# UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549

# FORM 10-QSB

# QUARTERLY REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

Commission File Number: 1-11140

OPHTHALMIC IMAGING SYSTEMS

|California                      |  | 94-3035367                       
|------------------------------- |  | ---------------------------------
|(State or other jurisdiction of |  | (IRS Employer Identification No.)
|incorporation or organization)  |  |                                  

(916) 646-2020(Issuers telephone number)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d)
of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes 
  No

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

As of August 11, 2006, 16,085,652 shares of common stock,
no par value, were outstanding.

Transitional Small Business
Disclosure Format:  Yes     No



---

OPHTHALMIC IMAGING
SYSTEMS

FORM 10-QSB

FOR THE QUARTER ENDED
June 30, 2006

|PART I  | FINANCIAL INFORMATION                                                                             | Page
|------- | ------------------------------------------------------------------------------------------------- | ----
|Item 1. | Financial Statements (unaudited)                                                                  |     
|        | Condensed Balance Sheet as of June 30, 2006                                                       | 2   
|        | Condensed Statements of Income for the Three and Six Months ended June 30, 2006 and June 30, 2005 | 3   
|        | Condensed Statements of Cash Flows for the Six Months ended June 30, 2006 and June 30, 2005       | 4   
|        | Notes to Condensed Financial Statements                                                           | 5   
|Item 2. | Management's Discussion and Analysis or Plan of Operation                                         | 11  
|Item 3. | Controls and Procedures                                                                           | 16  
|16     
|Item 6. | Exhibits                                                                                          | 16  

i



---

PART I      FINANCIAL
INFORMATION

|ITEM 1. |  | FINANCIAL
STATEMENTS
|------- |  | --------------------

1



---

Ophthalmic Imaging
Systems

Condensed Balance Sheet

June 30, 2006

(Unaudited)

|                                                          | 
|--------------------------------------------------------- | 
|Assets                                                    | 
|Current assets:                                           | 
|Cash and cash equivalents                                 | 
|Accounts receivable, net                                  | 
|Receivable from related party                             | 
|Inventories, net                                          | 
|Prepaid expenses and other current assets                 | 
|Deferred tax asset                                        | 
|                                                          | 
|Total current assets                                      | 
|                                                          | 
|Furniture and equipment, net of accumulated               | 
|depreciation and amortization of $354,521                 | 
|Restricted cash                                           | 
|Licensing Agreement                                       | 
|Other assets                                              | 
|                                                          | 
|Total assets                                              | 
|                                                          | 
|Liabilities and Stockholders' Equity                      | 
|Current liabilities:                                      | 
|Accounts payable                                          | 
|Accounts payable to related party                         | 
|Accrued liabilities                                       | 
|Deferred extended warranty revenue                        | 
|Customer deposits                                         | 
|Lease payable- current portion                            | 
|                                                          | 
|Total current liabilities                                 | 
|                                                          | 
|Noncurrent Liabilities:                                   | 
|Lease payable, less current portion                       | 
|                                                          | 
|Total liabilities                                         | 
|                                                          | 
|Stockholders' equity:                                     | 
|Common stock, no par value, 35,000,000 shares authorized; | 
|16,089,162 issued and outstanding                         | 
|Accumulated deficit                                       | 
|                                                          | 
|Total stockholders' equity                                | 
|                                                          | 
|Total liabilities and stockholders' equity                | 
|                                                          | 

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

2



---

Ophthalmic Imaging
Systems

Condensed Statements of
Income

(Unaudited)

|                                          | Three months ended June 30, |      | Six months ended June 30, |            |     
|----------------------------------------- | --------------------------- | ---- | ------------------------- | ---------- | ----
|                                          | 2006                        | 2005 |                           | 2006       | 2005
|Net revenues                              |                             |      | $                         | 3,817,196  |     
|                                          |                             |     
|Cost of sales                             |                             |      |                           | 1,691,077  |     
|                                          |                             |      |                           |            |     
|Gross profit                              |                             |      |                           | 2,126,119  |     
|                                          |                             |     
|Operating expenses:                       |                             |     
|                                          |                             |     
|Sales and marketing                       |                             |      |                           | 806,754    |     
|                                          |                             |     
|General and administrative                |                             |      |                           | 401,866    |     
|                                          |                             |     
|Research and development                  |                             |      |                           | 396,341    |     
|                                          |                             |      |                           |            |     
|Total operating expenses                  |                             |      |                           | 1,604,961  |     
|                                          |                             |      |                           |            |     
|Income from operations                    |                             |      |                           | 521,158    |     
|                                          |                             |     
|Interest and other expense, net           |                             |      |                           | 14,136     |     
|                                          |                             |      |                           |            |     
|Net income before income taxes            |                             |      |                           | 535,294    |     
|                                          |                             |     
|Income taxes                              |                             |      |                           |            |     
|                                          |                             |      |                           |            |     
|                                          |                             |     
|Net income                                |                             |      | $                         | 535,294    |     
|                                          |                             |      |                           |            |     
|                                          |                             |     
|Shares used in the calculation of basic   |                             |     
|net income per share                      |                             |      |                           | 16,087,041 |     
|                                          |                             |     
|Basic net income per share                |                             |      | $                         | 0.03       |     
|                                          |                             |      |                           |            |     
|                                          |                             |     
|Shares used in the calculation of diluted |                             |     
|net income per share                      |                             |      |                           | 17,750,871 |     
|                                          |                             |     
|Diluted net income per share              |                             |      | $                         | 0.03       |     
|                                          |                             |      |                           |            |     

