10KSB/A 1 f10ksba-123105.htm DECEMBER 31, 2005

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-KSB/A
Amendment No. 1

ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005

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

FOR THE TRANSITION PERIOD FROM _______________ TO _____________

Commission File No. 1-11140

OPHTHALMIC IMAGING SYSTEMS
(Name of small business issuer in its charter)


California	94-3035367

(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)


221 Lathrop Way, Suite I, Sacramento, CA	95815

(Address of principal executive offices)	(Zip Code)

Issuer’s telephone number: (916) 646-2020

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act: Common Stock, no par value

Check whether the issuer is not required to file reports pursuant to Section 13 or 15 (d) of the Exchange Act.

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

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.

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

The issuer’s revenues for its most recent fiscal year were $13,650,507.

The aggregate market value of the voting and non-voting common stock of the issuer held by non-affiliates as of February 22, 2006 was approximately $13,196,306 based upon the average bid and ask price of the common stock as quoted by Nasdaq OTC Bulletin Board on such date. As of February 22, 2006, there were 16,085,652 issued and outstanding shares of the issuer’s common stock.

Transitional Small Business Disclosure Format (check one): Yes No

As used herein, “OIS,” “we,” “us,” “our” and the “Company” refer to the Ophthalmic Imaging Systems.

Explanatory Note

In response to comments received from the Staff of the Securities and Exchange Commission (“SEC”), we are filing this Amendment No. 1 on Form 10-KSB/A (this “Amendment No. 1”) to revise and expand the disclosures made in Item 6, “Management’s Discussion and Analysis or Plan of Operation” and Note 4 in Item 7, “Financial Statements,” both of Part I of our Form 10-KSB for the fiscal year ended December 31, 2006, which was filed with the SEC on March 28, 2006 (the “Original 10-KSB”). In accordance with the rules of the SEC, the complete text of Item 6 has been set forth in this Amendment No. 1, including those portions of that text that have not been amended from that set forth in the Original 10-KSB.

Except for the revisions in Items 6 and 7, we have not undertaken in this Amendment No. 1 to modify or update any other disclosures in our Original 10-KSB, and this Amendment No. 1 does not reflect any events occurring after the date of filing of the Original 10-KSB.

Item 6.

Management’s Discussion and Analysis or Plan of Operation.

General

We make forward-looking statements in this report, in other materials we file with the SEC or otherwise release to the public, and on our website. In addition, our senior management might make forward-looking statements orally to analysts, investors, the media and others. Statements concerning our future operations, prospects, strategies, financial condition, future economic performance (including growth and earnings) and demand for our products and services, and other statements of our plans, beliefs, or expectations, including the statements contained in this Item 6, “Management’s Discussion and Analysis or Plan of Operation,” regarding our future plans, strategies and expectations are forward-looking statements. In some cases these statements are identifiable through the use of words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” and similar expressions. We intend such forward-looking statements to be covered by the safe harbor provisions contained in Section 27A of the Securities Act of 1933, as amended and in Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). You are cautioned not to place undue reliance on these forward-looking statements because these forward-looking statements we make are not guarantees of future performance and are subject to various assumptions, risks, and other factors that could cause actual results to differ materially from those suggested by these forward-looking statements. Thus, our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in: economic conditions generally and the medical instruments market specifically, legislative or regulatory changes that affect us, including changes in healthcare regulation, the availability of working capital, the introduction of competing products, and other risk factors described herein. These risks and uncertainties, together with the other risks described from time to time in reports and documents that we filed with the SEC should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. (There also are other factors that we do not describe, generally, because we currently do not perceive them to be material that could cause actual results to differ materially from our expectations.) Indeed, it is likely that some of our assumptions will prove to be incorrect. Our actual results and financial position will vary from those projected or implied in the forward-looking statements, and the variances may be material. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

To date, we have designed, developed, manufactured and marketed ophthalmic digital imaging systems and informatics solutions and has derived substantially all of its revenues from the sale of such products. The primary target market for our digital angiography systems and related products has been retinal specialists and general ophthalmologists.

In October 2001, MediVision, our parent company, signed an agreement to acquire a minority interest by Agfa Gevaert N.V. thus creating an alliance for joint development and marketing of an integrated, digital Ophthalmology PACS solution. These marketing efforts are anticipated to be implemented first in the US market, and are to include efforts by us. The extent and focus of future research and development efforts will depend, in large measure, on direction from MediVision, including potential collaborative projects between us and MediVision.

In June 2003, we signed a licensing agreement with NextGen Healthcare Information Systems, Inc., a subsidiary of Quality Systems, Inc. Under the terms of the agreement, we are a value added reseller of two computer-based practice management and medical records products: NextGen(R) Electronic Medical Records (EMR) and NextGen(R) Enterprise Practice Management (EPM).

This strategic business alliance diversifies our product portfolio, enabling us to offer a wider variety of products and comprehensive solutions to its customer base of ophthalmology departments and practices. The NextGen(R) EMR system creates and maintains complete medical records with minimal effort while it streamlines workflow, controls utilization, and manages critical data related to patient care outcomes. The NextGen(R) EPM system is a complete physician management system that provides a common registration system, enterprise-wide appointment scheduling, referral tracking, clinical support, a custom report writer, and patient financial management based on a managed care model.

In May 2003, we entered into a $150,000 line of credit agreement with our bank. Our line is secured by a pledged investment with the bank equal to the amount of the line of credit. The interest charged on the line of credit is at the prime rate and is due monthly. Advances on the line of credit mature on September 10, 2008.

In September 2003, we entered into a $1,200,000 debt agreement with Laurus Master Fund, Ltd (“Laurus”) in the form of a three-year convertible note with a fixed coupon price of 6.5% per annum. The convertible note may be converted by Laurus into our common stock at a fixed conversion price of $1.07. We also issued seven-year warrants to Laurus to purchase 375,000 shares of Common Stock at exercise prices ranging between $1.23 and $1.61 per share. On January 24, 2006, we re-paid all amounts outstanding under this convertible note.

In April 2004, we entered into a $1,000,000 debt agreement with Laurus in the form of a three-year convertible note with a fixed coupon price of 6.5% per annum. The convertible note may be converted by Laurus into our common stock at a fixed conversion price of $1.22. We also issued five-year warrants to Laurus to purchase 313,000 shares of our common stock at exercise prices ranging between $1.40 and $1.83 per share. On January 20, 2006, Laurus converted all amounts outstanding under this convertible note into 528,082 shares of our common stock.

On December 28, 2004, we entered into an investment agreement with Dutchess Private Equities Fund II, LP (“Dutchess”) providing for an equity line of credit. Pursuant to the investment agreement, Dutchess has agreed to provide us with up to $9,000,000 of funding during the thirty-month period beginning on the date that the registration statement we agreed to file providing for the resale of the shares of common stock issuable under the investment agreement is declared effective by the Securities and Exchange Commission (the “SEC”). During this thirty-month period, we may request a drawdown under the investment agreement by selling shares of its common stock to Dutchess, and Dutchess will be obligated to purchase the shares. We are under no obligation to request any drawdowns under the investment agreement.

The amount that we can request in any drawdown notice is, at our election, the greater of (A) up to 200% of the average daily volume of our common stock for the ten trading days prior to the date of the drawdown notice multiplied by the average of the three daily closing bid prices for the common stock immediately preceding the date of the drawdown notice or (B) $100,000; provided that we may not request more than $1,000,000 in any single drawdown. As of December 31, 2005, our registration statement was not declared effective; accordingly, no drawdowns have been made. At December 31, 2005, we had stockholders’ equity of $4,624,198 and our current assets exceeded its current liabilities by $4,617,125. The 2003 and 2004 convertible loan agreements with Laurus have had a favorable impact on our current ratio. There can be no assurance that we will be able to achieve or sustain significant positive cash flows, revenues or profitability in the future.

MediVision Transactions

From August 2000 through July 1, 2001, we executed several promissory notes in favor of MediVision, an Israeli corporation and majority shareholder in our Company. The Short-Term Note had a maximum principal balance of $260,000 available, while the Working Capital Funding Agreement and Amendment No.1 to this agreement provided an additional funding of $2,500,000. Both Notes and the Amendment bear interest at the rate of 9.3% per annum and are secured by all of our assets. The principal amount outstanding, together with any and all accrued interest on the Working Capital Note and Amendment, was payable by August 31, 2003, except that MediVision may, at its option, at any time convert any amount of principal and interest then outstanding into shares of our common stock at a conversion price of $.80 per share on the Working Capital Note and $0.185 per share on the Amendment No.1 to the Working Capital Note. In May 2003, we entered into Amendment No. 2 to the Working Capital Funding Agreement and the Short Term Note with MediVision whereby the repayment terms on the debt were extended on all principal and interest due until January 1, 2005. As a result of cash payments and product shipments to MediVision discussed below, the principal and interest was paid during the first quarter of 2004. In June 2003, MediVision exercised its option, as stipulated in the Working Capital Funding Agreement, Amendment No. 1, to convert $1,150,000 of principal and interest at a conversion price of $0.185 per share into 6,216,216 shares of common stock.

In March 2004, our Board of Directors approved a line of credit to MediVision of $1,000,000 at 9.3% interest for two years. In January 2005, our Board of Directors approved an additional loan advance of $150,000 for a 30-day term.

On March 2, 2005, we entered into a Loan and Security Agreement and Promissory Note with MediVision (the “Loan Agreement”) whereby we agreed to loan MediVision up to $2,000,000. The Loan Agreement incorporated the $1,150,000 previously approved by our Board of Directors. Under the agreement, interest is 7.25% per annum and was paid on February 28, 2006, along with all outstanding principal due at that date. The Promissory Note was secured by 2,409,000 shares of our common stock owned by MediVision. The number of shares was based on the average closing price of our common stock during the last ten (10) business days of February 2005, which was $1.11, discounted by 25%. In the event that MediVision were to sell any shares of our stock it owns during the period of the agreement, a minimum of 50% of the proceeds from such sales would be required to be paid to us to reduce the outstanding amount owed. On July 28, 2005, we and MediVision entered into an amendment to the Loan Agreement whereby MediVision repaid $1,000,000 to us, decreasing the agreed upon loan of $2,000,000 to $1,000,000 and the amount of shares securing the loan was decreased by 1,204,500 shares.

