**UNITED STATES        SECURITIES AND EXCHANGE COMMISSION        Washington, 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 September 30,        2007

Commission File Number: 1-11140

**OPHTHALMIC IMAGING SYSTEMS**

(Exact name of small business issuer as        specified in its charter)

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

**221 Lathrop Way, Suite I, Sacramento, CA        95815**(Address of principal executive        offices)

**(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 x           No         o

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

As of November 14, 2007, 16,833,496 shares        ofcommonstock, no par value, were        outstanding.

Transitional Small Business Disclosure        Format:  Yes  o          No          x

         

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OPHTHALMIC IMAGING SYSTEMS

FORM 10-QSB

FOR THE QUARTER ENDED September 30,        2007

| **PART I**  | **FINANCIAL                    INFORMATION**                                                                                         | **Page** |
|-------------|--------------------------------------------------------------------------------------------------------------------------------------|----------|
|        |                                                                                                                                 |          |
| Item 1.     | Financial Statements                    (unaudited)                                                                                  | 1        |
|        |                                                                                                                                 |          |
|             | Condensed                    Balance Sheet as of September 30, 2007                                                                  | 2        |
|        |                                                                                                                                 |          |
|             | Condensed                    Statements of Income for the Three and Nine Months ended September 30, 2007 and                    2006 | 3        |
|        |                                                                                                                                 |          |
|             | Condensed                    Statements of Cash Flows for the Nine Months ended September 30, 2007 and                    2006       | 4        |
|        |                                                                                                                                 |          |
|             | Notes to                    Condensed Financial Statements                                                                           | 5        |
|        |                                                                                                                                 |          |
| Item 2.     | Management's                    Discussion and Analysis or Plan of Operation                                                         | 13       |
|        |                                                                                                                                 |          |
| Item 3.     | Controls and                    Procedures                                                                                           | 23       |
|        |                                                                                                                                 |          |
| **PART II** | **OTHER                    INFORMATION**                                                                                             | 24       |
|        |                                                                                                                                 |          |
| Item 1.     | Legal                    Proceedings                                                                                                 | 24       |
|        |                                                                                                                                 |          |
| Item 6.     | Exhibits                                                                                                                             | 25       |
|        |                                                                                                                                 |     |

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PART I      FINANCIAL        INFORMATION

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

 

 

 

 

 

1

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| Ophthalmic Imaging Systems                                                                                                             |
|----------------------------------------------------------------------------------------------------------------------------------------|
| Condensed Balance                    Sheet                                                                                             |
| September 30,                    2007                                                                                                  |
| (Unaudited)                                                                                                                            |
| **Assets**                                                                                                                             |   |   |
| Current                    assets:                                                                                                     |   |   |
|                                                                                                                                   | Cash and cash                    equivalents |   | $                    5,082,231 |
|                                                                                                                                   | Accounts                    receivable, net |   | 3,234,660 |
|                                                                                                                                   | Accounts                    receivable from related party |   | 314,929 |
|                                                                                                                                   | Note receivable                    from related party |   | 914,475 |
|                                                                                                                                   | Inventories,                    net |   | 632,798 |
|                                                                                                                                   | Prepaid expenses                    and other current assets |   | 298,314 |
|                                                                                                                                   | Deferred tax                    asset |   | 1,424,750 |
|                                                                                                                                   |                           Total current                assets |   |   | 11,902,157 |
| Furniture and                    equipment, net of accumulated                                                                         |   |   |
|                                                                                                                                   | depreciation and                    amortization of $533,950 |   | 443,308 |
| Restricted                    cash                                                                                                     |   | 166,381 |
| Licensing                    agreement                                                                                                 |   | 273,808 |
| Prepaid                    products                                                                                                    |   | 310,000 |
| Capitalized                    Merger Costs                                                                                            |   | 321,531 |
| Other                    assets                                                                                                        |   | 88,737 |
|                                                                                                                                   |                            Total                assets |   |   | $                    13,505,922 |
|                                                                                                                                   |   |   |
| **Liabilities                    and Stockholders' Equity**                                                                            |   |   |
| Current                    liabilities:                                                                                                |   |   |
|                                                                                                                                   | Accounts                    payable |   | $                    539,558 |
|                                                                                                                                   | Accrued                    liabilities |   | 1,392,148 |
|                                                                                                                                   | Deferred extended                    warranty revenue |   | 1,536,102 |
|                                                                                                                                   | Customer                    deposits |   | 73,449 |
|                                                                                                                                   | Lease payable-                    current portion |   | 8,969 |
|                                                                                                                                   |                             Total current                liabilities |   |   | 3,550,226 |
|                                                                                                                                   |   |   |
| Noncurrent                    liabilities:                                                                                        |   |   |
|                                                                                                                                   | Line of                    credit |   | 150,000 |
|                                                                                                                                   | Lease payable,                    less current portion |   | 8,413 |
|                                                                                                                                   |                              Total                liabilities |   |   | 3,708,639 |
|                                                                                                                                   |   |   |
| Stockholders'                    equity:                                                                                          |   |   |
|                                                                                                                                   | Common stock, no                    par value, 35,000,000 shares authorized; |   |
|                                                                                                                                   |                        16,833,496 issued and                outstanding |   | 16,441,858 |
|                                                                                                                                   | Accumulated                    deficit |   | (6,644,575) |
|                                                                                                                                   |                              Total stockholders'                equity |   | 9,797,283 |
|                                                                                                                                   |                              Total liabilities and                stockholders' equity |   |   | $                    13,505,922 |
| *The                    accompanying notes are an integral part of these unaudited condensed financial                    statements.* |

 

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| Ophthalmic Imaging Systems                        |
|---------------------------------------------------|
| Condensed                    Statements of Income |
| (Unaudited)                                       |