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

3



---

Ophthalmic Imaging
Systems

Condensed Statements of
Cash Flows

(Unaudited)

|                                                       | Six months ended June 30,
|------------------------------------------------------ | -------------------------
|
|Operating activities:                                  |                          
|Net income                                             |                          
|Adjustments to reconcile net income to net cash        |                          
|provided by operating activities                       |                          
|Depreciation and amortization                          |                          
|Compensation expense related to FAS123R                |                          
|Non-cash interest charge                               |                          
|Net decrease in current assets other                   |                          
|than cash and cash equivalents                         |                          
|Net increase in other assets                           |                          
|Net increase  in current liabilities other             |                          
|than short-term borrowings                             |                          
|                                                       |                          
|Net cash provided by operating activities              |                          
|                                                       |                          
|Investing activities:                                  |                          
|Acquisition of furniture and equipment                 |                          
|                                                       |                          
|Financing activities:                                  |                          
|Principal payments on notes payable                    |                          
|Proceeds from note receivable from related parties     |                          
|Proceeds from notes payable, other                     |                          
|Proceeds from sale of stock                            |                          
|Advances to related parties                            |                          
|                                                       |                          
|Net cash provided by (used in) financing activities    |                          
|                                                       |                          
|Net increase in cash and equivalents                   |                          
|Cash and equivalents, beginning of the period          |                          
|                                                       |                          
|Cash and equivalents, end of  the period               |                          
|                                                       |                          
|Supplemental schedule of noncash financing activities: |                          
|Conversion of notes payable with common stock          |                          
|Conversion of interest with common stock               |                          
|Addition to receivable from                            |                          
|Related party in exchange for inventory and            |                          
|Other noncash transactions, net                        |                          
|                                                       |                          
|Supplemental schedule of cash flow information:        |                          
|Cash paid for interest                                 |                          
|Cash paid for taxes                                    |                          

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

4



---

Ophthalmic Imaging
Systems

Notes to Condensed Financial
Statements

Three and Six Month
Periods ended June 30, 2006 and 2005

(Unaudited)

|Note 1. | Basis of Presentation
|------- | ---------------------

| | The
accompanying unaudited condensed balance sheet as of June 30, 2006, condensed statements
of income for the three and six month periods ended June 30, 2006 and 2005 and the
condensed statements of cash flows for the six month periods ended June 30, 2006 and 2005
have been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-QSB and Item 310(b) of
Regulation S-B. Accordingly, they do not include all of the information and footnote
disclosures required by generally accepted accounting principles for complete financial
statements. It is suggested that these condensed financial statements should be read in
conjunction with the audited financial statements and notes thereto included in
Ophthalmic Imaging Systems (the Companys) Annual Report for the
year ended December 31, 2005 on Form 10-KSB. In the opinion of management, the
accompanying condensed financial statements include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the Companys
financial position and results of operations for the periods presented. The results of
operations for the period ended June 30, 2006 are not necessarily indicative of the
operating results for the full year.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Note 2. | Net Income Per Share
|------- | --------------------

| | Basic
earnings per share (EPS), which excludes dilution, is computed by dividing
income available to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that could occur
if securities or other contracts to issue common stock, such as stock options, result in
the issuance of common stock, which shares in the earnings of the Company. The treasury
stock method is applied to determine the dilutive effect of stock options in computing
diluted EPS.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

5



---

| | Unaudited
Three Months Ended
June 30, | Unaudited
Six Months Ended
June 30,                 
| | ------------------------------------- | ----------------------------------------------------
|
| |                                       | Numerator for basic and diluted net income per share
| |                                       |                                                     
| |                                       | Denominator for basic net income per share:         
| |                                       | Weighted average shares                             
| |                                       |                                                     
| |                                       | Effect of dilutive:                                 
| |                                       | employee/director stock options                     
| |                                       |                                                     
| |                                       | Dilutive potential common shares                    
| |                                       |                                                     
| |                                       |                                                     
| |                                       | Denominator for diluted net income per share        
| |                                       |                                                     
| |                                       | Basic net income per share                          
| |                                       |                                                     
| |                                       | Diluted net income per share                        
| |                                       |                                                     

| | As
of June 30,  2006 and June 30, 2005 there were  21,500 and  735,500  options and
 warrants,                 respectively  whose  exercise  price  exceeded the average
 market price of the stock and have                 been excluded from this computation.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Note 3. | Related Parties Transactions
|------- | ----------------------------

