CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)(Unaudited)

See Notes to Consolidated Financial Statements (Unaudited)

54

PHOTONIC PRODUCTS GROUP, INC.INC AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 —SUMMARY-SUMMARY OF ACCOUNTING POLICIES

a.Basis of Presentation

The accompanying unaudited interim consolidated financial statements of Photonic Products Group, Inc. (the “Company”) reflect all adjustments, which are of a normal recurring nature, and disclosures which, in the opinion of management, are necessary for a fair statement of results for the interim periods.  It is suggested that these consolidated financial statements be read in conjunction with the audited consolidated financial statements as of December 31, 2006 and 2005 and for the years then ended and notes thereto included in the Company’s report on Form 10-K and Amendment No. 1 on Form 10-K/A, filed with the Securities and Exchange Commission.

b.Inventories

Inventories are stated at the lower of cost (first-in-first-out basis) or market basis (net realizable value).  Work in process inventory for the period is stated at actual cost, not in excess of estimated realizable value.  Costs include labor, material and overhead.

Inventories are comprised of the following:

c.Income Taxes

The Company recognizes deferred tax assets and liabilitiesaccounts for the expected future tax consequencesincome taxes under Statement of events that have been recognized in the Company’s financial statements or tax returns.Financial Accounting Standards (“SFAS”) No, 109, “Accounting for Income Taxes.”  Deferred tax assets and liabilities are determined based on the differencedifferences between the financial statement carrying amountsreporting and the tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect in the years in whichwhen the differences are expected to reverse.

d.Net Income Perper Share

The basic net income per share is computed using the weighted average number of common shares outstanding for the applicable period.  The diluted income per share is computed using the weighted average number of common shares plus potential common equivalent shares outstanding, including the additional dilution related to the conversion of stock options, warrants, convertible preferred shares, and potential common shares issuable upon conversion of outstanding convertible notes, except if the effect on the per share amounts is anti-dilutive.  For the three and six months ended June 30, 2006, the potential dilutive effect of all outstanding common share equivalents have been excluded from the diluted computation because their effect is anti-dilutive.

The following is the reconciliation of the basic and diluted earnings per share computations required by Statement of Financial Standards (“SFAS”) No. 128 (“Earnings per Share’)

e.Stock Based Compensation

The Company’s 2000 Equity Compensation Program, which is shareholder approved, permits the grant of share options to its employees for up to 400,000 shares of common stock as stock compensation per calendar year.  All stock options under the Plan are granted at the fair market value of the common stock at the grant date.  Employee stock options vest ratably over a three year period and expire 10 years from the grant date.

Effective January 1, 2006, the Company’s Plan is accounted for in accordance with the recognition and measurement provisions of Statement of Financial Accounting Standards(“Standards (“FAS”) No. 123 (revised 2004), Share-Based Payment (“FAS 123(R)”), which replaces FAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations.  FAS 123 (R) requires compensation costs related to share-based payment transactions, including employee stock options, to be recognized in the financial statements. 

In addition, the Company adheres to the guidance set forth within Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 107, which provides the Staff’s views regarding the interaction between SFAS No. 123(R) and certain SEC rules and regulations and provides interpretations with respect to the valuation of share-based payments for public companies.

Prior to January 1, 2006, the Company accounted for similar transactions in accordance with APB No. 25 which employed the intrinsic value method of measuring compensation cost.  Accordingly, compensation expense was not

recognized for fixed stock options if the exercise price of the option equaled or exceeded the fair value of the underlying stock at the grant date.

While FAS No. 123 encouraged recognition of the fair value of all stock-based awards on the date of grant as expense over the vesting period, companies were permitted to continue to apply the intrinsic value-based method of accounting prescribed by APB No. 25 and disclose certain pro-forma amounts as if the fair value approach of SFAS No. 123 had been applied.  In December 2002, FAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of SFAS No. 123, was issued, which, in addition to providing alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation, required more prominent pro-forma disclosures in both the annual and interim financial statements.  The Company complied with these disclosure requirements for all applicable periods prior to January 1, 2006.

In adopting FAS 123(R), the Company applied the modified prospective approach to transition.  Under the modified prospective approach, the provisions of FAS 123 (R) are to be applied to new awards and to awards modified, repurchased, or cancelled after the required effective date.  Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date.  The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated for either recognition or pro-forma disclosures under FAS 123.