In August 2002, our Board of Directors, at MediVision’s request, authorized us to guarantee and/or provide security interests in our assets for certain of MediVision’s loans with financial institutions, on the maximum aggregate amount of approximately $1,900,000. In August 2002, MediVision subordinated to the financial institutions its security position in our assets, which had been granted in consideration of loans to us from MediVision. In December 2002, our Board of Directors approved our issuance of two debentures in favor of the financial institutions to act as security for the debt of MediVision, which debentures were secured by a first lien on all of our assets. Such debentures and lien were signed in December 2002. The purpose of both debentures was to guarantee and/or provide a security interest for certain debts and liabilities of MediVision. On July 20, 2005, we replaced the existing debentures and lien in favor of the banks that we issued in an aggregate amount of up to $1,900,000, with a new debenture and lien in an aggregate amount of up to $2,000,000. One of the terminated debentures was issued in favor of United Mizrahi Bank Ltd. and the other terminated debenture was issued in favor of Bank Leumi Le-Israel. In lieu of the terminated debentures, we entered into a new Secured Debenture (the “Debenture”) in favor of United Mizrahi Bank Ltd., in an amount of up to $2,000,000 (plus interest, commissions and all expenses). Under the terms of the Debenture, we guarantee the payment of all of the debts and liabilities of MediVision to United Mizrahi Bank. The Debenture is secured by a first lien on all of our assets. MediVision pledged 2,345,500 shares of our common stock it owns to us in order to secure the Debenture. The number of shares securing the Debenture is comprised of the 1,204,500 shares previously securing the promissory note under the Loan Agreement to cover $1,000,000 and 1,141,000 shares of our common stock (based on the average closing price of our common stock during the last ten (10) business days of February 2005, which was $1.17, discounted by 25%) to cover the second $1,000,000. The amount owed to the financial institutions by MediVision and secured by us as of December 31, 2005 was approximately $2,000,000.As a result of the amendments to the Loan Agreement and the Debenture, the total number of shares securing the promissory note under the Loan Agreement and the Debenture, is 3,550,000 out of the 9,420,851 shares of our common stock owned by MediVision as of February 22, 2006.

At June 30, 2005 we had recorded a net amount due from MediVision of approximately $1,955,558 on the promissory note and approximately $28,539 net, due for products and services. On July 28, 2005, pursuant to the aforementioned Debenture signed by us, MediVision executed the amended Loan Agreement and paid back $1,000,000 of the loan from us; reducing the amount MediVision owed us on the promissory note to $955,558. On September 20, 2005, pursuant to a Common Stock Purchase Agreement, dated as of September 16, 2005, between MediVision and Meadowbrook Opportunity Fund LLC, MediVision sold 400,000 shares of our common stock to Meadowbrook Opportunity Fund LLC at a price of $1.20 per share. MediVision used $240,000 of the proceeds from this sale to repay part of the aforementioned loan to us, reducing the amount MediVision owes us on the promissory note to $717,556, plus accrued interest under the loan. On December 8, 2005, MediVision sold 310,000 shares to the clients of an institutional investor at the price per share of $1.45. MediVision used $225,000 of the proceeds from this sale to repay part of the aforementioned loan to us, reducing the amount MediVision owes us on the promissory note to $492,556, plus accrued interest under the loan. On February 14, 2006, MediVision sold 1 million shares of our common stock to Wasatch Advisors, Inc. at the market price of $1.80 per share. MediVision used $492,556 of the proceeds from this sale to repay the remaining principal balance of the aforementioned loan to us.

Pursuant to a Common Stock Purchase Agreement dated as of June 1, 2004 between MediVision and S2 Partners LP, MediVision sold 550,000 shares of our common stock to S2 Partners LP at a price of $1.35 per share. On June 23, 2004, MediVision, through Nollenberger Capital Partners Inc. acting as its agent, sold an additional 500,000 shares of our common stock at a price of $1.38 per share.

As a result of the foregoing transactions, on December 31, 2005 and February 22, 2006, MediVision owned approximately 67% and 59%, respectively, of our outstanding common stock.

New Accounting Pronouncements.

Financial Accounting Pronouncement SFAS 123(R)

In December 2004 the FASB issued Statement Number 123 (revised 2004) (SFAS 23 (R)), Share-Based Payments. SFAS 123 (R) requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments such as stock options granted to employees. The Company is required to apply SFAS 123 (R) on a modified prospective method. Under this method, the Company is required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at the date of adoption. In addition, the Company may elect to adopt SFAS 123 (R) by restating previously issued financial statements, basing the expense on that previously reported in their pro forma disclosures required by SFAS 123. SFAS 123 (R) is effective for the first reporting period beginning after June 15, 2005. For companies filing under Regulation S-B, SFAS 123 (R) is effective the beginning of the first interim or annual reporting period that begins after December 15, 2005, which for the Company will be the first quarter of the year ending December 31, 2006. The Company anticipates adopting SFAS No. 123(R) beginning in the quarter ending March 31, 2006. Management has not completed its evaluation of the effect that SFAS 123 (R) will have, but believes that the effect will be consistent with its previous pro forma disclosures.

Financial Accounting Pronouncement SFAS 151

In November 2004, the FASB issued SFAS No. 151, Inventory Costs (SFAS 151). SFAS 151 requires that abnormal amounts of idle facility expense, freight, handling costs and spoilage be recognized as current period charges. Further, SFAS 151 requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. Unallocated overheads must be recognized as an expense in the period in which they are incurred. SFAS 151 is effective for inventory costs incurred beginning in the first quarter of 2006. The Company is currently evaluating the effect of SFAS 151 on its financial statements and related disclosures.

Financial Accounting Pronouncement SFAS 154

On June 7, 2005, the FASB issued Statement No. 154 (SFAS 154), Accounting Changes and error Corrections — a replacement of Accounting Principles Board (APB) Opinion No. 20, Accounting Changes, and SFAS no. 3, Reporting Accounting Changes in Interim Financial Statements. Under the provisions of SFAS 154, voluntary changes in accounting principles are applied retrospectively to prior periods’ financial statements unless it would be impractical to do so. SFAS 154 supersedes APB Opinion No. 20, which required that most voluntary changes in accounting principles be recognized by including in the current period’s net income the cumulative effect of the change. SFAS 154 also makes a distinction between “retrospective application” of a change in accounting principle and the “restatement” of financial statements to reflect the correction of an error. The provisions of SFAS 154 are effective for accounting changes made in fiscal years beginning after December 15, 2005. Management of the Company does not expect the adoption of this standard to have a material impact on its financial position or results of operations.

Critical Accounting Policies

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained in the financial statements is, to a significant extent, financial information based on effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value obtained when earning income, recognizing an expense, recovering an asset or relieving a liability.

Management is also required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from these estimates. In addition, GAAP itself may change from one previously acceptable method to another. Although the economics of the Company’s transactions would not change, the timing of the recognition of such events for accounting purposes may change.

Revenue Recognition

The Company’s revenue recognition policies are in compliance with applicable accounting rules and regulations, including Staff Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition in Financial Statements,” American Institute of Certified Public accountants (“AICPA”), Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” SOP 98-9, “Modification of SOP 97-2", with Respect to Certain Transactions and Emerging Issues Task Force Issue 00-21, “Revenue Arrangements with Multiple Deliverables.”

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

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

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

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

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

Tax Provision

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

In order to realize our tax asset in 2004 and 2005, we needed to evaluate whether we will more likely than not be able to realize our deferred tax asset for 15 and 14 years ahead, respectively. We were not profitable for seventeen consecutive years between 1984 and 2000. We became profitable in 2001 and have been profitable for the last five years. There is significant uncertainty in projecting future profitability due to the history of our business, and the rapidly changing medical technology market that we are in.

We used the following analysis to determine whether we needed to recognize a valuation allowance for our deferred tax asset, and if so, how much. In our analysis, we assumed, based on management’s determination, that we will be able to use all of our unlimited NOL amounts. We then assessed the amount of future capped net operating losses we will more likely than not be able to use. In 2004, we made an assessment that we will be able to use four years of capped net operating losses in the future. In 2004, we did not have enough available information to look beyond the year 2009 when assessing the amount of deferred tax assets that are more likely than not to be used. In 2005, due to our increased confidence with an additional year of profitability, and indications of a profitable future year ahead of us, we increased our assessment that we will be able to use five years of capped net operating losses in the future and projected taxable income in 2006. In 2005, we did not have enough available information to look beyond the year 2011 when assessing the amount of deferred tax assets that are more likely than not to be used. Forming a conclusion that a valuation allowance is not needed is difficult if there is a history of losses in the company, especially if the losses were not due to an extraordinary item.

In the fourth quarter of every fiscal year, we participate in the industry’s largest tradeshow of the year, which results in approximately 25% of our revenue generated in the last month of the fiscal year. This tradeshow substantially influences the outcome of our profitability for that year, as well as gives us an indication of the years to come. Significant resources are invested in the tradeshow each year. We can also see how the market responds to our new products, as well as our competitor’s products.