| | On
March 2, 2005, we entered into a Loan and Security Agreement and Promissory Note with
MediVision (the Loan Agreement) whereby we agreed to loan MediVision up to
$2,000,000. Under the terms of the agreement, interest is 7.25% per annum and is payable
on February 28, 2006 along with all outstanding principal due at that date. The note was
secured by 2,409,000 shares of our common stock owned by MediVision. The number of shares
was based on the average closing price of shares of our stock during the period covering
the last ten (10) business days of February, 2005, which average closing price was $1.11,
discounted by 25%. In the event that MediVision were to sell any shares of our stock it
owns during the period of the agreement, a minimum of 50% of the proceeds from such sales
would be required to be paid to us to reduce the outstanding amount owed. On July 28,
2005, we and MediVision entered into an amendment to the Loan Agreement whereby
MediVision repaid $1,000,000 to us, decreasing the agreed upon loan of $2,000,000 to
$1,000,000 and the amount of shares securing the loan was decreased by 1,204,500 shares.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
July 20, 2005, our Board of Directors, at MediVisions request, authorized us to
guarantee and/or provide security interests in our assets for certain of MediVisions
loans with United Mizrahi Bank Ltd. We entered into a Secured Debenture (the Debenture)
in favor of United Mizrahi Bank Ltd., in an amount of up to $2,000,000 (plus interest,
commissions and all expenses).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

6



---

| | Under
the terms of the Debenture, we guarantee the payment of all of the debts and liabilities
of MediVision to United Mizrahi Bank. The Debenture is secured by a first lien on all of
our assets. MediVision pledged 2,345,500 shares of our common stock it owns to us in
order to secure the Debenture.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amount owed to the financial institutions by MediVision and secured by us as of June 30,
2006 was approximately $2,000,000.
| | -------------------------------------------------------------------------------------------------------------------------------

| | On
July 28, 2005, pursuant to the aforementioned Debenture signed by us, MediVision executed
the amended Loan Agreement and paid back $1,000,000 of the loan from us; reducing the
amount MediVision owed us on the promissory note to $955,558. On September 20, 2005,
pursuant to a Common Stock Purchase Agreement, dated as of September 16, 2005, between
MediVision and Meadowbrook Opportunity Fund LLC, MediVision sold 400,000 shares of our
common stock to Meadowbrook Opportunity Fund LLC at a price of $1.20 per share.
MediVision used $240,000 of the proceeds from this sale to repay part of the
aforementioned loan to us, reducing the amount MediVision owes us on the promissory note
to $715,556, plus accrued interest under the loan. On December 8, 2005, MediVision sold
310,000 shares to the clients of an institutional investor at the price per share of
$1.45. MediVision used $225,000 of the proceeds from this sale to repay part of the
aforementioned loan to us, reducing the amount MediVision owes us on the promissory note
to $492,556, plus accrued interest under the loan. On February 14, 2006, MediVision sold
1 million shares of our common stock to Wasatch Advisors, Inc. at the market price of
$1.80 per share. MediVision used $492,556 of the proceeds from this sale to repay the
remaining principal balance of the aforementioned loan to us.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result of the foregoing transactions, as of June 30, 2006, MediVision owns
approximately 59% of our outstanding common stock.
| | ----------------------------------------------------------------------------------------------------------------------------------

| | On
June 28, 2006, we and MediVision entered a License and Distribution Agreement whereby
MediVision appointed us to be its exclusive distributor of a new digital imaging system
in the Americas and the Pacific Rim (excluding China and India), for a term of ten years.
In return, we paid $273,808, consisting of a cash payment of $200,000, and recognition of $73,808
of research and development advances made in previous periods.  Additionally, we are obligated to
pay an advance totalling $460,000 based on the
completion of certain phases of development of the new digital imaging system and the
completion of certain documents, and granted MediVision a license to use our OIS
WinStation software and any other applicable OIS system and the accompanying intellectual
property rights therein. The advanced funds will be recovered as we purchase new
digital imaging systems in accordance with the specified quotas.  The quota
mandates that we purchase a minimum amount of the new digital imaging systems each year.
 If we fail to satisfy our quota obligation, then we may
pay MediVision the gross profit on the shortfall units to maintain exclusivity in the
agreed upon territory. If no such shortfall payment is made, such failure to meet the
quota will constitute a material breach and MediVision may terminate the exclusivity
provision or the entire agreement. The quotas for 2007, 2008, 2009, and 2010 are 50, 70, 80, and 90 units,
respectively, and will be at least 95 units for each year thereafter. The initial term of
the agreement is for ten years, which will be automatically renewed in one year periods.
Either party may terminate the agreement with at least 6 months prior written notice,
provided that, we meet the purchase quota.
Cash payments made under this agreement for exclusive distribution rights have been
capitalized and will be amortized over the term of the agreement.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

7



---

| | At
June 30, 2006 we had recorded a net amount due to MediVision of approximately $212,000
for research and development.
| | -----------------------------------------------------------------------------------------------------------------------

| | Sales
to MediVision during the three and six months ended June 30, 2006 totaled approximately
$57,000 and $147,000. Sales to MediVision during the three and six months ended June 30,
2005 totaled approximately $139,000 and $406,000, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the three and six-month periods ended June 30, 2006, we paid approximately $238,000 and
$476,000, respectively, to MediVision for research and development performed by
MediVision on our behalf. During the three and six-month periods ended June 30, 2005, we
paid approximately $193,000 and $370,000, respectively, to MediVision for research and
development performed by MediVision on our behalf.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
June 30, 2006 we had recorded a net amount due from CCS Pawlowski, a subsidiary of
MediVision, of approximately $139,000 for products and services. Sales to CCS Pawlowski
during the three and six months ended June 30, 2006 totaled approximately $158,000 and
$212,000, respectively. Sales to CCS Pawlowski during the three and six months ended June
30, 2005 totaled approximately $15,000 and $60,000, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Note 4. | Stock Based Compensation
|------- | ------------------------