As a result of the adoption of FAS 123 (R), the Company’s results forDuring the three month periodand six months ended March 31,June 30, 2007 includeand 2006, the Company recognized share-based compensation expense totaling $9,105.  Such amounts have been$9,105, $18,210, in the 2007 periods and $12,443 and $42,647 in the 2006 periods, respectively.  For the three months ended June 30, 2007 and 2006, the amount included in the Consolidated Statements of Operations within cost of goods sold ($2,442),was $2,442 and $3,508, and $6,663 and $8,935 within selling, general and administrative expenses ($6,663), as appropriate.expense, respectively.  For threesix months ended March 31,June 30, 2007 and 2006, share-based compensation expense was $30,204 including $4,398$4,884 and $7,906 within cost of goods sold and $25,806$13,326 and $34,741 within selling, general and administrative expense, as appropriate.  No income tax benefit has been recognized in the income statement for share-based compensation arrangements due to history of operating losses.

Stock option compensation expense in 2007 and 2006 is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period.

The weighted average estimated fair value of stock options granted in the threesix months ended March 31,June 30, 2007 and 2006 was $1.47 and $1.43,$1.46, respectively.  The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model.  During 2007, the Company took into consideration guidance under SFAS 123R and SEC Staff Accounting Bulletin No. 107 (SAB 107) when reviewing and updating assumptions.  The expected volatility is based upon historical volatility of our stock and other contributing factors.  The expected term is based upon the contractual term of the options.  The Company’s uses the available rate on zero-coupon government obligations with a remaining term equal to the expected life of the options as the basis for its risk-free interest rate.

The assumptions made in calculating the fair values of options are as follows:

The CompanyThere were no options granted 29,039 options under the Plan during the three months ended March 31, 2007 at an exercise price of $1.50 per share.June 30, 2007.  In the three months ended March 31,June 30, 2006, 67,20010,000 options were granted at an exercise price of $1.50$1.75 per share.  For the six months ended June 30, 2007 there were 29,039 options granted at an exercise price of $1.50 as compared with 77,200 options granted at an average exercise price of $1.53

for the six months ended June 30, 2006.  Stock grants are issued at a price that is equal to the closing market price on the date of each grant.

The following table represents our stock options granted, exercised, and forfeited during the first threesix months of 2007.

The following table represents non-vested stock options granted, vested, and forfeited during the threesix months ended March 31,June 30, 2007.

As of March 31,June 30, 2007, there was $89,896$79,511 of unrecognized compensation costs, net of estimated forfeitures, related to non-vested stock options, which is expected to be recognized over a weighted average period of approximately 2.8 years.  The total fair value of shares vested during the threesix months ended March 31,June 30, 2007 and 2006, was $65,000$70,911 and $152,000,$66,631, respectively.

f.New Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

The Company adopted FIN 48 effective January 1, 2007 and the adoption did not have a material impact on our consolidated financial statements or effective tax rate and did not result in any unrecognized tax benefit.

Interest costs and penalties related to income taxes are classified as interest expense and general and administrative costs, respectively, in our consolidated financial statements.  For the six months ended June 30, 2007 and 2006, the Company did not recognize any interest or penalty expense related to income taxes.

As of June 30, 2007, all of the Company’s deferred tax assets are fully reserved by a valuation allowance equal to 100% of the net deferred tax assets   In addition, the Company has significant net operating loss carryovers which are subject to a valuation allowance due to the uncertain nature of the realization of the losses.  The Company has determined that it is not reasonably possible for the amounts of unrecognized tax benefits to significantly increase or decrease within the next 12 months.  The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction.

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“Statement No. 157”). The standard provides enhanced guidance for using fair value to measure assets and liabilities and also responds to investors’ requests for expanded information about the extent to which companies’ measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. While the standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, it does not expand the use of fair value in any new circumstances. Statement No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Management of the Company is evaluating the impact of this standard, but does not anticipate that it will have a significant impact on its financial statements.

Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (“Statement 159”), was issued in February 2007. Statement 159 allows entities to choose, at specified election dates, to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Statement 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. Statement 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. Statement 159 does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in Statements No. 157, Fair Value Measurements, and No. 107, Disclosures about Fair Value of Financial Instruments. Statement 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact of FAS 159 on its financial position or results of operations.

