** **

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

**FORM 10-K**

 

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**ANNUAL****REPORT****PURSUANT****TO****SECTION** **13****OR****15(d)****OF**

**THE****SECURITIES****EXCHANGE****ACT****OF 1934**

 

**Forthe fiscal year ended December 31, 2003**

 

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**CommissionFile Number: 0-11625**

 

**MFICCORPORATION**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                                    |   | **04-2793022**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **30 Ossipee Road, P.0. Box 9101**                              |   |                                 |
| **Newton, Massachusetts**                                       |   | **02464-9101**                       |
| (Address of principal executive offices)                        |   | (Zip Code)                           |

 

Registrant’s telephone number,including area code: **(617) 969-5452**

Securities registered pursuant toSection 12(b) of the Act:  **None**

Securities registered pursuant toSection 12(g) of the Act: **Common Stock, $.01 par value**

 

Indicate by check mark whetherthe registrant;  (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes ýNo o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

 

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The aggregate market value of Common Stock held by non-affiliates ofthe registrant (without admitting that any person whose shares are not includedin determining such value is an affiliate), based upon the closing sale priceof the Common Stock on March 31, 2004 as reported on the NASDAQ Over-the-CounterBulletin Board was $27,121,627.

 

The number of shares outstanding of the registrant’s Common Stock as ofMarch 31, 2004 was 10,802,494 shares.

 

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**MFICCorporation**

**2003Form 10-K Annual Report**

**Tableof Contents**

 
|           | **PART I**                                                                                  |   |
|----------------|---------------------------------------------------------------------------------------------|--------|
| Item  1.       | Business                                                                                    |   |
| Item 2.        | Description of Properties                                                                   |   |
| Item 3.        | Legal Proceedings                                                                           |   |
| Item 4.        | Submission of Matters to a Vote of Security  Holders                                        |   |
|           |                                                                                        |   |
|           | **PART II**                                                                                 |   |
|           |                                                                                        |   |
| Item 5.        | Market for Registrant’s Common Equity and  Related Stockholder Matters                 |   |
| Item 6.        | Selected Financial Data                                                                     |   |
| Item 7.        | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
| Item 7A.       | Quantitative and Qualitative Disclosures  about Market Risk                                 |   |
| Item 8.        | Financial Statements and Supplementary Data                                                 |   |
| Item  9.       | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure       |   |
| Item 9A        | Controls and Procedures                                                                     |   |
|           |                                                                                        |   |
|           | **PART III**                                                                                |   |
|           |                                                                                        |   |
| Item 10.       | Directors and Executive Officers of the  Registrant                                         |   |
| Item 11.       | Executive Compensation                                                                      |   |
| Item 12.       | Security Ownership of Certain Beneficial  Owners and Management                             |   |
| Item 13.       | Certain Relationships and Related Transactions                                              |   |
| Item 14.       | Independent Accountant Fees For Fiscal 2003  and Fiscal 2002                                |   |
| Item  15.      | Exhibits,  Financial Statements Schedules and Reports on Form 8-K                           |   |
|           |                                                                                        |
| Signatures     |                                                                                        |
|           |                                                                                        |
| Certifications |                                                                                        |

 

 

This Report contains “forward-looking statements” within the meaning ofthe Private Securities Litigation Reform Act of 1995. Such statements aresubject to certain risks and uncertainties, including without limitation thosediscussed in Item 7 under the heading “Factors which may affect futureoperations.”  Such forward-lookingstatements speak only as of the date on which they are made, and the Companycautions readers not to place undue reliance on such statements.

 

Microfluidizer®is a trademark of the Company, which has been registered with the United StatesPatent and Trademark Office. Microfluidicsäis a trademark of the Company for which a registration application has beenfiled with the United States Patent and Trademark Office.  All other trademarks or trade names referredto herein are the property of their respective owners.

 

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**Item 1.            BUSINESS**

 

#### Company Overview:

 

MFICCorporation (MFIC or the Company), through its wholly-owned subsidiary, MicrofluidicsCorporation (Microfluidics Division), specializes in manufacturing andmarketing a broad line of Microfluidizer® high shear fluid materials processingsystems used in numerous applications in the coatings, pharmaceutical, biotech,food, and cosmetics industries. Microfluidizer® high shear fluid processor systems areproduced at the Microfluidics Division. Until its sale on February 9, 2004, theCompany operated its Morehouse-COWLES Division which manufactured and sold abroad line of mechanical fluid materials processing systems used for a varietyof grinding, dispersing, milling, and blending applications across a variety ofindustries. The Morehouse-COWLES Division manufactured and distributed highshear dispersers, dissolvers, colloid mills, horizontal media mills, verticalmedia mills, and sold grinding media for such equipment.

 

For almost 20years MFIC has offered Microfluidizer® high shear fluid processor equipmentcapable of creating nanostructures (commonly defined as having dimensions inthe 10-1000 nanometer range), including nanoparticles, microemulsions, andnanosuspensions. The equipment’s ability to produce commercial quantities ofsuch materials has been important to producers of pharmaceuticals, coatings andin other industries. The Company’s management believes that futurecommercialization and growth of nanotechnology will be, enabled in large part,by such manufacturing capability.

 

Microfluidizer®fluid processing equipment is used by industry to formulate stable emulsions,dispersions, and liposomes, and is used in general for deagglomeration and forcell disruption in the biotech industry and for liposomal encapsulation.Emulsions are found in a broad variety of common products, including processedfoods, pharmaceuticals, and specialty coatings such as photographic films.Dispersions are often employed in products such as pharmaceuticals, inks,pigments and coatings.  The Companybelieves that the processing technique of the Microfluidizer®equipment enhances the stability and consistency of emulsions and dispersionsdue to the equipment’s unique ability to consistently produce uniform micronand sub-micron scale particles in many applications.  Liposomes, which are biodegradable cell-like structures, are usedto encapsulate medications or nutrients, and are typically used in cosmetic orpharmaceutical products.  In addition,Microfluidizer® processor equipment is used in biotechnologyapplications to harvest, through cell disruption, the cultivated productcontents of plant and animal cells.  Thedesign and operation of the Microfluidizer® systems with itspatented and proprietary fixed geometry interaction chamber results inconsistent, uniform and reproducible results. Further, the Company guaranteesscaleup of formulations and results on its equipment from drops per minute onits laboratory and bench top models to gallons per minute on its productionmodels. In many critical formulations Microfluidizer® processorsproduce better quality products for our customers. Further, the proprietaryequipment enables manufacture of unique products which cannot otherwise beproduced.

 

The Company’sproduct lines are used to create stable emulsions and dispersions throughdeagglomeration and particle size reduction. These formulations may beliquid/liquid or liquid/solid formulations and are generally prepared inquantities ranging from less than one gallon to several thousand gallons in anindustrial environment.

 

The Microfluidizer® equipment is generally used in theprocessing of high value-added end-products that require extremely smallparticle sizes.

 

The Companywas incorporated in Delaware in 1983. The Company, formerly named BiotechnologyDevelopment Corporation, changed its name effective June 8, 1993 toMicrofluidics International Corporation, and again changed its name effectiveJuly 12, 1999 to MFIC Corporation. Its principal executive offices are locatedat 30 Ossipee Road, in Newton, Massachusetts, 02464-9101 and its telephonenumber is (617) 969-5452.

 

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The Technology:

 

The Company’sMicrofluidizer® materials processor equipment is based on patentsand related technology that were licensed by the Company from Arthur D.Little & Co. in 1983 and subsequently purchased by the Company in1985. The Company holds two United States patents related to the apparatus andprocess used to intimately mix liquids and disperse particulate solids inmicroemulsions.  See “Patents andProprietary Rights Protection.”

 

TheMicrofluidizer® material processor differs from conventionalmechanical mixing and processing technologies in that it utilizes highlypressurized product streams that travel in precisely defined microchannels andcollide at ultra-high velocities in a small, confined space.  There are no moving parts in this mixing andcollision zone (“Fixed Geometry”) Combined forces of shear and impact which onthe fixed geometry design acts upon products to create what the Companybelieves are finer, more uniform, and more reproducible dispersions andemulsions than can be produced by any other means.

 

The Company’sMicrofluidizer® processor technology is used in materials processingand product formulation to mix materials that are normally very difficult tomix. The Microfluidizer® processor technology allows manufacturersin the chemical, pharmaceutical, biotechnology, cosmetic,and food processing industries to produce higher quality products with bettercharacteristics on a more consistent basis than with other blending, mixing, orhomogenizing techniques. Additionally, the equipment is used for celldisruption to harvest the cultivated contents of animal and/or plant cells andfor liposomal encapsulation of materials for the cosmetics and biotech/biopharma industry.

 

#### Commercial Applications: 

 

TheMicrofluidizer® equipment can be used to mix and formulate stableemulsions, dispersions and liposomes, and for cell disruption.

 

Emulsions arehomogenous mixtures of oil and water components (or other normally immisciblecomponents), which, if mixed properly, do not readily separate.  Emulsions comprise many products, such asfood additives, medicines (including injectable drugs), photographic films, andpolymers.  The Company believes that,generally, an emulsion processed with Microfluidizer® equipment willexhibit improved stability and require reduced concentrations of costlyemulsifying agents that are otherwise needed to enhance product stability.

 

Dispersionsare mixtures of fine solids suspended in liquid so that the two do not separatereadily after processing.  Similar toemulsions, dispersions are used in a variety of consumer and industrialproducts, including pigments, medicines (including injectable drugs), paintsand inks, iron oxide for magnetic tapes, phosphorescent coatings for TV screensand fluorescent lamps, barium titanate for capacitors, toners and inkjet inks.

 

Liposomes arebiodegradable cell-like structures, formed from materials such as cholesteroland lecithin, which can be used to encapsulate medications or nutrients.  Pharmaceutical and cosmetic manufacturersuse liposomes as a delivery system to target active ingredients for specificanatomical sites and to prolong their efficacy.  To date, liposomes have been used commercially in two predominantapplications: medical diagnostic agents and cosmetics.  Applications include the encapsulation ofdye to be used as a marker in medical diagnostic tests and the encapsulation ofingredients for deeper skin penetration, or time-release control, as well aspharmaceutical, food and specialized agricultural applications.

 

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In thebiotechnology industry, Microfluidizer® equipment is currently usedto harvest, by cell rupture, the contents of bacteria and mammalian plant oranimal cells.  The precision with whichthe Microfluidizer® equipment can be used to break up materialsallows the encapsulating cell wall to be ruptured without damage to orcontamination of the cell contents. The Microfluidizer® equipmentminimizes the amount and presence of cell wall debris and eliminated grindingmedia contamination, thus minimizing downstream processing requirements.

 

TheMicrofluidizer® equipment is generally used in commercialapplications where a scientist, formulator or chemist is trying to develop orimprove a product formulation for an expensive, high value-added end product.Microfluidizer® equipment is initially employed in a researchlaboratory, with the equipment subsequently being used in scaleup to pilotscale production of new or improved products, and ultimately, for fullproduction scale volumes as the improved product comes to market. Fromlaboratory to production, it has been demonstrated that the volume of productsprocessed range from less than one quarter of a gallon per minute to 18 gallonsper minute.

##### ** **

##### **TheCompany currently manufactures and markets the following lines of equipment:**

 

The HC Series:  The HC Series, also known as “Homogenizers,” is alaboratory-scale series of equipment that is intended to impart moderate levelsof energy into a customer’s product with greater flow rates than the moreenergy intensive Microfluidizer® devices. Operating pressures ofproducts in the Company’s HC Series can range from under 500 psi to ashigh as 8,000 psi, and will process as much as two liters of fluid perminute.

 

The M-110 Series:  The M-110Series, is a laboratory product line that operates with available laboratoryair and is designed primarily for research  anddevelopment applications. Standard models can generate pressures as high as25,000 psi and  have a product flow rateon the order of one-half liter per minute. The M-110EH includes an on-boardelectric hydraulic pump system for high performance “lab scale” micro-mixing atprocessing pressures up to 25,000 psi and flow rates up to 450 ml/min.  It has numerous standard features andoptions including explosion-proof motors and steam sterilization.

 

The M-140 Series: The M-140K Series, is a laboratory-scale unitdeveloped  for customers in the chemical,biotechnology, pharmaceutical, cosmetic and food processing industries thatrequire elevated operating pressures and higher shear forces to achieve betterperformance.  The M-140K can achieveoperating pressures up to 40,000 psi. The M-140K has a built-in hydraulicsystem and utilizes a bi-directional intensifier pump that provides a highlyuniform pressure profile. It has been designed with many accessories andoptions including an explosion proof motor, control package, and solvent sealquench.

 

The M-210 Series: The M-210 Series is a pilot unit and is primarilymarketed to pharmaceutical, cosmetic and food product manufacturers who havecreated a successful new or improved formulation on the M-110 Series unit andwould like to increase their production capacity.  The M-210 Series unit is  typicallyused for testing formulations at greater volume levels before initiatingfull-scale production. For some customers (such as pharmaceutical productmanufacturers), the M-210 Series may have the capacity to function as aproduction unit.

 

The M-700 Series:  The M-700Series was introduced at the end of fiscal 1998 and was initially designed,engineered, and constructed for use in “rugged” industrial environments such ascoatings, paints and pigments research and manufacturing. This product line wasespecially designed to

 

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withstand such hazards as dust,grease, and water spray.  Through use ofour own proprietary designed intensifier pump and other components, the systemhas also proven to be more cost-effective in many user applications.

 

More recently, because of themarket demands of the pharmaceutical, biotech and cosmetic industries, theM-700 product line was upgraded to all stainless steel construction, and meetsGood Manufacturing Practices (GMP) requirements. (See discussion under heading“Government Regulations”.)  It alsooffers steam in place (SIP) and clean in place (CIP) options.

 

The M-700 Series equipment isavailable in a variety of configurations and flow rates depending upon motorsize and the number of intensifier pumps. On the low end of the spectrum is the 15 HP, single intensifier pumpM-7115 machine with flow rates ranging from 1.0 gpm at 10,000 psi to 0.4 gpm at30,000 psi.  The next size up is the 25HP, single intensifier pump, M-7125 machine with flow rates ranging from 2.0gpm at 10,000 psi to 0.6 gpm at 30,000 psi. Until September 30, 2003, the largest offering of the M-700 seriesproduct line was the 50 HP, dual intensifier pump M-7250 machine with flowrates ranging from 4.0 gpm at 10,000 psi to 1.2 gpm at 30,000 psi.

 

On September 30, 2003,Microfluidics introduced a new addition to the M-700 series product line, the100 HP, dual intensifier pump, Model M-710 machine with flow rates ranging from12 gpm at 4,000 psi to 3.0 gpm at 30,000 psi. This model has the equivalentthroughput of the larger and more expensive M-610-100 H.P model.

