Optical Systems, Inc.

Rating: Speculative Buy Market Data Symbol Exchange Current Price Price Target July 8, 2008 OPSY OTCPK $0.16 $0.50 Speculative Rating Buy Outstanding Shares 94.6 million Market Cap. $15.1 million Average Volume NA Source: Yahoo Finance, Analyst estimates
Company Overview Optical Systems Inc. (OPSY), through its wholly owned subsidiary, Automotive Software Designers, Inc., provides front office software for automotive dealerships nationwide. OPSY’s “save-a-deal” software has been shown to significantly improve dealer efficiency by automating workflow within a dealership, eliminating manual forms and reducing the time needed to desk and finance a deal. The Company further differentiates its software from industry competitors’ products by providing value-added services such as management consulting, network support and business development call center services to clients. At present, OPSY has 21 franchised automotive dealerships using its front office software. In June 2008, the Company announced

the opening of a business development call center which will further support its save-a-deal customers. Integrated with OPSY’s sales information system the business development call center will help auto dealers convert more leads into showroom sales by promptly responding to customer enquiries. The Company has installed its save-a-deal software at Frank Kent Honda, one of the oldest and largest Honda dealers in Teas. This and other dealer relationships are enhancing the Company’s visibility and multiplying its sales opportunities. More recently, OPSY announced a marketing partnership with Alphatrade.com, a media and marketing company, where Alphatrade will assist OPSY with digital marketing, media and networking. The Company has raised $2.4 million in capital since its inception and is contemplating a $2 million strategic financing arrangement with potential partners. These funds would be used for marketing purposes and expanding the Company’s customer base. In November 2007, the Company, formerly known as Optical Systems Holdings, acquired 100% of the issued and outstanding stock of Automotive Software Designers, Inc (ADS), which owned the save-a-deal software. Prior to closing this deal, ADS’s owner B.J. Grisaffi acquired a majority stake in OPSY. Mr. Grisaffi has more than 30 years of automotive dealership and related experience and currently serves as OPSY’s President, CEO and a director. In addition, two prominent directors have been added in 2008. Keith Orr, a legendary figure in the automotive industry

and CEO/co-owner of Orr Automotive, recently joined OPSY’s board. So has William Mokry, an automotive industry veteran who held executive management positions with two major U.S. auto manufacturers. Mr. Mokry currently owns and manages a multi-location sub-prime automobile sales and finance company. Management believes the new business development call center the Company opened last month significantly enhances the value proposition OPSY offers customers since it frees dealership sales professionals to focus on selling and closing car sales, rather than chasing down leads. The save-a-deal business development call center is unique in that it is staffed by trained vehicle sales professionals and not the more typical low-skill call center workers. Preliminary results suggest that save-a-deal dealerships utilizing the services of the business development call center can expect to more than double closing rates for their stores. Investment Highlights Auto dealerships seek competitive advantages through better sales tools The Company serves a competitive, highly fragmented automotive dealership market consisting of some 21,800 franchised dealers nationwide and tens of thousands of independent dealers. Intense competition for customers has given car buyers strong bargaining power. As a result, industry profit margins are under pressure. Unable to boost prices on most vehicle models, dealers are focusing instead on maintaining

margins through greater efficiency. OPSY’s save-a-deal front office software enables dealers to significantly improve efficiency by automating workflow, eliminating paper forms and streamlining deal financing. Dealers desperate for sales follow-up tools OPSY is addressing an unmet market need by developing call centers that provide customer follow-up calls for save-a-deal dealers. The ability to offer this highly profitable service is a natural offshoot of the save-a-deal package since the system requires the dealer’s sales associate to acquire a customer’s information at the point of sale. Auto dealerships are in desperate need of efficient, reliable sales follow-up tools and the Company’s call centers are uniquely positioned to fill that need. OPSY’s integrated software is supported by valued-added services The Company’s save-a-deal software combines sales prospecting, CRM, deal desking and inventory management functionalities in one integrated tool. OPSY also offers its dealer customers valueadded services such as management consulting, networking solutions and business development call center support. The Company’s feature-rich software and related services differentiates OPSY’s product from the competition. Other software vendors serving this niche market offer software limited to only one particular application such as desking, inventory management or Internet CRM.