NOTE 2 —– CONVERSION OF CONVERTIBLE PREFERRED SHARESSH

On April 16, 2007, the Company called for the redemption of its Series A 10% Convertible Preferred Stock (the “Series A”).  On April 30, 2007, the Company received notice that Clarex Limited, the holder of all the shares of the Series A, elected to convert the 500 Preferredpreferred shares into 500,000 shares of the Company’s common stock, in accordance with the Series A“Series A” Agreement.  The “Series A” preferred shares were cancelled and 500,000 common shares of the Company were issued on that date.

NOTE 3 —– PRE-PAYMENT OF SUBORDINATED CONVERTIBLE NOTE PAYABLE

On June 28, 2007, the Company made a pre-payment of $500,000 against the unpaid principal of its $1,000,000 subordinated convertible note maturing on March 31, 2008.  The holder of the note, Clarex Limited, agreed to waive its right to apply pre-payment amounts first against accrued and unpaid interest on the note prior to applying any amount to unpaid principal.

NOTE 4 – IMPACT OF UNAUTHORIZED PERSONAL TRANSACTIONS BY FORMER CFO

As previously reported, over a period of approximately six years, from the second quarter of 2000 through the second quarter of 2006, the Company’s former Chief Financial Officer, William Miraglia, had engaged in unauthorized and personal transactions totaling $860,000.

These transactions were entered by the former CFO into the Company’s accounts as Selling, General and Administrative expenses.  Although the transactions were unauthorized and personal in nature, based upon a review of the accounting treatment of individual transactions, the Company concluded that all material charges have been reflected as part of the reported expenses, reported net income, earnings per share and cash flows in the appropriate periods.  A total of $47,000 was recorded in Selling, General and Administrative expenses in the first quarter of 2006 and an additional $10,000 was recorded in Selling, General and Administrative expenses in the second quarter of 2006.  A claim to recover a portion of these losses under the Company’s employee dishonesty insurance policy was settled in the third quarter of 2006 in the amount of $300,000, the policy limit, and has been reflected in the Company’s 2006 financial results for 2006.as of the recovery date.

As a result of the foregoing discoveries, Mr. Miraglia was terminated for cause from his employment with the Company on June 14, 2006.  Upon termination of his employment, Mr. Miraglia signed an agreement to make restitution to the Company.  To date, he has repaid $5,000.  In light of a number of factors, the Company does not believe that any significant recoveries from Mr. Miraglia are likely in the near term, but the Company is keeping all of its options open.  The Company has been cooperating with the U.S. Attorney’s office in its ongoing investigation into this matter.

Note 5 – SUBSEQUENT EVENT

In July 2007, 70,000 stock options granted under the Company’s 2000 Equity Compensation Program were exercised at an average exercise price of $0.87 per share.

Disclosure: Forward Looking Statements

This Quarterly Report contains forward-looking statements as that term is defined in the federal securities laws.  The Company wishes to insure that any forward-looking statements are accompanied by meaningful cautionary statements in order to comply with the terms of the safe harbor provided by the Private Securities Litigation Reform Act of 1995.  The events described in the forward-looking statements contained in this Quarterly Report may not occur. 

Generally these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of our plans or strategies, projected or anticipated benefits of acquisitions to be made by us, projections involving anticipated revenues, earnings, or other aspects of our operating results.  The words “may”, “will”, “expect”, “believe”, “anticipate”, “project”, “plan”, “target”, “intend”, “estimate”, and “continue”, and their opposites and similar expressions are intended to identify forward-looking statements.  We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks, and other influences, many of which are beyond our control, that may influence the accuracy of the statements and the projections upon which the statements are based.  Actual results may vary from these forward-looking statements for many reasons, including the following factors:

·                  adverse changes in economic or industry conditions in general or in the markets served by the Company and its customers

·                  actions by competitors

·                  inability to add new customers and/or maintain customer relationships

·                  inability to retain key employees.

The foregoing is not intended to be an exhaustive list of all factors that could cause actual results to differ materially from those expressed in forward-looking statements made by the Company.  Investors are encouraged to review the risk factors set forth in the Company’s most recent Form 10-K as filed with the Securities and Exchange Commission on March 30, 2007.  Any one or more of these uncertainties, risks, and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate.  Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements.  Except as required by law, we undertake no obligation to publicly update or revise any forward looking statements, whether from new information, future events, or otherwise.

Readers are further cautioned that the Company’s financial results can vary from quarter to quarter, and the financial results for any period may not necessarily be indicative of future results.