 

All M-700 series machines areoffered with the capability of operating at 40,000 psi. Additionally, during2003 the Company introduced several new options and equipment features to theM-700 series product offerings including:

 

(i)                                     The M-700Microfluidizer Containment System, which is utilized for the processing ofhighly toxic cancer drugs and other hazardous materials. The first such recentlyinstalled system is now producing pharmaceutical product.

 

(ii)                                 The M-700Microfluidizer Split System (separating the power source from themixing/processing apparatus) accommodates demands of limited space within cleanrooms and for noise abatement within pharmaceutical production facilities. Inconjunction with this system, the Company also introduced a Level II SteamSterility Option for all pilot and production systems used for production ofinjectable and other pharmaceuticals. This option enables compliance withstringent regulatory production requirements. The Company has delivered such asystem to a pharmaceutical manufacturer.

 

(iii)                               UltraClean in Place (UCIP) option, which improves the ability to clean in place(CIP) Microfluidizer processor systems between product batch runs or beforestorage. This capability differentiates our Microfluidizer materials processorsystems from all other competitive products. Several pilot and productionsystems incorporating this option have already been delivered.

 

The M-610 Series:  The M-610 Series consists of custom-built models used forlarge-scale production.  These unitshave flow rates of up to 18 gallons per minute and generate operating pressuresup to 40,000 psi. Generally, these models are available in 25 HP, 50 HP, 75 HP,100 HP, and 200 HP.

 

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Multiple Stream Mixer/Reactor (MMR): TheCompany has introduced its patented Multiple Stream Mixer-Reactor (MMR) systemas a continuous chemical reactor, which the Company believes may become astandard device for conducting chemical reactions, many of which can beconfigured to produce nanoparticles. This system produces uniform nanoparticleswith phase purity previously unachievable with conventional batch reactiontechnology. This degree of reaction chemistry control can lead tocost-effective product improvements and the development and manufacture of newnanomaterials in scalable quantities. Applications for the new technologyinclude improving the performance of catalysts, planarization polishing media,superconductors, abrasive silica, recording media, photographic media andpigments. It also may be used in the development and production of uniquepharmaceutical products. The Company is proceeding with projects involvingother companies seeking to optimize or enable drug delivery, catalysts andcoatings products, as well as an internal program on nanopolymer creation fordrug delivery and other applications. The Company anticipates making deliveryof its first MMR laboratory development systems (in the $200,000-$250,000 salesprice range) in 2004, with   productionsystems (in the $750,000 - $1,500,000 sales price range) in 2005. The Companybelieves that the MMR systems and technology make it a leader in the provisionof systems for continuous production of uniform, reproducible, microparticles,nanoparticles and nanodroplets.

 

**Morehouse-COWLES Division:**

 

On February 9,2004, pursuant to an Asset Purchase Agreement (the “Asset Purchase Agreement”)dated February 5, 2004 between MFIC Corporation (“MFIC”)  and a wholly owned subsidiary of NuSilCorportation, a California corporation (“NuSil”), MFIC sold substantially allof the assets and selected liabilities of its Morehouse-COWLES Division (the“Division”), to NuSil.  Other thanNuSil’s prior purchases of products from the Division, there were nopreexisting relationships between MFIC and NuSil.

 

Prior toFebruary 9, 2004, the Company-operated Morehouse-COWLES Division manufacturedgrinding and dispersing equipment used in a broad number of industriesincluding the coatings and ink industries. The products included high-speedsingle and multi-shaft dissolvers and dispersers, stone mills, and vertical andhorizontal media mills. As one of the early inventors of dispersers,dissolvers, stone mills, and media mills, the one hundred-year-old COWLES nameis an industry-accepted symbol of quality, reliable products. TheMorehouse-COWLES Division manufactures products that are generally used forblending, mixing, deagglomeration and dispersion of paints and coatings, inks,adhesives, sealants, and pigment dispersions. These applications are moreconventional whereby the formulations are less expensive to produce and thevolumes of product produced are large. The Morehouse-COWLES product lines are used in broader, high volume,lower value-added applications requiring less stringent particle sizereduction.

 

TheMorehouse-COWLES equipment is used independent of the Microfluidizer®processor equipment in the preparation of many industrial fluid formulationswhere the desired product characteristics do not require the sub-micron size ofparticles created by Microfluidizer® processing.

 

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**Epworth Mill Division:**

 

Prior to October1, 2000, the Company’s Epworth Mill Division products consisted of ball millsand horizontal media mills. The division was also engaged in the sale anddistribution of grinding media.  Ballmills are used in coarse grinding application of liquid slurries such as orefrom mines or coarse slurries of material that will later be processed intofiner slurries.  Ball mills use largemedia in a horizontal rotating cylindrical vessel to crush and grind theproduct being processed. The patented Zinger® horizontal media millutilizes a unique design for grinding and dispersing solid materials in aliquid carrying medium.  The design isbased upon established rotating, horizontal shaft technology but adds theunique capability of enhanced mechanical activity between the grinding mediaand the product formulation.  Theenhanced mechanical activity is achieved through a unique combination ofspecially designed rotors and containment vessels.  In comparison to traditional horizontal media mills, the Zingermedia mill technology has demonstrated significantly improved productivity interms of greater volumes of product processed at acceptable quality than thecomparably sized and priced horizontal media mills. On July 24, 2000, theCompany announced that it would transfer the manufacturing and sale of itsZinger® horizontal media mills from its Michigan-based Epworth MillDivision to the Morehouse-COWLES Division plant in Fullerton, California. Thetransfer began on October 1, 2000, and was completed in the fourth quarter offiscal 2000.

 

On September30, 2000, the Company ceased operations of the Ball Mill repair business anddecided to sell its Ball Mill operation conducted at the Epworth Mill Divisionthrough a broker.   On April 13, 2001the Company concluded the sale of the assets of the division’s operation for$200,000 in cash and a promissory note, which resulted in a loss on the sale ofthese assets of approximately $53,000.

 

#### Marketing and Sales:

 

The Company’smarketing and sales activities are conducted through a corporate marketing andsales group that is responsible for the worldwide marketing and sales of allproducts.

 

Marketingprograms include media advertising, a website, direct mail, seminars, tradeshows and telemarketing. In addition, the Company has an active program offield demonstrations, as well as demonstrations to potential users in theCompany’s laboratories located in Newton, Massachusetts, Fullerton, California,and Lampertheim, Germany. Distributors and sales agents worldwide are supportedwith trade advertising, collateral literature and trade show materials.  The distributors and sales agents alsoadvertise directly on their own behalf and attend regional and internationaltrade shows.  As an aid to the marketingand sales activity for the equipment, the Company provides prospectivecustomers with access to its applications laboratories. These laboratoriesprovide free processing and particle size and distribution analysis of aprospective customer’s sample formulation. Additionally, a prospective customermay pay for subsequent laboratory time and services on a fee for servicesbasis, which includes equipment rentals.

 

The Companysells its equipment in the United States through a network of independentmanufacturer’s representative firms who are managed by the Company’s regionalsales managers. In Canada, the Company has an exclusive distributor for theCompany’s product line. In Europe, the Company sells its equipment through anetwork of independent regional sales agents and distributors who are managedby the Company’s European Sales organization. In Asia and the Pacific Rim, the Company sells through a network ofdistributors and independent manufacturer’s representative firms. Customers inother geographical regions are assisted directly by Company sales staff.

 

##### **Customers:**

 

The users ofthe Company’s systems are in various industries, including the chemical,pharmaceuticals, food, cosmetic and biotechnology industries.  Two customers accounted for 21% and 11%,respectively, of the revenues from continuing operations in 2003. Two customersaccounted for

 

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18% and 16% ofthe revenues from continuing operations in 2002, respectively.  Two customers accounted for 17% and 10% ofthe trade accounts receivable from continuing operations as of December 31,2003, respectively, and one customer accounted for 13% of the trade accountsreceivable as of December 31, 2002.  Areduction or delay in orders from these or other significant customers could havea material adverse effect on the Company’s results of operations.  No customer accounted for more than 10% ofthe Company’s revenues in 2001.

 

#### Competition:

 

The patentedMicrofluidizer® equipment product line of high shear fluidprocessors has direct competition in its major markets, includingpharmaceutical and coatings/chemical applications, but management believes thatthe Company’s products have larger installed bases and competitive performanceadvantages over products of our competitors. The Company believes that the Microfluidizer® processorequipment product line offers the highest shear forces available in the processequipment market today. It has been proven in many instances that for criticalformulations Microfluidizer® processors produce better qualityproducts for our customers.

 

The M-700Series of fluid processors, together with the M-210 and M-610 product lines,provide high shear fluid processing capabilities for sanitary, sterile, andindustrial applications.  The Companybelieves that the Microfluidizer® product line provides a distinctadvantage over the product lines of our competitors with respect to theprocessing of abrasive slurries or solids dispersed in liquids in large partbecause of the Company’s unique, wear-resistant, diamond interaction chamberand the special design of the intensifier pumping system.

 

The MMRsystems may encounter significant competition and there are other companiesthat possess patents and claims to equipment or processes that claim to makeproduction quantities of nanoparticles. At least one of these companies, FiveStar Technologies Inc. (“Five Star”), has raised significant investment capitalfrom venture capital sources ($4.5 million in its second round) for itspatented technology. Five Star claims the use of hydrodynamic cavitation toachieve production or nano and micro materials. Five Star also claims that itsprocess is inherently scalable. Although the Company believes that its MMRsystem is superior in design and function there can be no assurance that FiveStar, or others, will not pose a competitive impediment to sales of theCompany’s MMR system.

 

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The Companyfaces, and will continue to face, intense competition from other companies whomanufacture and sell fluid processing systems. The Company is subject tosignificant competition from organizations that are pursuing technologies andproducts that are similar to the Company’s technology and products. TheCompany’s future success will depend in large part on its maintaining itscurrent technologically superior product line and competitive position in thefluid processing systems field.  Rapidtechnological development by the Company or others may result in the Company’sproducts or technologies becoming obsolete before the Company recovers theexpenses it incurs in connection with their development.  Products offered by the Company could bemade obsolete by less expensive or more effective technologies.  There can be no assurance that the Companywill be able to make the enhancements to its technology necessary to competesuccessfully with newly emerging technologies. The Company expects competition to intensify in the fluid processingsystems field as technical advances are made and become more widely known.

 

#### Research and Development:

 

The Company’sresearch and development efforts are focused on: (i) developing new processingapplications for the process industries and further enhancing thefunctionality, reliability and performance of existing products, and (ii)development of the Multiple-Stream High Pressure Mixer/Reactor (MMR) by: (a)working with customers who assist in the development of the system with bothapplication knowledge and financial support, and (b) internal development programrelating to interaction chamber design and creation of a varietynanomaterials.  There can be noassurance that the Company will be able to meet the enhancement challengesposed by applications of its core Microfluidizer® processorbusiness.  Likewise there can be noassurance that the Company will be able to design and manufacture chambers forits MMR applications that will deliver the desired result for specificapplications.  Research and developmentcosts for continuing operations were $785,849, $583,683, and $537,428 in 2003,2002, and 2001, respectively.  Patentcoverage for the MMR has been obtained both in the United States and in Europe(with national entry in process) and is prosecuting the patent application inCanada.

 

#### CooperativeResearch Arrangements:

 

The Companysubsidizes research and development activities centered around Microfluidizer®processor technology at a number of research centers anduniversities.  The Company’s subsidy ofthese activities takes the form of substantial reduction or elimination of thecustomary rental charges for the Microfluidizer® equipment providedfor use. The Company has, in past years, subsidized research and development inthe following fields at the following universities: The University ofMassachusetts, Lowell – biotechnology; Lehigh University – polymer chemistry;Université Laval (Quebec) – food science; Worcester Polytechnic Institute (WPI)– catalytic chemistry; and Purdue University – pharmaceuticals.  In addition to their research activities,these universities provide the Company with contacts at industrial companiesthat may utilize the Microfluidizer® processing technology.  Additionally, on occasion, research reports,technical papers, and doctoral theses may be published, which document the useof Microfluidizer® technology. Finally, the Company engages in manyinformal co-operative development efforts with its customers.

 

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In addition toproviding subsidies, the Company has, in the past, entered into a researcharrangement with Worcester Polytechnic Institute (WPI).  The Company commenced supported research anddevelopment at WPI in 1988 and continued such support until the mid 1990’s.  In 1992, the Company entered into acooperative venture with WPI to develop, patent and license for WPI, for itscommercial applications, the Microfluidizer® process technology inthe following fields: (i) the production of catalysts used in chemical andpetroleum processing; (ii) the manufacture of advanced ceramic materials;and (iii) the destruction of volatile organic compounds and other organiccontaminants in process waste water. The Company and WPI applied for UnitedStates and foreign patents in 1992 and 1993, respectively, which cite theMicrofluidizer® processing technology as enabling the above processtechnologies. The two applied-for United States patents were both granted andissued to WPI in the United States in 1995. In 1996 one applied for patent wasgranted to WPI in France for European entry in the Patent Cooperation Treat(PCT) countries. The program is inactive at this time.

 

Patents andProprietary Rights Protection:

 

To protect itsproprietary rights, the Company relies on a combination of U.S. patent andtrademark laws, trade secrets, confidentiality agreements, contractualprovisions and technical means. In the event of patent infringement or breachof confidentiality, there can be no assurance that these measures will beadequate or that the Company will have sufficient resources to prosecute orprevail in an action against a third party. In addition, the Company has not sought patent or trademark protectionfor its Microfluidizer® equipment’s interaction chamber in anycountry other than the United States and, as such, its proprietary rights arenot subject to the protection of patent or trademark laws of foreign countrieswhere the Company’s equipment is sold. The Company’s Microfluidizer® equipment process patentexpires on March 13, 2007 and its device patent expired on August 6,2002.  The Company does not believe thatthe expiration of its patent will result in any material detriment to theCompany since the Company has made many alterations, improvements and advancesto its equipment over the years with such modification and innovations havingbeen treated by the Company as trade secrets. In 1997 the Company completeddevelopment of a novel adaptation of its Microfluidizer® equipment –a Multiple Stream High Pressure Mixer/ Reactor (MMR).  In August 1997, the Company filed a patent application for thedevice and its processes with the United States Patent and Trademark Office(USPTO), and filed a Patent Cooperation Treaty (PCT) application on May 5,1998. In July and November 2000, the USPTO issued to the Company notices ofallowances of utility patent claims regarding the MMR and the use thereof. OnSeptember 18, 2002, the European Patent Office advised the Company it wouldgrant its MMR patent substantially as applied for, including its device andprocess claims.  The Company is in theprocess of pursuing national entry in France, Germany, Italy, The Netherlands,and the United Kingdom.  The Company isprosecuting its MMR patent in Canada.

