national and local tax payments in Italy for calendar years 2006, 2007
and 2008, based on the foreign operations, as required by local
law.  The Company recorded a provision for taxes on QR’s operations at
the combined required statutory tax rate.  The Company has a deferred
tax asset of approximately $834,000, all of which relates to its foreign
operations.  The Company increased its valuation allowance on the US
portion of its deferred tax asset by approximately $680,000 in the second
quarter of the current Fiscal Year, as it does not believe that it is more
likely than not that it will be able to utilize these prior year operating loss
carry forwards based on the recent losses and anticipated market
conditions.  The Company has accounted for the recently enacted
Italian Finance Bill of 2008 which reduced the overall tax rate from 37.25% to
31.4%, and accordingly decreased its foreign deferred tax asset by approximately
$100,000 in the second quarter of the current Fiscal Year.  The
decrease in the deferred tax asset as well as the increase in the valuation
allowance has been reflected as part of the tax provision in the accompanying
financial statements.  The Company’s foreign operations recorded a
deferred tax liability of approximately $643,000 related to the considerable
unrealized exchange gain on the intercompany note denominated in US dollars, as
it will only be taxed when realized and when repayment is made.  The
Company had approximately $7.7 million in federal net operating loss
carryforwards, and approximately $12.4 million in state net operating loss carry
forwards, as of March 31, 2008.





Third Quarter Fiscal 2008
Versus Third Quarter Fiscal 2007





Sales for
the third quarter fiscal year 2008 were $8.56 million, an increase of
approximately $1.4 million, or 20.2% compared to the third quarter fiscal 2007,
principally due to increases in volume.  Approximately $2.97 million
of this increase can be attributed to the worldwide sales of the
three-dimensional dental x-ray imaging systems manufactured by QR in
Italy.  Prior to the purchase of QR, the Company was the exclusive
distributor in the United States, Canada and Latin America (excluding Brazil)
for QR’s three-dimensional dental x-ray imaging system.  The Company
sells this product into both the dental and medical ENT market.  The
Company’s veterinary products business decreased considerably due to lower than
anticipated demand for the very specialized digital equine systems and general
purpose analog x-ray systems designed for general veterinary
applications.  There was a decrease for the Company’s two-dimensional
filmless digital dental radiography system as the Company continues to
transition to a direct sell sales force, from a dealer specific sales
force.  The Company’s other dental x-ray systems showed a slight
decrease in the current quarter as intra-oral x-rays have become a commodity
product.  The Company’s analog film processor business showed a
decrease of approximately 7% in the current quarter, due to the transition from
analog to digital imaging processing.  US health-care professionals
continue to migrate to digital imaging equipment that 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 23.7% increase in international sales, generated from
the United States, between the periods.





19




Gross
profit as a percent of sales increased 6.8 percentage points between the third
quarter Fiscal 2007 and the third quarter Fiscal 2008 comparable
periods.   This increase can mainly be attributed to the profit
margins realized from QR.





Selling,
general, and administrative costs increased approximately $1.9 million or 71%,
between the third quarter Fiscal 2007 and the third quarter Fiscal
2008.  Approximately $1.35 million of this increase is due to
operating costs in Italy associated with the acquisition of
QR.  Included in the Italian operation’s costs is approximately
$300,000 to increase the allowance for doubtful accounts related to accounts
receivables acquired as part of the acquisition.  The balance of this
increase is mainly due to increases in general and administrative costs as
marketing and technical support were fairly constant between the two
periods.  The increase in general and administrative costs is
attributable to (1) approximately $400,000 to increase the US allowance for
doubtful accounts due to a delinquent Canadian distributor, (2) the expensing of
stock options issued in Fiscal Year 2007, that fully vested in the current
quarter, and (3) costs associated with the Company’s initial compliance with
Section 404 of the Sarbanes-Oxley Act of 2002.





Amortization
of intangibles in the third quarter Fiscal 2008 compared to the prior year
increased $314,482 or 100% and resulted from the amortization of the other
intangibles created from the acquisition of QR.  Prior to April 2007,
the Company did not have any such intangibles.





Research
and development costs increased approximately $328,300, or 195%, between the
third quarter Fiscal 2007 and third quarter Fiscal 2008.  The
Company’s research and development efforts and technologies were significantly
enhanced by the acquisition of QR.  Most of this increase is due to
research and development efforts in Italy.  The Company continues to
invest in the design, development and refinement of its existing digital imaging
products, as well as the design and development of new digital imaging products
for the human dental and broad veterinary applications, including both hardware
and software enhancements.  Research and development costs may
fluctuate between reporting periods, due to changing research and development
consulting agreements, initiation or completion of certain project tasks, and
market demands.  Research and development costs may increase over the
next several years as the Company evaluates its strategy to develop and market
additional high tech digital products.