|                                                                                                                                   | Three months                    ended September 30, |                                        | Nine months ended                    September 30, |
|----------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------|---------------------------------------------|----------------------------------------------------|
|                                                                                                                                   | 2007                                                |                                        | 2006                                               |   | 2007 |   | 2006 |
|                                                                                                                                   |                                                |                                        |                                               |   |   |   |   |
| Net                    revenues                                                                                                        | $                    3,156,681                      |                                        | $                    3,927,257                     |   | $                    10,934,694 |   | $                    11,395,147 |
| Cost of                    sales                                                                                                       | 1,337,237                                           |                                        | 1,709,611                                          |   | 4,651,256 |   | 4,964,845 |
| Gross                    profit                                                                                                        | 1,819,444                                           |                                        | 2,217,646                                          |   | 6,283,438 |   | 6,430,302 |
| Operating                    expenses:                                                                                                 |                                                |                                        |                                               |   |   |   |   |
|                                                                                                                                   | Sales and                    marketing              | 780,249                                     |                                               | 825,023 |   | 2,456,253 |   | 2,476,196 |
|                                                                                                                                   | General and                    administrative       | 349,729                                     |                                               | 425,448 |   | 1,305,192 |   | 1,194,348 |
|                                                                                                                                   | Research and                    development         | 368,788                                     |                                               | 413,302 |   | 1,169,607 |   | 1,175,550 |
|                                                                                                                                   |                                                | Total operating                    expenses | 1,498,766                                          |   | 1,663,773 |   | 4,931,052 |   | 4,846,094 |
| Income from                    operations                                                                                              | 320,678                                             |                                        | 553,873                                            |   | 1,352,386 |   | 1,584,208 |
| Interest and                    other income (expense), net                                                                            | 46,304                                              |                                        | 39,328                                             |   | 153,628 |   | 29,163 |
| Net income before                    income taxes                                                                                      | 366,982                                             |                                        | 593,201                                            |   | 1,506,014 |   | 1,613,371 |
| Income taxes                    (expense) benefit                                                                                      | (23,358)                                            |                                        | 13,632                                             |   | (51,540) |   | 13,632 |
|                                                                                                                                   |                                                |                                        |                                               |   |   |   |   |
| Net                    income                                                                                                          | $                    343,624                        |                                        | $                    606,833                       |   | $                    1,454,474 |   | $                    1,627,003 |
|                                                                                                                                   |                                                |                                        |                                               |   |   |   |   |
| Shares used in                    the calculation of basic                                                                             |                                                |                                        |                                               |   |   |   |   |
|                                                                                                                                   | net income per                    share             | 16,827,122                                  |                                               | 16,102,997 |   | 16,627,821 |   | 16,026,730 |
|                                                                                                                                   |                                                |                                        |                                               |   |   |   |   |
| Basic net income                    per share                                                                                          | $ 0.02                                              |                                        | $ 0.04                                             |   | $ 0.09 |   | $ 0.10 |
|                                                                                                                                   |                                                |                                        |                                               |   |   |   |   |
| Shares used in                    the calculation of diluted                                                                           |                                                |                                        |                                               |   |   |   |   |
|                                                                                                                                   | net income per                    share             | 17,925,671                                  |                                               | 17,862,301 |   | 18,092,671 |   | 17,701,767 |
|                                                                                                                                   |                                                |                                        |                                               |   |   |   |   |
| Diluted net                    income per share                                                                                        | $ 0.02                                              |                                        | $ 0.03                                             |   | $ 0.08 |   | $ 0.09 |
|                                                                                                                                   |
| *The                    accompanying notes are an integral part of these unaudited condensed financial                    statements.* |

 

3

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Ophthalmic        Imaging Systems

Condensed Statements of Cash        Flows

(Unaudited)

|                                                                                                                                                                        | Nine months ended                    September 30, |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------|
|                                                                                                                                                                        | 2007                                               | 2006 |
|                                                                                                                                                                             |                                               |   |
| **Operating                    activities:**                                                                                                                                |                                               |   |
| Net                    income                                                                                                                                               | $                    1,454,474                     | $                    1,627,003 |
| Adjustments to                    reconcile net income to net cash (used in)                                                                                                |                                               |   |
|                            provided by operating activities                                                                              |                                               |   |
|                                  Depreciation and amortization                                             | 131,456                                            | 52,212 |
|                                  Compensation Expense                                                      | 23,136                                             | 16,958 |
|                                  Loss on disposal of equipment                                             | (1,070)                                            | -- |
|                                  Net (increase) decrease in current assets other                           |                                               |   |
|                                         than cash and cash equivalents  | (319,016)                                          | 163,035 |
|                                  Capitalized Merger Costs                                                  | (321,531)                                          | -- |
|                                  Net (increase) in other assets                                            | (409,617)                                          | (261,072) |
|                                  Net (decrease) increase in current liabilities other                      |                                               |   |
|                                         than short-term borrowings      | (795,543)                                          | 41,093 |
| Net cash provided                    by operating activities                                                                                                                | (237,711)                                          | 1,639,229 |
| **Investing                    activities:**                                                                                                                                |                                               |   |
| Acquisition of                    furniture and equipment                                                                                                                   | (183,141)                                          | (189,533) |
|                                                                                                                                                                             |                                               |   |
| **Financing                    activities:**                                                                                                                                |                                               |   |
| Principal                    payments on notes payable                                                                                                                      | (6,625)                                            | (152,262) |
| Advance to                    related parties                                                                                                                               | (817,793)                                          | -- |
| Proceeds from                    note receivable from related parties                                                                                                       | --                                                 | 486,803 |
| Proceeds from                    exercise of options                                                                                                                        | 163,644                                            | 12,445 |
| Proceeds from                    line of credit, net                                                                                                                        | --                                                 | 150,000 |
| Net cash (used                    in) provided by financing activities                                                                                                      | (660,774)                                          | 496,986 |
| Net (decrease)                    increase in cash and equivalents                                                                                                          | (1,081,626)                                        | 1,946,682 |
| Cash and                    equivalents, beginning of the period                                                                                                            | 6,163,857                                          | 3,940,706 |
| Cash and                    equivalents, end of the period                                                                                                                  | $                    5,082,231                     | $                    5,887,388 |
|                                                                                                                                                                             |                                               |   |
| **Supplemental                    schedule of noncash financing activities:**                                                                                               |                                               |   |
|                                  Conversion of notes payable to common stock                               | $ --                                               | $                    688,067 |
|                                  Conversion of interest to common stock                                    | $ --                                               | $                    1,994 |
|                                  Addition (Reduction) to receivable from                                   |                                               |   |
|                                  Related party in exchange for inventory and                               |                                               |   |
|                                         other noncash transactions, net | $                    298,248                       | $                    (50,469) |
|                                                                                                                                                                             |                                               |   |
| **Supplemental                    schedule of cash flow information:**                                                                                                      |                                               |   |
| Cash paid for                    interest                                                                                                                                   | $                    1,647                         | $                    6,740 |
| Cash paid for                    taxes                                                                                                                                      | $                    193,285                       | $                    117,660 |
|                                                                                                                                                                        |                                               |   |
| *The                    accompanying notes are an integral part of these unaudited condensed financial                    statements.*                                      |

 

4

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Notes to Condensed        Financial Statements

Three and Nine Month Periods ended September        30, 2007 and 2006        (Unaudited)

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

|   | The accompanying unaudited                    condensed balance sheet as of September 30, 2007, condensed statements of                    income for the three and nine month periods ended September 30, 2007 and 2006                    and the condensed statements of cash flows for the nine month period ended                    September 30, 2007 and 2006 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 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, 2006 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 September 30, 2007 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. |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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|                                                                    | Unaudited                    Three Months EndedSeptember                    30, | Unaudited

NineMonths                    EndedSeptember                    30, |
|-------------------------------------------------------------------------|---------------------------------------------------------------------------------|--------------------------------------------------------------------------------|
|                                                                    | 2007                                                                            | 2006                                                                           | 2007 | 2006 |
| Numerator for                    basic and diluted net income per share | $                    343,624                                                    | $                    606,833                                                   | $                    1,454,474 | $                    1,627,003 |
|                                                                    |                                                                            |                                                                           |   |   |
| Denominator for                    basic net income per share:          |                                                                            |                                                                           |   |   |
| Weighted average                    shares                              | 16,827,122                                                                      | 16,102,997                                                                     | 16,627,821 | 16,026,730 |
|                                                                    |                                                                            |                                                                           |   |   |
| Effect of                    dilutive:                                  |                                                                            |                                                                           |   |   |
| Employee/director                    stock options                      | 1,098,548                                                                       | 1,759,304                                                                      | 1,464,850 | 1,675,037 |
| Dilutive potential                    common shares                     | 1,098,548                                                                       | 1,759,304                                                                      | 1,464,850 | 1,675,037 |
|                                                                    |                                                                            |                                                                           |   |   |
| Denominator for                    diluted net income per share         | 17,925,671                                                                      | 17,862,301                                                                     | 18,092,671 | 17,701,767 |
| Basic net income                    per share                           | $ 0.02                                                                          | $ 0.04                                                                         | $ 0.09 | $ 0.10 |
|                                                                         |                                                                                 |                                                                                |  |  |
| Diluted net income                    per share                         | $ 0.02                                                                          | $ 0.03                                                                         | $ 0.08 | $ 0.09 |

|    | As of September 30, 2007 there                    were 402,000 options and warrants whose exercise price exceeded the average                    market price of the stock and have been excluded from this computation. There                    were no such options and warrants excluded as of September 30, 2006.