 

The Company maintains confidentialityagreements with its employees and also maintains confidentiality agreements andnon-competition agreements with those third parties to whom it disclosesnon-public technical information relating to its equipment.  The Company believes that enforcement of theprovisions of such agreements should adequately protect the Company’sproprietary information.  However, inthe event of a material breach of such agreements certain of the Company’svaluable intellectual property may be disclosed to third parties (includingcompetitors). In such event, despite provisions for equitable relief anddamages in the event of such breaches the Company may suffer competitively andbe materially impacted negatively as a result of such unauthorized disclosure.

 

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Manufacturing:

 

At present,the Microfluidics Division subcontracts the manufacture and/or machining andfinishing of many of the components of its equipment to third parties, with theCompany undertaking the remaining fabrication, assembly and performancetesting.  The Microfluidics Division hasselected certain primary suppliers based upon pricing terms, quality of theirproducts, and the vendor’s performance record. The Company believes that there are adequate available alternatemanufacturing sources and suppliers for all of its components and raw materialsrequirements.

 

The loss of any primarysupplier could have a material, adverse effect on the Company’s business,financial condition, or results of operations. Therefore, the Company has identified alternative suppliers for its mostcritical components of its equipment (“Alternative Sources”). There can be noassurance that a transition to such “Alternative Sources” will not entailtransitional delays, quality assurance and quality control difficulties, ontime delivery problems, any or all of which would likely have an impact on theCompany’s production of equipment and may have a material adverse effect on theCompany’s business, financial condition, or results of operations.

 

KeyManagement / Personnel:

 

The Company’scontinued operation, innovation and growth are to some significant degreereliant on the continued services of its key executive officers and leadingtechnical personnel. The Company does not maintain employment contracts withits key management or leading technical personnel. Though the Company believesthat it can identify and recruit replacement key management and technicalpersonnel, there can be no assurance as to such availability, the length oftime required to obtain such replacement management and technical personnel,the salary level that may have to be paid to obtain their respective services,or the impact on operations that may be experienced through the interim absenceof such key management and technical personnel.  The loss of key management or leading technical personnel could,therefore, have a material adverse effect on the Company’s business, financialcondition, or results of operations.

 

#### Government Regulation:

 

Certain of theCompany’s customers utilize the Company’s products in processes and productionthat are subject to governmental regulation. For example, the manufacturing andmarketing of pharmaceutical products may require the approval of the Food andDrug Administration (FDA) within the United States and of comparable agenciesin foreign countries.  The FDA hasestablished mandatory procedures, safety standards and protocols that apply tothe manufacture, clinical testing and marketing of new pharmaceutical productsin the United States.  The process ofseeking and obtaining FDA approval of a new product often takes a number ofyears and often involves the expenditure of substantial resources by theCompany’s customers.  The FDA approvalprocess can result in long lead times that are attendant to manufacturingequipment orders for these applications.

 

Further, inaddition to product approvals, the FDA imposes requirements as to manufacturingpractices, record keeping and reporting (Good Manufacturing Practices or GMP).GMP-regulated companies are subject to inspections by the FDA (inclusive ofMicrofluidizer® processor equipment) and product approvals may bewithdrawn if GMP are not met.

 

At present,the Company’s customers include companies who are making FDA approved drugs,preparations, and products (example: x-ray film) for external use and companieswho utilize

 

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Microfluidizer®processor equipment for the formulation or production of FDA approvedparenteral (injectable) drugs or compounds.

 

For theCompany’s equipment entering Europe, CE compliance (Regulatory Compliance withEuropean Safety Standards) is required. All products manufactured by theMicrofluidics Division are CE compliant.

 

Various laws,regulations and recommendations relating to safe working conditions, laboratorypractices and the purchase, storage, movement, import and export, use anddisposal of harmful or potentially harmful substances that may be used inconnection with the Company’s research work are, or may, be applicable to itsactivities.  These laws include, amongothers, the United States Atomic Energy Act, the Clean Air Act, the Clean WaterAct, the Occupational Safety and Health Act, the National Environmental PolicyAct, the Toxic Substances Control Act, the Resource Conservation and RecoveryAct, national restrictions on technology transfer, import, export and customsregulations and other present and possible future local, state or Federalregulation.  The extent of adversegovernmental regulation, which might result from future legislation oradministrative action, cannot be accurately predicted.  Certain agreements that may be entered intoby the Company involving exclusive license rights may also be subject tonational or supranational antitrust regulatory control, the effect of whichcannot be predicted.

 

To date theCompany has not been effected by any United States governmental restrictions ontechnology transfer, import, export and customs regulations and other presentlocal, state or Federal regulation.  Theextent of adverse governmental regulation, which might result from futurelegislation or administrative action, cannot be accurately predicted. Inparticular, H.R. 3162 enacted on October 21, 2001 (the “Patriot Act”) and othergovernmental regulation may impose export restrictions on sale of equipment ortransfer of technology to certain countries or groups.  There can be no assurance that sale of theCompany’s equipment will not be impacted by such legislation or designation.Depending upon which countries and sales may be designated for trade restrictionsuch action could have a material adverse effect on the Company’s business,financial condition, or results of operations. Also, certain agreements that may be entered into by the Companyinvolving exclusive license rights may also be subject to national orsupranational antitrust regulatory control, the effect of which cannot bepredicted.

 

Backlog:

 

The Company’ssales order backlog related to continuing operations of accepted and unfilledorders at March 24, 2004, and March 14, 2003 was approximately $2,226,000 and$3,146,000, respectively. Backlog as of any particular date should not berelied upon as indicative of the Company’s net revenues for any future period.

 

Employees:

 

The Companyhas approximately 41 full-time employees as of March 24, 2004.  None of the Company’s employees are coveredby a collective bargaining agreement, and the Company considers its relationswith its employees to be satisfactory. The Company believes that its future success will depend in large parton its ability to attract and retain highly skilled employees.

 

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**Item 2. PROPERTIES**

 

The Company’scorporate headquarters are in Newton, Massachusetts.  The Company also maintains a sales office and laboratory facilityin Lampertheim, Germany and a sales office and applications laboratory inFullerton, California.  The Companyrents approximately 48,200 square feet of offices, production and research anddevelopment facilities at these locations for administrative, development andproduction activities. A portion of the space at the Newton, MA facility issublet to a non-affiliated company for a total of $12,000 per annum under atenant at will arrangement. The lease terms expire at various times throughAugust 2006. The Company has the option to extend the leases for up to fiveadditional years.  The Company believesthese facilities will be adequate for operations for the next several years.

 

 

**Item 3. LEGAL PROCEEDINGS**

 

The Company is not a party to any materiallegal proceedings.

 

 

**Item 4.   SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS**

 

No matterswere submitted to a vote of the Company’s security holders during the quarterended December 31, 2003.

 

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**Item 5.****           MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

Market

 

The Company’sCommon Stock is traded on the Over-the-Counter Bulletin Board under the symbolMFIC.  The following table sets forththe range of quarterly high and low bid quotations for the last two fiscalyears, as furnished by the National Association of Securities Dealers AutomatedQuotation System.  The quotationsrepresent interdealer quotations without adjustment for retail markups, markdowns,or commissions, and may not necessarily represent actual transactions.

 
| **Quarters  Ended** |   | **12/31  2003** |   | **9/30  2003** |   | **6/30  2003** |   | **3/31  2003** |   | **12/31  2002** |   | **9/30  2002** |   | **6/30  2002** |   | **3/31  2002** |   |
|---------------------|--------|-----------------|--------|----------------|--------|----------------|--------|----------------|--------|-----------------|--------|----------------|--------|----------------|--------|----------------|--------|
|                |   |            |   |           |   |           |   |           |   |            |   |           |   |           |   |           |   |
| Low                 |   | $               | 0.85   |           | $      | 0.57           |   | $              | 0.20   |            | $      | 0.23           |   | $              | 0.25   |           | $      | 0.28 |   | $ | 0.35 |   | $ | 0.41 |   |
| High                |   | $               | 2.70   |           | $      | 1.90           |   | $              | 0.73   |            | $      | 0.47           |   | $              | 0.43   |           | $      | 0.42 |   | $ | 0.45 |   | $ | 0.55 |   |

 

 

Holders

 

As of March24, 2004, there were approximately 470 holders of record of the Company’sCommon Stock.

 

Dividends

 

The Companyhas never paid any cash dividends on its Common Stock and presently anticipatesthat no dividends on its Common Stock will be declared in the foreseeablefuture. The Company’s current policy is to retain all of its earnings tofinance future growth. In addition, pursuant to loan covenants contained in theCompany’s loan agreement with its commercial lender, the Company may not paydividends without the commercial lender’s prior approval.

 

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Equity Compensation Plan Information:

 

The information in the table below is as of December 31, 2003.  See also the Consolidated FinancialStatements – Note 10.

 
| **Plan category**                                           |   | **Number of  securities  to be issued upon  exercise of  outstanding options,  warrants and rights** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights** |   | **Number  ofsecurities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** |      |
|-------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
|                                                        |   | **(a)**                                                                                              |   | **(b)**                                                                            |   | **(c)**                                                                                                                                               |      |
| Equity compensation plans approved by  security holders     |   | 1,929,662                                                                                            |   | $                                                                                  | 0.74   |                                                                                                                                                  | 1,206,898 |   |
|                                                        |   |                                                                                                 |   |                                                                               |   |                                                                                                                                                  |      |   |
| Equity compensation plans not approved by  security holders |   | —                                                                                               |   | —                                                                             |   | —                                                                                                                                                |      |
|                                                        |   |                                                                                                 |   |                                                                               |   |                                                                                                                                                  |      |
| Total                                                       |   | 1,929,662                                                                                            |   | $                                                                                  | 0.74   |                                                                                                                                                  | 1,206,898 |   |

 

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# **Item 6.     SELECTED FINANCIAL DATA**

 

The selectedfinancial information presented below is derived from the audited consolidatedfinancial statements of the Company for each of the five year period endedDecember 31, 2003. The information set forth below should be read inconjunction with Management’s Discussion and Analysis of Financial Conditionand Results of Operations and the Consolidated Financial Statements and relatedNotes included elsewhere in this Form 10-K.  All fiscal years noted below have been restated to reflect thediscontinued operations of MFIC Corporation.

 

**SelectedStatement of Operations Data**

 
|                                                                                                             |   | **Year Ended  December 31,  2003** |       | **Year Ended  December 31,  2002** |   | **Year Ended  December 31,  2001** |   | **Year Ended  December 31,  2000** |       | **Year Ended  December 31,  1999** |   |
|------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|------------|------------------------------------|--------|------------------------------------|--------|------------------------------------|------------|------------------------------------|--------|
| Total revenues                                                                                                   |   | $                                  | 10,459,631 |                               | $      | 9,514,180                          |   | $                                  | 11,210,375 |                               | $      | 10,034,585 |   | $ | 8,675,871 |   |
| Total costs and expenses                                                                                         |   | 9,693,551                          |       | 8,872,465                          |   | 10,934,902                         |   | 10,449,756                         |       | 9,284,229                          |   |
| Income (loss) from continuing operations                                                                         |   | 766,080                            |       | 641,715                            |   | 275,473                            |   | (415,171                           | )          | (608,358                           | )      |
| Interest expense                                                                                                 |   | (116,097                           | )          | (179,429                           | )      | (261,754                           | )      | (350,486                           | )          | (542,045                           | )      |
| Other expense                                                                                                    |   | —                             |       | —                             |   | (53,142                            | )      | (250,000                           | )          | —                             |   |
| Interest income                                                                                                  |   | 9,508                              |       | 7,191                              |   | 7,032                              |   | 248                                |       | 9,835                              |   |
| Gain on sale of investments                                                                                      |   | —                             |       | —                             |   | —                             |   | —                             |       | 11,864                             |   |
| Net income (loss) from continuing  operations before extraordinary item                                          |   | 659,491                            |       | 469,477                            |   | (32,391                            | )      | (1,015,409                         | )          | (1,128,704                         | )      |
| Gain on subordinated debt restructuring                                                                          |   | —                             |       | —                             |   | —                             |   | 194,500                            |       | —                             |   |
| Net income (loss) from continuing  operations                                                                    |   | 659,491                            |       | 469,477                            |   | (32,391                            | )      | (820,909                           | )          | (1,128,704                         | )      |
| (Loss) income from discontinued operations  (Net of loss from disposal of discontinued operations of $1,422,715) |   | (4,109,925                         | )          | (2,983,451                         | )      | (492,795                           | )      | 347,801                            |       | 274,270                            |   |
| Net loss                                                                                                         |   | (3,450,434                         | )          | (2,513,974                         | )      | (525,186                           | )      | (473,108                           | )          | (854,434                           | )      |
| Weighted-average shares outstanding:                                                                             |   |                               |       |                               |   |                               |   |                               |       |                               |   |
| Basic                                                                                                            |   | 7,767,712                          |       | 7,426,586                          |   | 7,375,102                          |   | 7,086,058                          |       | 5,818,588                          |   |
| Diluted                                                                                                          |   | 8,501,110                          |       | 7,470,090                          |   | 7,375,102                          |   | 7,086,058                          |       | 5,818,588                          |   |
| Basic amounts per common share:                                                                                  |   |                               |       |                               |   |                               |   |                               |       |                               |   |
| Net income (loss) per share from continuing  operations before extraordinary gain                                |   | $                                  | .08        |                               | $      | .06                                |   | $                                  | (.00       | )                                  | $      | (.14 | ) | $ | (.19 | ) |
| Extraordinary gain per share:                                                                                    |   | —                             |       | —                             |   | —                             |   | $                                  | .03        |                               | — |   |
| Net income (loss) per share from continuing  operations                                                          |   | $                                  | .08        |                               | $      | .06                                |   | $                                  | (.00       | )                                  | $      | (.11 | ) | $ | (.19 | ) |
| Basic net (loss) income per share from  discontinued operations                                                  |   | $                                  | (.52       | )                                  | $      | (.40                               | )      | $                                  | (.07       | )                                  | $      | .05 |   | $ | .04 |   |
| Basic, as reported                                                                                               |   | $                                  | (.44       | )                                  | $      | (.34                               | )      | $                                  | (.07       | )                                  | $      | (.06 | ) | $ | (.15 | ) |
| Diluted amounts per common share:                                                                                |   |                               |       |                               |   |                               |   |                               |       |                               |   |
| Net income (loss) per share from continuing  operations before extraordinary gain                                |   | $                                  | .08        |                               | $      | .06                                |   | $                                  | (.00       | )                                  | $      | (.14 | ) | $ | (.19 | ) |
| Extraordinary gain per share:                                                                                    |   | —                             |       | —                             |   | —                             |   | $                                  | .03        |                               | — |   |
| Diluted net income (loss) per share from  continuing operations                                                  |   | $                                  | .08        |                               | $      | .06                                |   | $                                  | (.00       | )                                  | $      | (.11 | ) | $ | (.19 | ) |
| Diluted net (loss) income per share from  discontinued operations                                                |   | $                                  | (.52       | )                                  | $      | (.40                               | )      | $                                  | (.07       | )                                  | $      | .05 |   | $ | .04 |   |
| Diluted, as reported                                                                                             |   | $                                  | (.44       | )                                  | $      | (.34                               | )      | $                                  | (.07       | )                                  | $      | (.06 | ) | $ | (.15 | ) |

 

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**Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL****CONDITIONAND RESULTS OF OPERATIONS**

 

 

# **CERTAIN FACTORS AND CAUTIONARY STATEMENT REGARDINGFORWARD-LOOKING STATEMENTS**

 

Managementbelieves that this report contains forward-looking statements that are subjectto certain risks and uncertainties including statements relating to theCompany’s plan to achieve, maintain and/or increase revenue growth and/oroperating profitability, and to attain net operating profitability. Suchstatements are based on management’s current expectations and are subject to anumber of factors and uncertainties that could cause actual results achieved bythe Company to differ materially from those described in the forward-lookingstatements. The Company cautions investors that there can be no assurance that theactual results or business conditions will not differ materially from thoseprojected or suggested in such forward-looking statements as a result ofvarious factors, including but not limited to, the following risks anduncertainties: (i) whether the performance advantages of the Company’sMicrofluidizer® materials processing equipment will be realized commercially orthat a commercial market for the equipment will continue to develop, (ii)whether the Company will have access to sufficient working capital throughcontinued and improving cash flow from sales and ongoing borrowingavailability, the latter being subject to the Company’s ability to comply withthe covenants and terms of the Company’s loan agreement with its senior lender,(iii) whether the Company’s expectation that the benefits of nanotechnologywill, in part, be realized by the ability of the MMR to produce innovativematerials in large quantities, and  (iv)whether the Company’s is able to increase the number of prototype MMRplacements and then manufacture and introduce commercial production MMRequipment. 