During the fourth quarter of 2004, we introduced a new product, the WS3200 system. This product was well received at our tradeshow and made up 59% of our system revenue for that quarter, and 19% of our system revenue for the whole year. If this system was not received well by the ophthalmic community, or a competing company came out with a similar system at the tradeshow, this would have had a significant impact on our profitability for the year and into the future. During the fourth quarter of 2005, we introduced four new products, the WS 11k system, Winstation XP Version 10.3, WS Manager and new Ophthalmology Office Retinal templates. These products were well accepted by practitioners and contributed to one-third of the annual system revenue in the fourth quarter. Mainly due to the annual tradeshow, we spent approximately 33% and 35% of our operating expenses for the year in the fourth quarter of fiscal 2004 and 2005, respectively. With this tradeshow behind us in the fourth quarter of 2004 and 2005, we were in a better position to assess our current and future performance, and determine whether it is more likely than not that we will be able to realize our deferred tax assets. Thus, this information prompted us to reduce our valuation allowance in the fourth quarters of 2004 and 2005. If we continue to be profitable in the future, we plan to continue to use the same methodology with regards to our assumptions and estimates pertaining to our income tax provision.

We re-evaluate our estimates and assumptions we use in our financials on an ongoing and quarterly basis. We adjust these estimates and assumptions as needed and as circumstances change. If circumstances change in the future, we will adjust our estimates and assumptions accordingly. At the present time, we cannot surmise whether our assumptions and estimates will change in the future. Based on historical knowledge, however, it is reasonably likely that there will be some changes in some of our estimates and assumptions.

Warranty Reserve

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

Historically, we estimated the cost of the various warranty services by taking into account the estimated cost of servicing routine warranty claims in the first year, including parts, labor and travel costs for service technicians. In the fourth quarter of 2005, we analyzed the margin of our total service department, the price of our extended warranty contracts, factored in the hardware costs of the various systems, and used a percentage for the first year warranty to calculate the cost per various systems for the first year manufacturer’s warranty. Based on this analysis, we increased our estimated cost per product in our general reserve for products shipped in the current year.

Other

We expense as incurred all costs, such as costs of services performed under the extended warranty contract.

Estimates are used in determining the expected useful lives of depreciable assets.

Results of Operations

Selected Financial Data

	Years Ended December 31,
	2005			2004			2003
Statement of Operations Data:
Net revenues	$	13,650,507		$	11,293,592		$	10,336,138
Cost of sales		5,766,883			4,793,518			4,526,564

Gross profit		7,883,624			6,500,074			5,809,574

Operating expenses:
Sales, marketing, general and administrative		4,882,005			4,113,609			3,804,909
Research and development		1,112,023			987,769			702,020

Total operating expenses		5,994,028			5,101,378			4,506,929

Income from operations		1,889,596			1,398,696			1,302,645
Other expense, net		(187,342	)		(252,100	)		(269,451	)

Net income before provision for income tax benefit		1,702,254			1,146,596			1,033,194
Provision for income tax benefit		53,000			558,000			405,000

Net income	$	1,755,254		$	1,704,596		$	1,438,194

Basic earnings per share	$	0.12		$	0.12		$	0.13

Shares used in the calculation of basic earnings per share		15,205,689			14,771,112			11,267,493

Diluted earnings per share	$	0.11		$	0.11		$	0.12

Shares used in the calculation of diluted earnings per
share		16,530,277			15,772,214			11,877,205

Statement of Cash Flows Data:
Net cash provided by operating activities	$	1,807,858		$	1,116,940		$	258,304
Net cash used in investing activities		(33,500	)		(22,625	)		(175,360	)
Net cash provided by (used in) financing activities		176,038			(376,039	)		805,856

Net increase in cash and cash equivalents	$	1,950,396		$	718,276		$	888,800

Comparison of Year Ended December 31, 2005 to Year Ended December 31, 2004

Revenues

We decided to present installation income within our revenues, versus a net effect within sales and marketing expenses. We reclassified the respective 2004 amounts for comparative purposes. Our revenues for the year ended December 31, 2005 were $13,650,507 ($13,013,510 without installation revenue) representing an increase of approximately 21% from revenues of $11,293,592 ($10,818,379 without installation revenues) for the year ended December 31, 2004. The increased revenues for 2005 include revenues from products of approximately $1,679,000, including installation, and service revenues of approximately $678,000. Digital angiography systems and Ophthalmology Office products accounted for approximately 86% and 89% of our total revenues during 2005 and 2004, respectively. Service revenue for the years ended 2005 and 2004 accounted for approximately 14% and 11% of our total revenues, respectively. The increased revenues in 2005 reflect the impact of a number of factors discussed in further detail below.

Gross Margins

The changed presentation in connection with presenting installation income within our revenues, versus a net effect within sales and marketing expenses, resulted in a decrease in gross margins from approximately 60% to 58% in fiscal 2005 and 2004, respectively. We anticipate that our gross margins will decrease as our sales of the Ophthalmology Office software products become more significant, since the gross margins associated with such sales are lower than the majority of the products that we currently market.

Sales and Marketing Expenses

The changed presentation of installation income within our revenues, versus a net effect within sales and marketing expenses, resulted in a change in sales and marketing expenses. We reclassified the respective 2004 amounts for comparative purposes.

Sales and marketing expenses accounted for approximately 25% of total revenues during fiscal 2005 and 26% during fiscal 2004. Sales and marketing expenses were $3,439,046 ($3,373,529 with net installation) during fiscal 2005, representing an increase compared to sales and marketing expenses of $2,907,844 ($2,936,100 with net installation) in fiscal 2004. The increase in sales and marketing expenses were primarily the result of increased commissions from increased sales of approximately $225,000, increased marketing tradeshow expenses of approximately $117,000, and the hiring of two new sales representatives of approximately $188,000.

General and Administrative Expenses

General and administrative expenses accounted for approximately 11% of total revenues during both fiscal 2005 and 2004. Expense levels increased to $1,442,959 during fiscal 2005, representing an increase of approximately 20% compared to expenses of $1,205,765 during fiscal 2004. Increased general and administrative expenses were primarily the result of increased legal expenses.

Research and Development Expenses

Research and development expenses increased by approximately 13% to $1,112,023 during 2005 from $987,769 during 2004. Such expenses accounted for approximately 8% and 9% of total revenues during fiscal 2005 and fiscal 2004, respectively. During 2005, we focused our research and development efforts on new digital image capture products. We expect our research and development expenditures to increase substantially. Outside consultants and MediVision currently conduct our research and development.

Other Expense, net

Other expenses were $187,342 during 2005 compared to $252,100 during 2004. These amounts were comprised of interest expense associated with the convertible notes to Laurus, debt financing amortization of costs associated with the set-up of the Laurus convertible notes, interest income related to the note receivable with MediVision, and financing arrangements provided to certain customers in connection with sales of our products. The financing arrangements are the result of tri-party arrangements with our customers and an intermediary lender. In substance these transactions allow the customer to obtain financing from an intermediary lender to pay amounts due to us. We incur these financing costs to expedite payment and lessen the necessary collection efforts. In these transactions, we record an interest expense for the difference between the face value of the receivable due from our customer and the discounted amount that we accept as full payment from the intermediary lender. We account for these fees within interest income/expense on the Statement of Income.

Income Taxes

At December 31, 2005 and 2004, management reviewed recent operating results and projected future operating results. At the end of each of these years, management determined that it was more likely than not that a portion of the deferred tax assets attributable to net operating losses would not likely be realized. Due to our limited history of profitable operations, management recorded a valuation allowance of $2,100,000 and $2,504,000 at December 31, 2005 and 2004, respectively. The amount of the valuation allowance will be adjusted in the future if management determines that it is more likely than not the deferred assets will be realized.

At December 31, 2005, we have a net operating loss carryover of approximately $3,346,000 for federal income tax purposes, which expires between 2007 and 2020, and a net operating loss carryforward of approximately $284,000 for California state income tax purposes, which expires through 2010. The State of California suspended the application of net operating losses for the 2002 and 2003 fiscal years and extended the carry forward period two years. Federal tax credit carryforwards of approximately $175,000 will begin to expire in 2007. Due to changes in ownership, which occurred in prior years, Section 382 of the Internal Revenue Code provides for significant limitations on the utilization of net operating loss carryforwards and tax credits. As a result, a portion of these loss and credit carryovers may expire without being utilized.

Net Income

We reported net income of $1,755,254, or $0.12 basic earnings per share and $0.11 diluted earnings per share during 2005, compared to net income of $1,704,596, or $0.12 basic earnings per share and $0.11 diluted earnings per share during 2004. Earnings per share is calculated in accordance with Financial Accounting Standards No. 128 (see Note 1 of Notes to Financial Statements included in Item 7 of this Form 10-KSB/A).

The results of operations for 2005 reflect the positive impact of our ongoing attention and resources to core marketing, selling, corporate operations and cost reduction measures. Growing sales of our digital angiography products and informatics solutions reflect the market’s acceptance of these products and the ongoing quality improvements to products to meet customers’ requirements. There can be no assurance, however, that there will be continued market acceptance of our products or that any continued market acceptance will result in significant future unit sales or revenue contribution.

Export Sales

Revenues from sales to customers located outside of the United States accounted for approximately 9% and 11% of our net sales for 2005 and 2004, respectively. Sales to MediVision, included in these totals, accounted for approximately 63% or $786,000 and 57% or $744,000 for 2005 and 2004, respectively.

Seasonality

The Company’s most effective marketing tool is the demonstration and display of its products at the annual meeting of the American Academy of Ophthalmology held during the fall of each year, with a significant amount of our sales orders generated during or shortly after this meeting. Accordingly, we expend a considerable amount of time and resources during the fourth quarter of our fiscal year preparing for this event.

Comparison of Year Ended December 31, 2004 to Year Ended December 31, 2003

Revenues

We decided to present installation income within our revenues versus a net effect within sales and marketing expenses. We reclassified the respective 2004 and 2003 amounts for comparative purposes.