                                                                                                                                                                                                            |
|---------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Note 3. | Related Party Transactions                    –

MediVision

On July 20, 2005 our Board of                    Directors 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).

  |
|    | 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 United Mizrahi                    Bank by MediVision and secured by us as of September 30, 2007 was approximately                    $2,000,000.                                                                                                                                                                                                                                                                                                                                                                      |

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|   | On April 9, 2007, we and                    MediVision entered into a promissory note, security agreement, and addendum to                    the license and distribution agreement as described below, in order to provide                    additional financing for the engineering of the Electro-Optical Unit. We loaned                    MediVision $800,000, distributed in various monthly sums as needed in                    accordance with the budget and schedule attached to the Addendum, beginning in                    April 2007 for amounts budgeted from January 2007 through December 2007. The                    loan incurs interest of 8% per annum and repayment will commence on May 1,                    2009. Repayments will be made in 24 equal payments, payable on the first of                    each month. The monthly amount will be calculated based on the amount of                    principal outstanding on April 30, 2009. Upon a default under the addendum or                    the related Promissory Note or Security Agreement, the principal and interest                    outstanding on the loan will become immediately due and payable. The loan is                    secured by shares of our common stock, owned by MediVision. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | The amount of shares pledged under                    the loan was calculated using the amount of loan given to MediVision divided by                    $1.83, the average closing price of our common stock for the ten business days                    prior to April 9, 2007, less a 25% discount. If MediVision defaults on its                    repayment obligation as specified in the addendum, we may seek repayment by                    foreclosing on the shares pledged as collateral or, alternatively, we have the                    option to receive a portion of MediVision’s ownership interest in patent                    rights relating to the Electro-Optical Unit, calculated based on the amount of                    principal and interest outstanding on the loan, which is in default at the time                    we exercise this option, multiplied by 25%.                                                                                                                                                                                                                                                                                                                                                                                         |
|   | On September 25, 2007, we and                    MediVision entered into a second addendum to the license and distribution                    agreement as described below, in order to provide additional financing for the                    engineering of the Electro-Optical Unit. This addendum amends the License and                    Distribution Agreement entered into on June 28, 2006 (as described below) and                    amended the First Addendum dated April 9, 2007 (as described below). Under this                    second addendum, we agreed to increase the loan amount from an aggregate amount                    of $800,000 to an aggregate amount of up to $1,100,000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | This addendum also contains the                    following provisions in connection with the Revised Loan, (1) the number of                    MediVision’s shares of the Company’s stock acting as collateral for                    the Revised Loan will be recalculated as set forth in the Second Addendum, (2)                    the formula to calculate the Company’s right to exercise an option in the                    MV Patent Rights (as described in the License and Distribution Agreement below,                    as amended) will be changed in accordance with the Revised Loan amount and as                    set forth in the Second Addendum, and (3) certain increases to the number of                    advance order units and certain options thereto.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | The amount of shares pledged under                    the loan was calculated using the amount of loan given to MediVision divided by                    $1.02, the average closing price of our common stock for the ten business days                    prior to September 25, 2007, less a 25% discount.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   | As of September 30, 2007, we had                    paid MediVision $800,000 and MediVision pledged as collateral 784,314 shares of                    our stock based on the calculated fixed share price of $1.02.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

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|   | As of September 30, 2007,                    MediVision owns approximately 56% of our outstanding common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 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 advances totaling                    $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. On September 21, 2006, we paid $160,000 based on the completion of the                    first milestone in the agreement. On June 20, 2007, we paid $150,000 based on                    the completion of the second milestone in the agreement.                                                                                                                                                                         |
|   | 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 upon sale                    of the first product. |
|   | On April 9, 2007, we and                    MediVision entered into an addendum to the license and distribution agreement                    in order to extend various dates and deadlines as specified in the original                    agreement. As long as we continue to make loan payments to MediVision as                    described above, MediVision shall provide to us monthly reports regarding the                    progress of performance of the tasks and the use of the loan proceeds. We also                    have rights, upon reasonable notice, to visit and inspect all facilities at                    which any tasks relating to the products are performed by MediVision and/or                    third parties and to test prototypes of the Electro-Optical Unit. We also have                    the right to make decisions regarding the performance of the engineering of the                    Electro-Optical Unit pursuant to the budget and schedule, including decisions                    concerning changes to personnel involved in the engineering, changes in the                    subcontractors used, and the use of the proceeds from the loan for the                    engineering and manufacture of the Electro-Optical Unit.                                                                                                                                                                      |

8

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|   | On September 25, 2007, we and                    MediVision entered into an addendum to the license and distribution agreement                    in order to provide additional financing for the engineering of the                    Electro-Optical Unit, and to revise terms related to the agreement. If                    MediVision defaults on its repayment obligation as specified in the addendum,                    we may seek repayment by foreclosing on the shares pledged as collateral or,                    alternatively, we have the option to receive a portion of MediVision’s                    ownership interest in patent rights relating the Electro-Optical Unit,                    calculated based on the amount of principal and interest outstanding and in                    default at the time we exercise this option, divided by 1,100,000, multiplied                    by 34.375%. |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | During the quarter, we also entered into a non-binding agreement to acquire                    MediVision. Under the terms of the proposed acquisition, MediVision’s                    outstanding shares will be converted into shares of OIS common stock at a yet                    to be determined conversion ratio. Outstanding options and warrants to purchase                    MediVision shares will be converted into options or warrants to purchase shares                    of OIS Common Stock. Once the acquisition is completed, MediVision will operate                    as our wholly owned subsidiary. We have capitalized the direct costs associated                    with the merger. To date, these costs have accumulated to approximately                    $322,000.                                                                                                                           |
|   | At September 30, 2007, we recorded                    a net amount due from MediVision of approximately $300,000 for                    products.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   | Sales to MediVision during the three and nine months ended September 30, 2007                    totaled approximately $50,000 and $361,000, respectively. Sales to MediVision                    during the three and nine months ended September 30, 2006 totaled approximately                    $64,000 and $211,000, respectively. Sales derived from product shipments to                    MediVision are made at transfer pricing which is based on volume discounts                    similar to those available to other resellers and distributors of the                    Company’s products.                                                                                                                                                                                                                                                                                                                      |
|   | During the three and nine month                    period ended September 30, 2007, we paid approximately $319,000 and $981,000,                    respectively, to MediVision for research and development performed by                    MediVision on our behalf. During the three and nine month period ended                    September 30, 2006, we paid approximately $285,000 and $761,000, respectively,                    to MediVision for research and development performed by MediVision on our                    behalf.                                                                                                                                                                                                                                                                                                                                                                                             |
|   | CCS Pawlowski

At September 30, 2007, we recorded                    a net amount due from CCS Pawlowski, a subsidiary of MediVision, of                    approximately $15,000 for products and services. Sales to CCS Pawlowski during                    the three and nine months ended September 30, 2007 totaled approximately                    ($4,000) and $142,000, respectively. Sales to CCS Pawlowski during the three                    and nine months ended September 30, 2006 totaled approximately $63,000 and                    $275,000, respectively.                                                                                                                                                                                                                                                                                                                                                           |

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|    | MediStrategy                    Ltd.