Installed dealership base and new marketing partnership The Company has installed its save-a-deal software at 21 dealerships nationwide and recently completed a software installation at Frank Kent Honda, one of the oldest and largest Honda dealerships in Texas. The Company plans to further boost its brand visibility and sales prospects through a marketing partnership with Alphatrade.com. This marketing company is known for its ability to tailor its programs to target specific demographics in a cost-effective manner. Brand awareness in the automotive industry is essential to OPSY’s long-term success; Alphatrade is designing a marketing program specifically tailored to achieving this objective. OPSY anticipates robust revenue growth and profitability in 2008 With all the development work on its principal software package essentially completed, the Company’s 2008 R&D spending requirements are minimal and OPSY is free to redirect its resources towards marketing and sales. Management targets 50% quarter-over-quarter growth over the next several quarters and estimates 2008 revenues will fall in a $0.7 million range. High gross margins on both software and business development call center sales (i.e. 95% margins) enabled OPSY to turn profitable in the first quarter of 2008 and we anticipate the Company will report a modest net profit for full-year 2008. Experienced management team directs OPSY’s growth

Company President/CEO, B.J. Grisaffi, has more than 30 years of experience managing automobile dealerships. He, along with his team, pioneered the save-a-deal program and led the development of the software. Keith Orr, who recently joined the Company as a director, is a legendary figure in the automotive industry He was the CEO and majority owner of Orr Automotive Group. and brings to OPSY substantial marketing, sales, product development and dealership management experience. In July, William Mokry, an automotive industry veteran who held executive management positions with two major U.S. auto manufacturers, was added to the board. Mr. Mokry currently owns and manages a multi-location, sub-prime automobile sales and finance company.

Automotive Dealership Market Highly fragmented and competitive market The vast majority of new car sales in the U.S. are generated by some 21,800 franchised automotive dealerships nationwide which have combined annual revenues of approximately $675 billion. The industry is highly fragmented, with the top dealerships accounting for less than 10% of industry revenues. However, the automotive dealership industry has begun to consolidate in recent years due to declining new vehicle sales, competition from on-line sources, and other competitive challenges which have resulted in pricing and margin pressure. Unable to raise vehicle prices, car dealers are focusing instead on improving efficiencies as a means for boosting profits. This scenario is creating demand for integrated software products that can help improve front office efficiency. Vendors of value-added software and services such as Optical Systems, Inc. are uniquely well-positioned to address the evolving needs of this niche market. Exhibit 1: State-by-state breakdown of auto dealerships

Alaska 38

Washington 383 Montana 132 Oregon 274 Idaho 123 Wyoming 70 Nebraska 213 Nevada 118 Utah 153 Colorado 284 California 1,594 South Dakota 117 Iowa 369 North Dakota Minnesota 96 38 Wisconsin 597 Michigan 759

Vermont 97

Maine 144 New Hampshire 169

New York 1,112 Pennsylvania 1,161

Massachusetts 478 Rhode Island 63 Connecticut 320 Delaware 65 New Jersey 574 D.C. 1 Maryland 358

Arizona 256 New Mexico 140

Hawaii 66

Ohio Indiana 958 West Illinois 521 Virginia Virginia 934 551 169 Kentucky Missouri Kansas 258 North Carolina 298 494 692 Tennessee South 420 Carolina Oklahoma 299 Arkansas Georgia 326 267 Alabama 603 Mississippi 345 242 Louisiana Texas 1,346 337 Florida 948

Source: NADA

Exhibit 2: Breakdown of U.S. auto dealerships, by volume of new-unit sales
10,000 Num of dealerships ber 7,500 5,000 2,500 0 0-149 150-399 1988 1998 400-749 2008 750+

Source: NADA Industry Analysis Division More vehicles on the road today than ever before The number of vehicles operating in the United States grew to more than 248 million in June, 2007. The number of vehicles on the road increased 2% annually between 2000 and 2007. Although new vehicles registrations have declined modestly in recent years, the used car market remains robust, providing automotive dealers with ample opportunities for increasing sales volume In addition to selling cars, most dealers now generate significant incremental profits from selling insurance and financing services to their customers. The increasing complexity of automotive dealership operations has created the need for software tools that can streamline and automate several processes. Exhibit 3: Total Vehicles in operation by year
260

240

Millions

220

200

180 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: The Polk Co. & NADA

Exhibit 4: Aftermarket income (As % of new- and used-vehicle department gross profit)
30% 25% 20% 15% 10% 5% 0% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

F inance and insurance

Service contract and other

Source: NADA Industry Analysis Division

Margin gains targeted through efficiencies Intense competition among automotive dealers has led to declining industry profits. The profitability of new vehicles sales has been adversely impacted by lower sales volume, large inventories, generous consumer incentives and higher floor plan and energy costs. In the last two years, net profits on new vehicle sales have fallen below the breakeven level for most automotive dealers. As a result, auto dealers must now rely on used car sales to generate more of their profits. Although net profits on used car sales have declined marginally in recent years, these sales remain very attractive compared to new car sales. NADA (National

