Contents

This item of the annual report on Form 10-K is divided into the following sections:

· Executive Summary - Provides a brief overview of the year's results and known uncertainties expected to have an effect on future results.

· Results of Operations - Analyzes our financial results comparing sales, operating margins, and expenses to prior periods including our expectations of the effect of trends and uncertainties on future results.

· Liquidity and Capital Resources - Analyzes our cash flow from operating, investing, and financing activities and further discusses current and projected liquidity.

· Critical Accounting Estimates - Discusses the most significant accounting estimates that we believe are essential to aid in understanding our reported financial results.

· Inflation - Reviews the impact of inflation on reported results.

Executive Summary

We provide innovative products for chemical analysis and monitoring. Our products perform detection, analysis, measurement, and monitoring applications in a wide variety of industries including environmental testing, food, pharmaceutical, semiconductor, power generation, chemical, petrochemical, and security. Headquartered in College Station, Texas, we sell our products throughout the world utilizing a direct sales force as well as a network of independent sales representatives and distributors. Our primary strategy is to identify market niches we can penetrate using our product development capabilities, manufacturing processes and marketing skills with the goal of assuming a market leadership position. Management continually emphasizes product innovation, quality improvement, performance enhancement, and on-time delivery while striving for product cost improvements to promote added value for our products.

Our 2008 results were much improved compared to 2007 despite the challenges of a tumultuous economy, investment portfolio losses, and a significant decline in Air Monitoring Systems segment revenues. We were very pleased to achieve an increase in overall sales of 7%, due in large part to the strength of growth in certain product lines within our Laboratory Products segment. Going into 2008, we anticipated a decline in Air Monitoring Systems segment sales due to a temporary lull in governmental projects. Our objective was to overcome this revenue shortfall through an increased emphasis on our Laboratory Products segment product lines, particularly our GC and TOC products. We accomplished this objective despite a slowing economy which began to impact our sales during the fourth quarter.

Margins for the year were down slightly from 2007 due largely to the lower volume of Air Monitoring Systems segment sales. Gross profit was up because of sales growth described above. Our 2008 SG&A expenses declined significantly as compared to 2007 when we incurred above normal legal and consulting expenses associated with our 2007 stock option investigation. R&D expenses increased in 2008 due in large part to the purchase of materials we will use in building our prototype, beta versions of the new process TOC and miniaturized mass spectrometer products.

Operating earnings were much improved from 2007 because of our sales growth and lower SG&A expenses. However, our improved operating results were partially offset by the impact of losses on our preferred stock holdings during the year. Because of the continued instability in financial markets, we liquidated our investment portfolio during the third quarter. Our tax expense was lower than normal in 2008 due to a tax benefit recorded during the third quarter in connection with uncertain tax positions which are no longer at risk. Despite our investment losses, we recorded net income of $1,020,000 in 2008, a significant improvement from 2007.

We continued to return value to OI shareholders during 2008 through both dividend payments and share repurchases. Our total return of value to shareholders exceeded $3,500,000.

To promote future sales growth and expand our product offerings, we entered into several strategic alliances in 2008. During the second quarter, we entered into an agreement with DANI Instruments, S.p.A., a well-established Italian analytical instrument company, under which we will sell certain gas chromatography ("GC")-related products to broaden our largest product line. We also signed a VAR agreement with Agilent Technologies, Inc., the industry leader in GC solutions, during the second quarter. Earlier in the year, we announced that we would be working with Picarro Inc., to develop a solution combining our TOC technology with Picarro's cavity ring-down spectroscopy technology. This new technology won a major new product innovation award at the 2009 Pittsburgh Conference, our industry's largest exhibition. These alliances have not yet impacted our sales but should begin to do so before the end of 2009.

Looking ahead, we face a very serious challenge as we are impacted by the overall economic downturn in 2009. Our backlog at the end of 2008 declined approximately 50% and we are experiencing a substantial slowdown in orders at the outset of 2009, as are other suppliers of capital equipment in all industries. Our visibility going forward is limited, but we will weigh cost control options to reduce our break-even point and maintain cash. While we are confident our new products and strategic alliances will result in longer term sales growth, we believe that the short-term sales outlook is not favorable.

Our financial position remains strong despite our investment portfolio losses and the return of capital to shareholders during the year. We ended the year with cash and liquid investments of $3,434,000 and have not borrowed against our bank line of credit. We believe that our strong financial position should provide us stability during the current economic downturn while we continue to build the foundation for future growth.

Results of Operations

The following table summarizes the results of our operations for each of the past two years. All percentage amounts were calculated using the underlying data in thousands.