For the
third quarter Fiscal 2008, the gain on foreign currency transactions amounted to
$992,678.  This gain is an unrealized non-cash foreign currency gain
on the US dollar denominated intercompany note and recorded by QR.  A
deferred tax liability has been recorded in Italy for this unrealized gain, in
accordance with local laws.  There was no foreign currency gain or
loss recorded in the three month period ended March 31, 2007.





For the
third quarter Fiscal 2008, net interest expense was approximately
$220,000.  For the third quarter Fiscal 2007, net interest income was
approximately $13,500.  There was minimal interest income in the third
quarter Fiscal 2008 compared to approximately $53,000 in the third quarter
Fiscal 2007.  The decrease in interest income is due to the
utilization of all cash raised from the private placements in Fiscal Years 2007
and 2006 for the acquisition of QR in April 2007.  There was
approximately $225,000 of interest expense in the current third quarter,
compared to approximately $39,500 in the comparable period in the prior
year.  The current quarter had approximately $6.0 million more in
average borrowings on the senior secured debt and foreign lines of
credit.  The significant increase in borrowings was used to fund a
portion of the purchase price of QR and to provide continued working capital for
the growth of the new digital imaging product lines.





The
Company made several small state tax payments in the US in the third quarter
Fiscal 2008, based on the consolidated loss from operations and made the
required national and local tax payments in Italy for Fiscal Year 2008, based on
the foreign operations, as required by local law.  The Company
recorded a provision for taxes on QR’s operations at the combined required
statutory tax rate.  The Company has a net deferred tax asset of
approximately $834,000, all of which relates to its foreign
operations.  The Company’s foreign operations recorded a deferred tax
liability of approximately $643,000 related to the sizeable unrealized exchange
gain on the intercompany note denominated in US dollars, as it will only be
taxed when realized and when repayment is made.  The Company had
approximately $7.7 million in federal net operating loss carry forwards, and
approximately $12.4 million in state net operating loss carry forwards as of
March 31, 2008.





20




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 prior to the current quarter, the Company
had not had any significant bad debt write-offs.  In the quarter ended
March 31, 2008, the Company increased its allowance for doubtful accounts by
$700,000 to include anticipated losses from accounts receivables acquired as
part of the acquisition of QR in April 2007, and a delinquent Canadian
distributor. The allowance for doubtful accounts is based on the Company’s
continued 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, finished goods, 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 current warranty information available to
the Company.





The
Company offers extended warranties in connection with sales of its digital
sensors.  The Company continues to specifically monitor the rate and
costs of these claims and reviews the adequacy of its warranty liability and
makes any changes as, and if, deemed 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.





21





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 and liabilities reflect the tax
rates expected to be in effect in the period in which the differences are
expected to reverse.  Any changes in tax laws which affect the
effective tax rates will affect the deferred tax asset and will be reflected in
the accompanying current tax provision.  The Company records a
valuation allowance to reduce its tax asset when it is more likely than not that
a portion of the amount may not be realized.  The Company estimates
its valuation allowance based on an estimated forecast of its future
profitability.  Any significant changes in future profitability
resulting from variations in future revenues or expenses could affect the
valuation allowance on the deferred tax asset and operating results could be
affected.  In reviewing the valuation allowance, the Company considers
future taxable income and determines whether it is more likely than not that a
portion of the deferred tax asset will be realized.  Changes in these
circumstances, such as an increase or decline in estimated future taxable
income, would result in a re-determination of the valuation
allowance.  In the second quarter Fiscal Year 2008, the Company
increased its valuation allowance on the US portion of its deferred tax asset by
approximately $680,000, as it does not believe that it is more likely than not
that it will be able to utilize these prior year operating loss carry forwards
based on the recent losses and anticipated market conditions. The Company has
recorded deferred tax assets and liabilities associated with its foreign
operations.  Certain tax assets were acquired upon the acquisition of
QR in April 2007 and primarily relate to the financial statement carrying amount
of existing assets and liabilities and their respective tax bases.