| | At
June 30, 2006, we had six stock-based compensation plans (the Plans). On
January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS)
No. 123R, Share-Based Payments, which addresses the accounting for
stock-based payment transactions whereby an entity receives employee services in exchange
for equity instruments, including stock options. SFAS No. 123R eliminates the
ability to account for stock-based compensation transactions using the intrinsic value
method under Accounting Principles Board Opinion (APB) No. 25, Accounting
for Stock Issued to Employees, and instead generally requires that such
transactions be accounted for using a fair-value based method. The Company has elected
the modified prospective transition method as permitted under SFAS No. 123R, and
accordingly prior periods have not been restated to reflect the impact of SFAS No. 123R.
The modified prospective transition method requires that stock-based compensation expense
be recorded for all new and unvested stock options that are ultimately expected to vest
as the requisite service is rendered beginning on January 1, 2006. Stock-based
compensation for awards granted prior to January 1, 2006 is based upon the
grant-date fair value of such compensation as determined under the pro forma provisions
of SFAS No. 123, Accounting for Stock-Based Compensation. The Company
issues new shares of common stock upon the exercise of stock options.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

8



---

| | The
Company uses a Black-Scholes option valuation model to determine the fair value of
stock-based compensation under SFAS No. 123R, consistent with that used for pro
forma disclosures under SFAS No. 123. The Black-Scholes model incorporates various
assumptions including the expected term of awards, volatility of stock price, risk-free
rates of return and dividend yield. The expected term of an award is generally no less
than the option vesting period and is based on the Companys historical experience.
Expected volatility is based upon the historical volatility of the Companys stock
price. The risk-free interest rate is approximated using rates available on U.S. Treasury
securities with a remaining term equal to the options expected life. The Company
uses a dividend yield of zero in the Black-Scholes option valuation model as it does not
anticipate paying cash dividends in the foreseeable future.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Stock
Options
| | -------------

| | In
calculating compensation related to stock option grants, the fair value of each stock
option is estimated on the date of grant using the Black  Scholes option pricing
model and the following weighted average assumptions:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                        | Three Months EndedJune
30, 2006 | Six Months Ended
June 30, 2006
|----------------------- | ------------------------------- | ------------------------------
|Dividend Yield          | None                            | None                          
|Expected volatility     | 71.40 %                         | 71.40                         
|Risk-free interest rate | 4.27                            | 4.27                          
|Expected term (years)   | 10                              | 10                            

| | The
Company recorded an incremental $4,000 and $13,000 of stock-based compensation expense
during the three and six months ended June 30, 2006, respectively, as a result of the
adoption of SFAS No. 123R. The following table presents the impact of the adoption
of SFAS No. 123R on selected statement of operations line items for the three and
six months ended June 30, 2006:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         | For the Three Months Ended | For the Six Months Ended |                
|------------------------ | -------------------------- | ------------------------ | ---------------
|
|
|
|Net Income               | $          535             | $          541           | $             6
|                         |                            |                          |                
|Basic Income Per Share   | $         0.03             | $         0.03           | $         ---- 
|Diluted Income Per Share | $         0.03             | $         0.03           | $         ---- 

| | A
summary of the changes in stock options outstanding under our equity-based compensation
plans during the six months ended June 30, 2006 is presented below:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               | Shares |           | Weighted
Average
Exercise Price |       | Weighted Average
Remaining
Contractual Term
(Years) |      | Aggregate
Intrinsic Value |          
|------------------------------ | ------ | --------- | ------------------------------- | ----- | --------------------------------------------------- | ---- | ------------------------- | ---------
|Outstanding at January 1, 2006 |        | 2,107,543 |                                 | $0.55 |                                                     | 7.45 |                           | 2,845,183
|Granted                        |        | 190,000   |                                 | $1.84 |                                                     | 9.95 |                           | 11,400   
|Exercised                      |        | 3,510     |                                 | $0.63 |                                                     | 0    |                           | 0        
|Forfeited/Expired              |        | 2,000     |                                 | $0.68 |                                                     | 0    |                           | 0        
|Outstanding at June 30, 2006   |        | 2,292,033 |                                 | $0.66 |                                                     | 7.90 |                           | 2,842,121
|Exercisable at June 30, 2006   |        | 1,738,991 |                                 | $0.51 |                                                     | 6.97 |                           | 2,417,917

| | The
incremental stock-based compensation expense resulting from the adoption of SFAS No.123R
represents expense related to stock options granted prior to, but not yet vested as of,
January 1, 2006. As of June 30, 2006, the Company had $40,000 of total unrecognized
expense related to non-vested stock-based compensation, which is expected to be
recognized through 2009. The total fair value of options vested during the three and
six-month periods ended June 30, 2006 was $3,359 and $12,853, respectively. Cash received
from stock option exercises for the three-month and six-month periods ended June 30, 2006
was $ 0 and $2,194, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | There
were 170,000 and 190,000 options granted for the three and six-month period ended June
30, 2006, respectively, all of which were qualified options, granted to non-executive
employees. The exercise price of the 170,000 options granted is $1.83. The exercise price
of the 20,000 options granted is $1.96. The total intrinsic value of options exercised
during the three- and six-month periods ended June 30, 2006 was $0 and $3,773,
respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