 

**CriticalAccounting Policies**

 

The Company considers certain accountingpolicies related to revenue recognition and related receivables as well as thevaluation of inventories to be critical policies due to the estimationprocesses involved in each.

 

****Revenue Recognition********   The Company’spolicy is to recognize revenue from sales of machines and spare parts uponshipment to our customers and the fulfillment of all contractual terms andconditions, pursuant to the guidance provided by Staff Accounting Bulletin No.101, Revenue Recognition in Financial Statements (SAB 101), issued by theSecurities and Exchange Commission.****

 

****Rental income from the lease ofequipment is recognized on a straight-line basis over the term of the leaseagreement.****

 

****Judgments are required inevaluating the creditworthiness of our customers.  In all instances, revenue is not recognized until the Company hasdetermined that collection is reasonably assured.****

 

****Should changes in conditionscause management to determine the aforementioned criteria are not met forcertain future transactions, revenue recognized for any reporting period couldbe adversely affected.****

 

****Allowancefor Doubtful Accounts********   The Company’s policy is to maintainallowances for estimated losses resulting from the inability of our customersto make scheduled payments. The Company regularly evaluates the collectibilityof our trade receivable balances based on a combination of factors. When acustomer’s account balance becomes past due, we initiate dialogue with thecustomer to determine the cause. If it is determined that****

 

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**** ****

****the customer will be unable tomeet its financial obligation to us. The Company records a specific allowance to reduce the relatedreceivable to the amount we expect to recover given all information presentlyavailable.****

 

****The Company believes our reportedallowances are adequate as of December 31, 2003 and 2002.  If the financial condition of our customerswere to deteriorate, however, resulting in their inability to make payments,the Company may need to record additional allowances, which would result inadditional expenses being recorded for the period in which such determinationwas made.****

 

****InventoryValuation********The Companyvalues its inventory at the lower of cost or net realizable value on afirst-in-first-out method.  Managementregularly evaluates inventory quantities on hand and records a provision forobsolete or excess inventory levels greater than those of anticipated usage inthe subsequent two years. There are external factors that may require anadjustment to the anticipated demand including, but not limited to,technological changes in our markets, our ability to meet changing customerrequirements, competitive pressures in products and prices, and theavailability of key components from our suppliers. Purchasing requirements andalternative usage avenues are explored within these processes to mitigateinventory exposure. When recorded, our Company’s reserves are intended toreduce the carrying value of our inventory to its net realizable value.****

 

****Impairment  ********It has been the Company’s policy to review the carryingvalues of long-lived assets and amortizable intangibles for impairment wheneveran event or changes in circumstances indicated that the carrying amount of anasset may not be recoverable.****

 

****ProductWarranties********   The Company’s products are generally soldwith a twelve month warranty provision that require us to remedy deficienciesin quality or performance of our products at no cost to our customers onlyafter it has been determined that the cause of the deficiency is not due to theactions of the machine operator or product used in the machine.****

 

 

**Fiscal2003 Compared to Fiscal 2002**

 

In 1998, theCompany purchased the assets and liabilities of Morehouse-COWLES Inc.(“Morehouse-COWLES”).  This was done tocomplete a strategic combination with the Microfluidics Division, in order toenhance the Company’s position in the coatings market, which, at the time, wasthe dominant part of the Company’s business.

 

Since thattime, the direction of the core business of the Company changed significantlyfrom coatings to other areas, (in particular the Health Care sector).  The Company determined that it could nolonger support the previous strategic plan and the Company, therefore, prepareda plan to divest the Morehouse-COWLES Division.

 

It wasexpected that the sale would positively impact the Company’s cash flow, andwould allow the Company to focus on the core business, and expand its sales andmarketing resources for the Company’s Microfluidizer® processsystems line, and promote its new MMR nanoparticle production systems.

 

During thefourth quarter of 2003, management committed to a plan to sell substantiallyall the assets and associated liabilities of Morehouse-COWLES.  Accordingly, at year end, the Companyreported the division as discontinued operations and reclassified the assetsand associated liabilities as available for sale. The search for a buyereventually resulted in NuSil Corporation, a California corporation (“NuSil”)making an offer in December 2003 to purchase the Morehouse-COWLES Division’sassets and related liabilities at a price that was acceptable to the Company.

 

On February 9,2004, pursuant to an Asset Purchase Agreement (the “Asset Purchase Agreement”)dated February 5, 2004 between MFIC Corporation (“MFIC”) and a wholly ownedsubsidiary of NuSil, MFIC sold substantially all of the assets and selectedliabilities of its Morehouse-COWLES Division (the “Division”), to NuSil.  Other than NuSil’s prior purchases ofproducts from the Division, there were no preexisting relationships betweenMFIC and NuSil.

 

The assets ofthe division that were sold included accounts receivable, furniture, fixturesand equipment, inventory and supplies, books and records, bids, contracts,prepaid expenses, leases, intellectual property, goodwill, domain names andclaims, all as described in the Asset Purchase Agreement (collectively, the “Assets”).  In addition, certain rights and obligationsarising after February 9, 2004 under the division’s PacifiCare Group HealthInsurance Policy were assigned.  Thedivision’s cash or cash equivalents on hand on February 9, 2004 were excludedfrom the assets being sold.  Under theAsset Purchase Agreement, the division’s executory obligations under certaincontracts and bids, and the division’s accounts payable as of February 9, 2004in the amount of $623,240, were assumed by NuSil.

 

The purchaseprice (other than the assumption of accounts payable described in the precedingparagraph) paid under the Asset Purchase Agreement was $918,238.  Of the purchase price, $768,238 (the“Closing Cash”) was paid in cash, $100,000 was paid in the form of a PromissoryNote (the “Purchase Note”) and $50,000 (the “Holdback Payment”) was withheldfor payment at a future date subject to any purchase price adjustments andoffsets, as provided for in the Asset Purchase Agreement.

 

The ClosingCash was paid directly to PNC Bank, National Association (“PNC”), to be appliedto MFIC’s outstanding balance under MFIC’s Revolving Credit Loan with PNC (the“Revolving Credit Loan”).

 

Theaforementioned Purchase Note bears interest at 5 percent per annum, is securedby the Assets pursuant to a Security Agreement dated February 5, 2004 (the“Security Agreement”) between the parties and is subject to certain offsets asprovided in the Asset Purchase Agreement. Principal and interest on the Purchase Note are payable on February 9,2005, unless there is a claim for an offset as allowed for under the AssetPurchase Agreement, which claim might delay final payment of amounts due underthe Purchase Note until final resolution of any such claim under the proceduresoutlined in the Asset Purchase Agreement.

 

Pursuant tothe Asset Purchase Agreement, MFIC entered into a Noncompetition andNonsolicitation Agreement, dated February 5, 2004, which limits MFIC’s abilityto compete with the business of the division for a period of five years.

 

The sale generateda loss of approximately $1,400,000.  Dueto the sale of the Morehouse-COWLES Division, goodwill associated with the 1998purchase of this division in the amount of $2,100,000 has been impaired in2003.

 

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**Resultsof Continuing Operations**

 

Total revenuesfor the year ended December 31, 2003 from continuing operations were$10,459,631 as compared to revenues of $9,514,180 for the year ended December31, 2002, representing an increase of $945,451, or 10%.

 

North Americansales for the year ended December 31, 2003 decreased to approximately$5,337,000, or 17%, as compared to North American sales of approximately$6,462,000 for the year ended December 31, 2002.  This decrease in North American sales was principally due to adecrease in the sale of machines. Foreign sales were approximately $5,123,000 for the year ended December31, 2003 compared to $3,052,000 for the year ended December 31, 2002, anincrease of $2,071,000 or 68%. This increase in foreign sales was principallydue to an increase in the sale of machines.

 

Total cost ofgoods sold for 2003 from continuing operations was $4,988,226 or 48% ofrevenue, as compared to $4,438,351 or 47% of revenue for 2002.  The increase in cost of goods sold reflectsprimarily the increase in sales generated by the Company.  The Company’s major product lines havedifferent profit margins, as well as multiple profit margins within eachproduct line.  In the course of theperiods compared, there may be significant changes in the cost of revenues as apercentage of revenue depending on the mix of product sold.  Also, the cost of sales as a percent ofrevenue will differ between laboratory and pilot plant units sold, due to thedifference in costs between air driven and electric-hydraulic units.

 

Totaloperating expenses from continuing operations for 2003 were $4,705,325 or 45%of revenue, as compared to $4,434,114 or 47% of revenue for 2002, which is anincrease of $271,211 or 6%.

 

Research anddevelopment expenses for 2003 were $785,849 compared to $583,683 for 2002, anincrease of $202,166 or 35%.  Theincrease in research and development expenses is primarily due to an increasein research costs of approximately $131,000, and an increase in payroll andrelated costs of approximately $96,000, partially offset by a decrease inamortization costs of approximately $12,000, and a decrease in outside contractservices of approximately $13,000.

 

Sellingexpenses for 2003 increased approximately $101,000, from $2,086,547 in 2002 to$2,187,389 or 5%. The increase was due principally to an increase ofapproximately $124,000 in payroll and related costs, approximately $100,000 intravel and entertainment costs, and $54,000 in delivery costs, partially offsetby a decrease in advertising expenses of approximately $107,000 and a decreasein commission expense of approximately $70,000.

 

General andadministrative expenses for 2003 decreased by approximately $32,000, from$1,763,884 for the year ended December 31, 2002, to $1,732,087, or 2%.  The decrease in general and administrativeexpenses is primarily due to a decrease in payroll costs of approximately$87,000, a decrease in professional fees of approximately $58,000, and adecrease in corporate expenses of approximately $37,000, offset by increases inbad debt expense of approximately $101,000 and overhead costs of approximately$48,000.

 

Interestexpense for 2003 decreased from $179,429 in 2003 to $116,097, a decrease of$63,332, or 35%.  The decrease was dueprincipally to a reduction in the interest rate paid, and a reduction in theamount of debt borrowed.

 

Interestincome for 2003 increased to $9,508 from $7,191 for 2003, an increase of$2,317.  The increase is due to interestearned on the note and accounts receivable remaining from the sale of the BallMill operation.

 

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**Resultsof Discontinued Operations**

 

Total revenuesfor the year ended December 31, 2003 from discontinued operations were$3,655,237 as compared to revenues of $5,059,202 for the year ended December31, 2002, representing a decrease of $1,403,965, or 28%.  The decrease in revenues is due primarily toa decrease in machine sales of approximately $930,000, and a decrease in spareparts of approximately $496,000.

 

North Americansales for the year ended December 31, 2003 decreased to approximately$2,798,000, or 28%, as compared to North American sales of approximately$3,880,000 for the year ended December 31, 2002.  This decrease in North American sales was principally due to adecrease in the sale of machines. Foreign sales were approximately $835,000 for the year ended December31, 2003 compared to $1,179,000 for the year ended December 31, 2002, adecrease of approximately $344,000 or 29%.

 

Total cost ofgoods sold for 2003 was $2,601,957 or 71% of revenue, as compared to $3,626,407or 72% of revenue for 2002.  Thedecrease in cost of goods sold reflects primarily the decrease in salesgenerated by the division.  Thedivision’s major product lines have different profit margins, as well asmultiple profit margins within each product line.  In the course of the periods compared, there may be significantchanges in the cost of revenues as a percentage of revenue depending on the mixof product sold.

 

Total operatingexpenses for 2003 were $1,640,490 or 45% of revenue, as compared to $1,754,837or 35% of revenue for 2002, which is a decrease of $114,347 or 7%.

 

Research anddevelopment expenses for 2003 were $318,105 compared to $322,811 for 2002, adecrease of $4,706 or 1%.  The decreasein research and development expenses is primarily due to a decrease in payrolland related costs of approximately $6,000.

 

Sellingexpenses for 2003 decreased approximately $143,000, from $1,006,746 in 2002 to$863,337 or 14%.  The decrease was dueprincipally to the reduction of selling expenses at the Eastern sales officelocated in South Haven, Michigan of approximately $70,000, a decrease inpayroll and related costs of approximately $68,000, a decrease in commissionexpense of approximately $24,000, and a decrease in travel expenses ofapproximately $79,000, partially offset by increases of approximately $95,000in advertising costs and approximately $14,000 in demonstration cost expenses.

 

General andadministrative expenses for 2003 increased by approximately $34,000, from$425,280 for the year ended December 31, 2002 to $459,048, or 8%.  The increase in general and administrativeexpenses is primarily due to an increase in professional fees of approximately$16,000.

 

Under SFAS No.142, goodwill impairment is deemed to exist if the net book value of areporting unit exceeds its estimated fair value.  Upon adoption of SFAS No. 142 in the first quarter of 2002, theCompany recorded a one-time, noncash charge of $2,661,409 to reduce thecarrying value of its goodwill.  Suchcharge is nonoperational in nature and is reflected in discontinued operationsin the accompanying consolidated statement of operations pursuant to the SFASNo. 142 transition rules.

 

22

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**Fiscal2002 Compared to Fiscal 2001**

 

**Resultsof Continuing Operations**

 

 

Total revenuesfor the year ended December 31, 2002 from continuing operations were $9,514,180as compared to revenues of $11,210,375 for the year ended December 31, 2001,representing a decrease of $1,696,195 or 15%.

