The accompanying notes are an integral part of these consolidated interim financial statements.

PRECISION OPTICS CORPORATION, INC.

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)

Principles of Consolidation and Operations

The accompanying consolidated financial statements include the accounts of Precision Optics Corporation, Inc. and its wholly-owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation.

These consolidated financial statements have been prepared by the Company, without audit, and reflect normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of the results of the thirdsecond quarter and ninesix months of the Company’s fiscal year 2017.2018. These consolidated financial statements do not include all disclosures associated with annual consolidated financial statements and, accordingly, should be read in conjunction with footnotes contained in the Company’s consolidated financial statements for the year ended June 30, 2016,2017, together with the Report of Independent Registered Public Accounting Firm filed under cover of the Company’s 20162017 Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 28, 2016.2017.

Use of Estimates

The preparation of these consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Income (Loss) Per Share

Basic income (loss) per share is computed by dividing net income or net loss by the weighted average number of shares of common stock outstanding during the period. Diluted income (loss) per share is computed by dividing net income or net loss by the weighted average number of shares of common stock outstanding during the period, plus the number of potentially dilutive securities outstanding during the period such as stock options and warrants. For the three and ninesix months ended MarchDecember 31, 2017 and 2016, the effect of such securities was antidilutive and not included in the diluted calculation because of the net loss generated in these periods.

The following is the calculation of loss per share for the three and ninesix months ended MarchDecember 31, 2017 and 2016:

The number of shares issuable upon the exercise of outstanding stock options and warrants that were excluded from the computation as their effect was antidilutive was approximately 5,152,5471,708,867 and 4,168,0005,113,224 for the three months ended MarchDecember 31, 2017 and 2016, respectively, and approximately 5,152,5474,739,960 and 4,168,0005,113,224 for the ninesix months ended MarchDecember 31, 2017 and 2016, respectively.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

In assessing the likelihood of utilization of existing deferred tax assets, management has considered historical results of operations and the current operating environment. Based on this evaluation, a full valuation reserve has been provided for the deferred tax assets.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued ASU No. 2014-09, Revenue from Contracts with Customers which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required regarding customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. The standard will be effective for the Company for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The Company is reviewing the financial statement effect, if any, of implementing ASU No. 2014-09, that will go into effect on July 1, 2018.

Inventories are stated at the lower of cost (first-in, first-out) or market and consisted of the following:

The Company entered into a five-year capital lease obligation in January 2016 for the acquisition of manufacturing equipment totaling $51,252. At MarchDecember 31, 2017, future minimum lease payments under the capital lease obligation are as follows:

Stock-basedThe following table summarizes stock-based compensation costs recognized duringexpense for the quartersthree and six months ended MarchDecember 31, 2017 and 2016 amounted to $44,310 and $51,705 respectively, and the costs were included in the accompanying consolidated statements of operations in: selling, general and administrative expenses (2017 - $28,949; 2016 $33,721), research and development expenses (2017 - $6,692, 2016 - $9,316) and cost of goods sold (2017 - $8,669; 2016 - $8,668). Stock-based compensation costs recognized during the nine month periods ended March 31, 2017 and 2016 amounted to $154,743 and $194,133, respectively, and were included in the accompanying consolidated statements of operations in: selling, general and administrative expenses (2017 - $106,035; 2016 - $94,099), research and development expenses (2017 - $22,701, 2016 - $48,023) and cost of goods sold (2017 - $26,007, 2016 - $52,011). 2016:

No compensation has been capitalized because such amounts would have been immaterial.

The following tables summarize stock option activity for the ninesix months ended MarchDecember 31, 2017:

Information related to the stock options outstanding as of MarchDecember 31, 2017 is as follows:

The aggregate intrinsic value of the Company’s “in-the-money” outstanding and exercisable options as of MarchDecember 31, 2017 was $5,500.$5,750 and $5,650, respectively.

As of September 30, 2017, there were warrants outstanding for the issuance of an aggregate of 666,667 shares of common stock, $0.01 par value, at a purchase price of $0.01 per share. All warrants for 666,667 shares were exercised on or before October 16, 2017, by payment to the Company for the aggregate purchase price of $6,667. There are no warrants for the purchase of the Company’s stock outstanding as of December 31, 2017.