9



---

| | Prior
to the adoption of SFAS No. 123R, the Company accounted for its stock-based awards
to employees and directors using the intrinsic value method of accounting in accordance
with APB No. 25. Under the intrinsic value method, compensation cost is generally the
excess, if any, of the quoted market price of the stock at the grant or other measurement
date over the exercise price.     The Company recorded no
compensation expense under APB No. 25 and FIN No. 44 for the three and six months ended
June 30, 2005.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Had
compensation expense related to the Companys stock option awards to employees and
directors been determined under the fair value method prescribed under SFAS No. 123, the
Companys net loss and loss per share would have been the pro forma amounts set
forth in the table below:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                   | For the Three Months Ended June 30, 2005 | For the Six Months Ended June 30, 2005
|------------------------------------------------------------------ | ---------------------------------------- | --------------------------------------
|Net income as reported                                             | $         405,951                        | $         740,111                     
|Stock-based employee compensation included in net loss as reported | ---                                      | ---                                   
|                                                                  
|Stock-based employee compensation expense                         
|determined under fair value method, net of tax                     | $           (5,030)                      | $         (10,060)                    
|Net income                                                         | $         400,921                        | $         730,051                     
|Basic Income Per Share                                             | $               0.03                     | $               0.05                  
|Diluted Income Per Share                                           | $               0.03                     | $               0.05                  

|Note 5. | Warranty Obligations
|------- | --------------------

| | We
generally offer a one-year warranty to our customers. Our warranty requires us to repair
or replace defective products during the warranty period. At the time product revenue is
recognized, we record a liability for estimated costs that may be incurred under our
warranties. The costs are estimated based on historical experience and any specific
warranty issues that have been identified. The amount of warranty liability accrued
reflects our best estimate of the expected future cost of honoring our obligations under
the warranty plans. We periodically assess the adequacy of our recorded warranty
liability and adjust the balance as necessary.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

10



---

| | The
following provides a reconciliation of changes in our warranty reserve.
| | ---------------------------------------------------------------------------

|                                        | Unaudited
Three Months Ended
June 30, | Unaudited
Six Months Ended
June 30,
|--------------------------------------- | ------------------------------------- | -----------------------------------
|
|Warranty balance at beginning of period | $ 562,950                             | $ 396,981                          
|Net provision for current period        | 23,400                                | 54,000                             
|Warranty costs incurred                
|                                        | (84,250)                              | (40,968)                           
|                                        |                                       |                                    
|Warranty balance at end of period       | $ 502,100                             | $ 410,013                          
|                                        |                                       |                                    

|ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
|------- | ---------------------------------------------------------

We
make forward-looking statements in this report, in other materials we file with the
Securities and Exchange Commission (the SEC) or otherwise release to the
public, and on our website. In addition, our senior management might make forward-looking
statements orally to analysts, investors, the media, and others. Statements concerning our
future operations, prospects, strategies, financial condition, future economic performance
(including growth and earnings) and demand for our products and services, and other
statements of our plans, beliefs, or expectations, including the statements contained in
this Item 2, Managements Discussion and Analysis or Plan of Operation,
regarding our future plans, strategies and expectations are forward-looking statements. In
some cases these statements are identifiable through the use of words such as
anticipate, believe, estimate, expect,
intend, plan, project, target,
can, could, may, should, will,
would, and similar expressions. We intend such forward-looking statements to
be covered by the safe harbor provisions contained in Section 27A of the Securities Act of
1933, as amended and in Section 21E of the Securities Exchange Act of 1934, as amended
(the Exchange Act). You are cautioned not to place undue reliance on these
forward-looking statements because these forward-looking statements we make are not
guarantees of future performance and are subject to various assumptions, risks, and other
factors that could cause actual results to differ materially from those suggested by these
forward-looking statements. Thus, our ability to predict results or the actual effect of
our future plans or strategies is inherently uncertain. Factors which could have a
material adverse effect on our operations and future prospects include, but are not
limited to, changes in: economic conditions generally and the medical instruments market
specifically, legislative or regulatory changes that affect us, including changes in
healthcare regulation, the availability of working capital, and the introduction of
competing products. These risks and uncertainties, together with the other risks described
from time to time in reports and documents that we file with the SEC should be considered
in evaluating forward-looking statements and undue reliance should not be placed on such
statements. (There also are other factors that we do not describe because currently, we do
not perceive that such factors will cause actual results to differ materially from our
expectations.) Indeed, it is likely that some of our assumptions will prove to be
incorrect. Our actual results and financial position will vary from those projected or
implied in the forward-looking statements and the variances may be material. We expressly
disclaim any obligation to update or revise any forward-looking statements, whether as a
result of new information, future events, or otherwise, except as required by law.