Our revenues for the year ended December 31, 2004 were $11,293,592 ($10,818,379 without installation revenue) representing an increase of approximately 9% from revenues of $10,336,138, ($9,944,827 without installation revenue) for the year ended December 31, 2003. The increased revenues for 2004 include revenues from initial deliveries of our newest digital angiography system, the WinStation 3200TM and the OIS WebStationTM common software platform released in October of 2004. Digital angiography systems and peripherals, including upgrades and installation, accounted for approximately 89% and 92% of our total revenues during 2004 and 2003, respectively. Service revenue for the years ended 2004 and 2003 accounted for approximately 11% and 8% of our total revenue, respectively. The increased revenue levels during the 2004 period reflect the impact of a number of factors discussed in further detail below.

Gross Margins

The changed presentation in connection with presenting installation income within our revenues, versus a net effect within sales and marketing expenses, resulted in a decrease in gross margins from approximately 60% in during fiscal 2004 and 2003, to 58% in fiscal 2004 and 56% in fiscal 2003. It is anticipated that our gross margins will decrease as our sales of the Ophthalmology Office software products become more significant, since the gross margins associated with such sales are below the majority of the products that we currently market.

Sales and Marketing, Expenses

The changed presentation in connection with presenting installation income within our revenues, versus a net effect within sales and marketing expenses, resulted in a change in sales and marketing expenses. We reclassified the respective 2004 and 2003 amounts for comparative purposes.

Sales and marketing expenses accounted for approximately 26% of total revenues during fiscal 2004 and 27% during fiscal 2003. Sales and marketing expenses were $2,907,844 ($2,936,100 with net installation), during fiscal 2004, representing an increase of approximately 6% compared to expenses of $2,736,276 ($2,915,848 with net installation) in fiscal 2003. Increased expenses were primarily the result of increased commissions of approximately $108,000 and additional marketing personnel of approximately $80,000.

General and Administrative Expenses

General and administrative expenses accounted for approximately 11% and 10% of total revenues during both fiscal 2004 and 2003, respectively. Expense levels increased to $1,205,765 during fiscal 2004, representing an increase of approximately 13% compared to expenses of $1,068,635. Increased general and administrative expenses were primarily the result of increased investor relations expenses of approximately $81,000 and legal expenses of approximately $33,000.

Research and Development Expenses

Research and development expenses increased by approximately 41% to $987,769 during 2004 from $702,020 during 2003. Such expenses accounted for approximately 9% and 7% of total revenues during fiscal 2004 and fiscal 2003, respectively. We focused our recent research and development efforts on new digital image capture products. We expect our research and development expenditures to increase. Outside consultants and MediVision currently conduct our research and development.

Other Expense, net

Other expenses were $252,100 during 2004 compared to $269,451 during 2003. These amounts were comprised principally of interest expense associated with the convertible notes to Laurus during fiscal 2004 and 2003, respectively and interest expense associated with financing arrangements provided to certain of the Company’s customers in connection with sales of its products. The financing arrangements are the result of tri-party arrangements with our customers and an intermediary lender. In substance these transactions allow the customer to obtain financing from an intermediary lender to pay amounts due to us. We incur these financing costs to expedite payment and lessen the necessary collection efforts. In these transactions, we record an interest expense for the difference between the face value of the receivable due from our customer and the discounted amount that we accept as full payment from the intermediary lender. We account for these fees within interest income/expense on the Statement of Income.

Interest income in both 2004 and 2003 was insignificant.

Income Taxes

At December 31, 2004 and 2003, management reviewed recent operating results and projected future operating results. At the end of each of these years, management determined that it was more likely than not that a portion of the deferred tax assets attributable to net operating losses would not likely be realized. Due to our limited history of profitable operations, management has recorded a valuation allowance of $2,504,000 and $3,497,000 at December 31, 2004 and 2003, respectively. The amount of the valuation allowance will be adjusted in the future if management determines that it is more likely than not the deferred assets will be realized.

At December 31, 2004, we had a net operating loss carryover of approximately $4,531,000 for federal income tax purposes, which expires between 2007 and 2020, and a net operating loss carryforward of approximately $1,306,000 for California state income tax purposes, which expires through 2010. The State of California suspended the application of net operating losses for the 2002 and 2003 fiscal years and extended the carry forward period two years. Federal tax credit carryforwards of approximately $175,000 will begin to expire in 2007. Due to changes in ownership, which occurred in prior years, Section 382 of the Internal Revenue Code provides for significant limitations on the utilization of net operating loss carryforwards and tax credits. As a result, a portion of these loss and credit carryovers may expire without being utilized.

Net Income

We reported net income of $1,704,596, or $0.12 basic earnings per share and $0.11 diluted earnings per share during 2004, compared to a net income of $1,438,192, or $0.13 basic earnings per share and $0.12 diluted earnings per share during 2003. Earnings per share is calculated in accordance with Financial Accounting Standards No. 128 (see Note 1 of Notes to Financial Statements included in Item 7 of this Form 10-KSB/A).

The results of operations for 2004 reflect the positive impact of our ongoing attention and resources to core marketing, selling, corporate operations and cost reduction measures. Growing sales of our digital angiography products reflect the market’s acceptance of these products and the ongoing product quality improvements made to meet customers’ requirements. There can be no assurance, however, that there will be continued market acceptance of our products or that any continued market acceptance will result in significant future unit sales or revenue contribution.

Export Sales

Revenues from sales to customers located outside of the United States accounted for approximately 11% and 9% of our net sales for 2004 and 2003, respectively. Sales to MediVision, included in these totals, accounted for approximately 57% or $744,000 and 56% or $482,000 for 2004 and 2003, respectively.

Seasonality

Our most effective marketing tool is the demonstration and display of our products at the annual meeting of the American Academy of Ophthalmology held during the fall of each year, with a significant amount of our sales orders generated during or shortly after this meeting. Accordingly, we expend a considerable amount of time and resources during the fourth quarter of its fiscal year preparing for this event.

Liquidity and Capital Resources

Our operating activities provided cash of $1,807,858 during 2005 as compared to generating cash of $1,116,940 during 2004. The cash provided by operations during 2005 was substantially due to our increased profitability, including the increase in deferred tax assets, of approximately $485,000, accrued liabilities of approximately $411,000, and customer deposits of approximately $437,000, partially offset by increased receivables of approximately $668,000. Net cash used in investing activities was $33,500 during 2005 versus $22,625 during 2004. Our primary investing activities consisted of minor capital asset acquisitions. We anticipate continued near-term capital expenditures in connection with increasing our pool of demonstration equipment, as well as our ongoing efforts to upgrade existing management information and corporate communication systems. We anticipate that related expenditures, if any, will be financed from cash flow from operations, or other financing arrangements available, if any.

We generated cash of $176,038 in financing activities during 2005 as compared to the usage of cash of $376,039 during 2004. The cash generated in financing activities during 2005 was principally from repayments of borrowings under existing arrangements with MediVision of approximately $472,000 offset by payment of principal on notes with Laurus Master Fund of approximately $335,000. The cash used in financing activities during 2004 was principally from repayments of borrowings under existing arrangements with MediVision of approximately $201,000 and advances to MediVision during fiscal 2004 of approximately $1,055,000. These amounts were offset by the signing of the $1,000,000 convertible debt instrument with Laurus.

On December 31, 2005, our cash and cash equivalents were $3,940,706. Management anticipates that additional sources of capital beyond those currently available to it may be required to continue funding of research and development for new products and selling and marketing related expenses for existing products.

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

Trends

We are unaware of any known trends, events or uncertainties that have or are reasonably likely to have a material impact on our financial condition, results from operations, or short or long-term liquidity.

Inflation

We believe that inflation has not had a material or significant impact on our revenue or our results of operations.

Off Balance Sheet Arrangements

The Company has a Secured Debenture in favor of United Mizrahi Bank Ltd., in an amount of up to $2,000,000 (plus interest, commissions and all expenses). Under the Debenture, we guaranteed the payment of all the debts and liabilities of MediVision to United Mizrahi Bank. The Debenture is secured by a first lien on all of our assets. MediVision pledged 2,345,500 shares of our common stock it owns to us in order to secure the Debenture. The amount owed to the financial institutions by MediVision and secured by us as of December 31, 2005 was approximately $2,000,000.

Item 7.

Financial Statements.

The Company’s financial statements for the year ended December 31, 2005 are attached hereto.

OPHTHALMIC IMAGING SYSTEMS

FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2005 AND 2004 AND

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004 AND

REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

F-1

OPHTHALMIC IMAGING SYSTEMS

FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2005 AND 2004 AND

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

Table of Contents

	Page
Report of Independent Registered Public Accounting Firm	F-3
Balance Sheet	F-4
Statement of Income	F-6
Statement of Stockholders' Equity	F-7
Statement of Cash Flows	F-8
Notes to Financial Statements	F-10

F-2

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
Ophthalmic Imaging Systems

We have audited the accompanying balance sheet of Ophthalmic Imaging Systems as of December 31, 2005 and 2004, and the related statements of income, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Ophthalmic Imaging Systems as of December 31, 2005 and 2004, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ Perry-Smith LLP

Sacramento, California
March 3, 2006

F-3

OPHTHALMIC IMAGING SYSTEMS

BALANCE SHEET

December 31, 2005 and 2004

	2005		2004
ASSETS
Current assets:
Cash and cash equivalents	$	3,940,706	$	1,990,310
Accounts receivable, net of allowance for doubtful accounts of
$286,426 and $301,839		2,841,203		1,855,009
Receivable from related party (Note 6)		690,756		--
Inventories (Note 2)		380,676		515,391
Prepaid expenses and other current assets		300,077		189,393
Deferred tax asset (Note 9)		1,124,000		1,029,000

Total current assets		9,277,418		5,579,103

Restricted cash (Note 7)		150,000		150,000
Furniture and equipment, at cost, net (Note 3)		107,787		150,487
Receivable from related party (Note 6)		--		1,055,512
Other assets		55,355		137,929