November 2016

On NovemberAugust 22, 2016,2017, the Company entered into agreements with accredited investors for the sale and purchase of 1,333,334 units with each unit consisting466,668 unregistered shares of one share of the Company’sits common stock, $0.01 par value and one warrant to purchase one-half of one share of the Company’s common stock, at a purchase price of $0.60$0.45 per unit.share. The Company received $780,000$210,001 in gross cash proceeds from the offering and settled an outstanding accounts payable balance with a consultant in the amount of $20,000 by issuing units.offering. The Company is using the net proceeds from this placement for general working capital purposes.

The warrants issued in this offering will vest on October 2, 2017 and expire on October 16, 2017. The warrant exercise price is variable and depends on the Company’s achievement of certain performance criteria (both defined below). The warrant exercise price was agreed to be $0.40 per share if the Company achieved both of the revenue and income performance criteria, the exercise price will be $0.20 per share if the Company achieves one of the performance criteria, and the exercise price will be $0.01 if the Company does not achieve either of the performance criteria.

Pursuant to the revenue criterion, the Company must achieve at least $1.85 million of revenue in any one quarter during the fiscal year ending June 30, 2017. Pursuant to the income criterion, the Company must have achieved positive net income in any two quarters during the fiscal year ending June 30, 2017. Both criteria will be determined under U.S. Generally Accepted Accounting Principles and by the Company’s audited consolidated annual financial statements and the Company’s quarterly financial statements.

In conjunctionConcurrently with the offering, the Company also entered into a registration rights agreement with the investors, whereby the Company was obligated to file a registration statement with the Securities Exchange Commission on or before 90 calendar days after November 22, 2016 to register the resale by the investors of the 1,333,334 shares and warrant shares purchased in the offering. The registration statement was filed with the Securities and Exchange Commission on February 3, 2017 and became effective on February 24, 2017.

In conjunction with the offering, certain anti-dilution provisions of the warrants issued in conjunction with our June 25, 2008 and September 28, 2012 financing transactions were triggered. For purposes of this calculation, all warrants issued in this offering are assumed to be exercised at an exercise price of $0.20, because as of March 31, 2017 the Company did not meet the income criteria (defined above). As a result, the number of existing June 25, 2008 warrants increased from 568,776 to 577,366 and the related exercise price of the warrants decreased from $0.89 to $0.88 per share. The June 25, 2008 warrants expired on May 11, 2017. Also, as a result of the offering, the number of existing September 28, 2012 warrants increased from 2,503,237 to 2,532,629 and 240,144 to 244,485, respectively, and the related exercise price decreased from $0.97 to $0.96 and from $0.77 to $0.76, respectively. 

October 2015

On October 19, 2015,placement, the Company entered into agreementsan agreement with accredited investorsan investor for the sale and purchase of 1,044,77688,888 unregistered shares of the Company’sits common stock $0.01 par valuefor services provided to the Company at a purchase price of $0.67$0.45 per share. The Company received $700,000 in gross proceeds from the offering. The Company used the net proceeds from this placement for general working capital purposes.

In conjunctionconnection with the placement, the Company also entered into a registration rights agreement with the investors, whereby the Company was obligated to file a registration statement with the Securities Exchange Commission on or before 90 calendar days after October 19, 2015August 22, 2017 to register the resale by the investors of the 1,044,776555,556 shares of the Company’sour common stock purchased in the placement. The registration statement was filed with the Securities and Exchange Commission on January 19, 2016November 20, 2017 and became effective on February 1, 2016.

In conjunction with the offering, certain anti-dilution provisions of the warrants issued in conjunction with the Company’s June 25, 2008 and September 28, 2012 financing transactions were triggered. As a result, the number of existing June 25, 2008 warrants increased from 493,398 to 517,222 and the related exercise price of the warrants decreased from $1.03 to $0.98 per share. Also, as a result of the offering, the number of existing September 28, 2012 warrants increased from 2,189,724 to 2,293,013 and 217,322 to 222,559, respectively, and the related exercise price decreased from $1.11 to $1.06 and from $0.85 to $0.83, respectively.

December 13, 2017.