Automobile Dealers Association) claims that despite lower profits, dealer gross margins have remained relatively stable; it is only net margins that have declined. To improve net margins, automotive dealers are seeking way to reduce overhead and automate processes, installing software and other efficiency tools that can provide a rapid return on investment. Exhibit 5: New-vehicle department net profit
200 150 '000s $ '000s $ 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 100 50 0 -50

Exhibit 6: Used-vehicle department net profit
160 120 80 40 0

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Source: NADA Industry Analysis Division Cluttered software competitive landscape Many vendors have developed software with applications for automotive dealerships; product offerings range from pure CRMrelated software to Internet-based applications and database management services. This niche software market is characterized by rapidly changing technology needs, continuous innovations and a growing emphasis on ease of use. Factors that determine the most successful software vendors are the size of the installed

2007

customer base, hassle-free usage, strong branding and product functionality. OPSY offers the industry’s most complete end-to-end software solutions for car sales and dealership front office operations. The Company further differentiates its product with value-added services such as management consulting, networking solutions and business development call center services for save-a-deal dealerships.

Exhibit 7: OPSY competitive advantage.
Optical Systems, Inc
Software Solutions Management Consulting Network Solutions Call Center Solutions

The Reynolds & Reynolds Company

Software Solutions

Professional Services

IT Solutions

Automatic Data Processing

Business Outsourcing solutions

Dealerstrack Holdings Inc.

Software Solutions

Cobalt

Internet Advertising and Marketing services

Source: Company Reports Product Strategy OPSY has developed a superior software solution that provides a broad range of functionalities. The Company markets the industry’s only integrated lead sourcing, Internet CRM, desking and inventory management tool. In addition to feature-rich software, OPSY supports its save-a-deal customers with business development call center, management consulting and network solution services. OPSY’s President/ CEO B.J. Grisaffi, and new directors Keith Orr and William Mokry have extensive dealership

management backgrounds and have imparted their accumulated wisdom in the Company’s feature-rich software. Save-a-deal software The Company’s save-a-deal software offers customers the following: -Document and source all sales prospects from the Internet, telephone, walk-in traffic and appointments; - Facilitate, control and monitor follow-up with the CRM tool; - Control and monitor the sales process with a customized desk dealing tool; -Control new and used vehicle inventories with inventory management tools. Exhibit 8: Products and services
Optical Systems Inc. Products and Services

Products

Services

Save-A-Deal Software

Business Development Center Solutions Inventory Management

Deal Deskings

Sales Department One Piece

Finance Department Menu

Management Consulting

Save-A-Deal Reports

Internet CRM Capabilities

Drivers License Scanner

DMS Integration

Network Solutions

Source: Company Reports The Company also provides management consulting to dealerships on a weekly basis, drawing on the experience of personnel who have held positions such as General Manager, Sales Manager and Finance and Insurance Manager. Recognizing the industry’s desperate need for customer follow-up calls, OPSY has integrated its save-a-deal software with a business development call center that will enable automotive dealers to convert more leads into showroom sales. The Company also provides network services that help automotive dealers solve their complex IT problems. Few dealerships have the in-house technical expertise to address network issues. Business Strategy The Company’s business strategy encompasses every aspect of its operations from product development and positioning to marketing, brand building and funding strategies. Call center solution enhances customer acquisition and retention OPSY is enhancing its value proposition to automotive dealerships by leveraging the customer leads gathered through

the front office software with business development call centers which convert leads into showroom sales. Preliminary results indicate that dealers using the support services of the business development call center can expect to more than double closing rates for their stores. The call center frees dealership sales personnel from mundane, low value tasks such as handling incoming preliminary sales inquiries, making outbound follow up calls to customers and qualified prospects, and calling\emailing prospective Internet leads. The Company staffs its call center with trained vehicle sales personnel instead of the inexperienced, low skill workers typically associated with call center operations. Management consulting services and network services further enhance offerings OPSY makes management consulting services available to its auto dealer customers and also uses its contacts with senior network engineers to assist customers in solve complex network issues. Plans shift from R&D to revenue generation With product development essentially complete, OPSY is shifting its focus from research and development to product sales and marketing. Management targets growth averaging 50% per quarter over the next several quarters and shifting its marketing plan into high gear with Alphatrade’s help. Creating brand awareness

The Company recognizes that brand awareness within the automotive marketplace is essential for its longer-term success. Accordingly, OPSY is partnering with marketing guru Alphatrade to create and roll out a highly targeted and effective marketing campaign. Plans to raise funds via an equity private placement The Company currently has 21 franchised dealers using its savea-deal software and is discussing a strategic financing arrangement with potential partners which could raise $2.0 million in additional capital and fund further expansion of its marketing efforts and customer base. Exhibit 9: Business Strategy
Creating brand awareness

Raising funds via private placement

Business Strategy

Call center services for customer acquisition and retention,

Shift from R&D to revenue generation.