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Overview

To
date, we have designed, developed, manufactured and marketed ophthalmic digital imaging
systems and informatics solutions and have derived substantially all of our revenues from
the sale of such products. The primary target market for our digital angiography systems
and related products has traditionally been retinal specialists. In 2003, we made a
strategic decision to expand our product offering to include the ophthalmic informatics
field. In 2004, we introduced our Ophthalmology Office line composed of Electronic
Medical Records (EMR) and Enterprise Practice Management (EPM)
software products by NextGen Healthcare Information Systems, Inc. and our Ophthalmic
Picture Archiving and Communication System (Ophthalmic PACS). This decision
enabled us to offer a wider variety of products and comprehensive solutions to our
customer base of ophthalmology departments and practices.

At
June 30, 2006, we had a stockholders equity of $6,349,476 and our current assets
exceeded our current liabilities by $5,812,231.

The
following discussion should be read in conjunction with the unaudited interim financial
statements and the notes thereto which are set forth in Item 1, Financial
Statements (unaudited). In the opinion of management, the unaudited interim period
financial statements include all adjustments, which are of a normal recurring nature,
that are necessary for a fair presentation of the results of the periods. There can be no
assurance that we will be able to achieve or sustain significant positive cash flows,
revenues, or profitability in the future.

Critical Accounting
Policies

Our
financial statements are prepared in accordance with United States generally accepted
accounting principles (GAAP). The financial information contained in the
financial statements is, to a significant extent, financial information based on
transactions and events that have already occurred. A variety of factors could affect the
ultimate value obtained when earning income, recognizing an expense, recovering an asset
or relieving a liability. Our revenue recognition policies are in compliance with
applicable accounting rules and regulations, including Staff Accounting Bulletin No. 104 (SAB
104), Revenue Recognition in Financial Statements, American Institute of Certified
Public accountants (AICPA), Statement of Position (SOP) 97-2,
Software Revenue Recognition, SOP 98-9, Modification of SOP 97-2, with Respect to Certain
Transactions and Emerging Issues Task Force Issue 00-21, Revenue Arrangements with
Multiple Deliverables. As such, revenue is recorded when there is evidence of an
arrangement, delivery has occurred, the price is fixed and determinable and
collectability is reasonably assured. Revenue from installation and training services are
recognized when such services are performed. Revenue generated from service contracts are
recognized ratably over the term of the contracts. Estimates are used relative to the
expected useful lives of depreciable assets. Management is also required to make
estimates and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements and revenues and expenses during the reporting period. Actual results could
differ from those estimates. In addition, GAAP itself may change from one previously
acceptable method to another method. Although the economics of our transactions would be
the same, the timing of the recognition of such events that would impact transactions
could change.

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Results of Operations

Revenues

On December 31, 2005, due to a continued increase in installation activity, we elected to classify
installation income within our revenues, versus a net effect within sales and marketing
expenses. We reclassified the respective 2005 amounts of $173,926 and $329,171 for the
three and six-month periods ending June 30, 2005 for comparative purposes.

Our
revenues for the second quarter ended June 30, 2006 were $3,817,196, ($3,635,883
excluding installation revenue), representing a 22% increase from revenues of $3,123,505
($2,949,579 excluding installation revenue) for the second quarter ended June 30, 2005. Revenues
for the first six months of fiscal 2006 were $7,467,890 ($7,076,829 excluding
installation revenue), representing a 22% increase from revenues of $6,118,775
($5,789,604 excluding installation revenue), for the comparable six months of fiscal
2005. The increase in revenues is due primarily to higher revenues generated from the
digital angiography systems and informatics products. Digital angiography systems and
informatics products accounted for approximately 84% and 86% of our revenue for the
second quarters of 2006 and 2005, respectively, and 86% of our revenue for the six months
ended June 30, 2006 and 2005. Service revenues accounted for approximately 16% and 14% of
our revenue for the second quarters of 2006 and 2005, respectively, and approximately 14%
of our revenue for the six months ended June 30, 2006 and 2005. Revenues from sales of
the our products to related parties were approximately $215,000 and $359,000 during the
three and six month periods ended June 30, 2006 and $184,000 and $467,000 for the
comparable three and six month periods ending June 30, 2005, respectively.

Gross Margins

Gross
margins were approximately 56% (59% before installation change) during the three and six
month periods ended June 30, 2006 as compared to 57% (59% before installation change) for
three and six month periods ended June 30, 2005. The changed presentation in connection
with presenting installation income within our revenues, versus a net effect within sales
and marketing expenses, resulted in a three percent decrease in gross margins for the
three and six month period ended June 30, 2006, and a two percent decrease in gross
margins for the three and six month periods ended June 30, 2005. We anticipate that our
gross margins will decrease, as our sales of the Ophthalmology Office software products
become more significant, because gross margins associated with the sales of these
products are lower than the majority of the products that we currently sell.

Sales and Marketing
Expenses

The
changed presentation of installation income within our revenues, versus a net effect
within sales and marketing expenses, resulted in a change in sales and marketing
expenses. We reclassified the respective 2005 amounts for comparative purposes.

Sales
and marketing expenses accounted for approximately 21% of total revenues during the
second quarter of fiscal 2006 as compared to approximately 23% during the second quarter
of fiscal 2005. Actual expenses increased to $806,754 ($811,578 before the installation
change) during the second quarter of 2006 versus $718,022 ($686,390 before the
installation change) during the second quarter of 2005. For the first six months of
fiscal 2006 and 2005 such expenses accounted for approximately 22% and 24% of total
revenues for the respective six-month

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periods.    
          Actual expenses increased to $1,651,173 ($1,640,106 before the installation
          change) during the first six months of fiscal 2006 versus $1,478,881 ($1,414,395
          before the installation change) during the first six months of fiscal 2005. The
          primary contributing factors to the increased expenses were new hires to the
          sales force and higher commissions associated with increased revenue levels.