We have a service agreement with                    MediStrategy Ltd. ("MS"), an Israeli company owned by Noam Allon, a former                    Director of the Company, serving on the Board until December 2004. Under the                    terms of the agreement, MS provides services to us primarily in the business                    development field in ophthalmology, including business cooperation, mergers and                    acquisitions, identifying and analyzing new lines of business and defining new                    product lines or business opportunities to be developed. All services provided                    by MS are performed solely by Noam Allon.                                                                                                                                                              |
|---------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    | In consideration for the services                    provided, we agreed to pay MS a monthly sum of $3,300. In addition, MS is to be                    paid a yearly performance bonus of up to $20,000 upon achievement of goals                    under the terms of the agreement determined by MS, Noam Allon and the Company's                    Chairman of the Board. As of September 1, 2005, the monthly sum changed from                    $3,300 to $4,000, and the yearly performance bonus changed from $20,000 to                    $10,000. During the year ended December 31, 2006, MS earned fees of $48,000.                    This amount remains accrued, but not paid as of September 30, 2007. During the                    first nine months of 2007, MS earned fees of $36,000. This amount remains                    accrued, but not paid as of September 30, 2007. |
|    | Jonathan Adereth

Starting January 2005, Jonathan                    Adereth, a former director, serves as a consultant to management. We agreed to                    the following in connection with his service as a consultant. (i) to pay to Mr.                    Adereth, a monthly retainer of $2,000, (ii) to pay to Mr. Adereth a daily fee                    of $500 for physical attendance in meetings, and (iii) to reimburse Mr. Adereth                    for reasonable expenses incurred in connection with his services as a                    consultant to management.                                                                                                                                                                                                                                                                                                      |
| Note 4. | Share Based                    Compensation

At September 30, 2007, we have                    four active stock-based compensation plans (the “Plans”). Options                    granted under these plans generally have a term of ten years from the date of                    grant unless otherwise specified in the option agreement. The plans generally                    expire ten years from the inception of the plans. Options granted under these                    agreements have a vesting period of three to four years. Incentive stock                    options under these plans are granted at fair market value on the date of grant                    and non-qualified stock options granted can not be less than 85% of the fair                    market value on the date of grant.                                                                  |
|    | There were no new stock option                    plans approved during the three and nine months ended September30, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|    | A summary of the changes in stock                    options outstanding under our equity-based compensation plans during the nine                    months ended September30,                    2007 is presented below:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

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|                                                 | Shares    | Weighted Average                    Exercise Price | Weighted Average                    Remaining Contractual Term (Years) | Aggregate                    Intrinsic Value |
|------------------------------------------------------|-----------|----------------------------------------------------|------------------------------------------------------------------------|----------------------------------------------|
| Outstanding at                    January 1, 2007    | 2,222,699 | $0.65                                              | 7.03                                                                   | $5,890,152                                   |
| Granted                                              | 8,000     | $2.83                                              | 9.44                                                                   | --                                           |
| Exercised                                            | (325,500) | $0.50                                              | --                                                                     | --                                           |
| Forfeited/Expired                                    | (120,983) | $0.93                                              | --                                                                     | --                                           |
| Outstanding at                    September 30, 2007 | 1,784,216 | $0.67                                              | 6.34                                                                   | $1,480,899                                   |
| Exercisable at                    September 30, 2007 | 1,575,841 | $0.58                                              | 6.14                                                                   | $1,449,773                                   |

|   | We use the Black-Scholes-Merton                    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-Merton 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-Merton option valuation                    model as it does not anticipate paying cash dividends in the foreseeable                    future. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 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-Merton option                    pricing model and the following weighted average assumptions:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

|                                       | Three Months                    Ended September 30, 2007 | Nine Months Ended                    September 30, 2007 |
|--------------------------------------------|----------------------------------------------------------|---------------------------------------------------------|
| Dividend                    Yield          | None                                                     | None                                                    |
| Expected                    volatility     | 60.01                    %                               | 60.01                    %                              |
| Risk-free                    interest rate | 4.27                                                     | 5.21                                                    |
| Expected term                    (years)   | 9.21                                                     | 9.21                                                    |

|   | The Company recorded an                    incremental $8,000 and $23,000 of stock-based compensation expense during the                    three and nine months ended September 30, 2007, respectfully.                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | As of September 30, 2007, the                    Company had $21,135 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 nine month periods                    ended September 30, 2007 was $7,712 and $23,136, respectively. Cash received                    from stock option exercises for the three and nine month periods ended                    September 30, 2007 was $8,120 and $163,644, respectively. |

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|   | There were no options granted for                    the three month period ended September 30, 2007. There were 8,000 options                    granted for the nine month periods ended September 30, 2007. The total                    intrinsic value of options exercised during the three and nine month periods                    ended September 30, 2007 was $25,880 and $508,242, respectively. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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

 

|                                                                | Unaudited                    Three Months Ended                    September 30, | Unaudited                    Nine Months Ended                    September 30, |
|---------------------------------------------------------------------|----------------------------------------------------------------------------------|---------------------------------------------------------------------------------|
|                                                                | 2007                                                                             | 2006                                                                            | 2007 | 2006 |
| Warranty balance                    at beginning of period          | $                    340,275                                                     | $                    502,100                                                    | $                    395,575 | $                    614,500 |
| Reductions for                    warranty services provided        | (69,688)                                                                         | (87,188)                                                                        | (175,313) | (233,688) |
| Changes for                    accruals in current period           | (34,550)                                                                         | 7,725                                                                           | 15,775 | 41,825 |
| Changes for                    accruals for pre-existing warranties | --                                                                               | --                                                                              | -- | -- |
|                                                                |                                                                             |                                                                            |   |   |
| Warranty balance                    at end of period                | $                    236,038                                                     | $                    422,637                                                    | $                    236,038 | $                    422,637 |

 

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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. 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 informatics solutions has been        retinal specialists and general ophthalmologists.

At September 30, 2007, we had        stockholders’ equity of $9,797,283 and our current assets exceeded our current        liabilities by $8,351,931.

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 accounting principles generally accepted in the        United States (“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.

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 these        estimates. In addition, GAAP itself may change from one previously acceptable method to        another. Although the economics of our transactions would not change, the timing of the        recognition of such events for accounting purposes may change.

*Revenue Recognition*

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.”

Under EITF 00-21, the multiple components of        our revenue are considered separate units of accounting in that revenue recognition occurs        at different points of time for product shipment, installation and training services, and        service contracts based on performance or contract period.

         

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Revenue for the product shipment is recognized        when title passes to the customer, which is upon shipment, provided there are no conditions        to acceptance, including specific acceptance rights. If we make an arrangement that        includes specific acceptance rights, revenue is recognized when the specific acceptance        rights are met. Upon review, we concluded that consideration received from our customer        agreements are reliably measurable because the amount of the consideration is fixed and no        specific refund rights are included in the arrangement. We defer 100% of the revenue from        sales shipped during the period that we believe may be uncollectible.