The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and the notes thereto presented elsewhere herein.  The discussion of results should not be construed to imply any conclusion that such results will necessarily continue in the future.

Critical Accounting Policies

Our significant accounting polices are described in Note 1 of the Consolidated Financial Statements.  In preparing our financial statements, we made estimates and judgments that affect the results of our operations and the value of assets and liabilities we report.  Our actual results may differ from these estimates under different assumptions or conditions.

For additional information regarding our critical accounting policies and estimates, see the section entitled “Managements Discussion and Analysis of Financial Condition and Results of Operations” in our annual report filed with the Securities and Exchange Commission on Form 10-K for the year ended December 31, 2006.

Results of Operations

PPGI’s business units’ products continue to fall into two product categories: optical components (including standard and custom optical components and assemblies, crystals, and crystal components), and laser accessories (including wavelength conversion instruments that employ nonlinear or electro-optical crystals to perform the function of wavelength conversion, or optical switching, and optical Q-switches.Q-switches).  Currently, its optical components product lines and services are brought to market via three PPGI business units: INRAD, Laser Optics, and MRC Optics.  Laser accessories are brought to market by INRAD.

11

Revenues

Total sales for the three months ended March 31,June 30, 2007 were $3,541,000$3,679,000 as compared with total sales of $3,663,000$3,531,000 for the same three months in 2006,2006; up 4.2%.  Total sales for the six months ended June 30, 2007 were slightly higher at $7,220,000 as compared with $7,194,000 for the same period last year.

Sales of INRAD laser accessories were again strong in the second quarter, up 41% from the second quarter of last year, and up 57% for the first half of 2007 compared with the same period in 2006.

Second quarter sales of optical components were up slightly at 0.5% compared with the second quarter of last year.  Optical component quarterly revenues, both on a decreaseyear-to-year and current year second quarter to current year first quarter basis, increased for Laser Optics and INRAD, and declined at MRC Optics.  Overall, sales of 3.3%.  Salesoptical components were down 3.5% for the first six months of 2007 as compared with the first half of 2006.

The decline in second quarter shipments of custom optical components at MRC, from first quarter levels, was attributable to a decrease in thisshippable backlog from a slippage in the awarding of certain new production contracts originally expected to be booked in the first quarter.  Instead, these new contracts were booked in the second quarter, decreased by approximately 4.3%and included the awarding of contracts with a multi-year sales outlook from the same period inU.S. Army to provide both new and refurbished precision metal optical mirrors for the prior year, with a reduction in demand for UV filter crystals from a defense industry OEM customer.  This was offset somewhat by an approximately 1% increase inM1A1 Abrams tank fire-control electro-optical suite.

Company sales of laser accessories.  Sales of optical components remained strongwere mainly to customers within the aerospace/aerospace, defense, and process control and metrology industry sectors.  ShipmentsSales to two aerospace/defense industry customers represented 19.8% and 14.4% of total revenues in this quarter.  Sales to the same two defense industry customers represented 19.4% and 14.8% of total revenues for the first quarter represented 15.3% and 18.8% of total sales in the period, respectively.  During fiscal yearsix months.

In 2006, sales to these same two aerospacedefense industry customers represented 13.0%20.3% and 13.6%12.8% of total revenues in the first quarter.second quarter, respectively.  For the six months ended June 30, 2006 the two defense industry customers represented 16.1% and 13.2% of total revenues.

Product bookings for the quarter ended March 31,June 30, 2007 were $4,960,000 as compared with $2,271,000increased by 7.0% to $3,369,000 from $3,149,000 for the same period last year, anyear.  For the first six months, product bookings of $8,326,000 were up 53.6% and showed a significant increase, compared with $5,420,000 in the first six months of 118%.  In this year’s first quarter,last year.