DuringOn December 22, 2017, the nine months ended March 31, 2017Tax Cuts and 2016,Jobs Act was signed into law. The Tax Cuts and Jobs Act will significantly change the taxation of U.S.-based multinational corporations, by, among other things, reducing the U.S. corporate income tax rate, adopting elements of a territorial tax system, affecting the deductibility of capital expenditures, assessing a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, continuing the moratorium on Medical Device Excise Tax, and the creation of new taxes on certain foreign-sourced earnings. The legislation is unclear in some respects and will require interpretations and implementing regulations by the Internal Revenue Service, as well as state tax authorities, and the legislation could be subject to potential amendments and technical corrections, any of which could lessen or increase certain adverse impacts of the legislation. The Company sold equipment that was previously written off for proceeds totaling $1,515 and $26,948, respectively, and recorded gains of $1,515 and $26,948, respectively, which are included within operating expensesis in the accompanying consolidated statementsprocess of operations.determining what, if any, effect those provisions will have on its financial results.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes to those statements included elsewhere in this Quarterly Report on Form 10-Q for the quarter and ninesix months ended MarchDecember 31, 2017 and with our audited consolidated financial statements for the year ended June 30, 20162017 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 28, 2016.2017.

This Quarterly Report on Form 10-Q contains forward-looking statements. When used in this report, the words “expects,“anticipate,” “anticipates,“suggest,” “suggests,“estimate,” “believes,“plan,” “intends,” “estimates,” “plans,” “projects,“project,” “continue,” “ongoing,” “potential,” “expect,” “predict,” “believe,” “intend,” “may,” “will,” “should,” ��could,“could,” “would” and similar expressions are intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements.  Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described in this report, the risks described in our Annual Report on Form 10-K for the year ended June 30, 20162017 and other reports we file with the Securities and Exchange Commission. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made.  We do not intend to update any of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations, except as required by law.

Overview

We have been a developerdeveloping and manufacturer ofmanufacturing advanced optical instruments since 1982. Today, the vast majority of our business is the design and manufacture of high-quality medical devices and approximately 5%less than 10% of our business is the design and manufacture of military and industrial products. Our medical instrumentation line includes traditional endoscopes and endocouplers as well as other custom imaging and illumination products for use in minimally invasive surgical procedures. Much of our recent development efforts have been targeted at the development of next generation endoscopes. ForOver the last ten years, we have funded internal research and development programs to develop next generation capabilities for designing and manufacturing 3D endoscopes and very small Microprecision™ lenses, anticipating future requirements as the surgical community continues to demand smaller and more enhanced imaging systems for minimally invasive surgery.

Our unique proprietary technology in the areas of micro optical lenses and prisms, micro medical fiber and CMOS based cameras, and custom design of medical grade instruments, combined with recent developments in the areas of 3D displays, has allowed us to begin commercialization of related product and service offerings to a widening group of customers addressing various medical device, defense and aerospace applications. Thus, a portion of our revenues are now derived from engineering and design services we performed for our customers to incorporate our technologies and capabilities into their medical device products. We believe that new products based on these technologies provide enhanced optical and imaging qualities for many uses including existing surgical procedures and can enable development of many new procedures enabled by the small sizemedical device products and image quality of our camera modules.related medical procedures.

We are registered to the ISO 9001:2008 and ISO 13485:2003 Quality Standards and comply with the FDA Good Manufacturing Practices and the European Union Medical Device Directive for CE marking of our medical products. Our internet website is www.poci.com. Information on our website is not intended to be integrated into this report.

The markets in which we do business are highly competitive and include both foreign and domestic competitors. Many of our competitors are larger and have substantially greater resources than we do. Furthermore, other domestic or foreign companies, some with greater financial resources than we have, may seek to produce products or services that compete with ours. We routinely outsource specialized production efforts as required to obtain the most cost effective production. Over the years, we have achieved extensive experience collaborating with other optical specialists worldwide and since the 1990s, we have maintained a presence in Asia, specifically Hong Kong, to support business and quality control activities throughout the region as needed.

We believe that competition for sales of our medical products and services, which have been principally sold to original equipment manufacturers, or OEM, customers, is based on our ability to design and produce technical features, performance, engineering service and production scheduling, on-time delivery, quality control and product reliability, and competitive pricing.