Installation revenue is recognized when the        installation is complete. Separate amounts are charged and assigned in the customer quote,        sales order and invoice, for installation and training services. These amounts are        determined based on fair value, which is calculated in accordance with industry and        competitor pricing of similar services and adjustments according to what the market will        bear. There is no price reduction in the product price if the customer chooses to not have        us complete the installation.

Extended product service contracts are offered        to our customers and are generally entered into prior to the expiration of our one year        product warranty. The revenue generated from these transactions are recognized over the        contract period, normally one to four years.

In general, our arrangements with customers,        resellers, and distributors do not provide any special rights or privileges with respect to        refund or return rights, and in most cases, we do not have arrangements that include        acceptance rights. If we make such arrangements for acceptance rights, revenue is        recognized when the specific acceptance rights are met.

*Tax Provision*

We calculate a tax provision quarterly and        assess how much deferred tax asset is more likely than not to be used in the future.        According to IRS rule 382, our net operating losses prior to August of 2000 are capped at        $389,000 per year as of fiscal year 2000 for 20 years. We use the following analysis to        assess whether we will more likely than not realize the deferred tax asset. We assume that        we will be able to use all of our unlimited NOL amounts. We then assess the amount of our        future capped net operating losses we will more likely than not be able to use.

To realize our tax asset, we must evaluate        whether we will more likely than not be able to realize the deferred tax asset for a        certain number of years in the future. We were not profitable for seventeen consecutive        years between 1984 and 2000. We turned a profit in 2001 and have been profitable for the        last five years. There is significant uncertainty projecting future profitability due to        the history of our business, and the volatility of the market that we are in. We calculate        our tax provision quarterly and assess how much deferred tax asset is more likely than not        to be used in the future.

In the fourth quarter of every fiscal year, we        participate in the industry’s largest tradeshow of the year, which contributes        approximately 25% of our revenue generated in the last month of the fiscal year. This        tradeshow substantially influences the outcome of our profitability for that year, as well        as gives us an indication of the years to come. Significant expenses, resources, and risk        are put into the tradeshow every year in hopes of generating revenue. We can also see how        the market responds to our new products, as well as our competitor’s products. With        this tradeshow behind us in the fourth quarter of every fiscal year, we are in a better        position to assess how we are doing, will be doing in the years to come, and determine        whether it is more likely than not that we will be able to realize our deferred tax        assets.

         

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*Warranty Reserve*

We have two types of warranty reserves. A        general product reserve on a per product basis, and specific reserves created as we become        aware of issues. The product reserve is calculated based on a fixed dollar amount per        system shipped each quarter. The unanticipated reserves usually arise from the introduction        of new products at our largest tradeshow of the year in October/November of every year.        When a new product is introduced, we reserve for specific problems arising from potential        issues during the implementation phase. As time passes, and the issues are resolved, we        reduce the specific reserve. These types of issues can cause our warranty reserve to        fluctuate outside of sales fluctuations.

Historically, we estimated the cost of the        various warranty services by taking into account the estimated cost of servicing routine        warranty claims in the first year, including parts, labor and travel costs for service        technicians. In the third quarter of 2007, we reduced the specific reserve accrual for the        archiving issues by $79,550. The Company expects no further exposure related to this        specific archiving issue.

*New Accounting        Pronouncements*

In June 2006, the Financial Accounting        Standards Board (FASB) issued FASB Interpretation (FIN) No. 48 “Accounting for        Uncertainty in Income Taxes– an interpretation of FASB Statement 109”. FIN 48        establishes a single model to address accounting for uncertain tax positions. FIN 48        clarifies the accounting for income taxes by prescribing a minimum recognition threshold a        tax position is required to meet before being recognized in the financial statements. FIN        48 also provides guidance on derecognition, measurement classification, interest and        penalties, accounting in interim periods, disclosure and transition. We adopted FIN 48 as        of January 1, 2007. The provisions of FIN 48 have been applied to all tax positions of the        Company as of January 1, 2007.  There was no cumulative effect of applying the        provisions of FIN 48 and there was no significant effect on our provision for income taxes        for the three and nine months ended September 30, 2007.  Upon adoption as of January        1, 2007, we had no derecognition adjustments to our existing reserves for uncertain tax        positions.

In December 2006, the Financial Accounting        Standards Board (“FASB”) released Statement of Financial Accounting Standards        No. 157 – Fair Value Measurements. This statement defines fair value in generally        accepted accounting principles (“GAAP”), and expands disclosures about fair        value measurements. This standard applies under other accounting pronouncements that        require or permit fair value measurements and is intended to increase consistency and        comparability. This statement shall be effective for financial statements issued for fiscal        years beginning after November 15, 2007. The adoption of FASB 157 is not expected to have a        material impact on our financial position, results of operations or cash flows.

Results of Operations

*Revenues*

Our revenues for the three months ended        September 30, 2007 were $3,156,681, representing a 20% decrease from revenues of $3,927,257        for the three months ended September 30, 2006. The decrease in revenues between the        quarters is due to a decrease of product sales in the three months ended September 30, 2007        compared to the three months ended September 30, 2006. The decrease in product sales was        due to the impact of a large contract in the third quarter of 2006. Our revenues for the        nine months ended September 30, 2007 were $10,934,694, representing a 4% decrease from        revenues of $11,395,147 for the nine months ended September 30, 2006. The decrease in        revenues for the nine months ended September 30, 2007 is due to the impact of two large        contracts over the second and third quarters of 2006.

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Products accounted for approximately 74% and        85% of our revenue for the third quarters of 2007 and 2006, respectively. Products        accounted for approximately 79% and 85% of our revenue for the nine months ended September        30, 2007 and 2006, respectively. Service revenues for these products accounted for        approximately 26% and 15% of our revenue for the third quarters of 2007 and 2006,        respectively. Service revenues for these products accounted for approximately 21% and 15%        of our revenue for the nine months ended September 30 2007 and 2006, respectively. The        increase in service revenue is mainly derived from increases in our extended service        contract revenue. The volume of extended service contracts sold continues to increase        relative to total sales as we continue to educate our customers about the benefits of the        contracts. This education process has been ongoing for the last five years and the service        revenue increases as more customers buy extended service contracts. The other components of        service revenue have stayed relatively constant. Total service revenue during the three and        nine months ended September 30, 2007 was comprised mostly of service contract revenue and        the rest consists of non warranty repairs and parts, and technical support phone billings        for customers not under warranty.

Revenues from sales of our products to related        parties were approximately $46,000 and $127,000 during the three month periods ended        September 30, 2007 and September 30, 2006, respectively. Revenues from sales of our        products to related parties were approximately $503,000 and $245,000 during the nine month        periods ended September 30, 2007 and September 30, 2006, respectively.

*Gross Margins*

Gross        margins were approximately 58% and 56% during the three month period ended September 30,        2007 and September 30, 2006, respectively. Gross margins were approximately 57%        during the nine month period ended September 30, 2007 as compared to 56% for the nine month        period ended September 30, 2006. Gross margins increased slightly due to product mix.