Sales by Segment  $(000)     2008         2007       $ Change       % Change
Laboratory Products          21,836       18,415         3,421           18.6 %
Air-Monitoring Systems        7,133        8,718        (1,585 )        -18.2 %
Total                        28,969       27,133         1,836            6.8 %

Net Revenues. Total net revenues for the year ended December 31, 2008 increased $1,836,000, or 6.8%, compared to 2007. The bulk of our sales growth was attributable to the Laboratory Products segment. Air-Monitoring System sales decreased significantly due to a temporary lull in governmental projects which utilize our MINICAMS products.

In the Laboratory Products segment, 2008 sales increased 18.6% compared to 2007. This growth was driven largely by domestic product sales, which increased 23%, while our international sales were up by 8%. The strong domestic sales growth was attributable to our GC product line as we gained market share in the domestic market and expanded our sales efforts in the governmental and educational areas. Our international sales growth was primarily attributable to Europe as our distributors were successful in promoting our GC products, particularly our purge and trap product line. TOC product sales also exhibited solid growth due largely to international sales, with improved sales volume in the Asia Pacific region. We experienced a slight decline in ACA product line sales during the year, but have recently obtained regulatory approval for a new cyanide-analysis method that should enhance future sales.

Service revenue increased $189,000, or 6%, during 2008 in comparison to 2007. This increase was largely attributable to increased billings under our contract with the U.S. Army. During 2007, we were awarded a contract from the U.S. Army to further refine the technology initially developed under the Wyle contract, with revenues under this contract continuing through 2008. We are confident the innovative TOC analyzer technology developed pursuant to these contracts will provide commercial sales opportunities in the future.

Because of the global economic climate, we anticipate a significant slowing of sales during 2009, particularly in the Laboratory Products segment.

Gross Profit by Segment  $(000)     2008        % of Sales        2007        % of Sales       $ Change
Laboratory Products                  10,030            45.9 %       8,389            45.6 %        1,641
Air-Monitoring Systems                4,237            59.4 %       5,390            61.8 %       (1,153 )
Total                                14,267            49.2 %      13,779            50.8 %          488

Gross Profit. Our overall margins decreased 1.6% during 2008 compared to 2007 because of lower sales in our Air-Monitoring Systems segment. Margins in our Laboratory Products segment increased slightly due to increased volume which reduced manufacturing variances. Margins in the Air-Monitoring Systems segment declined because of lower product revenues, with service margins down due to increased billings under lower margin government contracts. Though margin percentages were lower than 2007, our gross profit increased $488,000 in 2008 because of higher overall sales. We anticipate further pressure on margins during the coming year due to aggressive competition with orders for capital equipment likely to decline in 2009.

SG&A Expenses by Segment  $(000)     2008        % of Sales        2007        % of Sales       $ Change
Laboratory Products                    6,697            30.7 %       7,851            42.6 %       (1,154 )
Air-Monitoring Systems                 2,259            31.7 %       2,629            30.2 %         (370 )
Total                                  8,956            30.9 %      10,480            38.6 %       (1,524 )

Selling, General and Administrative, (or "SG&A") Expenses. SG&A expenses for 2008 decreased $1,524,000, or 15%, compared to 2007. Our 2008 SG&A expenses declined significantly as compared to 2007 when we incurred above normal legal and consulting expenses associated with our 2007 stock option investigation. SG&A expense decreased to 30.9% of revenues during 2008, compared to 38.6% in 2007. We continue to explore cost cutting initiatives such as reductions in payroll expenses, board of director expenses, and travel & entertainment expenses.

R&D Expenses by Segment  $(000)     2008        % of Sales        2007        % of Sales       $ Change
Laboratory Products                   2,126             9.7 %       1,688             9.2 %          438
Air-Monitoring Systems                1,725            24.2 %       1,628            18.7 %           97
Total                                 3,851            13.3 %       3,316            12.2 %          535

Research and Development Expenses. R&D expenses increased $535,000 during 2008, or 16%, compared to 2007. The increase in R&D expenses was largely attributable to the purchase of materials that will be used in the construction of prototype, beta units for our new ion-CCD based miniaturized mass spectrometer and our new TOC product based on technology originally developed for NASA. We expect to complete the initial build of beta units during the first quarter of 2009 and anticipate that products will be available for sale during the third quarter. R&D expenditures should begin to decline in 2009 as we complete the development of these new products. R&D expenses represented 13.3% of revenues for 2008 and 12.2% of revenues in 2007.