We believe that our future success depends to a large degree on our ability to develop new optical products and services to enhance the performance characteristics and methods of manufacture of existing products. Accordingly, we expect to continue to seek and obtain product-related design and development contracts with customers and to selectively invest our own funds on research and development, particularly in the areas of Microprecision™ optics, micro medical cameras and 3D endoscopes.

For the yearsix months ended June 30, 2016,December 31, 2017, approximately 62%75% of our sales were made to seven customers. Of these, three arefour were medium to large, international, medical device companies who haveand one was a large defense contractor. Each of these customers has been our customer for numerous years. The other two customers for many years. These three customers continue to purchasewere early-stage companies developing endoscopic products that incorporate our unique design capabilities. Sales to these seven customers included both products we developed over five years ago and both now purchase new products that were developed and launched into production by us more recently. The other four top customers purchase products that we developed in recent years, andare currently developing which rely heavily on our unique, proprietary Microprecision™ lens technology and optical visualization system expertise.

Current sales and marketing activities are intended to broaden awareness of the benefits of our new technology platforms, which we believe are ready for general application to medical device projects requiring surgery-grade visualization from sub-millimeter sized devices and 3D endoscopy. We market directly to established medical device companies primarily in the United States that we believe could benefit from our advanced endoscopy visualization systems. Through this direct marketing, referrals, attendance at trade shows including Medical Design and Manufacturing West and MD&M East, and periodically a presence in online professional association websites, we have expanded our on-going pipeline of projects to significant medical device companies as well as well-funded emerging technology companies. We expect our customer pipeline to continue to expand as development projects transition to production orders and new customer projects enter the development phase.

General

This management’s discussion and analysis of financial condition and results of operations is based upon our unaudited consolidated financial statements, which have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

There have been no significant changes in our critical accounting policies as disclosed in the Notes to our Financial Statements contained in our Annual Report on Form 10-K for the year ended June 30, 20162017 filed with the Securities and Exchange Commission on September 28, 2016.2017.

Results of Operations

Our total revenues for the quarter ended MarchDecember 31, 2017, the third quarter of our fiscal year 2017, were $983,186,$812,773, as compared to $1,140,825$601,590 for the same period in the prior year, a decreasean increase of $157,639,$211,183, or 13.8%35.1%. Revenues decreasedincreased during the quarter ended MarchDecember 31, 2017 compared to the same quarter of the prior year in the engineering services categoryand production categories by 11%75% and slightly decreased16%, respectively. The majority of our revenues are derived from engineering design and manufacturing services related to products marketed or under development by our OEM customers. Therefore, our revenues are subject to fluctuations on a product by product basis from period to period. The increase in the production category by 3%. The engineering revenue decrease was primarily due to the transition to production of one project and completion of initial phases of two other customer projects, one of which we have already received new orders for and the other which is expected to continue in the future. Offsetting these declines were revenues from thirteen additional engineering projects worked on during the quarter ended MarchDecember 31, 2017 virtually all relatingwhen compared to CMOS and other Microprecision™ technology applications. The 3% decline in production revenuesthe same quarter of the prior year resulted primarily from the lossan increase in sales of a subassembly customer project utilizing Microprecision™ technology, and cyclical declines in two traditional products. These declines were offset by increased production revenues from various product categoriesto a long-standing customer. Engineering service revenue during the quarter ended MarchDecember 31, 2017, including traditionalwhen compared to the same quarter of the prior year included a similar number of projects, but increases in revenue from two specific customers, one of which is now transitioning from the engineering to production phase. We believe most engineering design projects have the potential to generate production revenues when our customers achieve commercialization of the products optical components and assemblies.under design.