*Sales and Marketing Expenses*

Sales        and marketing expenses accounted for approximately 25% of total revenues during the third        quarter of fiscal 2007 as compared to approximately 21% during the third quarter of fiscal        2006. Actual expenses decreased to $780,249 during the third quarter of 2007 versus        $825,023 during the third quarter of 2006, representing a decrease of $44,774 or 5%. Sales        and marketing expenses accounted for approximately 23% and 22% of total revenues during the        first nine months of fiscal 2007 and fiscal 2006, respectively. Actual expenses decreased        to $2,456,253 during the first nine months of 2007 versus $2,476,196 during the first nine        months of 2006, representing a decrease of $19,943 or 1%.

*General and Administrative Expenses*

General        and administrative expenses were $349,729 in the third quarter of fiscal 2007 and $425,448        in the third quarter of fiscal 2006, representing a decrease of $75,719 or 18%. Such        expenses accounted for approximately 11% of revenues during the third quarters of 2007 and        2006. The decrease was primarily due to lower legal expenses related to capitalizing direct        merger related costs in 2007 versus expensing these costs in 2006. General and        administrative expenses were $1,305,192 in the first nine months of fiscal 2007 and        $1,194,348 in the first nine months of fiscal 2006, representing an increase of $110,844 or        9%. Such expenses accounted for approximately 12% and 11% of revenues during the first nine        months of 2007 and 2006, respectively. The increase was primarily due to a steady amount of        legal expenses during the first nine months of 2007 compared to an abnormally low amount of        legal expenses accounted for during the first nine months of 2006 due to the reimbursement        of legal fees we received related to the JDI lawsuit, offset by capitalizing merger related        costs in 2007 versus expensing these costs in 2006.

         

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*Research and Development Expenses*

Research        and development expenses were $368,788 in the third quarter of fiscal 2007 and $413,302 in        the third quarter of fiscal 2006, representing a decrease of $44,514 or 11%. Such expenses        accounted for approximately 12% of revenues during the third quarter of 2007 and 11% of        revenues during the third quarter of 2006. Research and development expenses were        $1,169,607 in the first nine months of fiscal 2007 and $1,175,550 in the first nine months        of fiscal 2006, representing a decrease of $5,943 or 1%. Such expenses accounted for        approximately 11% and 10% of revenues during the first nine months of 2007 and 2006,        respectively. The decrease in the third quarter of fiscal 2007 resulted from a decrease in        the purchase of prototype parts. Our research and development expenses are derived        primarily from our continued research and development efforts on new digital image capture        products. Outside consultants and MediVision currently conduct most of our research and        development activities.

*Interest and other income (expense), net*

Interest        and other income (expense) were $46,304 during the third quarter of fiscal 2007 versus        $39,328 during the third quarter of fiscal 2006. For the nine months ended September 30,        2007 and 2006, interest and other income (expense) were $153,628 and $29,163, respectively.        The increase is primarily due to an increase in our interest income resulting from our        increased average cash balance and our interest on our note receivable from        MediVision.

*Income Taxes*

        Income tax expense (benefit) was $23,358 during the third quarter of fiscal 2007        versus ($13,632) during the third quarter of fiscal 2006.

Income        tax expense (benefit) was $51,540 and ($13,632) during the first nine months of 2007 and        2006, respectively.

We        calculate a tax provision quarterly and assess how much deferred tax asset is more likely        than not to be used in the future. In determining whether we will more likely than not        realize the deferred tax asset, we assume that we will be able to use all of our unlimited        NOL amounts. We then assess the amount of our future capped net operating losses we will        more likely than not be able to use.

*Net Income*

We        recorded net income of $343,624, or $0.02 per share basic and diluted earnings, for the        third quarter ended September 30, 2007 as compared to net income of $606,833 or $0.04 and        $0.03 per share basic and diluted earnings for the third quarter ended September 30, 2006.        We recorded net income of $1,454,474, or $0.09 and $0.08 per share basic and diluted        earnings, respectively, for the nine months ended September 30, 2007 as compared to net        income of $1,627,003 or $0.10 and $0.09 per share basic and diluted earnings for the nine        months ended September 30, 2006.

         

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*Balance Sheet*

Our        assets increased by $2,222,949 as of September 30, 2007 as compared to September 30, 2006.        This increase was primarily due to an increase in accounts receivable of $1,444,987, note        receivable to MediVision of $820,617, deferred tax asset of $286,076, capitalized merger        costs of $321,531, and prepaid products related to the new digital imaging system that        MediVision is working on of $150,000, offset by a decrease cash of        ($805,156).

Our        liabilities decreased by $603,862 primarily due to a decrease of customer deposits of        $472,011, a decrease in accounts payable of $261,543, a decrease in accrued salary and        commissions of $76,257, a decrease of warranty reserve of $186,600, offset by an increase        in deferred warranty revenue of ($453,782).

Our        stockholders’ equity increased by $2,826,618 primarily due to net income from the        previous 12 months of $2,078,231, and the increase in common stock of $748,387 primarily        due to the exercise of warrants by Laurus Master Fund.

*Liquidity and Capital Resources*

Our        operating activities used cash of ($237,711) during the nine months ended September 30,        2007 as compared to cash generated of $1,639,229 in the nine months ended September 30,        2006. The cash used from operations during the first nine months of 2007 was principally        from an increase in accounts receivable of ($376,886), an increase in deferred tax asset of        ($252,750), capitalization of merger related costs of ($321,531), an increase in prepaid        products of ($150,000), a decrease in accounts payable of (261,543), a decrease in customer        deposits of ($472,011), a decrease in warranty accrual of ($186,600), offset by our        profitable operations from the period of $1,454,474, decrease of inventory of $175,440, and        increase in depreciation of $131,456.

Cash        used in investing activities was $183,141 during the first nine months of 2007 as compared        to $189,533 during the first nine months of 2006. Our investing activities consisted of        purchases of software and equipment. We anticipate continued capital expenditures in        connection with our ongoing efforts to upgrade our existing management information and        corporate communication systems. We also 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        used cash in financing activities of ($660,774) during the first nine months of fiscal 2007        as compared to cash generated of $496,986 during the first nine months of fiscal 2006. The        cash used in financing activities during the first nine months of 2007 was principally from        an advance made to MediVision in the amount of ($817,793), offset by proceeds from the        exercise of stock options by employees of $163,644. The cash generated in financing        activities during the first nine months of 2006 was principally from proceeds on the note        receivable from MediVision of $486,803, draw on our line of credit of $150,000, offset by        repayments of the debt to Laurus Master Fund of $144,579.

On        September 30, 2007 our cash and cash equivalents were $5,082,231. 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.

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.

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*Material Agreement –*

On        September 25, 2007, we entered into a Second Addendum to the License and Distribution        Agreement (the “Second Addendum”) with MediVision, our parent company,        primarily to provide additional financing for the engineering of the Electro-Optical Unit.        This Second Addendum amends the License and Distribution Agreement entered into on June 28,        2006 and amended pursuant to a First Addendum to License and Distribution Agreement dated        April 9, 2007 (the “License and Distribution Agreement, as amended”). Under the        Second Addendum, we agreed to increase the loan amount set forth in the License and        Distribution Agreement, as amended, from an aggregate amount of up to $800,000 to an        aggregate amount of up to $1,100,000, to be represented by a revised promissory note (the        “Revised Loan”). The Second Addendum also contains the following provisions in        connection with the Revised Loan, (1) we and MediVision will execute new versions of the        previously issued Promissory Note and Security Agreement that were attached as exhibits to        the License and Distribution Agreement, as amended, (2) MediVision’s obligation to        repay the Revised Loan will be revised to reflect the increased loan amount, (3) the number        of MediVision’s shares of our stock acting as collateral for the Revised Loan will be        recalculated as set forth in the Second Addendum (described below), (4) the formula to        calculate our right to exercise an option in the MV Patent Rights (as defined in the        License and Distribution Agreement, as amended) will be changed in accordance with the        Revised Loan amount and as set forth in the Second Addendum, and (5) certain increases to        the number of advance order units and certain options thereto.