   Operating Income(Loss) by
        Segment  $(000)             2008         % of Sales        2007        % of Sales       $ Change
Laboratory Products                   1,207              5.5 %      (1,150 )          -6.2 %        2,357
Air-Monitoring Systems                  253              3.5 %       1,133            13.0 %         (880 )
Total                                 1,460              5.0 %         (17 )          -0.1 %        1,477

Operating Income/(Loss). Our consolidated operating income improved significantly in 2008 due to higher earnings in our Laboratory Products segment, which were largely attributable to increased sales and reduced SG&A expenses. Although Laboratory Products produced improved results, the Air-Monitoring segment generated significantly lower operating earnings because of lower sales volume.

Interest and Other (loss)/income. In 2008 we had a non-operating loss of $464,000 compared to non-operating income of $471,000 in 2007. This decrease of $935,000 was primarily due to losses recognized when we liquidated our preferred stock holdings during the second and third quarters of 2008 as well as reduced interest and dividend income, which resulted from reduced investment holdings and lower interest rates. Our total loss recognized on the sale of investments in 2008 was $713,000. These losses were partially offset by dividend and interest income. We anticipate lower interest income in the future because of lower cash holdings and continued low interest rates.

Provision For Income Taxes. Effective January 1, 2007, we adopted the provisions of FIN 48 and established certain unrecognized tax benefits related to uncertain tax positions. As of September 30, 2008, we were no longer subject to U.S. Federal income tax examination on a portion of these uncertain tax positions and accordingly recorded a tax benefit of $285,000 during the third quarter of 2008. Because of the impact of this tax benefit, as well as certain permanent differences between our book and taxable income that reduce our tax liability, our effective tax rate for 2008 totaled (2.4)%. In 2007, our effective tax rate was (22.7)% due primarily to permanent differences between our book and taxable income that reduce our tax liability. These permanent differences include R&D tax credits as well as the dividends received deduction and the domestic production activities deduction.

Liquidity and Capital Resources

We consider a number of liquidity and working capital performance ratios in evaluating our financial condition. The following table includes certain ratios, working capital information, and summarized cash flows for use in understanding our current liquidity and recent trends in this area:

($ in thousands) 2008 2007

Ratio of current assets to current liabilities        4.6          4.2
Total liabilities to equity                            20 %         24 %
Working capital                                  $ 13,294     $ 15,587
Cash, cash equivalents and investments           $  3,434     $  6,476

                 Changes in Cash and Cash Equivalents

Net cash provided by (used in):
Operating activities                             $  1,331     $ (1,369 )
Investing activities                                1,959        7,025
Financing activities                               (3,512 )     (4,965 )

Net increase (decrease) in:
Cash and cash equivalents                            (222 )        691

Cash and cash equivalents:
Beginning of year                                   3,356        2,665
End of year                                         3,134        3,356

Cash provided by operating activities during 2008 totaled $1,331,000, a significant improvement from 2007, due largely to higher operating income and a decline in accounts receivable, which resulted from enhanced collection efforts. In addition, accounts payable declined during 2008 due to lower purchase commitments as the economy slowed in the fourth quarter.

Cash provided by investing activities totaled $1,959,000 in 2008, compared to $7,025,000 in 2007. During both years we liquidated a significant portion of our investment holdings to fund repurchases of our stock. The reduction in investment holdings was considerably larger in 2007 due to our Modified Dutch Auction Self-Tender and to pay costs associated with the stock option investigation. Purchases of property, plant and equipment totaled $348,000 in 2008, a decrease of $428,000 from 2007, with the bulk of this decrease due to the higher level of funds expended in 2007 related to our ERP system implementation that year. Our 2008 capital expenditures primarily include the purchase of equipment used in our laboratory products and Air Monitoring Systems segment manufacturing areas. We had no material commitments for the purchase of property, plant and equipment outstanding as of December 31, 2008.

Cash used in financing activities totaled $3,512,000 in 2008 compared to $4,965,000 in 2007. During 2008, we repurchased 284,569 shares of OI common stock under our stock repurchase program at an average price of $10.85. In 2007, we purchased 301,080 shares of OI common stock pursuant to our Modified Dutch Auction Self-Tender, for an aggregate cost of $4,365,660, exclusive of legal and administrative expenses associated with this transaction. We repurchased an additional 21,115 shares during 2007 under our stock repurchase program at an average price of $12.16 per share. We may purchase up to an additional 37,007 shares under the current stock repurchase program as of December 31, 2008.