Our total revenues for the ninesix months ended MarchDecember 31, 2017 were $2,434,324,$1,841,519, as compared to $2,954,024$1,451,138 for the same period in the prior year, a decreasean increase of $519,700,$390,381, or 17.6%26.9%. Revenues decreasedThe increase in revenues for the six month period ended December 31, 2017 compared to the same period of the prior year resulted from increases in engineering and production revenues of 41% and 18%, respectively. The engineering revenue increase during the nine monthsquarter ended MarchDecember 31, 2017 incompared to the engineering services categorysame period of the prior year resulted primarily from two large customer projects, one of which is now transitioning to production. These increases were partially offset by 3% and in the production category by 14%. Production revenues decreased due to thepreviously mentioned loss of a customer’s Microprecision™ technology product and cyclical declines in traditional laryngoscopes, partially offset by an increase infiscal 2017. Production revenues increased during the advanced surgical visualization product. Engineering revenues for the nine monthsquarter ended MarchDecember 31, 2017 declined primarily due to the transition to production of one project and completion of initial phases of two other customer projects. However, offsetting these engineering revenue declines in the nine months ended March 31, 2017 were revenues from twenty five additional projects during the period. Engineering projects worked on by us during the nine months ended March 31, 2017 increased by 71% to a total of thirty-six, compared to the number of projects in the same period of the prior year demonstratingdue to the expansionaddition of our sales pipelinean optical component project and deepening demand for CMOS and other Microprecision™ capabilities offered by us.a cyclical increase in traditional laryngoscopes.

Gross profit for the quarter ended MarchDecember 31, 2017 was $278,124, as$300,222, compared to $273,533$148,407 for the same period in the prior year, reflecting an increase of $4,591.$151,815, or 102.3%. Gross profit for the quarter ended MarchDecember 31, 2017 as a percentage of our revenues was 28.3%36.9%, an increase from the gross profit percentage of 24.0%24.7% for the same period in the prior year. Gross profit for the ninesix months ended MarchDecember 31, 2017 was $593,582,$686,964, as compared to $622,893$315,458 for the same period in the prior year, reflecting a decreasewhich reflects an increase of $29,311.$371,506 or 117.8%. Gross profit for the ninesix months ended MarchDecember 31, 2017 as a percentage of our revenues was 24.4%37.3%, an increase from the gross profit percentage of 21.1%21.7% for the same period in the prior year. The increase in our gross profit percentage in the most recent quarter and nine months was due primarily to increased margins realized from production of various traditional and Microprecision™ devices, components and sub-assemblies during the quarter and nine months ended March 31, 2017, plus the reduction in fixed production costs realized from the shut-down of our thin film coating department in early fiscal 2017. Comparative margins also improved in fiscal 2017 due to the elimination of manufacturing inefficiencies and reduced margins in fiscal 2016 from the subassembly product referenced above that is no longer produced by us. Further, our quarterlyQuarterly gross profit and gross profit percentage depend on a number of factors, including overall sales volume, thefacility utilization, product sales mix, of products sold, and the costs of engineering services and initial production in connection with new products. We believeThe improvement in our gross profit performance during the quarter and six month periods ended December 31, 2017 resulted from increased revenues absorbing a higher percentage of fixed manufacturing costs, and lower fixed compensation expense during the quarter. Management expects compensation costs to increase since new hires for these or similar positions are planned. Additionally, targeted or better margins will increase further as periodic saleswere realized on most engineering and production projects during the quarter ended December 31, 2017, including the larger revenue projects in each category, due to experienced related efficiencies in producing traditional products and facility utilization increase.engineering development activities associated with Microprecision™ technologies.

Research and development expenses were $122,313$90,031 for the quarter ended MarchDecember 31, 2017, compared to $118,285 for the same period in the prior year, an increase of $4,028, or 3.4%. The increase in the quarter ended March 31, 2017 compared to the same period in the prior year was primarily due to the decrease in our engineering services revenue, partially offset by a reduction in engineering headcount and related wages during the quarter. As a result of decreases in engineering revenue, a smaller portion of our fixed engineering cost is included in cost of goods sold and remains in research and development expenses. Research and development expenses were $358,520 for the nine months ended March 31, 2017, compared to $377,199$119,215 for the same period in the prior year, a decrease of $18,679,$29,184, or 5.0%24.5%. The decrease inResearch and development expenses were $208,458 for the nine month periodsix months ended MarchDecember 31, 2017, compared to the same period in the prior year, was primarily due to the decrease in engineering headcount and related wages during the period as engineering revenues were substantially equivalent between the nine months ended March 31, 2017 and 2016.