The        Revised Loan will incur interest of 8% per annum. As previously set forth under the License        and Distribution Agreement, as amended, repayment will commence on May 1, 2009 and will be        made 24 equal payments, payable on the first of each month. The monthly amount will be        calculated based on the amount of principal outstanding on April 30, 2009. Upon a default        under the License and Distribution Agreement, as amended, the Second Addendum, or the        related Promissory Note or Security Agreement, the principal and interest outstanding on        the Revised Loan will become immediately due and payable.

The        Revised Loan is secured by shares of our common stock, owned by MediVision. The amount of        shares pledged under the Revised Loan is 784,314 shares, calculated as the amount of the        Revised Loan, divided by the average closing price of our common stock for the ten business        days prior to September 25, 2007 ($1.36), discounted by 25% ($1.36).

As        previously set forth under the License and Distribution Agreement, as amended, if        MediVision defaults on its repayment obligation as specified in the License and        Distribution Agreement, as amended, or the Second Addendum, we may seek repayment by        foreclosing on the shares pledged as collateral or, alternatively, we have the option of        receiving a portion of MediVision’s ownership interest in patent rights relating to        the Electro-Optical Unit, calculated based on the amount of principal and interest        outstanding on the Revised Loan, which is in default at the time we exercise this option,        divided by 1,100,000 multiplied by 34.375%.

We        entered into a non-binding agreement to acquire MediVision. Under the terms of the proposed        acquisition, MediVision’s outstanding shares will be converted into shares of OIS        common stock at a yet to be determined conversion ratio. Outstanding options and warrants        to purchase MediVision shares will be converted into options or warrants to purchase shares        of OIS Common Stock. Once the acquisition is completed, MediVision will operate as our        wholly owned subsidiary. The terms of the acquisition are currently in        negotiations.

         

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        Subsequent Event

On        October 29, 2007, we entered into a Purchase Agreement (the “Purchase        Agreement”) with the purchasers named therein (the “Purchasers”),        pursuant to which we issued to the Purchasers (i) an aggregate of  $2,750,000 in        principal amount of its 6.5% Convertible Notes Due April 30, 2010 (the        “Notes”), which Notes are convertible into 1,676,829 shares (the        “Underlying Shares”) of our common stock, no par value, and (ii) warrants        (“Warrants”) to purchase an aggregate of 616,671 shares (the “Warrant        Shares”) of our common stock at an exercise price of $1.87 per share. We will use the        proceeds from the issuance of the Notes for working capital and potential        acquisitions.

        Description of the Notes

The        Notes are convertible at any time, at the option of the Purchasers, into 1,676,829 shares        of our common stock, at a conversion price of $1.64 per share. We may not effect any        conversion of the Notes and each Purchaser of the Notes is not permitted to convert its        Notes into shares of Common Stock if such conversion would give such Purchaser a beneficial        ownership of more than 9.99% of the outstanding shares of Common Stock. This 9.99%        limitation may be waived by the Purchaser upon not less than 61 days prior notice to        us.

We        will pay monthly interest on the outstanding principal amount of the Notes at a rate per        annum equal to 6.5% (the “Interest Amount”). We will also pay to the Purchasers        one twelfth (1/12) of the principal amount of the Notes on the last business day of each        other month beginning June 30, 2008 (the “Bi-Monthly Amount”); provided that,        prospectively following each conversion of the Notes by any Purchaser, the Bi-Monthly        Amount shall be automatically reduced by an amount equal to (a) the principal amount        converted in such conversion, divided by (b) the number of remaining Bi-Monthly payment        dates scheduled to occur under the Notes. Subject to the Notes, we have the right to        satisfy payment of the Interest Amount or Bi-Monthly Amount, as the case may be, in full        either in cash or in shares of Common Stock at our option. We are prohibited from        exercising its right to pay the Interest Amount or Bi-Monthly Amount in shares of Common        Stock (and must deliver cash in respect thereof) on the applicable payment date if (i)        there fails to exist Effective Registration (as defined in the Notes) or an Event of        Default (as defined in the Notes) shall have occurred and be continuing under the Notes, or        (ii) the VWAP (as defined in the Notes) on each of the ten (10) trading days immediately        preceding the applicable payment date is not greater than $1.00, unless otherwise waived in        writing by the Purchasers in whole or in part at the Purchasers’        option.

If        at any time the market price of our Common Stock is equal to or greater than $3.50 (which        figure shall be appropriately and equitably adjusted for stock splits, stock dividends, and        similar events) for thirty (30) consecutive trading days (a “Pricing Period”),        then we will have the right to compel the Purchasers to convert up to 50% of the principal        amount of Notes then held by the Purchasers. Additionally, if at any time the market price        of our common stock is equal to or greater than $6.00 (which figure shall be appropriately        and equitably adjusted for stock splits, stock dividends, and similar events) for a Pricing        Period, then we will have the right to compel the Purchasers to convert up to the entire        principal amount of Notes then held by the Purchasers. Notwithstanding the foregoing, we        are not entitled to exercise any forced conversion right unless at all times during the        applicable Pricing Period, among other things, (i) the resale of all Registrable Securities        (as defined below) is covered by an effective registration statement in accordance with the        terms of the Registration Rights Agreement which registration statement is not subject to        any suspension or stop orders; (ii) the resale of such Registrable Securities may be        effected pursuant to a current and deliverable prospectus that is not subject at the time        to any blackout or similar circumstance; (iii) the VWAP is greater than $1.00; (iv) none of        OIS or any direct or indirect subsidiary of OIS will be subject to any bankruptcy,        insolvency or similar proceeding; and (vii) we have paid all prior interest and principal        payments due under the Notes.

         

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The        conversion price of the Notes will be adjusted and the number of shares of our common stock        to be issued upon conversion of the Notes will be adjusted upon the occurrence of, among        other things, the payment of stock dividend or a stock split, (as defined in the Notes). In        addition, the Notes include certain anti-dilution provisions if we issue or sell any of our        common stock or convertible securities, or any warrants or other rights to subscribe for or        to purchase or any options for the purchase of our common stock, or directly or indirectly        effectively reduces the conversion, exercise or exchange price for any convertible        securities that are currently outstanding, at or to an effective per share selling price        which is less than the greater of (i) the closing price on the trading day next preceding        such issue or sale or, in the case of issuances to holders of our common stock, the date        fixed for the determination of stockholders entitled to receive such warrants, rights, or        options, or (ii) the then applicable conversion price. Upon the occurrence of an        anti-dilution event specified in the immediately preceding sentence the conversion price of        the Notes will be adjusted pursuant to a weighted-average formula.