At MRC, order intake for optical components was especially strong forstronger than in the first quarter, and resulted in boosting backlog levels.  One new MRC Optics defense industry customer booking represented 19.6% of total second quarter bookings.  At Laser Optics, while order intake at INRAD and MRC for optical components was moderate.  Major OEM customer orders do not usually follow a strict seasonal trend, and major production releases from aerospace/defense industry customers usually occur once or twice per year at irregular intervals.  In this year’s first quarter, orders from four major OEM customers accounted for 67% ofone new orders.  Of these, one large order for high precision crystal optical components was from a major defense industry OEM customer in the infra-red imaging systems sector, another was for precision X-ray monochrometers from a major multinational manufacturer of X-ray analytical process control and metrology equipment, another was for UV filter crystal components from a defense industry manufacturer of aircraft missile warning sensors and self-protection systems, while the fourth was for laser accessories and specialty laser frequency doubling crystals from a major manufacturer of commercial laser systems.  In last year’s first quarter,customer released orders from three INRAD and MRC Optics OEM customers accounted in the aggregate for 56%that represented 18.8% of total new orders.  One order was from a major defense industry OEM customer, on a new program, which represented 30% of total bookingsorders for the quarter.  Another order, representing 17% of new orders was from another defense industry OEM who issued a follow-on production release for proprietary INRAD filter crystal components used in their anti-aircraft missile warning systems, while the third was from an industrial factory automation sector customer.

Product backlog at March 31,on June 30, 2007 was $8,450,000 which compares withapproximately $8,032,000, up 31.6% from a backlog of $6,484,000$6,104,000 at the same point in 2006 and a2006.  By comparison, product backlog ofwas $6,969,000 on December 31, 2006.

Based upon theThe increase in backlog at the end ofexperienced during the first half is expected to have a positive impact on third quarter and related delivery schedules, management expects revenues to trend moderately higher in the second quarter.revenues.

Cost of Goods Sold

For the three-month period ended March 31,June 30, 2007, the cost of goods sold as a percentage of product revenues was 61.0% as62.1% compared with 67.6%to 68.2% for the same

period last year.  For the full year 2006, the actual cost of goods sold percentage was 67.4%.

Gross margin was 39.0% in the first quarter, compared with 32.4% in the first quarter of last year.  Gross margin in 2006 was 32.6% for the full year.  In dollar terms, firstsecond quarter cost of goods sold was $2,159,000$2,286,000 compared with $2,475,000 in the same period$2,410,000 in 2006, down 12.8%5.1%, despite a revenue increase of 4.2%.  A part of this decrease is attributable to the 3.3% decrease in revenues.  However, thisThe reduction in cost of goods sold was primarily a result of improved operational productivity and related overhead cost reduction,and labor cost reductions in this quarter compared to the previous period.  Work-in-process inventory levels increasedsame period last year.

Gross margin of $1,393,000 or 37.9% in the period as production backlogs for the second quarter, rosecompared with gross margins of $1,122,00 or 31.8% in the comparable period of 2006 and $1,381,000 or 39.0% in the first quarter of this year.  Higher sales and improved margins contributed to record levels, positively affectinghigher second quarter 2007 gross margins versus the same period in 2006.

For the six month period ended June 30, 2007, the cost of goods sold was 61.6% of sales or $4,445,000 compared to 67.9% of sales and $4,885,000 for six months in 2006.  Overall, the cost of goods sold was favorably impacted by the interrelated factors of improved efficiencies and productivity and lower overhead costs.  Correspondingly, gross margin.margin for the six months ended June 30, 2007 improved to $2,775,000 or $466,000 higher, at 38.4% of sales as compared to $2,309,000 or 32.1% in the 2006 comparable period.

Selling, General and Administrative Expenses

Selling, general and administrative expenses (“SG&A” expenses) in the second quarter or 2007 were $857,000,down $90,900 to $901,800 representing 24.5% of sales compared to $992,700, or 24.2%28.1% of sales in the second quarter of 2006, on a period over period revenue increase of 4.2%.  SG&A expenses for the first six months of 2007 decreased by $97,600 to $1,758,500, or 24.4% of sales, compared with $1,856,100, or 25.8% of sales in the first six months of 2006, on a revenue increase of 1.0%.

SG&A expenses in the second quarter of 2006 and for the six months ended June 30, 2006, included a total of approximately $81,000 of non-recurring costs incurred in connection with the investigation into misappropriation of Company funds for personal use by its former CFO.  These expenses included additional costs for legal advice, forensic consulting, temporary accounting assistance, and special meetings of the Audit Committee of the Board of Directors.  Increased expenses also resulted from recruitment costs incurred in connection with the Company’s successful search for its new CFO in the first half of 2006.

Income from Operations

The Company realized income from operations of $491,500, or 13.4% of sales in the second quarter.  This compares favorably to an operating income of $129,100 or 3.7% of sales for the second quarter of 2006.