Selling, general and administrative expenses were $318,581 for the quarter ended March 31, 2017, compared to $407,406$236,207 for the same period in the prior year, a decrease of $88,825,$27,749, or 21.8%11.7%. The decrease in research and development expenses during the quarter and six months ended December 31, 2017, compared to the same periods of the prior year, resulted from a temporary reduction in engineering department staffing and a higher percentage of available engineering resources being consumed in revenue generating engagements with our customers for the development of their products. In-house research and development and certain internal functions not directly related to customer engagements are classified as research and development expenses.

Selling, general and administrative expenses were $1,003,590$270,035 for the nine monthsquarter ended MarchDecember 31, 2017, compared to $1,179,520$342,487 for the same period in the prior year, a decrease of $175,930,$72,452, or 14.9%21.2%. TheSelling, general and administrative expenses were $566,619 for the six months ended December 31, 2017, compared to $686,269 for the same period in the prior year, a decrease of $119,650, or 17.4%.The decrease in the quarter and nine month periodsix months ended MarchDecember 31, 2017, compared to the same periods in the prior year was primarily due to reduced legal,stock based compensation expense relating to stock options and stock accrued for consulting travel, advertising and trade show expenses,services, plus reduced wages resulting from the retirement of a sales person duringin January 2017 and a temporarily vacated administrative position which has since been filled. The expense reductions were partially offset by a $25,000 increase in the quarter ended March 31, 2017.reserve for doubtful accounts receivable relating to one specific customer and increased sales commissions for a lesser amount.

No income tax provision was recorded in the first, second or third quarters of fiscal yearquarter and six month periods ended December, 2017 orand 2016 because of the losses generated in those periods.

Liquidity and Capital Resources

We have sustained recurring net losses for several years. During the quarter and ninesix month periodperiods ended MarchDecember 31, 2017, we incurred net losses of $163,353$60,326 and $768,856,$89,111, respectively. We also incurred net losses of $1,006,457 and $1,034,765 during the fiscal years ended June 30, 2017 and 2016, respectively, and used cash in operating activities of $631,924$667,434 and $876,298 during the nine month period ended March 31, 2017.same fiscal periods, respectively. As of MarchDecember 31, 2017, cash and cash equivalents were $158,589,$381,752, accounts receivable were $533,922,$753,152, and current liabilities were $1,252,988. We also incurred net losses of $222,097$1,529,694. Our working capital was $671,433 and $885,297 during the quarter$479,604 at December 31, 2017 and nine month period ended March 31, 2016, and during the nine month period ended March 31, 2016, we used cash in operating activities of $750,213. During the fiscal year ended June 30, 2016, we incurred a net loss from operations of $1,055,434 and used cash in operating activities of $876,298. As of June 30, 2016, cash and cash equivalents were $50,059, accounts receivable were $750,380, and current liabilities were $1,503,961.2017, respectively.

We have traditionally funded working capital needs through product sales, management of working capital components of our business, and by cash received from public and private offerings of our common stock, warrants to purchase shares of our common stock or convertible notes. We have incurred quarter to quarter operating losses during our efforts to develop current products including Microprecision™ optical elements, micro medical camera assemblies and 3D endoscopes. Our management believes that the opportunities represented by these products have the potential to generate sales increases to achieve sustained breakeven and profitable results. However, our current financial condition may raise doubt regarding our ability to continue as a going concern, as referenced by the Report of our Independent Registered Public Accounting Firm on our financial statements for the year ended June 30, 2016,2017, included in our Annual Report on Form 10-K.

We recognize that the working capital described above and our cash and accounts receivable as of May 9,December 31, 2017 of approximately $180,000 and $268,000, respectively, is low considering the level of cash currently beinghistorically used in operations.our operations at our current sales levels. Our accounts receivable and cash balances are subject to significant fluctuations based on the timing and amount of customer billings and accounts receivable collections as well as the terms of vendor payment obligations. If we are unable to increase quarterly sales revenues todo not increase and maintain near or above cash breakeven levels in the next threesix to sixnine months, we may be required to obtain cash for operations from non-working capital sources, which may not be available, in which case we would have to significantly decrease or cease operations.