Source: Beacon Equity Research

Competitive Analysis OPSY’s closest direct competitor, DealerTrack Holdings, generates annual sales approaching $250 million. DealerTrack Holdings and other competitors are described below:

DealerTrack Holdings Inc DealerTrack Holdings provides on-demand software and data solutions for U.S. automotive dealerships. The company utilizes the Internet to link automotive dealers with banks, finance companies, credit unions and other financing sources, and also other service and information providers, such as the major credit reporting agencies. As of December 31, 2007, DealerTrack Holdings had more than 22,000 automotive dealers (approximately 90% of all franchised dealers) in its network and over 450 financing sources as well as other service and information providers. The company is headquartered in Lake Success, New York and primarily operates in the U.S. and Canada. Automatic Data Processing Automatic Data Processing, Inc. provides computerized transaction processing, data communication and information services. ADP also provides payroll processing (including full departmental outsourcing) and human resource administration

services in Canada and Europe. It also offers wage and tax collection, and remittance services in Canada. ADP was incorporated in 1961, and is headquartered in Roseland, New Jersey. It operates primarily in the U.S. and has 46,000 employees. Reynolds and Reynolds Company Reynolds and Reynolds Company is an integrated solutions provider to automotive retailers. The company provides a range of services such as information technology, software solutions and professional services to the automotive segment. It also offers products and services for original equipment manufacturers. It is a private company operating primarily in the U.S. and Canada and employing about 4,300 people. Cobalt Group Cobalt Group provides Internet advertising and marketing services such as lead management, inventory marketing, image marketing advanced vehicle search, pre-owned marketing and Spanish-language marketing to automobile dealers and manufacturers. The company's services enable auto manufacturers and dealers to build brands through marketing and Internet advertising. Privately-owned Cobalt works with more than 27 manufacturers and 12,000 franchised dealers across the U.S. Financial Analysis

Financial Record OPSY had sales totaling $60,491 in 2007. The Company became active in November 2007 when it acquired Automotive Software Designers, Inc. For the quarter ending March 2008, the Company posted revenues of $134,680. Operating expenses totaled $157,013 in 2007, with payroll and related costs accounting for about 59.0% of the total and administrative expenses and selling & marketing expenses constituting 24.6% and 14.3%, respectively. The Company plans to increase sales and marketing expenditures in 2008 as its focus shifts from research and development to revenue generation. OPSY recorded a net loss of $109,522 in 2007. Net income turned positive in the first quarter of 2008 as a result of revenue growth that allowed for improved absorption of overhead costs. Exhibit 10: Selected income statement data First quarter Year ended ended March December 31, 31, 2008* 2007 Revenue Total Operating Expenses Operating Income Net Income / (Loss) EBITDA $134,680 $127,190 $157,013 $7,940 $7,940 ($10,546) (109,522) ($109,522) ($106,047) $60,491

Source: Company Reports, Pink Sheets

Liquidity and capital requirements As of March 31, 2008, the Company had cash and equivalents of $124,475 and no long-term liabilities. However, OPSY had a working capital deficit (excluding cash) of approximately $11,484. The Company will likely need to raise additional external financing to fund its 2008/09 business plan and is contemplating a $2 million strategic financing arrangement. Exhibit 11: Selected balance sheet data March 31, 2008 Cash & cash equivalents Net working capital ( excluding cash) Total assets Total long term liabilities Total current liabilities Stock holders’ Equity ( deficit ) $124,475 ($11,484) $ 714,137 N/A $90,211 $633,868

Source: Company 10-Q, Pink Sheets

Revenue Outlook With development work on its software product essential completed, OPSY is switching its focus to revenue generation. The Company is already off to a strong start in 2008, recording first quarter sales of $134,680 and a modest first quarter net profit. Management is targeting 50% quarter-over-quarter sales growth for the next several quarters. We expect OPSY to generate 2008 revenues in a $0.7-0.9 million range, which will consist of $0.2-0.4 million in business development call center sales and around $0.5 million in software sales.