Total assets	$	9,590,560	$	7,073,031

F-4

OPHTHALMIC IMAGING SYSTEMS

BALANCE SHEET
(Continued)

December 31, 2005 and 2004

	2005			2004
LIABILITIES AND ASSETS STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	512,914		$	472,167
Accrued liabilities (Note 4)		2,045,233			1,568,085
Deferred extended warranty revenue (Note 4)		861,486			793,972
Customer deposits		689,383			226,850
Notes payable - current portion (Note 5)		508,109			776,338

Total current liabilities		4,617,125			3,837,412

Notes payable, less current portion (Note 5)		349,237			838,362

Total liabilities		4,966,362			4,675,774


Commitments and contingencies (Note10)

Stockholders' equity:
Common stock, no par value, 35,000,000 shares authorized;
15,517,570 and 15,033,585 shares issued and outstanding in
2005 and 2004, respectively		14,974,007			14,502,320
Accumulated deficit		(10,349,809	)		(12,105,063	)

Total stockholders' equity		4,624,198			2,397,257

Total liabilities and stockholders' equity	$	9,590,560		$	7,073,031

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

F-5

OPHTHALMIC IMAGING SYSTEMS

STATEMENT OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

	2005			2004
Revenues:
Net sales	$	13,650,507		$	11,293,592
Cost of sales		5,766,883			4,793,518

Gross profit		7,883,624			6,500,074

Operating expenses:
Sales and marketing		3,439,046			2,907,844
General and administrative		1,442,959			1,205,765
Research and development (Note 6)		1,112,023			987,769

Total operating expenses		5,994,028			5,101,378


Income from operations		1,889,596			1,398,696

Other income (expense):
Interest expense		(90,958	)		(210,106	)
Other expense		(220,231	)		(54,860	)
Interest income		123,847			12,866

Total other expense		(187,342	)		(252,100	)

Net income before provision for income tax benefit		1,702,254			1,146,596

Provision for income tax benefit (Note 9)		53,000			558,000

Net income	$	1,755,254		$	1,704,596

Basic earnings per share	$	0.12		$	0.12

Shares used in the calculation of basic earnings per share		15,205,689			14,771,112

Diluted earnings per share	$	0.11		$	0.11

Shares used in the calculation of diluted earnings per share		16,530,277			15,772,214

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

F-6

OPHTHALMIC IMAGING SYSTEMS

STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

	Common Stock				Accumulated			Total Stockholders
	Shares		Amount		Deficit			Equity
Balance, January 1, 2004		14,403,929	$	13,836,188	$	(13,809,659	)	$	26,529
Conversion of principal and interest to common
stock (Note 5)		576,322		616,665		-			616,665
Exercise of nonqualified stock options (Note 8)		53,334		49,467		49,467			-

Net income		-		-		1,704,596			1,704,596

Balance, December 31, 2004		15,033,585		14,502,320		(12,105,063	)		2,397,257

Conversion of principal and interest to
common stock (Note 5)		383,985		410,864		-			410,864
Exercise of nonqualified stock options (Note 8)		100,000		48,929		-			48,929

Stock Based Compensation		-		11,894		-			11,894

Net income		-		-		1,755,254			1,755,254

Balance, December 31, 2005		15,517,570	$	14,974,007	$	(10,349,809	)	$	4,624,198

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

F-7

OPHTHALMIC IMAGING SYSTEMS

STATEMENT OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

	2005			2004
Cash flows from operating activities:
Net income	$	1,755,254		$	1,704,596
Adjustments to reconcile net income to net cash provided by operating
activities
Depreciation and amortization		76,200			116,186
Non-cash payment of interest		10,323			35,869
Loss on disposition of equipment		-			1,499
Net changes in operating assets and liabilities:
Accounts receivable		(1,093,467	)		(318,399	)
Inventories		134,715			(98,971	)
Prepaid expenses and other current assets		10,483			25,260
Deferred tax asset		(95,000	)		(529,000	)
Other assets		(38,592	)		(108,482	)
Accounts payable		40,747			(51,372	)
Accrued liabilities		477,148			77,872
Deferred extended warranty revenue		67,514			236,829
Customer deposits		462,533			25,053


Net cash provided by operating activities		1,807,858			1,116,940


Cash flows from investing activities:
Acquisition of furniture and equipment		(33,500	)		(23,515	)
Proceeds from disposition of equipment					890

Net cash used in investing activities		(33,500	)		(22,625	)


Cash flows from financing activities:
Repayment of notes payable to related parties		-			(200,979	)
Principal payments on notes payable		(344,919	)		(19,015	)
Advances to related parties		-			(1,055,512	)
(Repayments of) proceeds from borrowings underline of credit		-			(150,000	)
Proceeds from notes receivable from related parties		472,028
Proceeds from notes payable		-			1,000,000
Proceeds from sale of stock		48,929			49,467

Net cash provided by (used in) financing activities		176,038			(376,039	)


Net increase in cash and cash equivalents		1,950,396			718,276

Cash and cash equivalents, beginning of the year		1,990,310			1,272,034


Cash and cash equivalents, end of the year	$	3,940,706		$	1,990,310

Continued

F-8

OPHTHALMIC IMAGING SYSTEMS

STATEMENT OF CASH FLOWS
(Continued)
For The Years Ended December 31, 2005 And 2004

	2005		2004
Supplemental schedule of non cash financing activities:
Conversion of notes payable with common stock	$	400,541	$	580,796
Conversion of interest with common stock	$	10,323	$	35,869
Addition to capital lease obligation for equipment purchases	$	-	$	41,261
Reduction in aggregate debt payable to significant
shareholders in exchange for inventory and other
noncash transactions, net	$	-	$	(4,150	)
Addition to net receivable from significant shareholders in
exchange for inventory and other noncash transactions,
net	$	98,989	$	-
Assets acquired with borrowed funds	$	-	$	41,261


Supplemental schedule of cash flow information:
Cash paid for taxes	$	60,026	$	70,345
Cash paid for interest	$	75,052	$	63,833

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

F-9

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Business

Ophthalmic Imaging Systems (the “Company” or “OIS”) was incorporated under the laws of the State of California on July 14, 1986. The Company, headquartered in Sacramento, California, is engaged in the business of designing, developing, manufacturing and marketing digital imaging systems, image enhancement and analysis software and informatics solutions for use by practitioners in the ocular health field. The Company’s products are used for a variety of standard diagnostic test procedures performed in most eye care practices.

Use of Estimates

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.

Cash and Cash Equivalents

For purposes of the statement of cash flows, the Company considers highly liquid investments with original maturities of three months or less as cash equivalents.

At December 31, 2005, the Company had deposits with carrying amounts of $3,940,706 and bank balances of $4,498,744. Federally insured balances totaled $300,000 and uninsured balances totaled $4,198,744 at December 31, 2005.

Concentrations of Credit Risk and Export Sales

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash investments with high credit quality financial institutions. Concentrations of credit risk with respect to trade receivables are limited due to the Company’s policy of requiring deposits from customers, the number of customers and their geographic dispersion. The Company maintains reserves for potential credit losses and such losses have historically been within management’s expectations. No single customer comprised 10% or more of net sales, during the years ended December 31, 2005 or 2004.

Revenues from sales to customers located outside of the United States accounted for approximately 9% and 11% of net sales during the years ended December 31, 2005 and 2004, respectively.

F-10

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Inventories

Inventories, which consist primarily of purchased system parts, subassemblies and assembled systems, are stated at the lower of cost (determined using the first-in, first-out method) or market.

Accounts Receivable Allowance

The Company generally offers to its customers terms of 50% deposit paid up-front, remaining 50% less installation portion net 15 days after shipment of product, and the installation portion after installation is complete. The reserve of accounts receivable balances are estimated based on historical experience and any specific customer/installation issues that have been identified. The Company periodically assesses the adequacy of its recorded accounts receivable allowance, and adjusts the balance as necessary. As of December 31, 2005 and 2004, the accounts receivable allowance was $286,426 and $301,839 respectively.

Furniture and Equipment

Furniture and equipment are stated at cost and depreciated or amortized on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives generally range from three to seven years.

Revenue Recognition and Warranties

The Company derives revenue primarily from the sale, installation and training services of its products. In accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable, collectability is reasonably assured, contractual obligations have been satisfied, and title and risk have been transferred to the customer. The Company generally recognizes revenue from installation and training services when such services are performed. The Company generally provides a one-year warranty covering materials and workmanship and accruals are provided for anticipated warranty expenses.

Customers may purchase extended warranty coverage for additional one or four year periods. Revenues from the sale of these extended warranties are deferred and recognized in net sales on a straight-line basis over the term of the extended warranty contract.

Shipping and Handling Costs

Shipping and handling costs are included with cost of sales.

Advertising Costs

Advertising expenditures totaled approximately $62,178 and $82,413, for the years ended December 31, 2005 and 2004, respectively.

F-11

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Income Taxes

Deferred taxes are provided on a liability method, whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

Fair Value of Financial Instruments

At December 31, 2005 and 2004, the Company’s financial instruments included cash, cash equivalents, receivables, accounts payable, accrued liabilities and borrowings. With the exception of borrowings, the fair value of these financial instruments approximated their carrying value because of the short-term nature of these instruments. The fair value of the Company’s borrowings approximated their carrying value based upon management’s review of market prices for financial instruments with similar characteristics.

Earnings Per Share

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

Stock Based Compensation

The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related Interpretations in accounting for its stock option plans (the intrinsic value method). Under APB 25, if the exercise price of the Company’s employee stock options equals or exceeds the fair value of the underlying stock on the date of grant as determined by the Company’s Board of Directors, no compensation expense is recognized. See Note 8 for additional disclosures regarding the Company’s stock option plans.