We are currently evaluating several options to manage cash flow and raise capital, if necessary, including issuing debt, equity or entering into a strategic alliance. The sale of additional equity or convertible debt securities would result in additional dilution to our current stockholders, and debt financing, if available, may involve restrictive covenants that could restrict our operations or finances. Financing, if necessary, may not be available in amounts or on terms acceptable to us, if at all. If we are unable to secure additional capital, we may be required to curtail our research and development initiatives and take additional measures to reduce costs in order to conserve our cash in amounts sufficient to sustain operations and meet our obligations. If we cannot raise funds on acceptable terms or achieve positive cash flow, we may not be able to continue to conduct operations, develop new products, grow market share, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which couldwould negatively impact our business, operating results and financial condition, or impact our ability to continue to conduct operations as a going concern.

On November 22, 2016, we closed agreements with institutional and accredited investors for the sale and purchase of 1,333,334 shares of our common stock at a purchase price of $0.60 per share (see Note 5. Sale of Stock). We received $780,000 in gross cash proceeds from the offering. We are using the net proceeds from this placement for general working capital purposes.condition.

Capital equipment and patent application related expenditures during the ninesix months ended MarchDecember 31, 2017 and 2016 were $27,719$17,189 and $4,554,$31,691, respectively. Future capital equipment and patent application expenditures will be dependent upon future sales and success of on-going research and development efforts.

We have contractual cash commitments related to open purchase orders as of MarchDecember 31, 2017 of approximately $153,000,$338,000, including a $33,968$27,828 commitment remaining under a five-year capital lease obligation for the acquisition of equipment (see Note 3. Capital Lease Obligation). We have no other contractual cash commitments since leased facilities are currently on a month-to-month basis.

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

As a smaller reporting company, as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.

Item 4. Controls and Procedures.

Management’s Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and our Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures, including internal control over financial reporting, were not effective, as of MarchDecember 31, 2017, to ensure the information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934, as amended (i) is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures are intended to be designed to provide reasonable assurance that such information is accumulated and communicated to our management. Based on this evaluation, our management concluded that our internal control over financial reporting was not effective as of MarchDecember 31, 2017.

The following is a description of two material weaknesses in our internal control over financial reporting:

Segregation of Duties: As previously disclosed in our Annual Reports on Form 10-K for the fiscal years ended June 30, 2008-2016,2008-2017, our management identified a control deficiency during the 2008 fiscal year because we lacked sufficient staff to segregate accounting duties. We believe the control deficiency resulted primarily because we have the equivalent of one and one-half persons performing all accounting-related on-site duties. As a result, we did not maintain adequate segregation of duties within our critical financial reporting applications, the related modules and financial reporting processes. This control deficiency could result in a misstatement of balance sheet and income statement accounts in our interim or annual consolidated financial statements that would not be detected. Accordingly, management has determined that this control deficiency constitutes a material weakness. During the period beginning with fiscal year 2008 through June 30, 2016,2017, no audit adjustments resulting from this condition were required.

To address and remediate the material weakness in internal control over financial reporting described above, beginning with the quarter ended September 30, 2008, we instituted a procedure whereby our Chief Executive Officer, our Chief Financial Officer and other members of our Board of Directors perform a higher level review of the quarterly and annual reports on Form 10-Q and Form 10-K prior to filing.

We believe that the step outlined above strengthens our internal control over financial reporting and mitigates the material weakness described above. As part of our assessment of internal control over financial reporting for the fiscal year ended June 30, 2016,2017, our management has evaluated this additional control and has determined that it is operating effectively.

Inventory Valuation: As previously disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016,2017, we reported a material weakness with respect to the valuation of our inventories. Specifically, the amounts used to value our inventory at June 30, 2009 with respect to overhead rates and purchased items were often inconsistent with the supporting documentation, due to year-to-year changes in overhead rates and costs of purchased items that were not properly reflected in inventory valuation. Accordingly, management had determined that this control deficiency constituted a material weakness as of June 30, 2009. One audit adjustmentAudit adjustments of approximately $58,000 and $41,000 to our audited financial statements as of June 30, 2011 wasand June 30, 2017, respectively, were necessary as a result of this condition.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the first quarter of our fiscal year covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

To address and remediate the material weakness in internal control over financial reporting described above, beginning in the quarter ended September 30, 2009 and continuing through the quarter ended MarchDecember 31, 2017, we implemented processes to improve our inventory controls and documentation surrounding inventory valuation for overhead rates, and performed procedures to ensure that the pricing of inventory items was consistent with the supporting documentation. We believe that the step outlined above strengthens our internal control over financial reporting and mitigates the material weakness described above.