Though down from the prior year, we continue to have a high level of liquidity and a strong financial position as demonstrated by our current ratio, liability to equity ratio, and high level of working capital. While the current economic environment is likely to further erode our liquidity and financial position, we continue to believe that our liquid assets and availability under our revolving line of credit are sufficient to fund working capital, R&D, and capital expenditures for the near term. As the economy improves, we anticipate that cash flows from operations will generate sufficient cash flow to meet our long term liquidity needs.

Since liquidating our investment portfolio during the third quarter of 2008, we have invested a portion of our excess funds generated from operations in short-term securities, including money market funds invested in government backed securities, and FDIC insured certificates of deposit. Our primary goal has been preservation of capital with a secondary goal of return on invested cash. Because interest rates are historically low, we have established an investment committee consisting of two independent directors and our CEO/CFO to evaluate alternative investment options for excess funds to improve our returns. These investments may include less than investment grade bonds or other securities that the committee feels are likely to increase in value and/or provide a higher interest return. Any such investments made by the Investment Committee are likely to subject us to a higher risk of loss than our current insured or government backed investments.

Critical Accounting Estimates

Our preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires that we utilize key accounting policies and make certain estimates that could significantly influence the results of operations and financial position. The most critical of these accounting policies and estimates include revenue recognition policies and related warranty reserves, the valuation allowance for inventories, and uncollectible accounts receivable and intangible asset valuation.

Revenue Recognition and Warranty Reserves We derive revenue from three sources: system sales, part sales and services. For system and parts sales, we generally recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the contract price is fixed or determinable, title and risk of loss has passed to the customer, and collection is reasonably assured. Our sales are typically not subject to rights of return, and historically we have not experienced significant sales returns. We generally record system sales that include installation services as multiple-element arrangements. In these situations, we recognize product revenue upon shipment but defer the installation service revenue until the installation is complete. We defer revenue recognition for the fair value of any undelivered elements, such as accessories ordered by customers, until the completion of delivery to the customer. For certain system sales that involve unique customer acceptance terms or new specifications or technology with customer acceptance provisions, we do not recognize revenue until we receive customer acceptance. We record any deferred revenue from such system sales as an accrued liability.

Our products generally have a warranty ranging from 90 days to one year. Upon expiration of the warranty period, the customer may purchase an extended product warranty typically covering an additional period of one year. We generally invoice extended warranty billings to the customer at the beginning of the contract term and recognize the related revenue ratably over the duration of the contract. Unearned extended warranty revenue is treated as an accrued liability.

We record a reserve for warranty expenditures and periodically adjust the amount of the reserve as required to reflect actual warranty experience. In determining the warranty reserve, we consider our historical experience and various additional factors including expected product failure rates, material usage, and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage, or service delivery costs differ from our estimates, the estimated warranty liability could prove to be significantly over or understated. As of December 31, 2008 and 2007, our warranty liability totaled $317,000 and $496,000, respectively.

Accounts Receivable We maintain an allowance for doubtful accounts representing our estimate of that portion of accounts receivable which we may be unable to collect from customers. Customer receivables may prove uncollectible for a variety of reasons including deterioration of customer financial condition, or dissatisfaction with product performance. We regularly assess potential doubtful accounts and use the best information available, including customer correspondence and credit reports. Though our bad debts have not historically been significant, we could experience increased bad debt expense should a major customer or market segment experience a financial downturn or our estimate of uncollectible accounts, which is based on our historical experience, prove to be inaccurate.

Inventories Our inventories consist primarily of electronic equipment and various components. We operate in a fast-paced industry with frequent technological advances and new product introductions. Such occurrences can significantly impair customer demand for our products and the related inventory we have on hand. We regularly evaluate our inventory and maintain a reserve for excess or obsolete inventory. Generally, we record an impairment allowance for products with no movement in over twelve months that we believe to be either unsalable or salable only at a reduced selling price. We further use our judgment in evaluating the recoverability of all inventory based upon known and expected market conditions as well as future product plans. Should our competitors introduce a new technology or product that renders our current products obsolete, our allowance for inventory impairment may be inadequate.

Our inventory obsolescence charges totaled $18,000 and ($11,000) in fiscal 2008 and 2007 respectively. The inventory impairment allowance totaled approximately $654,000 and $732,000 at December 31, 2008 and 2007, respectively.

Intangible Assets Our intangible assets consist primarily of intellectual property, including patents and patent applications. In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, we review the recoverability and estimated useful lives of our intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be fully recoverable. As a result of our reviews, we have not recorded any material impairment charges during 2008 or 2007.

Inflation

Historically, neither inflation nor changing prices have had a material impact on our net revenues or results of operations. However, future inflationary trends could potentially impact our sales and earnings.