 

North Americansales for the year ended December 31, 2002 were approximately $6,462,000, a 13%decrease as compared to North American sales of approximately $7,444,000 forthe year ended December 31, 2001.  Thisdecrease in North American sales was principally due to a decrease in the saleof machines.  Foreign sales wereapproximately $3,052,000 for the year ended December 31, 2002 compared to$3,766,000 for the year ended December 31, 2001, a decrease of $714,000 or19%.  The decrease in foreign sales wasprincipally due to a decrease in the sale of machines compared to 2001.

 

Total cost ofgoods sold for 2002 was $4,438,351 or 47% of revenue, as compared to $5,629,484or 50% of revenue for 2001.  Thedecrease in cost of goods sold in absolute dollars reflects principally thedecrease in sales generated by the Company compared to the previous year.  It also reflects an increase in profitmargins.  The Company’s major productlines have different profit margins, as well as multiple profit margins withineach product line.  In the course of theperiods compared, there may be significant changes in the cost of revenues as apercentage of revenue depending on the mix of product sold.  Also, the cost of sales as a percent ofrevenue will differ between laboratory and pilot plant units sold, due to thedifference in costs between air driven and electric-hydraulic units.

 

Totaloperating expenses for 2002 were $4,434,114, or 47% of revenue, as compared to$5,305,418, or 47% of revenue, for 2001, which is a decrease of $871,304, or16%.

 

Research anddevelopment expenses for 2002 were $583,683 compared to $537,428 for 2001, anincrease of $46,255, or 9%.  Theincrease in research and development expenses is principally due to an increasein payroll costs, as a result of both an increase in headcount and payincreases.

 

Sellingexpenses for 2002 decreased approximately $177,000, or 8% from $2,263,226 to$2,086,547.  The decrease was dueprincipally to a decrease in payroll costs of approximately $141,000, adecrease in travel and entertainment of approximately $72,000, a decrease insupplies of approximately $23,000, partially offset by an increase in outsidecommissions of approximately $66,000.

 

For the yearended December 31, 2002, general and administrative expenses decreased byapproximately $741,000, from $2,504,764 for the year ended December 31, 2001,to $1,763,884, or 30%.  The decrease ingeneral and administrative expenses was principally due to a decrease inamortization of goodwill costs of approximately $422,000, as a result of theadoption of SFAS No. 142, media costs of approximately $169,000, professionalfees of approximately $86,000, and other cost decreases of approximately$64,000.

 

Interestexpense for 2002 decreased to $179,429 from $261,754 for 2001, a decrease of$82,325, or 31%.  The decrease was dueprimarily to a decrease in the interest rates charged the Company.

 

Interestincome for 2002 increased to $7,191 from $7,032 for 2001, an increase of $159or 2%.

 

23

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**Results of Discontinued Operations**

 

Total revenuesfor the year ended December 31, 2002 were $5,059,202 as compared to revenues of$4,300,639 for the year ended December 31, 2001, representing an increase of$758,563 or 18%.

 

North Americansales for the year ended December 31, 2002 were approximately $3,880,000, a 22%increase as compared to North American sales of approximately $3,186,000 forthe year ended December 31, 2001.  Theincrease in North American sales was due to an increase in the sale of bothmachines and spare parts.  Foreign saleswere approximately $1,179,000 for the year ended December 31, 2002, as comparedto foreign sales of approximately $1,114,000, an increase of $65,000 or1%.  The increase in foreign sales wasprincipally due to an increase in the sale of machines compared to 2001.

 

Total cost ofgoods sold for 2002 was $3,626,407 or 72% of revenue, as compared to $3,268,271or 76% of revenue for 2001.  The increasein cost of goods sold in absolute dollars reflects principally the increase insales generated by the division.  Italso reflects an increase in profit margins. The division’s major product lines have different profit margins, aswell as multiple profit margins within each product line.  In the course of the periods compared, theremay be significant changes in the cost of revenues as a percentage of revenuedepending on the mix of product sold.

 

Totaloperating expenses for 2002 were $1,754,837, or 35% of revenue, as compared to$1,525,163, or 35% of revenue, for 2001, which is an increase of $229,674, or15%.

 

Research anddevelopment expenses for 2002 were $322,811 compared to $320,063 for 2001, anincrease of 2,748, or 1%.

 

Sellingexpenses for 2002 increased approximately $221,000, or 28% from $786,192 to$1,006,746.  The increase was dueprincipally to an increase in media costs of approximately $136,000, in payrolland related costs of approximately $50,000, an increase in travel costs of approximately$73,000, and demonstration cost expenses of approximately $48,000, partiallyoffset by a decrease in commission costs of approximately $71,000.

 

For the yearended December 31, 2002, general and administrative expenses increased byapproximately $6,000, from $418,908 for the year ended December 31, 2001, to$425,280, or 2%.  The increase ingeneral and administrative expenses was principally due to an increase inpayroll and related costs of approximately $44,000, partially offset by adecrease in bad debt expense of approximately $31,000.

 

On July 24,2000, the Company announced that it would transfer the sales and manufacturingof its line of Zinger ® horizontal media mills from its Michigan-based EpworthMill Division to the Morehouse-COWLES plant in Fullerton, California. Thetransfer began on October 1, 2000 and did not have a material impact on theprofitability of the Company. Simultaneously, the Company ceased operations ofthe Ball Mill repair business and decided to sell its Ball Mill productline.  On March 19, 2001, the Companyreached an agreement to sell the Ball Mill operation for $200,000 in cash andnotes.

 

In October,2000, the Company entered into a settlement agreement related to a warrantyclaim against the Epworth Mill Division, pursuant to which the Company paid$100,000 upon execution of the agreement, and executed a promissory note for$350,000 payable two years from the execution date, with interest payablequarterly in arrears at 10% per annum. The Company paid off the balance of thisnote in December, 2002.

 

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**QUARTERLYRESULTS OF OPERATIONS**

 

 

The followingtable sets forth, for the periods presented, certain data from our consolidatedstatements of operations.  In the opinionof our management, the unaudited quarterly consolidated statement of operationsdata have been prepared on substantially the same basis as our auditedconsolidated financial statements and include all adjustments, consisting onlyof normal recurring adjustments, necessary for a fair presentation of thefinancial information for the periods presented.  This information should be read in conjunction with theconsolidated financial statements and related notes included elsewhere in thisAnnual Report on Form 10-K.  Theoperating results in any quarter are not necessarily indicative of the resultsthat may be expected for any future period. Fiscal 2003 and 2002 quarters have been restated to reflect thediscontinued operations of the Company.

 

Summarized unauditedquarterly financial data are as follows:

 
|                                                                                                 |   | **Fiscal  2003 Quarters** |      |
|------------------------------------------------------------------------------------------------------|--------|---------------------------|-----------|
|                                                                                                 |   | **First**                 |      | **Second** |   | **Third** |   | **Fourth** |   |
| Revenues                                                                                             |   | $                         | 2,949,677 |   | $ | 3,119,465 |   | $ | 1,912,738 |   | $ | 2,477,751 |   |
| Gross income                                                                                         |   | 1,491,923                 |      | 1,666,124 |   | 958,398 |   | 1,354,960 |   |
| Net income (loss) from continuing  operations                                                        |   | 405,571                   |      | 341,855 |   | (157,266 | ) | 69,331 |   |
| (Loss) from discontinued operations  Including loss on disposal of $1,422,715 in fourth quarter 2003 |   | (215,899                  | )         | (87,215 | ) | (186,080 | ) | (3,620,731 | ) |
| Net income (loss)                                                                                    |   | 189,672                   |      | 254,640 |   | (343,346 | ) | (3,551,400 | ) |
| Basic net income (loss) per share from  continuing operations:                                       |   | $                         | .05       |   | $ | .05 |   | $ | (.02 | ) | $ | .00 |   |
| Basic net loss per share from discontinued  operations                                               |   | $                         | (.03      | ) | $ | (.01 | ) | $ | (.02 | ) | $ | (.46 | ) |
| Basic, as reported                                                                                   |   | $                         | .03       |   | $ | .03 |   | $ | (.05 | ) | $ | (.45 | ) |
| Diluted net income (loss) per share from  continuing operations                                      |   | $                         | .05       |   | $ | .05 |   | $ | (.02 | ) | $ | .00 |   |
| Diluted net loss per share from  discontinued operations                                             |   | $                         | (.03      | ) | $ | (.01 | ) | $ | (.02 | ) | $ | (.46 | ) |
| Diluted, as reported                                                                                 |   | $                         | .03       |   | $ | .03 |   | $ | (.05 | ) | $ | (.45 | ) |

 

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|                                                              |   | **Fiscal  2002 Quarters** |      |
|-------------------------------------------------------------------|--------|---------------------------|-----------|
|                                                              |   | **First**                 |      | **Second** |   | **Third** |   | **Fourth** |   |
| Revenues                                                          |   | $                         | 2,739,707 |   | $ | 2,286,564 |   | $ | 2,003,723 |   | $ | 2,484,186 |   |
| Gross income                                                      |   | 1,442,428                 |      | 1,083,213 |   | 1,154,685 |   | 1,395,503 |   |
| Net income (loss) continuing operations                           |   | 235,659                   |      | (67,603 | ) | (19,056 | ) | 320,477 |   |
| (Loss) income from discontinued operations                        |   | (2,796,821                | )         | 123,034 |   | 32,742 |   | (342,406 | ) |
| Net (loss) income                                                 |   | (2,561,162                | )         | 55,431 |   | 13,686 |   | (21,929 | ) |
| Basis net income (loss) per share:                                |   |                      |      |   |   |   |   |   |   |
| Net income (loss) per share from continuing  operations           |   | $                         | .03       |   | $ | (.01 | ) | $ | (.00 | ) | $ | .04 |   |
| Basic net (loss) income per share from  discontinued operations   |   | $                         | (.38      | ) | $ | .02 |   | $ | .00 |   | $ | (.04 | ) |
| Basic, as reported                                                |   | $                         | (.33      | ) | $ | .01 |   | $ | .00 |   | $ | (.02 | ) |
| Diluted net income (loss) per share:                              |   |                      |      |   |   |   |   |   |   |
| Net income (loss) per share from continuing  operations           |   | $                         | .03       |   | $ | (.01 | ) | $ | .00 |   | $ | .04 |   |
| Diluted net (loss) income per share from  discontinued operations |   | $                         | (.38      | ) | $ | .02 |   | .00 |   | $ | (.04 | ) |
| Diluted, as reported                                              |   | $                         | (.33      | ) | $ | .01 |   | $ | .00 |   | $ | (.02 | ) |

 

26

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**LIQUIDITYAND CAPITAL RESOURCES**

 

The Companygenerated cash from operations of $236,292 in 2003, $398,748 in 2002 and$297,127 in 2001. In 2003, the Company’s principal operating cash requirementswere to fund its net loss, its increase in prepaid expenses, and decrease incurrent liabilities, offset by a decrease in trade and other receivables,inventories and other current assets.  In 2002, the Company’s principal operating cash requirements were tofund its decrease in current liabilities, and increase in other current assetsand prepaid expenses, offset by net income from operations, and a decrease inreceivables and inventory.  In 2001, theCompany’s principal operating cash requirements were to fund its net loss fromoperations, increase in other assets, and decreases in current liabilities,offset by a decrease in trade and other receivables, inventories, and prepaidexpenses.

 

The Companyused cash of $53,172, $38,706 and $108,861 for investing activities in 2003,2002, and 2001, respectively.  Net cashused in investing activities for both 2003 and 2002 included the proceeds fromthe sale of assets, net of the purchase of capital equipment.  Net cash used by investing activities for2001 resulted from the sale of assets from the Ball Mill operation offset bythe issuance of a note receivable in connection with the sale of the Ball Milloperation, and the purchase of fixed assets, partially offset by the sale offixed assets. The Company’s sale of assets principally related to usedequipment. As of December 31, 2003, the Company had no material commitments forcapital expenditures.

 

For financingactivities, the Company used cash of $217,806 in 2003, $362,472 in 2002, and$387,235 in 2001. In 2003, cash was used to pay down the line of credit,subordinated debt, and the line of credit term note, partially offset by theissuance of common stock.   In 2002 cashwas used to pay a note payable arising from a settlement agreement (See Note7-Debt), to pay down the term note, and the subordinated debt, and waspartially offset by proceeds from the line of credit, and the issuance ofcommon stock. Cash used in 2001 reflected the payments on the line of credit,line of credit term note, and subordinated debt, partially offset by theproceeds from the issuance of common stock.

 

The cash andcash equivalents balance at December 31, 2003 was $50,270, a decrease of$34,686 from the December 31, 2002 balance of $84,956. At December 31,2003, the Company maintained a line of credit and a term loan (collectively theCredit Facility) with PNC Bank, N.A. (the Lender). The line of credit facilityprovided for a maximum borrowing of $4,000,000. On March 3, 2004, the Companyreceived a new line of credit from Banknorth, N.A.  The proceeds of the new line of credit and term note were used topay off the balance due the previous lender, PNC.   As of December 31, 2003 and March 24, 2004, the Company hadborrowings under its’ line of credit of $2,425,613 and $589,781, respectively.

 

 

Under theterms of the line of credit with the previous Lender, the Company was subjectto a number of restrictions that impacted the Company’s use of funds.  The Company was limited to acquisition ofproperty of $250,000 per year or less, could not pay dividends, and maintainedcertain financial covenants as defined. In addition, the Company was required to maintain a lockbox arrangementwith the Lender, and all cash receipts were included in the lockbox and wereapplied against the outstanding line of credit.  As discussed in Note 7 to the consolidated financial statements,the Company was in violation of two covenants of the Credit Facility as ofDecember 31, 2002.  The Company hadpreviously received a waiver from the Lender and the previous Lender as ofDecember 31, 2001, but was required to meet such covenants thereafter. Asindicated in Note 7, the Company determined that violations of the tangible networth and liabilities to worth ratio covenant occurred for

 

27

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the quarter ended March 31, 2001.  The Company obtained a waiver for theseviolations from the Lender.  On March29, 2002, the Company and the previous Lender set new covenants for fiscal2002. Borrowings outstanding under the Credit Facility were secured by acollateral pledge to the Lender of substantially all of the assets of theCompany.  On February 19, 2003, theCompany and the Lender signed a third amendment to the original agreementextending the credit facility for one year until February 28, 2004.  On February 6, 2004, the Company and theLender entered into a Fourth Amendment and Waiver in connection with theCompany’s sale of the assets of the Morehouse-COWLES Division.  At December 31, 2003, the Company did notmeet the net income covenant and would have required a waiver from its previouslender.  However, in conjunction withthe new credit facility it obtained from the new lender, Banknorth, N.A., nowaiver was required from the previous Lender.