General and
Administrative Expenses

General
and administrative expenses were $401,866 in the second quarter of fiscal 2006 and
$325,636 in the second quarter of fiscal 2005. Such expenses accounted for approximately
11% and 10% of revenues during the second quarters of 2006 and 2005, respectively.
Expenses increased to $768,900 from $638,632 during the six month periods ended June 30,
2006 and 2005, respectively. For the first six months ended June 30, 2006 and 2005, such
expenses accounted for approximately 10% of total revenues The increased expenses were
the result of increases in our sales return reserve requirements, offset by a decrease in
legal expenses due to the reimbursement of legal fees related to a lawsuit that was
settled on February 23, 2006.

Research and Development
Expenses

Research
and development expenses were $396,341 in the second quarter of fiscal 2006 and $265,404
in the second quarter of fiscal 2005. Such expenses accounted for approximately 10% and
9% of revenues during the second quarter of 2006 and 2005, respectively. For the first
six months of fiscal 2006, such expenses were $762,248 and accounted for approximately
10% of total revenues, as compared to expenses of $507,811 and accounted for
approximately 9% during the first six months of 2005. We have been and will continue to
focus our research and development efforts on new digital image capture products. We
expect our research and development expenditures to increase substantially due to our
increased focus on developing new products. Outside consultants and MediVision currently
conduct most of our research and development.

Interest and Other
Expense, net

Interest
and other expenses were ($14,136) during the second quarter of fiscal 2006 versus $51,029
during the second quarter of fiscal 2005. For the six months ended June 30, 2006 and
2005, interest and other expenses were $10,165 and $103,618, respectively. These amounts
were comprised principally of interest income, and financing facilitations provided to
certain of our customers in connection with sales of our products.

Net Income

We
recorded net income of $535,294, or $0.03 per share basic and diluted earnings, for the
second quarter ended June 30, 2006 as compared to net income of $405,951 or $0.03 per
share basic and diluted earnings for the second quarter ended June 30, 2005. For the six
months ended June 30, 2006 and 2005, we recorded net income of $1,020,170 or $0.06 per
share basic earnings and diluted earnings, as compared to $740,111, or $0.05 per share
basic and diluted earnings, respectively.

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Balance Sheet

Our
assets increased by $2,625,877 during the second quarter of fiscal 2006 as compared to
the second quarter of fiscal 2005. There was a substantial increase in cash and
equivalents of $3,847,074, generated primarily from our profitable operations and receipt
of $1,955,588 in repayments from MediVision. We have also increased our inventory and
entered a long term distribution and license agreement for a new digital imaging system.
The increase in inventory is primarily in finished goods as several orders had been
substantially completed, but did not meet all of the applicable criteria for sales
recognition. The new long term license and distribution agreement required a cash payment
of $200,000, which has been capitalized and is reflected on our balance sheet. We have
exclusive distributing rights to a new digital imaging system in the Americas and the
Pacific Rim (not including China and India) and the indicated capitalized fee will be
amortized over the term of the agreement. Our liabilities decreased by $493,280 mainly
due to the repayment and conversion of our notes to Laurus Master Fund. Our stockholders equity
increased by $3,119,158 due to net income, and the conversion of a portion of our notes
payable to Laurus Master Fund into common stock.

Liquidity and Capital
Resources

Our
operating activities generated cash of $1,642,918 during the six months ended June 30,
2006 as compared to cash generated of $1,009,309 in the six months ended June 30, 2005.
The cash generated from operations during the first six months of 2006 was principally
from net income for the period, a decrease in accounts receivable, offset by an increase
in inventory. The cash generated from operations during the first six months of 2005 was
principally from net income for the period, a decrease in inventory, and an increase of
current liabilities.

Cash
used in investing activities was $66,489 during the first six months of 2006 as compared
to $8,750 during the first six months of 2005. Our investing activities consisted of
purchases of software and equipment. We anticipate continued near-term capital
expenditures in connection with our ongoing efforts to upgrade our existing management
information and corporate communication systems. We anticipate that related expenditures,
if any, will be financed from our cash flow from operations or other financing
arrangements available to us, if any.

We
generated cash in financing activities of $436,023 during the first six months of fiscal
2006 as compared to cash used of $884,785 during the first six months of fiscal 2005. The
cash generated in financing activities during the first six months of 2006 was
principally from proceeds on the note receivable from MediVision, offset by repayments of
the debt to Laurus. The cash used in financing activities during the first six months of
2005 was principally from advances on the note receivable from MediVision and repayments
of the debt to Laurus.

On
June 30, 2006 our cash and cash equivalents were $5,953,158. Management anticipates that
additional sources of capital beyond those currently available to us may be required to
continue funding for research and development of new products and selling and marketing
related expenses for existing products.