Goodwill and Other
Intangibles


Prior to
April 2007, the Company did not have any long-lived assets or
goodwill.  Long-lived assets held for use by the Company will be
reviewed for impairment whenever circumstances provide evidence that suggests
the carrying amount of the asset may not be recoverable.  The Company
will also perform ongoing impairment analysis on intangible assets related to
technology.  Determination of whether impairment exists will be based
upon comparison of the identifiable cash flows of the assets to the carrying
values of the respective assets, and if impaired the value of the asset will be
reduced.  Goodwill is not amortized, but will be tested for impairment
on an annual basis each June 30th, or whenever circumstances or events indicate
that the carrying amount may not be recoverable.  The impairment tests
will be based on a comparison of the fair value of the reporting unit to the
carrying value of the reporting unit.  Any identified impairment will
result in a charge to reduce the carrying value of the associated goodwill.Goodwill
and intangibles have been recorded on QR’s books in Euros in accordance with
generally accepted accounting principles as applied in the United States, and
therefore, their historical carrying values are subject to fluctuations in the
US dollar/Euro exchange rates.





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.





Exchange Rates and Currency
Conversion


The US
dollar is the Company’s reporting currency; its functional currency depends on
the country of operation.  For the nine-months ended March 31, 2008, a
significant amount of revenues and expenses were denominated in
Euros.  During this period the US dollar/Euro exchange rate has
continued to significantly fluctuate.  The amounts for Fiscal Year
2007 were not significant as QR was acquired in April 2007 and the rates did not
fluctuate significantly between the acquisition date and June 30,
2007.  The Company has recorded the intangibles related to the
acquisition of QR in Euros, and therefore, the gross carrying amount of these
intangibles will fluctuate with changes in the US dollar/Euro exchange
rate.  The Company has established an intercompany note related to the
acquisition of QR denominated in US dollars, and therefore there is an
unrealized gain or loss recorded on this note as the US dollar/Euro exchange
rates fluctuate.







Item 3: Quantitative and Qualitative Disclosures About Market
Risk


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





22


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





The
Company’s earnings and cash flows are subject to foreign currency exchange rate
risk, specifically the Euro/Dollar.  The Company does not believe that
it is materially exposed to foreign currency exchange rate risk due to the
volume of purchases in foreign currency relative to purchases in the functional
currency; however, the relative strength of the Dollar to the Euro does affect
the Company’s gross profit.  The Company continuously monitors all
changes in foreign currency and may adjust its pricing to customers to reflect
these changes.  The Company had purchased  and settled in
Fiscal Year 2007, a Euro hedge contract relative to the acquisition of QR to
limit the Company’s exposure to the Euro/Dollar exchange.  As of March
31, 2008, the Company did not have any outstanding hedge contracts.








Item
4:  Controls and Procedures





(a) Evaluation of disclosure
controls and procedures





The
Company’s 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, 2008, 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  third quarter ended March 31, 2008, 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.







23




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, 2007, and to the references therein, for a discussion of all
material pending legal proceedings to which the Company and its subsidiaries are
parties.





There were
several mediation sessions held in early 2008 relating to the environmental
claim involving a property in New Jersey owned by the Company between August
1984 and June 1985.  The Company has authorized their attorneys for
this matter to proceed with a possible settlement of which the Company’s
insurance carrier has agreed to equally share in this proposed
settlement.  The next settlement conference is  scheduled
for mid-May 2008.





The
Company filed a complaint on May 5, 2008 in United States District Court,
Southern District of New York, against Genexa Medical, Inc., a Canadian
distributor that is past due on amounts owed to the Company.  The
complaint seeks damages for unpaid principal, interest and fees.  The
Company has recorded a reserve of $395,000, which represents the entire
principal balance.





The
Company has received notification of a complaint filed in the Superior Court of
California, County of Placer, on December 19, 2007.  The Complaint
seeks damages in excess of $25,000.  The Company has not yet been
formally served with this Complaint.  The Company, through its
attorneys, has repeatedly agreed to a settlement, but has not received any
further communication.





In October
2007, the Company settled the lawsuit filed in May 2007 in the Supreme Court of
Orange County, New York, whereby it was named as a third party defendant in a
lawsuit which alleged that the Company’s negligence in manufacturing, designing,
assembling and distributing its digital radiographic sensors caused damages to
the plaintiff.  The Company’s responsibility for the settlement was
approximately $8,300.  The Company received a Stipulation
Discontinuing Action in this matter.





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








Item
6:__Exhibits.




31.1
      -
            Certification
      of Co-Chief Executive Officer pursuant to Exchange Act Rule 13a – 14
      (a).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.




24





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
      VozickDavid
      VozickChairman
      of the Board,(Co-Chief
      Executive Officer)Secretary,
      TreasurerDate:  May
      15, 2008/s/Donald
      RabinovitchDonald
      RabinovitchPresident(Co-Chief
      Executive Officer)Date:  May
      15, 2008/s/Elise
      NissenElise
      NissenChief
      Financial Officer(Principal
      Financial and Accounting Officer)Date:  May
      15, 2008