F-12

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock Based Compensation (Continued)

Pro forma disclosures of stock-based employee compensation expense disclosures are as follows:

	Year Ended December 31,
	2005			2004
Net income as reported	$	1,755,254		$	1,704,596

Deduct: total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effect	$	(51,199	)	$	(8,666	)

Pro forma net income	$	1,704,055		$	1,695,930

Basic earnings per share - as reported	$	0.12		$	0.12

Basic earnings per share - pro forma	$	0.11		$	0.11

Diluted earnings per share - as reported	$	0.11		$	0.11

Diluted earnings per share - pro forma	$	0.10		$	0.11

Impact of New Financial Accounting Standards

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board issued Statement Number 123 (revised 2004) (SFAS 123 (R)), Share-Based Payments. SFAS 123 (R) requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments such as stock options granted to employees. The Company is required to apply SFAS 123 (R) on a modified prospective method. Under this method, the Company is required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at the date of adoption. In addition, the Company may elect to adopt SFAS 123 (R) by restating previously issued financial statements, basing the expense on that previously reported in their pro forma disclosures required by SFAS 123. For companies filing under Regulation S-B, SFAS 123 (R) is effective the beginning of the first interim or annual reporting period that begins after December 15, 2005, which for the Company will be the first quarter of the year ending December 31, 2006. The Company anticipates adopting SFAS No 123 (R) beginning in the quarter ending March 31, 2006. Management has not completed its evaluation of the effect that SFAS 123 (R) will have, but believes that the effect will be consistent with its previous pro forma disclosures.

F-13

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Inventory Costs

In November 2004, the FASB issued SFAS No. 151, Inventory Costs (SFAS 151). SFAS 151 requires that abnormal amounts of idle facility expense, freight, handling costs and spoilage be recognized as current-period charges. Further, SFAS 151 requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. Unallocated overheads must be recognized as an expense in the period in which they are incurred. SFAS 151 is effective for inventory costs incurred beginning in 2006. The Company is currently evaluating the effect of SFAS 151 on the financial statements and related disclosures.

Financial Accounting Pronouncement SFAS 154

Reclassifications

The Company made a decision to present installation income within the revenue line versus a net effect within sales and marketing expenses. The 2004 and 2003 numbers were reclassified for comparative purposes.

INVENTORIES

Inventories consist of the following as of December 31, 2005 and 2004:

()()

	2005		2004
Raw materials	$	211,282	$	315,367
Work-in-process		70,631		119,634
Finished goods		98,763		80,390

	$	380,676	$	515,391

F-14

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

FURNITURE AND EQUIPMENT

Furniture and equipment consist of the following as of December 31, 2005 and 2004:

	2005			2004
Research and manufacturing equipment	$	151,916		$	148,941
Office furniture and equipment		259,636			235,603
Demonstration equipment		19,368			19,368

		430,920			403,912
Less accumulated depreciation and amortization		(323,133	)		(253,425	)


	$	107,787		$	150,487

ACCRUED LIABILITIES, PRODUCT WARRANTY AND DEFERRED REVENUE

Accrued liabilities consist of the following as of December 31, 2005 and 2004:

	2005		2004
Accrued compensation	$	763,137	$	565,176
Accrued warranty expenses		614,251		505,851
Other accrued liabilities		667,845		497,058


	$	2,045,233	$	1,568,085

Product Warranty

The Company generally offers a one-year warranty to its customers. The Company’s warranty requires it to repair or replace defective products during the warranty period. At the time product revenue is recognized, the Company records a liability for estimated costs that may be incurred under its warranties. The costs are estimated based on historical experience and any specific warranty issues that have been identified. Although historical warranty costs have been within expectations, there can be no assurance that future warranty costs will not exceed historical amounts. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the balance as necessary.

F-15

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

ACCRUED LIABILITIES AND PRODUCT WARRANTY (Continued)

Product warranty reserve changes consist of the following as of December 31, 2005 and 2004:

	2005			2004
Warranty balance at beginning of the year	$	505,851		$	438,450
Reductions for warranty services provided		(271,751	)		(292,875	)
Changes for accruals in current period		405,900			426,901
Changes for accruals for pre-existing warranties		(25,749	)		(66,624	)


Warranty Balance at end of the year	$	614,251		$	505,851

Deferred Extended Warranty Revenue

In addition to the Company’s one-year warranty, the Company offers an extended warranty for an additional charge to the customer. The Company records the sale of the extended warranty as deferred revenue and amortizes the revenue over the term of the agreement, generally one to four years. At December 31, 2005 and 2004, deferred extended warranty revenue was $861,486 and $793,972, respectively. At December 31, 2005 and 2004, service revenue was $1,902,278 and $1,223,923, respectively, and the related charges were $815,167 and $669,901, respectively.

NOTES PAYABLE

Notes payable consist of the following at December 31, 2005 and 2004:

	2005		2004
Laurus Master Fund Ltd. #1	$	135,676	$	579,662
Laurus Master Fund Ltd. #2		696,970		1,000,000
Other		24,700		35,038

		857,346		1,614,700

Less: current portion		508,109		776,338


Long-term portion	$	349,237	$	838,362

Maturities of notes payable are as follows:


Year Ending December 31,

2006	$	508,109
2007		346,084
2008		3,153


	$	857,346

F-16

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

NOTES PAYABLE (Continued)

Laurus Master Fund Ltd. #1

On September 25, 2003, the Company entered into a convertible term note and securities purchase agreement with Laurus Master Fund, Ltd. #1 (“Laurus 1”). Pursuant to the agreements, the Company sold to Laurus 1, a secured convertible term note in the principal amount of $1,200,000 bearing interest at the rate of six and one-half percent (6.5%) per annum, due September 25, 2006, convertible into shares of its common stock at a conversion price of $1.07 per share. Under certain circumstances, both the Company and Laurus 1 may exercise their right to convert all or a portion of the outstanding principal and interest into shares of common stock. Loan costs of $118,718 have been capitalized and are being amortized over the three-year life of the note. The Company granted to Laurus 1 a subordinated second priority security interest in its assets to secure the obligations under the note. Additionally, the Company issued a warrant to Laurus 1 to purchase 375,000 shares of its common stock at exercise prices ranging between $1.23 and $1.61 per share (Note 8).

In 2004, the Company opted to pay $580,796 of principal and $35,869 of interest in 576,322 shares of common stock. In 2005, the Company opted to pay $400,541 of principal and $10,323 of interest in 383,985 shares of common stock.

Laurus Master Fund Ltd. #2

On April 27, 2004, the Company entered into a convertible term note and securities purchase agreement with Laurus Master Fund, Ltd. #2 (“Laurus 2”). Pursuant to these agreements, the Company sold to Laurus 2, a secured convertible term note in the principal amount of $1,000,000 bearing interest at the rate of six and one-half percent (6.5%) per annum, due April 27, 2007, convertible into shares of its common stock at a conversion price of $1.22 per share. Under certain circumstances, both the Company and Laurus 2 may exercise their right to convert all or a portion of the outstanding principal and interest into shares of common stock. Loan costs of $70,980 have been capitalized and are being amortized over the three-year life of the note. The Company granted to Laurus 2 a subordinated second priority security interest in its assets to secure the obligations under the note. Additionally, the Company issued a warrant to Laurus 2 to purchase 313,000 shares of its common stock at exercise prices ranging between $1.40 and $1.83 per share (Note 8).

F-17

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

RELATED PARTY TRANSACTIONS

MediVision

During the period of August 2000 through July 1, 2001, we executed several promissory notes in favor of MediVision, an Israeli corporation and majority shareholder in our Company. The Short-Term Note had a maximum principal balance of $260,000 available, while the Working Capital Funding Agreement and Amendment No.1 to this agreement provided an additional funding of $2,500,000. Both Notes and the Amendment bear interest at the rate of 9.3% per annum and are secured by all of our assets. The principal amount outstanding, together with any and all accrued interest on the Working Capital Note and Amendment, was payable by August 31, 2003, except that MediVision may, at its option, at any time convert any amount of principal and interest then outstanding into shares of our common stock at a conversion price of $.80 per share on the Working Capital Note and $0.185 per share on the Amendment No.1 to the Working Capital Note. In May 2003, we entered in Amendment No. 2 to the Working Capital Funding Agreement and the Short Term Note with MediVision whereby the repayment terms on the debt were extended on all principal and interest due until January 1, 2005. As a result of cash payments and product shipments to MediVision discussed below, the principal and interest was paid during the first quarter of 2004. In June 2003, MediVision exercised its option, as stipulated in the Working Capital Funding Agreement, Amendment No. 1, to convert $1,150,000 of principal and interest at a conversion price of $0.185 per share into 6,216,216 shares of common stock.

In March 2004, our Board of Directors approved a line of credit to MediVision of $1,000,000 at 9.3% interest for two years. In January 2005 our Board of Directors approved an additional loan advance of $150,000 for a 30-day term.F-18

On March 2, 2005, we entered into a Loan and Security Agreement and Promissory Note with MediVision (the “Loan Agreement”) whereby we agreed to loan MediVision up to $2,000,000. The Loan Agreement incorporated the $1,150,000 previously approved by our Board of Directors. Under the terms of the agreement, interest is 7.25% per annum and is payable on February 28, 2006 along with all outstanding principal due at that date. The note was secured by 2,409,000 shares of our common stock owned by MediVision. The number of shares was based on the average closing price of shares of our stock during the period covering the last ten (10) business days of February, 2005, which average closing price was $1.11, discounted by 25%. In the event that MediVision were to sell any shares of our stock it owns during the period of the agreement, a minimum of 50% of the proceeds from such sales would be required to be paid to us to reduce the outstanding amount owed. On July 28, 2005, we and MediVision entered into an amendment to the Loan Agreement whereby MediVision repaid $1,000,000 to us, decreasing the agreed upon loan of $2,000,000 to $1,000,000 and the amount of shares securing the loan was decreased by 1,204,500 shares.