For the six months ended June 30, 2007, operating profit was $1,016,300 or 14.1% of sales, up significantly from a profit of $452,800 or 6.3% of sales for the first six months of 2006.  The year over year improvement in operating profit over six months was attributable to higher margins, an improved operating cost structure, and lower SG&A expenses, as discussed above.

Other Income and Expense

For three months ended June 30, 2007, net interest expense was $70,000, down from $108,800 in the second quarter last year.  Net interest expense of $144,900 for the first six months of 2007 fell by $85,900 from $230,800 in 2006.

The reduction in interest expense-net for three months and six months ending June 30, 2007, reflects, in part, the increased offset from the higher levels of interest income realized on higher cash balances.  Interest income totaled $43,000 and $79,000 for the three and six month periods ended June 30, 2007.  By contrast, interest income in the comparable periods of 2006 was $2,000 and $13,000, respectively.  Lower interest costs also resulted from decreased debt balances.  Approximately $174,000 in notes payable and capital lease obligation balances, were paid down, due to both scheduled and accelerated amortization payments, over the six months of 2007.

The accelerated payment of $500,000 against outstanding principal on a convertible note payable, which the Company made at the end of the period and which will result in reducing interest expense in future periods, did not have any significant impact in the second quarter of 2007.

In 2006, other expense included $13,000 of costs paid by the Company in the second quarter of that year to liquidate property and unemployment and disability taxes that subsequently came to light in connection with the Company’s December 2003 acquisition of Laser Optics, Inc.

Net Income

The Company had net income of $396,500 for the second quarter of 2007, as compared with a net profit of $6,800 for the second quarter of last year.  For the six months ended June 30, 2007, net profit improved to $873,000, or 23.8%$831,300, comparing favorably with a net profit of $208,500 in the same period last year.

Net Profit (Loss) Applicable to Common Shareholders and Earnings per Common Share

The Company distributed a common stock dividend, in the prior year.  This decreasesecond quarter of 2007 and 2006, to the holders of its Series A and B convertible preferred stock.  The number of common shares issued in dollar costs reflects management’s ongoing focussettlement of the dividend is determined based on tight control over coststhe coupon rate of the preferred shares, the total shares outstanding, and cash outflows.

Operating Income

the conversion price of each series of preferred shares.  The company realized operatingdividend value is calculated by reference to the market price of the common shares on the dividend distribution date.  The Company issued 133,280 common shares in 2007 and 134,000 common shares in 2006 representing dividends to preferred shareholders of $233,240 and $234,500, respectively.

During the second quarter of 2007, the Company recalled the entire issue of its Series A convertible preferred stock and the sole holder of the shares exercised its right to convert the 500 Series A shares into 500,000 shares of the Company’s common stock.

Net income applicable to common shareholders for the quarter ending March 31,three months ended June 30, 2007 was $163,200 or earnings per share of $525,000, equal$0.02, basic and diluted.  This compares with a net loss applicable to 14.8% of sales, as compared with operating income of $315,000, or 8.6% of sales,common shareholders for the same period last year.  As discussed above,in 2006 of $(227,700) or a loss per share of $(0.03), basic and diluted.

For the increase in income from operations, despite a 3.3% decrease in sales, was the result of improved margins resulting from increased productivity and improved operational efficiencies.

Other Income and Expenses

Interest expense-net in the first quarter ofsix months ended June 30, 2007, was $75,000, as compared with $113,000 in the first quarter of last year.

Interest expense-net decreased over prior periods due to the decrease in capital lease obligations for the comparative periods, and increased interest income realized on this year’s higher cash balances.

Net Income Applicable to Common Shareholders

The company had net income applicable to common shareholders of $435,000 for the period ending March 31, 2007,was $598,100 or $0.06$0.07 per share, basic, and $0.04$0.05 per share, diluted, as compared withdiluted.  For the six months ended June 30, 2006, net income applicableloss attributable to common shareholders was and $(26,000) or a loss of $202,000, or $0.03approximately $(0.00) per share, both basic and $0.02 per share diluted in the same period, last year.diluted.

Liquidity and Capital Resources

Net cash flow fromprovided by operating activities was positive at $287,000$1,531,200 for the first six months of 2007, up by 55% from net cash flow provided by operating activities of $985,300 in this year’sthe first quarter, but was below prior years comparable withsix months of 2006.