 

On March 3,2004, the Company entered into a Revolving Credit and Term Loan Agreement witha new lender, Banknorth, N.A. (the “New Lender”), providing the Company with a$2 million credit facility (the “Credit Facility”).  The proceeds drawn down from the New Lender under the creditfacility were used to pay off both the line of credit and term loan owed PNCBank N.A. (the previous Lender).

 

Under theterms of agreement with the New Lender, the Company has two covenants that itmust meet on an annual basis.  TheCompany borrows funds on the Revolving Credit Line at the prime rate. The $1million Term Loan is payable ratably over a four year period at the fixed ratecalculated equal to the Federal Home Loan Bank Classic Rate plus 2.5%.  See discussion of New Credit Facility, inthe notes to the Financial Statements.

 

The Company’s ability to continue plannedoperations is dependent upon access to financing which is potentially impactedby the Company’s ability to achieve future compliance with financial covenants.

 

Assuming thatthere is no significant change in the Company’s business, the Company believesthat cash flows from operations, together with existing cash balances, will besufficient to meet its working capital and debt service requirements for atleast the next twelve months.

 

Additionally,although the Company has raised approximately $3.6 million in a privateplacement offering which closed in March, 2004 (see Note 15 – SubsequentEvents), the Company may, from time to time, seek to raise additional capitalfor various initiatives that management believes advance the interests of theCompany.  The terms upon which theCompany may raise such additional capital may include private placements of itsstock, which placements are usually priced at discount to the then-currentmarket price of the Company’s stock (in order to compensate for the fact thatthe stock being sold is not freely-tradeable) or upon other terms thatmanagement believes appropriate under the circumstances

# ** **

 

**Recent AccountingPronouncements**

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidationof Variable Interest Entities, an Interpretation of Accounting ResearchBulletin No 51, Consolidated Financial Statements” (FIN 46).  FIN 46 establishes accounting guidance forconsolidation of variable interest entities that function to support theactivities of the primary beneficiary. FIN 46 applies to any business enterprise, both public and private, thathas a controlling interest, contractual relationship or other businessrelationship with a variable interest entity. The Company does not have any investments in or contractualrelationships or other business relationships with any variable interest entityand therefore, based on present facts and circumstances, the adoption of FIN 46is not expected to have a material impact on the Company’s consolidatedfinancial position or results of its operations.

 

In May 2003, the FASB issued SFAS No. 150,“Accounting for Certain Financial Instruments with Characteristics of BothLiabilities and Equity” (SFAS 150). SFAS 150 establishes standards for classifying and measuring asliabilities certain financial instruments that embody obligations of the issuerand have characteristics of both liabilities and equity.  SFAS 150 represents a significant change inpractice in the accounting for a number of financial instruments, includingmandatorily redeemable

 

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equity instruments and certain equityderivatives that frequently are used in connection with share repurchaseprograms.  The Company does not use suchinstruments in its share repurchase program. SFAS 150 is effective for all financial instruments created or modifiedafter May 31, 2003.  Adoption of SFAS150, based on present facts and circumstances, is not expected to have amaterial effect on the Company’s consolidated financial position or results ofits operations.

 

 

**Item7A.                 QUANTITATIVE ANDQUALITIVE DISCLOSURES ABOUT MARKET RISK**

 

The Company’sfinancial instruments are generally not subjected to changes in market value asa result of changes in interest rates due to the short maturities of theinstruments.  The Company’s fixed ratedebt is not exposed to cash flow or interest rate changes but is exposed tofair market value changes in the event of refinancing this fixed ratedebt.  The Company does not havesignificant exposure to fluctuations in foreign exchange rates.

 

The Companyhad approximately $2,484,000 of variable rate borrowings outstanding under itsrevolving credit agreement at December 31, 2003.  A hypothetical 10% adverse change in interest rates for thisvariable rate debt would have had an approximate $12,000 negative effect on theCompany’s earnings and cash flows on an annual basis.

 

For additional information about theCompany’s financial instruments, see Note 7.

 

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**Item8.**                    **FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

TheConsolidated Financial Statements of the Company and its Subsidiaries appear atthe end of this report starting on page F-1 and include:

 
| Report of Independent Auditors                                                                                              |   |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                        |   |   |
| Consolidated Balance Sheets as of  December 31, 2003 and 2002                                                          |   |   |
|                                                                                                                        |   |   |
| Consolidated Statements of Operations for  the years ended December 31, 2003, 2002 and 2001                            |   |   |
|                                                                                                                        |   |   |
| Consolidated Statements of Cash Flows for the years ended  December 31, 2003, 2002 and 2001                            |   |   |
|                                                                                                                        |   |   |
| Consolidated Statements of Changes in  Stockholders’ Equity for the years ended December 31, 2003, 2002 and  2001 |   |   |
|                                                                                                                        |   |   |
| Notes to Consolidated Financial Statements                                                                                  |   |   |

 

 

**Item 9.****                                                           CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

 

**None.**

 

 

**Item 9A.****                                                 ****CONTROLS ANDPROCEDURES**

 

(a)      *Evaluation of disclosure controls and procedures*.  Based on his evaluation as of a date within90 days prior to the filing date of this Annual Report on Form 10-K, ourprincipal executive officer and principal financial officer have concluded thatour disclosure controls and procedures (as defined in Rules 13a-14(c) and15d-14(c) under the Securities Exchange Act of 1934) are effective to ensure thatinformation required to be disclosed by us in reports that we file or submitunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in Securities and Exchange Commission rules andforms.

 

(b)    *Changes in internal controls*.  There were no significant changes in ourinternal controls or in other factors that could significantly affect thesecontrols subsequent to the date of their evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 

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**Item10.**                                                    **DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

Each director of the Company is electedannually and holds office for the ensuing year and until his successor has beenelected and qualified.  The names of theCompany’s current directors, executive officers, directors-elect and certaininformation about them are set forth below: 

 

| **Name**            |   | **Age** |   | **Title**                                                                |
|---------------------|--------|---------|--------|--------------------------------------------------------------------------|
|                |   |    |   |                                                                     |
| Irwin J. Gruverman  |   | 70      |   | Chief Executive Officer,  Chairman of the Board, Treasurer and Secretary |
|                |   |    |   |                                                                     |
| Robert P. Bruno     |   | 66      |   | President, Chief  Operating Officer, and Vice-President Sales/Marketing  |
|                |   |    |   |                                                                     |
| Jack M. Swig        |   | 55      |   | Vice President  –Corporate Development and General Counsel          |
|                |   |    |   |                                                                     |
| Dennis P. Riordan   |   | 57      |   | Controller                                                               |
|                |   |    |   |                                                                     |
| James N. Little     |   | 63      |   | Director                                                                 |
|                |   |    |   |                                                                     |
| Vincent B. Cortina  |   | 64      |   | Director                                                                 |
|                |   |    |   |                                                                     |
| Edward T. Paslawski |   | 53      |   | Director                                                                 |
|                |   |    |   |                                                                     |
| Leo Pierre Roy      |   | 46      |   | Director                                                                 |

 

IRWIN J.GRUVERMAN has served as the Chief Executive Officer, Chairman of the Board ofDirectors and Secretary of the Company since its inception in 1983.  He also currently serves as the Company’sTreasurer.  From the Company’s inceptionin 1983 to June 1993, and from November 21, 2000 until May 17, 2001, Mr.Gruverman served as its President.  Inaddition, Mr. Gruverman currently serves on the Board of Directors of thefollowing public companies:  NorthAmerican Scientific, Inc. and InVitro International, Inc.

 

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ROBERT P. BRUNO joined the Company on April 8, 1996 as Vice-Presidentof Sales/Marketing.  Mr. Bruno wasappointed as Chief Operating Officer on November 30, 2000.  Mr. Bruno was appointed as President on May17, 2001 with such appointment becoming effective on May 21, 2001.

 

JACK M. SWIG joined the Company as a full timeemployee in January 1996 and was appointed in January 1999 as the VicePresident – Corporate Development and General Counsel. He has served as theCompany’s General Counsel and Investor Relations Manager since 1993. Mr. Swighas almost 25 years venture capital, corporate finance and merchant/investmentbanking experience. 

 

DENNIS P. RIORDAN joined the Company on February 12, 1996 as theController.  Mr. Riordan previously served as Controller-Residential Group for Winthrop Management from May, 1989 to May, 1994. FromJune, 1986 to May, 1989, he served in various positions as an assistantcontroller at Krupp Management, a real estate concern. Prior to that, Mr.Riordan had spent twelve years in public accounting, primarily as an auditmanager.

 

JAMES N. LITTLE has served as a director of the Company since December1995. Dr. Little serves as President of Cetek Corporation, a biotechnology drugdiscovery company. From August 1998 until December 26, 2001, Dr. Little servedas Senior Vice President of Cetek. Prior to that, from 1981 to August 1998, Dr. Little served as a SeniorVice President of Sales, Marketing and Business Development for ZymarkCorporation, a manufacturer of scientific instrumentation.

 

VINCENT B.CORTINA has served as a director of the Company since May 1997.  Mr. Cortina serves as principal of CorvisAssociates, a management consulting firm. From 1999 until mid-2001, Mr. Cortinaserved as Director of Operations for Advanced Instruments, Inc., a manufacturerof laboratory and clinical instruments. Prior to that he served as a self-employed business consultant.  From 1990 to 1996 he served as President ofAdvanced Monitors, Inc., a company which develops and manufactures industrialand commercial instruments.

 

EDWARD T.PASLAWSKI has served as a director of the Company since June 2000. Mr.Paslawski is principalin the Arete Capital Group, a firm providing investment banking and financialadvisory services.  Prior to co-foundingArete, Mr. Paslawski served as the New England Regional Manager and VicePresident of LaSalle Business Credit, Inc., an asset-based lending subsidiaryof LaSalle Bank. Mr. Paslawski is the founder and managing partner of DurhamCapital, LLC, an investment-banking firm specializing in arranging andinvesting equity in start-ups and growth companies.  The company also provides merger and acquisition advisoryservices. He also serves as the Chairman of CEI Ventures Inc., the managingpartner of Coastal Ventures Limited Partnership and Coastal Ventures, LLC.  Mr. Paslawski has thirty years of commercialbanking and venture capital experience in senior lending positions with majorUS and international banks including The National Bank of Canada, MeridianCapital Corp., First National Bank of Boston, and The Industrial Bank of Japan.

 

LEO PIERRE ROY has served as a director of the Company since June 2000.Mr. Roy has more than 20 years of experience as a senior manager andconsultant. Mr. Roy currently serves as director of environmental services atVanasse Hangen & Brustlin, Inc. (VHB), a recognized leader in providing transportation, landdevelopment, and environmental services. Prior to joining VHB, Mr. Roy was the Vice President and ChiefOperating Officer of The Bioengineering Group, Inc., a firm engaged inconsulting in the areas of erosion control, water quality, ecologicalrestoration and bioremediation from 2000 to 2003.  Between 1998 and 2000 he has served as the President of Houqua& Company, Inc., a consulting firm specializing in strategic planning anddevelopment services.  From 1997 to1998, Mr. Roy served as President and

 

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Chief Operating Officer of Energy Answers Corporation, a designer,developer and owner of resource recovery, power, recycling and solid wastemanagement companies.  From 1992 to1996, Mr. Roy served first as Director of Waste Policy and Planning and lateras Undersecretary of the Executive Office of Environmental Affairs for theCommonwealth of Massachusetts.  From1990 to 1991, Mr. Roy was the Regional Manager of Special Projects for WasteManagement, Inc.  From 1985 to 1989, hewas the Vice President and Chief Operating Officer of Orne Enterprises, Inc., aventure capital, environmental technology holding company.

 

**Section16(a) Beneficial Ownership Reporting Compliance**

 

One timely filed Form 5 was notmade for Robert P. Bruno, Vincent B. Cortina, James N. Little, Edward T.Paslawski, Leo Pierre Roy and Jack M. Swig, each of which would have includedone transaction.  One timely filed Form5 was not made for Irwin J. Gruverman, which would have included twotransactions.  One timely filed Form 5was not made for Dennis P. Riordan, which have included threetransactions.  Reports for each of thesepersons were filed on the applicable Form 5 on March 29, 2004.

 

**Codeof Ethics**

 

The Company has adopted a Code of Ethics that applies to all of theCompany's employees, officers and directors, and which is attached to thisReport as Exhibit 14.  Any person mayreceive a copy, without charge, of the Company's Code of Ethics by sending arequest for the Code of Ethics to MFIC Corp., 30 Ossipee Road, Newton, MA02464-9101, ATTN: Investor Relations.

 

**Item11.****                                                    EXECUTIVECOMPENSATION**

 
|                                             |   |     |   | **Annual  Compensation** |    | **Long-Term Compensation** |   |
|--------------------------------------------------|--------|----------|--------|--------------------------|---------|----------------------------|--------|
| **Name and Principal  Position**                 |   | **Year** |   | **Salary**               |    | **Bonus**                  |   | **Securities  Underlying  Stock  Options (#)** |   | **All Other  Compensation(1)** |   |
|                                             |   |     |   |                     |    |                       |   |   |   |   |   |
| Irwin J. Gruverman                               |   | 2003     |   | $                        | 95,000  |                       | 0      |   | 50,000 |   | 0 |   |
| Chief Executive Officer,  Chairman of            |   | 2002     |   | $                        | 59,025  |                       | 0      |   | 150,000 |   | 0 |   |
| the Board of Directors,  Treasurer and Secretary |   | 2001     |   | $                        | 95,000  |                       | 0      |   | 75,000 |   | 0 |   |
|                                             |   |     |   |                     |    |                       |   |   |   |   |   |
| Robert P. Bruno                                  |   | 2003     |   | $                        | 150,000 |                       | 0      |   | 50,000 |   | 0 |   |
| President, Chief  Operating Officer,             |   | 2002     |   | $                        | 138,902 |                       | 0      |   | 50,000 |   | 0 |   |
| and Vice President Sales/Marketing               |   | 2001     |   | $                        | 118,059 |                       | 0      |   | 125,000 |   | 0 |   |

 

----

(1)           Consists of the Company’s matching contributions madeunder its 401(k) plan on behalf of each Named Executive Officer.

 

**Item12.**                                                    **SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

**Principal Holders Of Voting Securities**

 
| **Name and Address of  Beneficial Owner**                                    |   | **Amount and  Nature of  Beneficial  Ownership(1)** |   | **Percent of  Class(2)** |   |
|------------------------------------------------------------------------------|--------|-----------------------------------------------------|--------|--------------------------|--------|
|                                                                         |   |                                                |   |                     |   |
| Irwin J. Gruverman(3) 30  Ossipee Road Newton, Massachusetts 02464           |   | 1,979,555                                           |   | 21.7                     | %      |
|                                                                         |   |                                                |   |                     |   |
| Husic Capital Management(5)  555 California Street, San Francisco, CA. 94104 |   | 1,564,988                                           |   | 17.2                     | %      |
|                                                                         |   |                                                |   |                     |   |
| G.D. Searle & Co.(4)  Box 511D Chicago, Illinois 60680                   |   | 600,000                                             |   | 6.6                      | %      |

 

33

----

 

----

(1)                                  Information with respect to beneficial ownership is based uponinformation furnished by such shareholder.