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We
will continue to evaluate alternative sources of capital to meet our growth requirements,
including other asset or debt financing, issuing equity securities and entering into
other financing arrangements. There can be no assurance, however, that any of the
contemplated financing arrangements described herein will be available and, if available,
can be obtained on terms favorable to us.

Material Agreement

On
June 28, 2006, we and MediVision entered into a License and Distribution Agreement whereby
MediVision appointed us to be its exclusive distributor of a new digital imaging system in
the Americas and the Pacific Rim (excluding China and India), for a term of ten years. In
return, we paid $273,808, consisting of a cash payment of $200,000, and recognition of
$73,808 of research and development advances made in previous periods. Additionally, we
are obligated to pay an advance totaling $460,000 based on the completion of certain
phases of development of the new digital imaging system and the completion of certain
documents. We also granted MediVision a license to use our OIS WinStation software and any
other applicable OIS system and the accompanying intellectual property rights therein and
a license to use our patents to develop the new digital imaging system and fulfill its
obligations under this Agreement. Our foregoing appointment as an exclusive distributor is
conditional upon the payment of the advance and MediVisions successful completion of the
engineering, mass manufacture, and supply of the new
digital imaging system, which has specifically dedicated features for the retinal market,
in accordance with the technical specifications contained in the agreement.

The
advanced funds will be recovered as we purchase new digital imaging systems in accordance
with specified quotas. The quotas mandate that we purchase a minimum amount of the new
digital imaging system each year. The quotas for 2007, 2008, 2009, and 2010 are 50, 70,
80, and 90 units, respectively, and will be at least 95 units for each year thereafter. If
we fail to satisfy our quota obligation, then we may pay MediVision the gross profit on
the shortfall units to maintain exclusivity in the agreed upon territory. If no such
shortfall payment is made, such failure to meet the quota will constitute a material
breach and MediVision may terminate the exclusivity provision or the entire distribution agreement.

Under
this Agreement, we may not deal in the new digital imaging system
outside the agreed upon territory. Moreover, excluding our current products or
products derived from our current products, we may not deal in products that compete
directly with the new digital imaging system or represent or provide services to a company
which has a product or products that competes with the new digital imaging system. We also
agreed to, among other things, as confined to the agreed upon territory, (1) use
commercially reasonable efforts in promoting, marketing and selling the new digital
imaging system, (2) service customers who purchased the new digital imaging system in the
agreed upon territory, (3) diligently advertise the new digital imaging system in the
agreed upon territory in relevant journals and by direct mail, (4) cooperate with
MediVision in dealing with customer complaints concerning the new digital imaging system,
and (5) provide MediVision with a 12 month forecast of our intended purchases during such
year, including, at least 30 days prior to the beginning of each quota year, providing
MediVision with an annual purchase order that includes a breakdown of our purchases by
quarter; at least 70% of the applicable annual quota must be ordered in this annual
purchase order.

Under
this Agreement, excluding intellectual property rights, neither party is entitled to
damages as a result of loss of use, sales or profits, or any special, indirect,
incidental, or consequential loss or damage. Moreover, MediVision will not be liable to
OIS in connection with any patent infringement claim in certain instances whereby (1) the
new digital imaging system is combined with another device not manufactured by MediVision,
(2) the new digital imaging system is used in way other than for which it was designed,
and (3) the new digital imaging system is modified by OIS or a third party.

The
initial term of this agreement is for ten years, which will be automatically renewed in
one year periods. Cash payments made under this agreement for exclusive distribution
rights have been capitalized, and will be amortized over the term of the agreement.
Either party may terminate the agreement with at least 6 months prior written notice of
the intent to terminate, provided that, we meet the purchase quota.

|ITEM 3. | CONTROLS AND PROCEDURES
|------- | -----------------------

As
of the end of the period covered by this Report, our management, with the participation
of our Chief Executive Officer (principal executive officer) and the our Chief Financial
Officer (principal financial officer), evaluated the effectiveness of our disclosure
controls and procedures, as defined in Rule 13a-15(e) under the Exchange Act. Based
on that evaluation, these officers concluded that, as of June 30, 2006, our disclosure
controls and procedures were effective.

During
the quarter ended June 30, 2006, there were no changes in our internal control over
financial reporting that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.

|PART II | OTHER INFORMATION
|------- | -----------------

|ITEM 6. | EXHIBITS AND REPORTS
|------- | --------------------

|          |                                                                       
|--------- | ----------------------------------------------------------------------
|
|31.1     | Certification Required Under Section 302 of Sarbanes-Oxley Act of 2002
|31.2     | Certification Required Under Section 302 of Sarbanes-Oxley Act of 2002
|32       | Certification Required Under Section 906 of Sarbanes-Oxley Act of 2002

|* |  | Filed
herewith.
|- |  | ---------------

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SIGNATURES

In accordance with the requirements
of the Exchange Act, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

|                       |                           
|---------------------- | --------------------------
|
|                       | OPHTHALMIC IMAGING SYSTEMS
|Date:  August 14, 2006 |                           

| |        |                        
| | ------ | -----------------------
|
| | By:    | /s/ Gil Allon          
| |        |                        
| | Name:  | Gil Allon,             
| | Title: | Chief Executive Officer
| | By:    | Ariel Shenhar          
| |        |                        
| | Name:  | Ariel Shenhar,         
| | Title: | Chief Financial Officer

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