F-18

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

RELATED PARTY TRANSACTIONS (Continued)

MediVision (Continued)

In August 2002, our Board of Directors, at MediVision’s request, authorized us to guarantee and/or provide security interests in our assets for certain of MediVision’s loans with financial institutions, on the maximum aggregate amount of approximately $1,900,000. In August 2002, MediVision subordinated to the financial institutions its security position in our assets, which had been granted in consideration of loans to us from MediVision. In December 2002, our Board of Directors approved our issuance of two debentures in favor of the banks to act as security for the debt of MediVision, which debentures were secured by a first lien on all of our assets. Such debentures and lien were signed in December 2002. The purpose of both debentures was to guarantee and/or provide a security interest for certain debts and liabilities of MediVision. On July 20, 2005, we replaced the existing debentures and lien in favor of the banks that were issued by us in an aggregate amount of up to $1,900,000, with a new debenture and lien in an aggregate amount of up to $2,000,000. One of the terminated debentures was issued in favor of United Mizrahi Bank Ltd. and the other terminated debenture was issued in favor of Bank Leumi Le-Israel. In lieu of the terminated debentures, we entered into a new Secured Debenture (the “Debenture”) in favor of United Mizrahi Bank Ltd., in an amount of up to $2,000,000 (plus interest, commissions and all expenses). Under the terms of the Debenture, we guarantee the payment of all of the debts and liabilities of MediVision to United Mizrahi Bank. The Debenture is secured by a first lien on all of our assets. MediVision pledged 2,345,500 shares of our common stock it owns to us in order to secure the Debenture. The number of shares securing the Debenture is comprised of the 1,204,500 shares previously securing the promissory note under the Loan Agreement to cover $1,000,000 and 1,141,000 shares of our common stock (which number was based upon the average closing price of shares of our stock during the period covering the last ten (10) business days of February, 2005, which was $1.17, discounted by 25%) to cover the second $1,000,000. The amount owed to the financial institutions by MediVision and secured by us as of December 31, 2005 was approximately $2,000,000.

As a result of the amendments to the Loan Agreement and the Debenture, the total number of shares securing the promissory note under the Loan Agreement, and the Debenture, is 3,550,000 out of the 10,730,851 shares of our common stock owned by MediVision as of December 31, 2005.

At June 30, 2005 we had recorded a net amount due from MediVision of approximately $1,955,558 on the promissory note and approximately $28,539 net, due for products and services. On July 28, 2005, pursuant to the aforementioned Debenture signed by us, MediVision executed the amended Loan Agreement and paid back $1,000,000 of the loan from us; reducing the amount MediVision owed us on the promissory note to $955,558. On September 20, 2005, pursuant to a Common Stock Purchase Agreement, dated as of September 16, 2005, between MediVision and Meadowbrook Opportunity Fund LLC, MediVision sold 400,000 shares of our common stock to Meadowbrook Opportunity Fund LLC at a price of $1.20 per share. MediVision used $240,000 of the proceeds from this sale to repay part of the aforementioned loan to us, reducing the amount MediVision owes us on the promissory note to $715,556, plus accrued interest under the loan. On December 8, 2005, MediVision sold 310,000 shares to the clients of an institutional investor at the price per share of $1.45. MediVision used $225,000 of the proceeds from this sale to repay part of the aforementioned loan to us, reducing the amount MediVision owes us on the promissory note to $492,556, plus accrued interest under the loan. On February 14, 2006, MediVision sold 1 million shares of our common stock to Wasatch Advisors, Inc. at the market price of $1.80 per share. MediVision used $492,556 of the proceeds from this sale to repay the remaining principal balance of the aforementioned loan to us.

Pursuant to a Common Stock Purchase Agreement dated as of September 16, 2005 between MediVision and Meadowbrook Opportunity Fund LLC, MediVision sold 400,000 shares of our common stock to Meadowbrook Opportunity Fund LLC at a price of $1.20 per share.

On December 8, 2005, MediVision sold 310,000 shares of our common stock to the clients of an institutional investor at the price per share of $1.45. As a result of the foregoing transactions, as of December 31, 2005, MediVision owned approximately 67% of our outstanding common stock.On February 14, 2006, MediVision sold 1 million shares of our common stock to Wasatch Advisors, Inc. at the market price of $1.80 per share.

As a result of the foregoing transactions, as of February 22, 2006, MediVision owns approximately 59% of our outstanding common stock.

F-19

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

RELATED PARTY TRANSACTIONS (Continued)

MediVision (Continued)

At December 31, 2005, the Company had recorded approximately $631,129 of receivable and note due from MediVision as compared to $1,056,000 in aggregate debt and accrued interest owed to MediVision as of December 31, 2004. The changes are the result of cash payments and the net effect of other intercompany revenue and expense transactions.

Sales to MediVision during the fiscal years ended December 31, 2005 and 2004 totaled approximately $786,000 and $744,000, respectively. Sales derived from product shipments to MediVision are made at transfer pricing which is based on similar volume discounts that would be available to other resellers or distributors of the Company’s products.

During the year ended December 31, 2005 and 2004, the Company paid $667,400 and $687,100 to MediVision for research and development performed on behalf of the Company.

CCS Pawlowski

The Company entered into an agreement with CCS Pawlowski GmbH (“CCS”), a German subsidiary of MediVision, whereas CCS will be a distributor for the Company in the Germany and Austria territories.

At December 31, 2005, the Company had recorded approximately $60,000 of amounts due from CCS.

MediStrategy Ltd.

The Company has a service agreement with MediStrategy Ltd. (“MS”), an Israeli company owned by Noam Allon, a former Director of the Company, serving on the Board until December 2004. Under the terms of the agreement, MS provides services to the Company primarily in the business development field in ophthalmology, including business cooperation, mergers and acquisitions, identifying and analyzing new lines of business and defining new product lines or business opportunities to be developed. All services provided by MS are performed solely by Noam Allon.

In consideration for the services provided, the Company agreed to pay MS a monthly sum of $3,300. In addition, MS is to be paid a yearly performance bonus of up to $20,000 upon achievement of goals under the terms of the agreement determined by MS, Noam Allon and the Company’s Chairman of the Board. During the year ended December 31, 2004, MS earned fees in the amount of $39,600. $19,800 of the fees has been paid with the balance being accrued as of December 31, 2004. During the year ended December 31, 2005, MS earned fees of $42,400 which was accrued at December 31, 2005, and not yet paid in 2006. As of September 1, 2005, the monthly sum changed from $3,300 to $4,000, and the yearly performance bonus changed from $20,000 to $10,000.

F-20

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

RELATED PARTY TRANSACTIONS (Continued)

Jonathan Adereth

In 2004, Jonathan Adereth received $36,000 for his services as Chairman of the Board and an additional $3,500 for meetings attended. Mr. Adereth was also granted a stock option to purchase 40,000 shares at an exercise price of $0.68 per share in October 2004. Starting January 2005, Jonathan Adereth, serves as a consultant to the board of directors. The Company agreed to the following in connection with his service as a consultant. (i) to pay to Mr. Adereth, a monthly retainer of $2,000, (ii) to pay to Mr. Adereth a daily fee of $500 for physical attendance in meetings, and (iii) to reimburse Mr. Adereth for reasonable expenses incurred in connection with his services as a consultant to the Board of Directors.

LINE OF CREDIT

In May 2003, the Company entered into a $150,000 line of credit agreement with one of its banks, Wells Fargo. The line is secured by a pledged investment with the bank equal to the amount of the line of credit. Advances on the line bear interest at prime (7.25% at December 31, 2005) with interest due monthly. The line matures on September 10, 2008.

STOCKHOLDERS’EQUITY

Stock Option Plans

The Company applies APB 25 and related Interpretations in accounting for its stock options. Under APB 25, because the exercise price of the Company’s stock options equals or is greater than the market price of the underlying stock on the date of grant, no compensation expense is recognized.

The Company has six stock-based compensation plans and Individual Stock Option Agreements. Options granted under these plans generally have a term of ten years from the date of grant unless otherwise specified in the option agreement. The plans generally expire ten years from the inception of the plans. Options granted under these agreements have a vesting period of three to four years. Incentive stock options under these plans are granted at fair market value on the date of grant and non-qualified stock options granted can not be less than 85% of the fair market value on the date of grant.In December 2005, the Company’s Board of Directors approved a Stock Option Plan (the “2005 Plan”) under which all officers, employees, directors and consultants may participate. Subsequent to December 2005, the 2005 Plan was approved by consent of the Company’s majority shareholder. The 2005 Plan expires in December 2015. Options granted under the 2005 Plan are qualified stock options and will generally have a term of ten years from the date of grant, unless otherwise specified in the option agreement. The exercise prices of non-qualified stock options granted under the 2005 Plan cannot be less than the fair market value of the Company’s common stock on the date of grant. The maximum number of shares of the Company’s common stock which may be optioned and sold under the 2005 Plan is 750,000, all of which are available for granting of options as of December 31, 2005.

F-21

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

STOCKHOLDERS’EQUITY (Continued)

Stock Option Plans (Continued)

A summary of the Company’s plans as of December 31, 2005 is presented below:

Plan Name
1992 Option Plan	150,000	December 2002	1,500	$0.48 - $4.25
1995 Nonstatutory Plan	1,035,000	November 2005	-	$0.00
1997 Nonstatutory Plan	1,000,000	October 2002	60,000	$0.63 - $1.38
Individual Stock Option Agreements	126,360	November 1998	73,710	$0.63
2000 Option Plan	1,500,000	September 2010	1,333,333	$0.10 - $1.45	134,999
2003 Option Plan	750,000	October 2013	639,000	$0.68 - $1.10	111,000
2005 Option Plan	750,000	December 2015	-	$ 0.00	750,000

			2,107,543		995,999

A summary of the status of the Company’s stock option plans and changes during the periods is presented below:

			Weighted Average Exercise Price
Balance January 1, 2004	1,770,952		$	0.46


Options granted	684,000		$	0.67
Options canceled	(26,666	)	$	0.41
Options lapsed	(55,819	)	$	0.94
Options exercised	(53,334	)	$	0.48

Balance December 31, 2004	2,319,133		$	0.51

Options granted	126,000		$	1.19
Options canceled	(237,590	)	$	0.55
Options lapsed	-		$
Options exercised	(100,000	)	$	0.49


Balance December 31, 2005	2,107,543		$	0.55

F-22

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

STOCKHOLDERS’EQUITY (Continued)

Stock Option Plans (Continued)

The weighted average fair value of options granted during the years ended December 31, 2005 and 2004 were $1.19 and $.67, respectively.