The increase in positive net cash flow from operations of $419,000 in the same period last year.  Cash flow from operations decreased from that inover the first quartersix months of last year despite significantly higher net income primarily2007 was due to a greater deploymentnumber of cash into increased work-in-process inventory,factors, including improved profitability from operations resulting from a combination of higher margins and a higher liquidation of customer cash advances against product shipments during the comparable periods.

During the three month periods ended March 31, 2007, and March 31, 2006,reduced expenses, as discussed above.  In addition, net working capital requirements fell by $227,000 over the first six months of 2006 compared to a net decrease of $107,000 in 2006.  In all comparable periods, working capital requirements were fully funded from cash generated by operations.

Management expects that cash flow from operations will provide adequate liquidity for the Company’s operations throughout 2007.

Capital expenditures for the threesix months ended March 31,June 30, 2007 were $30,000,approximately $94,000, compared to $800,000$904,000 in the first quarterhalf of 2006.  Capital expenditures for all of fiscal 2006 were $987,000.  In the first quarterhalf of 2007, thesecapital expenditures were primarily for replacement or refurbishment of capitalmanufacturing equipment at the

end of its useful life, in addition to the acquisition of new computer hardware and engineering software.

life.  In the first quarterhalf of 2006, the major portion of capital additions represented major expenditures for equipment required in the performance of certain specific contracts and to give the Companyprovide an increased capability and a stronger competitive position for the Company, in the manufacture ofhigh precision spherical and aspherical lenses.lens production.

In February 2006, Clarex Limited provided the Company with $700,000 in financing to fund the acquisition of certain capital assets required for expanded capabilities to meet customer demand.  The terms call for repayment of the Company’s Promissory note in equal monthly installments, including interest & principal, commencing March 2006, until maturity in March 2013.  The Note bears an annual interest rate of 6.75%

During the first half of 2007, 341,100 stock options were exercised at a weighted average price of approximately $0.54 and converted into 341,100 shares of common stock.  This yielded a total of $183,000 in proceeds to the Company.  By comparison, in the first half of 2006, 25,000 stock options were exercised at a price of $1.00 per share for a total of $25,000 in proceeds.

The Company retired approximately $174,000 of notes payable (excluding convertible debt) and capital lease obligations, during the first six months of 2007, compared to $253,000 in 2006, reflecting the scheduled amortization of debt.

As previously discussed, on June 28, 2007, the Company accelerated payment of $500,000 against principal on the outstanding balance of its $1,000,000 subordinated convertible note maturing on March 31, 2008.  The holder of the note, Clarex Limited, agreed to waive its right to payment of accrued interest on the note, at this time, before re-payment of principal, in the best interests of the Company.  The unpaid balance of accrued interest is reflected in accrued liabilities, along with other liabilities, on the consolidated balance sheet.

For the six months ended June 30, 2007, cash and cash equivalents increased by $947,000 to $4,025,000, up from increased cash and cash equivalents for the first six months of 2006 of $554,000 and a June 30, 2006 cash balance of $1,710,000.

Management expects to continue to deploy excess cash from time to time into accelerating repayment of debt.

Management also expects that it may, from time to time, attempt to raise investment capital and to make investments in capital acquisitions, both in equipment and in complementary lines of businesses, to pursue its objective of growth in shareholder value and to maintain a competitive edge in the markets that it serves.

On April 16, 2007, the Company called for the redemption of its Series A 10% Convertible Preferred Stock (the “Series A”).  On April 30, 2007, the Company received notice that Clarex Limited, the holder of all the shares of the Series A, elected to convert the 500 preferred shares into 500,000 shares of the Company’s common stock, in accordance with the Series A Agreement.

Management expects to continue to deploy excess cash from time to time into repayment of debt.

Management also expects that it may from time to time attempt to raise investment capital and to make investments in capital acquisitions, both in equipment and acquisition of complementary lines of businesses, to pursue its objective of growth in shareholder value and to maintain a competitive edge in the markets that it serves.

In February 2006, a major shareholder and debt holder provided the Company with $700,000 in financing to fund the acquisition of certain capital assets required for expanded capabilities to meet customer demand.  The terms call for repayment of the Company’s Promissory note in equal monthly installments, including interest & principal, commencing March 2006, until maturity in March 2013.  The Note bears an annual interest rate of 6.75%.