Upon        any Change in Control Transaction (as defined in the Notes), the Purchasers have the right        thereafter to (A) convert the Notes, in whole or in part, at the lower of the conversion        price and the then applicable market price of our common stock into the shares of stock and        other securities, cash and/or property receivable upon or deemed to be held by holders of        our common stock following such Change in Control Transaction, and the Purchasers are        entitled upon such event to receive such amount of securities, cash or property as the        shares of our common stock into which the Notes could have been converted immediately prior        to such Change in Control Transaction would have been entitled if such conversion were        permitted, or (B) require us or our successor to redeem the Notes, in whole or in part, at        a redemption price equal to the greater of (i) 130% of the outstanding principal amount of        the Notes being redeemed and (ii) the product of (x) the average of the market price of our        common stock for the five (5) Trading Days immediately preceding the Purchaser’s        election to have its Notes redeemed and (y) the Conversion Ratio (as defined in the        Notes).

The        Notes contain certain events of default that are customarily included in financings of this        nature. If an event of default occurs, the Purchasers may declare all of the then        outstanding principal amount of the Notes, including any interest due thereon, to be due        and payable immediately. In the event of such acceleration, the amount due and owing to the        Purchaser shall be the greater of (1) 130% of the outstanding principal amount of the Notes        held by the Purchasers (plus all accrued and unpaid interest, if any) and (2) the product        of (A) the highest closing price for the five (5) Trading days immediately preceding the        Purchasers acceleration and (B) the Conversion Ratio (as defined in the        Note).

        Description of the Warrants

The        Warrants have an exercise period of five years from the date of issuance. The exercise        price of the Warrants is $1.87 and will be adjusted and the number of shares of our common        stock to be issued upon exercise of the Warrants will be adjusted upon the occurrence of,        among other things, the payment of stock dividend or a stock split. In addition, the        Warrants include certain anti-dilution provisions if we issue or sell any Common Stock or        convertible securities, or any warrants or other rights to subscribe for or to purchase or        any options for the purchase of its Common Stock or directly or indirectly effectively        reduces the conversion, exercise or exchange price for any convertible securities that are        currently outstanding, at or to an effective per share selling price which is less than the        greater of (i) the closing price on the trading day next preceding such issue or sale or,        in the case of issuances to holders of our common stock, the date fixed for the        determination of stockholders entitled to receive such warrants, rights, or options, or        (ii) the then applicable exercise price. Upon the occurrence of an anti-dilution event        specified in the immediately preceding sentence the exercise price of the Warrants will be        adjusted pursuant to a weighted-average formula.

         

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We        may not effect any exercise of the Warrants and each Purchaser is not permitted to exercise        its Warrants into shares of our common stock if such exercise would give such Purchaser a        beneficial ownership of more than 9.99% of the outstanding shares of our common stock. This        9.99% limitation may be waived by each Purchaser upon not less than 61 days prior notice to        us.

        Description of the Registration Rights Agreement

Pursuant        to the Registration Rights Agreement, dated October 29, 2007, among us and the Purchasers,        we agreed to prepare and file with the SEC within 30 days of October 29, 2007 (the        “Filing Date”) a registration statement covering the resale of the Underlying        Shares, the Warrant Shares and any other shares of our common stock issued or issuable upon        conversion of, or payment of interest or repayment of principal under, the Notes, and upon        the exercise of the Warrants (the “Registrable Securities”). If such        registration statement is not filed on or prior to the Filing Date, then we will make        pro-rata payments to the Purchasers as liquidated damages and not as a penalty, in an        amount equal to 1% of the sum of the aggregate principal amount then outstanding under the        Notes for each month (or portion thereof) following the Filing Date that such registration        statement has not been filed.

If        (A) the registration statement covering Registrable Securities is not declared effective by        the SEC within nine (9) months following October 29, 2007 (or the fifth day following the        date on which we are notified by the SEC that such Registration Statement will not be        reviewed or is no longer subject to further review and comments), or the registration        statement covering Additional Registrable Securities (as defined in the Registration Rights        Agreement) is not declared effective by the SEC within three months following demand        of a Purchaser relating to the Additional Registrable Securities to be covered thereby        (each of the foregoing deadlines, a “Registration Date”), (B) after a        Registration Statement has been declared effective by the SEC, sales cannot be made        pursuant to such Registration Statement for any reason, (C) the Registrable Securities (or        Additional Registrable Securities after issuance and registration) specifically are not        listed or included for quotation on the OTC Bulletin Board, the Nasdaq Stock Market, the        New York Stock Exchange or the American Stock Exchange (each an “Approved        Market”) or trading of our common stock is suspended or halted thereon, or (D) we        fail, refuse or are otherwise unable to timely issue Underlying Shares upon conversion of        the Notes or Warrant Shares upon exercise of the Warrants, in accordance with the terms of        the Notes and Warrants, or unlegended certificates for the Underlying Shares or Warrant        Shares, in each case within ten days following the Purchaser’s written demand        for issuance of such Underlying Shares or Warrant Shares or certificates, then we will make        pro-rata payments to the Purchaser as liquidated damages and not as a penalty, in an amount        equal to 1% of the sum of the aggregate principal amount then outstanding under the Notes        for each month (or portion thereof) following the Registration Date during which any of the        events described in (A), (B), (C) or (D) above occurs and is continuing, provided that (1)        such 1% figure shall increase to 2% if the Registration Statement is not declared effective        prior to the first anniversary of October 29, 2007, (2) the total amount of damages payable        pursuant to clause (A) above shall be limited to 17.5% of the original principal amount of        Notes if at the time of any such determination the Purchasers are permitted to sell the        Registrable Securities under Rule 144 promulgated under the Securities Act, and (3) the        Registration Date shall be extended one day for each day that we are prevented from        complying with its obligations set forth under subsection (A) above solely due to delays        caused by the Purchasers. Our obligation to keep the registration statement effective will        terminate upon the earlier of (i) the date on which all Registrable Securities or        Additional Registrable Securities have been sold, and (ii) the date on which all        Registrable Securities or Additional Registrable Securities, as the case may be, may be        sold pursuant to Rule 144(k).

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        Off-Balance Sheet Arrangement

We        have a Secured Debenture in favor of United Mizrahi Bank Ltd., in an amount of up to        $2,000,000 (plus interest, commissions and all expenses). Under the Debenture, we        guaranteed the payment of all 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 institution by MediVision and secured by us as of September        30, 2007 is approximately $2,000,000.

**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 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 September 30, 2007, our disclosure        controls and procedures were effective.

During        the quarter ended September 30, 2007, 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 1.     LEGAL PROCEEDINGS

On        May 11, 2007, we filed a civil action in the Superior Court of California for the County of        Sacramento against our former president Steven Verdooner.  The complaint alleges        against Mr. Verdooner claims of breach of fiduciary duty, intentional interference with        contract, and intentional interference with prospective economic advantage. The complaint        requests total damages against Mr. Verdooner in excess of $7,000,000.  Discovery has begun and no trial date has been        set yet.

         

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| 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: November 14, 2007 |                                          |  |
|                    |                                     |  |
|                    |                                          |  |
|                    | By:                                           | /s/ Gil Allon  |
|                    | Name:                    Title:               | Gil Allon,                    Chief Executive Officer |
|                    |                                          |  |
|                    |                                          |  |
|                    | By:                                           |  /s/ Ariel Shenhar |
|                    | Name:                    Title:               | Ariel Shenhar,                    Chief Financial Officer |
|                    |                                          |  |

 

 

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