 

(2)           Shares of Common Stock that a person or entity has theright to acquire within 60 days of March 24, 2004, according to Registrar andTransfer Company, the Company’s Transfer Agent, pursuant to the exercise ofoptions are deemed to be outstanding for the purpose of computing thepercentage ownership of such person or entity, but are not deemed to beoutstanding for the purpose of computing the percentage ownership of any otherperson or entity shown in the table. Percentage ownership is based on9,115,432 shares ofCommon Stock issued and outstanding on March 24, 2004.

 

(3)           Consists of (i) 342,300 shares of Common Stock, (ii) 383,750 shares of Common Stock subject tocurrently exercisable options, (iii) 153,505 shares of Common Stock ownedjointly by Mr. Gruverman and his wife, (iv) 100,000 shares of CommonStock owned by his wife, and (v) 1,000,000 shares of restricted Common Stock purchased byMr. Gruverman on February 28, 2000. Mr. Gruverman disclaimsbeneficial ownership of the 100,000 shares of Common Stock owned by his wife.

 

(4)           Information with respect to beneficial ownership is basedupon information furnished by G.D. Searle & Co. in a Form 4 filedwith the Securities and Exchange Commission on January 5, 1994.

 

(5)           Information with respect tobeneficial ownership is based upon information furnished by Husic CapitalManagement on form 4 and schedule 13G filed with the Securities and ExchangeCommission dated February 11, 2004 and January 15, 2004 respectively, whichownership is deemed to be under common control.

 

# **Beneficial Ownership OfDirectors And Executive Officers**

 

The following table sets forth for current directors and each executiveofficer named in the Executive Compensation table below, the positionscurrently held by each person with the Company and the number and percentage ofoutstanding shares of Common Stock beneficially owned by each person and by allcurrent directors and executive officers as a group as of February 12, 2004. 

 
|                                                                 |   | **Positions  and Offices with  the Company**                                            |   | **Amount and  Nature of  Beneficial Ownership  (1)(2)** |   | **Percent of  Class** |   |
|----------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|--------|---------------------------------------------------------|--------|-----------------------|--------|
|                                                                 |   |                                                                                    |   |                                                    |   |                  |   |
| Irwin J. Gruverman                                                   |   | Chief  Executive Officer, Chairman of the Board of Directors, Secretary, and  Treasurer |   | 1,979,555                                               | (3)    | 24.71                 | %      |
| Robert P. Bruno                                                      |   | President,  Chief Operating Officer, and Vice President Sales/Marketing                 |   | 282,050                                                 | (4)    | 3.5                   | %      |
| Dennis P. Riordan                                                    |   | Controller                                                                              |   | 113,327                                                 | (5)    | 1.41                  | %      |
| Jack M. Swig                                                         |   | V.P. –  Corporate Development and General Counsel                                  |   | 98,290                                                  | (6)    | 1.22                  | %      |
| Edward T. Paslawski                                                  |   | Director                                                                                |   | 41,875                                                  | (7)    |                  | *      |
| Leo Pierre Roy                                                       |   | Director                                                                                |   | 41,875                                                  | (8)    |                  | *      |
| James N. Little                                                      |   | Director                                                                                |   | 24,375                                                  | (9)    |                  | *      |
| Vincent B. Cortina                                                   |   | Director                                                                                |   | 24,375                                                  | (10)   |                  | *      |
|                                                                 |   |                                                                                    |   |                                                    |   |                  |   |
| All current directors and executive  officers as a group (8 persons) |   |                                                                                    |   | 2,665,722                                               | (11)   | 37.52                 | %      |

 

----

*              Less than 1%

 

(1)           Unless otherwise indicated, eachperson possesses sole voting and investment power with respect to the shares.

 

(2)           Shares of Common Stock that a personhas the right to acquire within 60 days of February 12, 2004, pursuant tothe exercise of options are deemed to be outstanding for the purpose ofcomputing the percentage ownership of such person, but are not deemed to beoutstanding for the purpose of computing the percentage ownership of any otherperson shown in the table. The inclusion herein of any shares of Common Stockdeemed beneficially owned does not constitute an admission of beneficialownership of those shares. Percentage ownership is based on 8,011,691 shares ofCommon Stock issued and outstanding on February 12, 2004.

 

(3)           Consists of (i) 342,300 sharesof Common Stock, (ii) 383,750 shares of Common Stock subject to currentlyexercisable options, (iii) 153,505 shares of Common Stock owned jointly byMr. Gruverman and his wife, (iv) 100,000 shares of Common Stock ownedby his wife, and (v) 1,000,000 shares of restricted Common Stock.Mr. Gruverman disclaims beneficial ownership of the 100,000 shares ofCommon Stock owned by his wife.

 

(4)           Consists of 278,750 shares of CommonStock subject to currently exercisable options, and 3,300 shares of CommonStock.

 

(5)           Consists of 103,750 shares of CommonStock subject to currently exercisable options and 9,577 shares of Common Stockowned jointly by Mr. Riordan and his wife.

 

(6)           Consists of 98,250 shares of CommonStock subject to currently exercisable options and 40 shares of Common Stockowned by Mr. Swig.

 

(7)           Consists of 41,875 shares of CommonStock subject to currently exercisable options.

 

(8)           Consists of 41,875 shares of CommonStock subject to currently exercisable options.

 

(9)           Consists of 24,375 shares of CommonStock subject to currently exercisable options.

 

(10)         Consists of 24,375 shares of CommonStock subject to currently exercisable options.

 

(11)         Includes 997,000 shares of Common Stocksubject to currently exercisable options. See footnotes 3 through 10 above.

 

**Item13.**                                                    **CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

During 2002and 2003, the Company leased a facility in South Haven, Michigan from B-2Enterprises, Inc. This entity is owned and controlled by Messrs. J.B. Jenningsand Bret A. Lewis, former principal shareholders.  In 2003 and 2002, the Company paid B-2 Enterprises, Inc.approximately $63,295 and $102,180 in rent, respectively.

 

34

----

 

**Item14.****                                                    INDEPENDENTACCOUNTANT FEES FOR FISCAL 2003 AND FISCAL 2002**

 

*Audit Fees*

 

The aggregatefees billed by Brown & Brown LLP for services completed during fiscal 2003and fiscal 2002 were approximately $70,000 and $74,000 respectively related toits audit and quarterly reviews.

 

*Financial Information Systems Design and Implementaion Fees*

 

During theyears ended December 31, 2003 and December 31, 2002, Brown & Brown LLP didnot provide any services to the Company relating to financial information systemsdesign and implementation.

 

*All Other Fees*

 

During theyears ended December 31, 2003 and December 31, 2002, Brown & Brown LLP waspaid approximately $16,000 and $8,000 respectively for non-audit services.  During the year ended December 31, 2002, Deloitte& Touche LLP was paid approximately $16,000 for non-audit services

 

The AuditCommittee has considered whether the provision of non-core audit services tothe Company by the Company’s principal auditor is compatible with maintainingindependence, and has made an affirmative decision in each instance that theprovision of such service was compatible with the principal auditor’sindependent role.

 

35

----

 

**Item 15.****                                                    EXHIBITS,FINANCIAL STATEMENT SCHEDULES AND REPORTS ON****FORM 8-K**

 

**(a)1.**        **Consolidated Financial Statements.**

 

The following Consolidated Financial Statements are included inItem 8:

 
|                                                                                                                         | **Page** |
|------------------------------------------------------------------------------------------------------------------------------|----------|
| Reports of Independent Auditors                                                                                              | F-1      |
|                                                                                                                         |     |
| Consolidated  Balance Sheets as of December 31, 2003 and 2002                                                           | F-2      |
|                                                                                                                         |     |
| Consolidated Statements of Operations for  the years ended December 31, 2003, 2002, and 2001                            | F-4      |
|                                                                                                                         |     |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2003, 2002,  and 2001                           | F-5      |
|                                                                                                                         |     |
| Consolidated Statements of Changes in  Stockholders’ Equity for the years ended December 31, 2003, 2002, and  2001 | F-6      |
|                                                                                                                         |     |
| Notes to Consolidated Financial Statements                                                                                   | F-7      |

 

**(b)****                                  Reportson Form 8-K.**

1.)           The Company filed a current report on Form8-K regarding preliminary unaudited fiscal 2003 and fourth quarter salesresults dated March 5, 2004.

 

2.)           The Company filed a current report on Form8-K regarding the commencement of a private placement offering dated February20, 2004.

 

3.)           The Company filed a current report on Form8-K regarding the disposition of selected assets and liabilities dated February13, 2004.

 

4.)           The Company filed a current report on Form8-K regarding changes in its certifying accountant dated October 29, 2001.

 

**(c)****                                  Exhibits.**

The Company hereby files as part of this Form10-K the Exhibits listed in Item 15(a)3 as set forth above.

 

**(d)****                                  FinancialStatement Schedules.**

 

The following Consolidated Financial Statement Schedule of theRegistrant is filed as part of this report:

 

Schedule II – Valuation and Qualifying Accounts and Reserves

 

36

----

 

**INDEPENDENT AUDITORS****REPORT**

 

 

The Board of Directors andStockholders of MFIC Corporation:

 

We haveaudited the accompanying consolidated balance sheets of MFIC Corporation andsubsidiaries as of December 31, 2003 and 2002 and the related consolidatedstatements of operations, stockholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2003. Our audits also included thefinancial statement schedule listed in the Index at Item 15(a).  These financial statements and schedule arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements and schedulebased on our audits.

 

We conducted our audits inaccordance with auditing standards generally accepted in the United States ofAmerica. Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audit provides a reasonable basisfor our opinion.

 

In our opinion, the 2003consolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of MFIC Corporation andsubsidiaries at December 31, 2003 and 2002 and the consolidated results oftheir operations and their cash flows for the three years in the period endedDecember 31, 2003, in conformity with accounting principles generally acceptedin the United States of America.  Also,in our opinion, the related financial statement schedule, when considered inrelation to the basic financial statements taken as a whole, presents fairly inall material respects the information set forth therein.

 

As discussed in Note 4 to thefinancial statements, on February 5, 2004, the Company entered into anagreement to sell a major division of its operations.  The division represents a significant portion of the Company’stotal assets and operations.

 
|                                                                         | /s/ BROWN  & BROWN, LLP |   |
|------------------------------------------------------------------------------|-----------------------------|--------|
|                                                                         |                        |
|                                                                         |                        |
| Boston,  Massachusetts                                                       |                        |
| March 11,  2004, Except for Note 15, as to which  the date is March 31, 2004 |                        |

 

F-1

----

**MFIC CORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                              |   | **December  31,** |          |
|-------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------------|
|                                                                                                              |   | **2003**          |          | **2002** |   |
| **ASSETS**                                                                                                        |   |              |          |   |   |
|                                                                                                              |   |              |          |   |   |
| *Current Assets:*                                                                                                 |   |              |          |   |   |
| Cash and cash equivalents                                                                                         |   | $                 | 50,270        |   | $ | 84,956 |   |
| Accounts receivable, less allowance for  doubtful accounts of $58,500 and $33,500 in 2003 and 2002, respectively. |   | 1,814,584         |          | 1,535,951 |   |
| Note receivable – current                                                                                    |   | 16,429            |          | 16,429 |   |
| Inventories, net                                                                                                  |   | 1,683,703         |          | 2,066,462 |   |
| Prepaid expenses                                                                                                  |   | 207,210           |          | 157,710 |   |
| Other current assets                                                                                              |   | 38,749            |          | 166,030 |   |
| Assets available for sale                                                                                         |   | 1,383,118         |          | 5,131,464 |   |
| **TOTAL CURRENT ASSETS**                                                                                          |   | **5,194,063**     | ** **    | **9,159,002** | ** ** |
|                                                                                                              |   |              |          |   |   |
| *Property and Equipment, at cost:*                                                                                |   |              |          |   |   |
| Furniture, fixtures and office equipment                                                                          |   | 330,022           |          | 288,472 |   |
| Machinery and equipment                                                                                           |   | 219,765           |          | 219,765 |   |
| Leasehold improvements                                                                                            |   | 50,568            |          | 45,337 |   |
|                                                                                                              |   | **600,355**       |          | **553,574** | ** ** |
| Less: Accumulated depreciation and  amortization                                                                  |   | (418,066          | )             | (356,764 | ) |
| **Net property and equipment**                                                                                    |   | **182,289**       | ** **    | **196,810** | ** ** |
|                                                                                                              |   |              |          |   |   |
| Note receivable – long-term                                                                                  |   | 54,761            |          | 71,190 |   |
| Patents, licenses and other assets (net of  accumulated amortization of $303,785 in 2003 and $299,985 in 2002)    |   | 55,978            |          | 59,778 |   |
| **TOTAL ASSETS**                                                                                                  |   | **$**             | **5,487,091** | ** ** | **$** | **9,486,780** | ** ** |

 

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

 

F-2

----

 
|                                                                                                                                                                                                   |   | **December  31,** |          |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------------|
|                                                                                                                                                                                                   |   | **2003**          |          | **2002** |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                          |   |              |          |   |   |
|                                                                                                                                                                                                   |   |              |          |   |   |
| *Current Liabilities:*                                                                                                                                                                                 |   |              | * *      |   | * * |
| Line of credit                                                                                                                                                                                         |   | $                 | 2,425,613     |   | $ | 2,681,987 |   |
| Accounts payable and accrued expenses                                                                                                                                                                  |   | 1,061,897         |          | 1,335,289 |   |
| Accrued interest– related party                                                                                                                                                                   |   | 2,639             |          | 14,980 |   |
| Accrued compensation and vacation pay                                                                                                                                                                  |   | 111,855           |          | 158,119 |   |
| Customer advances                                                                                                                                                                                      |   | 223,501           |          | 232,035 |   |
| Current portion of term note payable                                                                                                                                                                   |   | 58,735            |          | 95,004 |   |
| Current portion of long-term debt- related  party                                                                                                                                                      |   | 75,000            |          | 75,000 |   |
| Liabilities associated with assets available  for sale                                                                                                                                                 |   | 661,095           |          | 652,013 |   |
| **TOTAL CURRENT LIABILITIES**                                                                                                                                                                          |   | **4,620,335**     | ** **    | **5,244,427** | ** ** |
|                                                                                                                                                                                                   |   |              |          |   |   |
| Long-term debt, net of current portion-  related party                                                                                                                                                 |   | 6,250             |          | 81,250 |   |
| Term note                                                                                                                                                                                              |   | —            |          | 58,735 |   |
| Commitments (Note 11)                                                                                                                                                                                  |   |              |          |   |   |
| *Stockholders’ Equity:*                                                                                                                                                                           |   |              |          |   |   |
| Common Stock, par value $.01 per share,  20,000,000 shares authorized; 8,288,604 and 7,965,510 shares issued;  8,028,158 and 7,705,064 shares outstanding at December 31, 2003 and 2002,  respectively |   | 80,281            |          | 77,051 |   |
| Additional paid-in capital                                                                                                                                                                             |   | 13,150,862        |          | 12,945,520 |   |
| Accumulated deficit                                                                                                                                                                                    |   | (11,682,936       | )             | (8,232,502 | ) |
| Less: Treasury Stock, at cost, 260,446  shares at December 31, 2003 and 2002, respectively                                                                                                             |   | (687,701          | )             | (687,701 | ) |
|                                                                                                                                                                                                   |   |              |          |   |   |
| **TOTAL STOCKHOLDERS’ EQUITY**                                                                                                                                                                    |   | **860,506**       | ** **    | **4,102,368** | ** ** |
|                                                                                                                                                                                                   |   |              | ** **    |   | ** ** |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                    |   | **$**             | **5,487,091** | ** ** | **$** | **9,486,780** | ** ** |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