The following table summarizes information about the stock options outstanding at December 31, 2005:

	Options Outstanding					Options Exercisable
Range of Exercise Prices	Weighted Average Remaining Contractual Number		Weighted- Average Exercise Life	Price		Weighted- Average Exercise Number		Price
$ 0.31 - $ 1.37		2,051,043	7.8 years		$0.52		1,576,751		$0.46
$ 1.38 - $ 3.00		55,000	0.8 years		$1.43		55,000		$1.43
$ 3.01 - $ 4.50		1,500	3.7 years		$4.25		1,500		$4.25

		2,107,543					1,633,251

Pro forma information regarding net income and net income per share is required by SFAS 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to August 31, 1995 under the fair value method of that Statement. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for the years ended December 31, 2005 and 2004, respectively; dividend yield of zero; volatility factors of the expected market price of the Company’s common stock ranged from 91% to 95% for the years ended December 31, 2005 and 2004, risk-free interest rate of 4.42% and 4.04%; respectively, and a weighted-average expected life of 10 years.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

F-23

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

STOCKHOLDERS’EQUITY (Continued)

Stock Option Plans (Continued)

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information follows:

	2005		2004
Pro forma net income	$	1,704,055	$	1,695,930


Pro forma basic net income per share	$	0.11	$	0.11


Pro forma diluted net income per share	$	0.10	$	0.11

Warrants

The Company issued a warrant in September 2003 pursuant to the issuance of a note payable (Note 5). The warrant permits the holder to purchase up to 375,000 shares of common stock at a price of $1.23 per share for the first 100,000 shares; $1.39 per share for the next 125,000 shares and $1.61 per share for the remaining 150,000 shares. The warrant is exercisable through September 26, 2010.

The Company issued a warrant in April 2004 pursuant to the issuance of a note payable (Note 5). The warrant permits the holder to purchase up to 313,000 shares of common stock at a price of $1.40 per share for the first 83,000 shares; $1.59 per share for the next 105,000 shares and $1.83 per share for the remaining 125,000 shares. The warrant is exercisable through April 27, 2009.

INCOME TAXES

The income tax (benefit) expense for the years ended December 31, 2005 and 2004 consisted of the following:

	Federal			State			Total
2005

Current	$	28,000		$	14,000		$	42,000
Deferred		154,000			155,000			309,000
Change in valuation allowance		(426,000	)		22,000			(404,000	)


Total income tax (benefit)	$	(244,000	)	$	191,000		$	(53,000	)

2004

Current	$	(22,000	)	$	(7,000	)	$	(29,000	)
Deferred		376,000			88,000			464,000
Change in valuation allowance		(890,000	)		(103,000	)		(993,000	)


Total income tax (benefit)	$	(536,000	)	$	(22,000	)	$	(558,000	)

F-24

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

INCOME TAXES (Continued)

The Company’s effective tax rate for the years ended December 31, 2005 and 2004 was (3)% and (49)%. The reconciliation of the statutory rate to the effective rate is as follows:


Statutory rate	34	%	34	%

State income taxes, net of Federal benefit	6		6
Other	7		(11	)
Utilization of net operating losses	(44	)	(32	)
Change in valuation allowance	(6	)	(46	)

Total	(3	)%	(49	)%

The significant components of the Company’s deferred tax assets and liabilities are as follows:

	December 31,
	2005			2004
Deferred tax assets:
Net operating loss carry forwards	$	1,019,000		$	1,481,000
Inventory reserves		964,000			962,000
Payroll related accruals		194,000			143,000
Warranty accrual		263,000			217,000
Sales and accounts receivable reserves		153,000			165,000
Uniform capitalization		42,000			70,000
Deferred revenue		362,000			340,000
AMT credit carryover		70,000			-
R&D credit carryover		175,000			175,000


Total deferred tax assets		3,242,000			3,553,000

Valuation allowance		(2,100,000	)		(2,504,000	)


Net deferred tax assets		1,142,000			1,049,000

Deferred tax liabilities:
Depreciation		(18,000	)		(20,000	)


Net deferred tax assets	$	1,124,000		$	1,029,000

F-25

OPHTHALMIC IMAGING SYSTEMS

NOTES TO FINANCIAL STATEMENTS
(Continued)

INCOME TAXES (Continued)

At December 31, 2005 and 2004, management reviewed recent operating results and projected future operating results. At the end of each of these years, management determined that it was more likely than not that a portion of the deferred tax assets attributable to net operating losses would likely be realized. Due to the Company’s limited history of profitable operations, management has recorded a valuation allowance of $2,100,000 and $2,504,000 at December 31, 2005 and 2004, respectively. The amount of the valuation allowance will be adjusted in the future if management determines that it is more likely than not the deferred assets will be realized.

The Company has at December 31, 2005, a net operating loss carryover of approximately $3,346,000 for Federal income tax purposes which expires between 2007 and 2020, and a net operating loss carryforward of approximately $284,000 for California state income tax purposes which expires through 2010. The State of California has suspended the application of net operating losses for the 2002 and 2003 fiscal years and extended the carry forward period two years. Federal tax credit carryforwards of approximately $175,000 will begin to expire in 2007. Due to changes in ownership which occurred in prior years, Section 382 of the Internal Revenue Code provides for significant limitations on the utilization of net operating loss carryforwards and tax credits. As a result of these limitations, a portion of these loss and credit carryovers may expire without being utilized.

10.

COMMITMENTS AND CONTINGENCIES

Security Interest

In December 2002, the Company granted a security interest in substantially all assets of the Company to the United Mizrahi Bank Ltd. Bank, as security for amounts borrowed by MediVision from the bank and advanced to the Company under the note agreements (Note 6).

Equity Line of Credit

On December 28, 2004, the Company entered into an investment agreement with Dutchess Private Equities Fund II, LP (Dutchess) providing for an equity line of credit. Pursuant to the investment agreement, Dutchess has agreed to provide the Company with up to $9,000,000 of funding during the thirty month period beginning on the date that a registration statement the Company agreed to file providing for the resale of the shares of common stock issuable under the investment agreement is declared effective by the Securities and Exchange Commission. During this thirty month period, the Company may request a drawdown under the investment agreement by selling shares of its common stock to Dutchess, and Dutchess will be obligated to purchase the shares. The Company is under no obligation to request any drawdowns under the investment agreement.

The amount that the Company can request in any drawdown notice is, at the Company’s election, the greater of (A) up to 200% of the average daily volume of the Company’s common stock for the ten trading days prior to the date of the drawdown notice multiplied by the average of the three daily closing bid prices for the common stock immediately preceding the date of the drawdown notice or (B) $100,000; provided that the Company may not request more than $1,000,000 in any single drawdown.

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NOTES TO FINANCIAL STATEMENTS
(Continued)

10.

COMMITMENTS AND CONTINGENCIES (Continued)

As of December 31, 2005, the Company’s registration statement had not been declared effective; accordingly no drawdowns have been made.

Operating Leases

The Company leases its corporate headquarters and manufacturing facility under a noncancellable operating lease that expires in June 2007. The lease agreement provides for minimum lease payments of $105,864 for the year ended December 31, 2006, and $53,532 for the year ended December 31, 2007.Rental expense charged to operations for all operating leases was approximately $106,000 and $96,000, respectively during the years ended December 31, 2005 and 2004.

11.

SUBSEQUENT EVENTS

On January 24, 2006, the Company paid off the remainder of the $1,200,000, three-year, convertible note with Laurus Master Fund, Ltd (“Laurus”) entered into in September 2003.

On January 20, 2006, Laurus converted the balance of the $1,000,000, three-year convertible note entered into in April 2004 into 528,082 shares.

On February 21, 2006, MediVision sold 1 million shares of the Company’s common stock to Wasatch Advisors, Inc. at the market price of $1.80 per share. As a result of the foregoing transactions, as of February 22, 2006, MediVision owns approximately 59% of our outstanding common stock. MediVision used $492,556 of the proceeds from this sale to repay the remaining principal balance of the aforementioned loan to us.

On February 23, 2006, the United States District Court for the Eastern District of California granted monetary damages to the Company for the civil action lawsuit filed March 9, 2004. The Company was awarded $200,000 in damages.

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Signatures

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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Dated: March 28, 2007	By:	/s/ Gil Allon

	Name:	Gil Allon
	Title:	Chief Executive Officer
		(Principal Executive Officer)


	By:	/s/ Ariel Shenhar

	Name:	Ariel Shenhar
	Title:	Chief Financial Officer
		(Principal Financial and Accounting Officer)

Explanatory Note

Comparison of Year Ended December 31, 2005 to Year Ended December 31, 2004

Comparison of Year Ended December 31, 2004 to Year Ended December 31, 2003

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FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2005 AND 2004 AND

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004 AND

REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

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FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2005 AND 2004 AND

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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BALANCE SHEET

December 31, 2005 and 2004

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BALANCE SHEET (Continued)

December 31, 2005 and 2004

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STATEMENT OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

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STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

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STATEMENT OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

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NOTES TO FINANCIAL STATEMENTS

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BALANCE SHEET
(Continued)