We intend to continue to remediate material weaknesses and enhance our internal controls but cannot guarantee that our efforts will result in remediation of our material weaknesses or that new issues will not be exposed in this process.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

Our Company, on occasion, may be involved in legal matters arising in the ordinary course of our business. While management believes that such matters are currently insignificant, matters arising in the ordinary course of business for which we are or could become involved in litigation may have a material adverse effect on our business, financial condition or results of operations. We are not aware of any pending or threatened litigation against us or our officers and directors in their capacity as such that could have a material impact on our operations or finances.

Item 1A. Risk Factors.

Other than as described below, there have been no material changes from the risk factors previously disclosed in our annual report on Form 10-K for the fiscal year ended June 30, 2016,2017, as filed with the Securities and Exchange Commission on September 28, 2016.2017; and our quarterly report for the quarter ended September 30, 2017, as filed with the Securities and Exchange Commission on November 14, 2017.

As of MarchDecember 31, 2017, we may not have sufficient cash to continue operations for the next threesix to sixnine months.

For the quarter ended March 31, 2017, our cash and cash equivalents decreased by $357,989, and our operating loss for the quarter was $167,770.  As of MarchDecember 31, 2017, we had $158,589$381,752 in cash and cash equivalents, and $533,589$753,152 in accounts receivable. Asreceivable, and $1,529,694 in current liabilities. We incurred net losses of May 9,$89,111 and $1,006,457 during the six months ended December 31, 2017 we had approximately $180,000 of cash and cash equivalents and approximately $268,000 of accounts receivable.the fiscal year ended June 30, 2017, respectively. If quarterly sales revenues do not increase toand maintain near or above cash breakeven levels in the next threesix to sixnine months, we may be required to obtain cash for operations from non-working capital sources, which may not be available, in which case we would have to significantly decrease or cease operations. We are currently evaluating several options to manage cash flow and raise capital if necessary, including issuing debt, equity or entering into a strategic alliance. The sale of additional equity or convertible debt securities would result in additional dilution to our stockholders, and debt financing, if available, may involve restrictive covenants that could restrict our operations or finances. Financing, if necessary, may not be available in amounts or on terms acceptable to us, if at all. If we cannot raise funds on acceptable terms or achieve positive cash flow, we may not be able to continue to conduct operations, develop new products, grow market share, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which would negatively impact our business, operating results and financial condition.

The newly enacted Tax Cuts and Jobs Act may affect our financial results, including our net deferred tax asset, and we are in the process of evaluating its effects.

On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. The Tax Cuts and Jobs Act will significantly change the taxation of U.S.-based multinational corporations, by, among other things, reducing the U.S. corporate income tax rate, adopting elements of a territorial tax system, affecting the deductibility of capital expenditures, assessing a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, continuing the moratorium on Medical Device Excise Tax, and the creation of new taxes on certain foreign-sourced earnings. The legislation is unclear in some respects and will require interpretations and implementing regulations by the Internal Revenue Service, as well as state tax authorities, and the legislation could be subject to potential amendments and technical corrections, any of which could lessen or increase certain adverse impacts of the legislation. We are in the process of determining what, if any, effect those provisions will have on our financial results, and there can be no assurance of whether such additional effects will be positive or negative.

The Tax Cuts and Jobs Act also reduces the federal corporate income tax rate from 35% to 21% effective January 1, 2018, which we expect will positively impact our future effective tax rate and after-tax earnings in the United States. As a result of the reduction in the corporate income tax rate, we are required to revalue our net deferred tax asset to account for the future impact of lower corporate tax rates on this deferred amount and record any change in the value of such asset as a one-time non-cash charge on our income statement.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

We did not issue any unregistered equity securities during the quarter ended MarchDecember 31, 2017.

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

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.