In 2002,2004, the Company received $1,000,000 in proceeds from the issuance of a Subordinated Convertible Promissory Note.  The note originally due in January 2006, has been extended to December 31, 2008 and bears an interest rate of 6%. and was initially due on March 31, 2007, but its term has been extended to March 31, 2008.  Interest accrues yearly and along with principal may be converted into Common Stock, (and/or securities convertible into common shares).  The note is convertible into 1,000,000 Units consisting of 1,000,000 shares of Common Stock and Warrants to acquire 750,000 shares of Common Stock at a price of $1.35 per share.  The Holder of the Note is a related party to a major shareholder of the Company.

In June of 2003, the Company paid off existing debt with the proceeds of a $1,700,000 Secured Promissory Note held by a major investor in the Company.  The note was for a period of 36 months at an interest rate of 6% per annum.  The Company’s Board of Directors approved the issuance of 200,000 warrants to Clarex Limited, the lender, as a fee for the issuance of the Note.  In 2004, the Company approved the issuance of 200,000 additional warrants to Clarex, as additional consideration in connection with the same transaction.  The note was subsequently extended to December 31, 2008 without issuance of warrants or any other consideration.  The warrants are exercisable at $0.425 per share and $1.08 per share, respectively, approximately a 20% discount to market, and expire in March 2008 and May 2008.  The note is secured by all assets of the Company.

A Subordinated Convertible Promissory Note for $1,500,000 originally due in January 2006, has been extended to December 31, 2008 and bears an interest rate of 6%.  Interest accrues yearly and along with principal may be converted into Common Stock, and/or securities convertible into Common Stock.  The note is convertible into 1,500,000 Units consisting of 1,500,000 shares of Common Stock and Warrants to acquire 1,125,000 shares of Common stock at a price of $1.35 per share.  The Holder of the Note is a major shareholder of the Company.  The proceeds from the Note were used in the Company’s acquisition program.

In 2004, the Company received $1,000,000 in proceeds from the issuance of a Subordinated Convertible Promissory Note.  The note bears an interest rate of 6% and was initially due on March 31, 2007, but its term has been extended to March 31, 2008.  Interest accrues yearly and along with principal may be

converted into Common Stock, (and/or securities convertible into common shares).  The note is convertible into 1,000,000 Units consisting of 1,000,000 shares of Common Stock and Warrants to acquire 750,000 shares of Common Stock at a price of $1.35 per share.  The note holder is a major shareholder of the Company.

ITEM 3.                             QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company believes that it has limited exposure to changes in interest rates from investments in certain money market accounts.  The Company does not utilize derivative instruments or other market risk sensitive instruments to manage exposure to interest rate changes.  The Company believes that a hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of the Company’s interest sensitive money market accounts at March 31,June 30, 2007.  Interest on notes and leases are at fixed rates for the term of the debt.

ITEM 4.          CONTROLS AND PROCEDURES

a.Disclosure Controls and Procedures

During the firstsecond quarter of 2007, our management, including the principal executive officer and principal financial officer evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934) related to the recording, processing, summarization and reporting of information in the reports that we file with the SEC.  These disclosure controls and procedures have been designed to ensure that material information relating to us, including our subsidiaries, is made know to our management, including these officers and that this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the SEC’s rules and forms.  Due to inherent limitations of control systems, not all misstatements may be detected.  These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons; by collusion of two or more people, or by management override of the control.  Our controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met.

Based upon their evaluation as of June 30, 2007, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures wereare effective to reasonably ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

b.Changes in Internal Controls Overover Financial reportingReporting

There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter 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

None.

ITEM 1A.       RISK FACTORS

There were no material changes in the risk factors previously disclosed in the Company’s Report on Form 10-K for the year ended December 31, 2006 which was filed with the Securities and Exchange Commission on March 30, 2007.

ITEM 3.          UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5.          OTHER INFORMATION

On May 5, 2004, the Board of Directors amended the By-laws of the Company to eliminate the age restriction for Directors.  This information was omitted from the Company’s previous filings with the Securities and Exchange Commission.None.

ITEM 6.          EXHIBITS

31.1         Certificate of the Registrants Chief Executive Officer, Daniel Lehrfeld, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2         Certificate of the Registrants Chief Financial Officer, William J. Foote, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1         Certificate of the Registrants Chief Executive Officer, Daniel Lehrfeld, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2         Certificate of the Registrants Chief Financial Officer, William J. Foote, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

17Date:    August 13, 2007

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