The Company’s principal competitor, DealerTrack Holdings, produces annual revenues in a $250 million range supplying a limited software product to around 90% of the nation’s franchise auto dealers. Simply capturing 10% of that market creates a $25 million market opportunity for OPSY. Going forward, we anticipate growth in OPSY’s revenues to around $3.5 million in 2009 and $7 million in 2010, with sales rising to $17.5 million by 2012. Recurring revenues from the business development call centers provides a powerful tool for leverage software sales. Reflecting its high gross margins and lean operating structure, we expect OPSY to remain solidly profitable for full-year 2008 and beyond.

Valuation Analysis OPSY’s competitors were recently trading at Price/Sales multiples averaging around 2.6 times revenues and forward Price/Sales multiples averaging about 2.5 times revenues. Because of its higher projected revenue growth and recurring revenues from call center operations, we believe OPSY shares warrant a premium multiple relative to DealerTrack Holdings. We value OPSY shares at a 3.0 times forward Price/Sales multiple. Exhibit 12: Peer group

Marke PE P/S Ticke Shar t Cap. e Company r ($ 200 200 200 200 Name Symb Price 2007 Millio 8 9 7 8 ol n) DealerTra ck Holdings Inc TRAK Automatic Data Processin g Inc ADP Peer Avg Optical Systems, Inc OPS Y $0.16 15.1

20 09

$14.7 4

628 21.7

35. 4

12. 0

2.3

2.5 2.4

$42.6 4 2,213 19.4

19. 17. 1 7 2.5 2.6 2.5 27. 14. 20.5 2.4 2.6 2.5 2 9

Source: Reuters

(Share price as on July 9, 2008)

By multiplying our $17.5 million 2012 revenue estimate by a 3.0 times forward Price/sales multiple, we derive a $52.5 million market capitalization target for OPSY shares. We assume 10% share dilution resulting from the proposed strategic financing and divide the market capitalization target by 105 million fully diluted shares outstanding to derive our $0.50 price target. Accordingly, we are initiating coverage of Optical Systems, Inc. with a Speculative Buy rating and a $0.50 price target. With its feature-rich software and value-added call center services, we think OPSY is well-positioned to rapidly garner share in the

automotive dealer software market. We caution investors, however, that OPSY must confront and overcome many obstacles in achieving its market penetration goals. Some of the principal risks faced by the Company are discussed below.

Risk Factors Reliance on automotive industry The Company’s software and services address the specific needs of automotive dealerships. At present, OPSY is entirely dependent on automotive dealers for product sales. The U.S. economic slowdown has created a difficult sales environment for automotive dealer and high crude oil prices are adversely impacting sales of gas-guzzling vehicle models. Technology risks The Company also faces risks related to technology innovation. Its product may become outdated and the possibility exists that a competitor may introduce more feature-rich software. OPSY’s ability to adapt to changing technology and the evolving needs of its market niche will determine the Company’s future growth. Brand loyalty DealerTrack Holdings has relationships with nearly 90% of automotive dealerships. Although OPSY offers a more feature rich product as well as valued-added services, customers may be

hesitant to switch vendors and brand loyalty to DealerTrack Holdings may limit OPSY’s ability to garner market share. Lack of financing The Company has a working capital deficit and will likely need to raise additional third party financing to implement its 2008/09 business plan. A $2.0 million strategic financing is contemplated; however, there is no guarantee that OPSY will be able to raise the necessary capital. An equity sale dilutes the ownership interests of existing shareholders while debt financing increases the Company’s finance risk and debt servicing requirements.

Management B. J. Grisaffi, Chairman, President and Chief Executive Officer B. J. Grisaffi has more than 30 years experience managing automobile dealerships. He and his team pioneered the save-adeal program, introducing the only integrated automotive dealership front office software available in the market today. Mr. Grisaffi was the owner of Automotive Software Designers and acquired a majority stake in OPSY before the two companies were merged. He currently serves as President, CEO and a director of the merged business. Keith Orr, Director Keith Orr is a legendary figure in the automotive industry. He was the CEO and majority owner of Orr Automotive Group. Mr. Orr’s experience encompasses senior roles in marketing, sales, product development and dealership management. Mr. Orr holds a Bachelor’s degree in Business Management from the University of Texas at Arlington. William Mokry, Director Mr. Mokry joined OPSY’s board of directors in July 2008. This automotive industry veteran has held senior executive positions with two major U.S. auto manufacturers as well as ownership intererts in retail dealerships. He currently owns and manages a multi-location, , sub-prime auto sales and finance company.