F-3

----

 

**MFIC CORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
|                                                                                                            |   | **Years  Ended December 31,** |       |
|-----------------------------------------------------------------------------------------------------------------|--------|-------------------------------|------------|
|                                                                                                            |   | **2003**                      |       | **2002** |   | **2001** |   |
| Revenues                                                                                                        |   | $                             | 10,459,631 |   | $ | 9,514,180 |   | $ | 11,210,375 |   |
| Cost of goods sold                                                                                              |   | 4,988,226                     |       | 4,438,351 |   | 5,629,484 |   |
| Gross income                                                                                                    |   | 5,471,405                     |       | 5,075,829 |   | 5,580,891 |   |
| Operating expenses:                                                                                             |   |                          |       |   |   |   |   |
| Research and development                                                                                        |   | 785,849                       |       | 583,683 |   | 537,428 |   |
| Selling                                                                                                         |   | 2,187,389                     |       | 2,086,547 |   | 2,263,226 |   |
| General and administrative                                                                                      |   | 1,732,087                     |       | 1,763,884 |   | 2,504,764 |   |
| Total operating expenses                                                                                        |   | 4,705,325                     |       | 4,434,114 |   | 5,305,418 |   |
|                                                                                                            |   |                          |       |   |   |   |   |
| Income from continuing operations                                                                               |   | 766,080                       |       | 641,715 |   | 275,473 |   |
|                                                                                                            |   |                          |       |   |   |   |   |
| Interest expense                                                                                                |   | (116,097                      | )          | (179,429 | ) | (261,754 | ) |
| Interest income                                                                                                 |   | 9,508                         |       | 7,191 |   | 7,032 |   |
| Other expense                                                                                                   |   | —                        |       | — |   | (53,142 | ) |
|                                                                                                            |   |                          |       |   |   |   |   |
| Net income (loss) from continuing  operations                                                                   |   | 659,491                       |       | 469,477 |   | (32,391 | ) |
|                                                                                                            |   |                          |       |   |   |   |   |
| Loss from discontinued operations (Net of  loss from disposal of discontinued operations of $1,422,715 in 2003) |   | (4,109,925                    | )          | (2,983,451 | ) | (492,795 | ) |
| Net loss                                                                                                        |   | $                             | (3,450,434 | ) | $ | (2,513,974 | ) | $ | (525,186 | ) |
|                                                                                                            |   |                          |       |   |   |   |   |
| Weighted average number of common and  common equivalent shares outstanding:                                    |   |                          |       |   |   |   |   |
| Basic                                                                                                           |   | 7,767,712                     |       | 7,426,586 |   | 7,375,102 |   |
| Diluted                                                                                                         |   | 8,501,110                     |       | 7,470,090 |   | 7,375,102 |   |
| Basic amounts per common share:                                                                                 |   |                          |       |   |   |   |   |
| Net income (loss) per share from continuing  operations                                                         |   | $                             | .08        |   | $ | .06 |   | $ | (.00 | ) |
| Basic net (loss) per share from  discontinued operations                                                        |   | $                             | (.52       | ) | $ | (.40 | ) | $ | (.07 | ) |
| Basic, as reported                                                                                              |   | $                             | (.44       | ) | $ | (.34 | ) | $ | (.07 | ) |
|                                                                                                            |   |                          |       |   |   |   |   |
| Diluted amounts per common share:                                                                               |   |                          |       |   |   |   |   |
| Net income (loss) per share from continuing  operations                                                         |   | $                             | .08        |   | $ | .06 |   | $ | (.00 | ) |
| Diluted net (loss) per share from  discontinued operations                                                      |   | $                             | (.52       | ) | (.40 | ) | $ | (.07 | ) |
| Diluted, as reported                                                                                            |   | $                             | (.44       | ) | $ | (.34 | ) | $ | (.07 | ) |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

F-4

----

 

###### **MFIC CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
|                                                                                         |   | **Years  Ended December 31,** |       |
|----------------------------------------------------------------------------------------------|--------|-------------------------------|------------|
|                                                                                         |   | **2003**                      |       | **2002** |   | **2001** |   |
| *Cash flows from operating activities:*                                                      |   |                          |       |   |   |   |   |
| Net loss                                                                                     |   | $                             | (3,450,434 | ) | $ | (2,513,974 | ) | $ | (525,186 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:                 |   |                          |       |   |   |   |   |
| Change in accounting principle                                                               |   | —                        |       | 2,661,409 |   | — |   |
| Impairment of Goodwill                                                                       |   | 2,100,000                     |       | — |   | — |   |
| Provision for disposal of discontinued  operations                                           |   | 1,422,715                     |       | — |   | — |   |
| Depreciation and amortization                                                                |   | 264,101                       |       | 308,131 |   | 726,252 |   |
| Provision for loss on trade receivables                                                      |   | 24,378                        |       | 6,985 |   | (17,322 | ) |
| Provision for other receivables                                                              |   | 76,000                        |       | — |   | — |   |
| Provision for obsolete inventory                                                             |   | 60,000                        |       | — |   | — |   |
| Gain on sale of assets                                                                       |   | (26,931                       | )          | (42,268 | ) | (32,254 | ) |
| Issuance of restricted common stock to  consultants                                          |   | —                        |       | 11,668 |   | — |   |
| *Changes in assets and liabilities:*                                                         |   |                          |       |   |   |   |   |
| Receivables                                                                                  |   | 146,573                       |       | 242,043 |   | 143,892 |   |
| Inventories                                                                                  |   | (49,733                       | )          | 64,647 |   | 60,495 |   |
| Prepaid expenses                                                                             |   | (50,209                       | )          | (11,831 | ) | 42,413 |   |
| Other current assets                                                                         |   | 51,281                        |       | (40,229 | ) | (61,882 | ) |
| Current liabilities                                                                          |   | (331,449                      | )          | (287,833 | ) | (92,423 | ) |
| Loss on sale of Ball Mill repair business  assets                                            |   | —                        |       | — |   | 53,142 |   |
| Net cash provided by operating activities                                                    |   | 236,292                       |       | 398,748 |   | 297,127 |   |
|                                                                                         |   |                          |       |   |   |   |   |
| *Cash flows from investing activities:*                                                      |   |                          |       |   |   |   |   |
| Proceeds from sale of fixed assets                                                           |   | 26,931                        |       | 105,991 |   | 37,925 |   |
| Purchase of fixed assets                                                                     |   | (96,532                       | )          | (163,864 | ) | (200,000 | ) |
| Issuance of note receivable in connection  with sale of Ball Mill operation                  |   | —                        |       | — |   | (115,000 | ) |
| Proceeds from note receivable                                                                |   | 16,429                        |       | 19,167 |   | 8,214 |   |
| Proceeds from sale of Ball Mill repair  business assets (net of selling expenses of $40,000) |   | —                        |       | — |   | 160,000 |   |
| Net cash used in investing activities                                                        |   | (53,172                       | )          | (38,706 | ) | (108,861 | ) |
|                                                                                         |   |                          |       |   |   |   |   |
| *Cash flows from financing activities:*                                                      |   |                          | * *   |   | * * |   | * * |
| Net payments on bank line of credit                                                          |   | (256,374                      | )          | — |   | (188,223 | ) |
| Net proceeds from bank line of credit                                                        |   | —                        |       | 146,195 |   | — |   |
| Payments on term note                                                                        |   | (95,004                       | )          | (95,004 | ) | (155,004 | ) |
| Payments on note payable                                                                     |   | —                        |       | (350,000 | ) | — |   |
| Issuance of common stock under employee  stock purchase plan                                 |   | 11,713                        |       | 11,581 |   | 17,909 |   |
| Issuance of common stock under employee  stock option plan                                   |   | 144,859                       |       | 6,006 |   | 7,614 |   |
| Issuance of common stock purchased through  warrants                                         |   | 52,000                        |       |   |   |   |   |
| Purchase of common stock                                                                     |   |                          |       | — |   | (7,031 | ) |
| Payments on subordinated debt-related party                                                  |   | (75,000                       | )          | (81,250 | ) | (62,500 | ) |
| Net cash (used in) provided by financing  activities                                         |   | (217,806                      | )          | (362,472 | ) | (387,235 | ) |
|                                                                                         |   |                          |       |   |   |   |   |
| Net (decrease) in cash and cash equivalents                                                  |   | (34,686                       | )          | (2,430 | ) | (198,969 | ) |
| Cash and cash equivalents, beginning of  year                                                |   | 84,956                        |       | 87,386 |   | 286,355 |   |
| Cash and cash equivalents, end of year                                                       |   | $                             | 50,270     |   | $ | 84,956 |   | $ | 87,386 |   |
|                                                                                         |   |                          |       |   |   |   |   |
| Supplemental disclosure of cash flow  information:                                           |   |                          |       |   |   |   |   |
|                                                                                         |   |                          |       |   |   |   |   |
| Cash paid for interest                                                                       |   | $                             | 130,967    |   | $ | 204,977 |   | $ | 269,421 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

F-5

----

 

**MFIC****CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

 
|                                                         |   | **Common  Stock**      |   | **Treasury  Stock** |                 |       |
|--------------------------------------------------------------|--------|------------------------|--------|---------------------|----------------------|------------|
|                                                         |   | **Number  of  Shares** |   |                | **$0.01  Par Value** |       | **Additional  Paid-in  Capital** |   | **Accumulated  Deficit** |   | **Number  of  Shares** |   | **Stated at  Cost** |   | **Total  Stockholders’  Equity** |   |
| Balance, December 31, 2000                                   |   | 7,588,948              |   | $                   | 75,889               |       | $ | 12,891,904 |   | $ | (5,193,342 | ) | 250,219 |   | $ | (680,670 | ) | $ | 7,093,781 |   |
| Stock options exercised                                      |   | 24,375                 |   | 245                 |                 | 7,369      |   | — |   | — |   | — |   | 7,614 |   |
| Issuance of common stock under employee  stock purchase plan |   | 30,658                 |   | 306                 |                 | 17,603     |   | — |   | — |   | — |   | 17,909 |   |
| Purchase of treasury stock                                   |   | —                 |   | —              |                 | —     |   | — |   | 10,227 |   | (7,031 | ) | (7,031 | ) |
| Net loss                                                     |   | —                 |   | —              |                 | —     |   | (525,186 | ) | — |   | — |   | (525,186 | ) |
| Balance, December 31, 2001                                   |   | 7,643,981              |   | 76,440              |                 | 12,916,876 |   | (5,718,528 | ) | 260,446 |   | (687,701 | ) | 6,587,087 |   |
| Stock options exercised                                      |   | 19,375                 |   | 194                 |                 | 5,812      |   | — |   | — |   | — |   | 6,006 |   |
| Issuance of common stock under employee  stock purchase plan |   | 29,207                 |   | 292                 |                 | 11,289     |   | — |   | — |   | — |   | 11,581 |   |
| Issuance of common stock to consultants                      |   | 12,501                 |   | 125                 |                 | 11,543     |   | — |   | — |   | — |   | 11,668 |   |
| Net loss                                                     |   | —                 |   | —              |                 | —     |   | (2,513,974 | ) | — |   | — |   | (2,513,974 | ) |
| Balance, December 31, 2002                                   |   | 7,705,064              |   | 77,051              |                 | 12,945,520 |   | (8,232,502 | ) | 260,446 |   | (687,701 | ) | 4,102,368 |   |
| Stock options exercised                                      |   | 186,377                |   | 1,863               |                 | 142,996    |   | — |   | — |   | — |   | 144,859 |   |
| Issuance of common stock under employee  stock purchase plan |   | 36,717                 |   | 367                 |                 | 11,346     |   | — |   | — |   | — |   | 11,713 |   |
| Stock warrants exercised                                     |   | 100,000                |   | 1,000               |                 | 51,000     |   | — |   | — |   | — |   | 52,000 |   |
| Net loss                                                     |   | —                 |   | —              |                 | —     |   | (3,450,434 | ) | — |   | — |   | (3,450,434 | ) |
| Balance, December 31, 2003                                   |   | 8,028,158              |   | $                   | 80,281               |       | $ | 13,150,862 |   | $ | (11,682,936 | ) | 260,446 |   | $ | (687,701 | ) | $ | 860,506 |   |
|                                                              |        |                        |        |                     |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-6

----

 

**MFICCORPORATION**

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note1****                                                             ORGANIZATIONAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

 

**Organization**

 

MFIC Corporation (MFIC or the Company), through its wholly-ownedsubsidiaries, Microfluidics Corporation (Microfluidics) and MediControlCorporation (MediControl), as well as its operating division, Microfluidics,operates in one segment, specializing in producing and marketing a broad lineof proprietary fluid materials processing systems used for a variety ofgrinding, mixing, milling, and blending applications across a variety ofindustries and for use in numerous applications within those industries. Microfluidizer®materials processor systems are produced at the Microfluidics Division.

 

**Management’sPlans**

 

The Company’s ability to continue operations is dependent upon accessto financing, which is potentially impacted by the Company’s ability to achievefuture compliance with financial covenants. It is expected by management thatthe Company will be in compliance with required covenants.  Borrowings outstanding are secured by acollateral pledge of substantially all of the assets of the Company.

 

Management of the Company is executing plans for a return toprofitability; however, there can be no assurance that the Company will besuccessful in implementing these plans.

 

**Principlesof Consolidation**

 

The consolidated financial statements of the Company include theaccounts of the Company and its wholly owned subsidiaries.  All significant intercompany transactionsand balances have been eliminated in consolidation.

 

**Reclassifications**

 

As described in Note 4, in December 2003, the Company committed to aplan to sell substantially all the assets and associated liabilities of itsMorehouse-COWLES division.  As such, inaccordance with generally accepted accounting principles, results of operationshave been reclassified to reflect Morehouse-COWLES’ operating results, net ofincome taxes, as Discontinued Operations. Further, certain prior period balances have been reclassified to conformto the current period presentation.

 

**Useof Estimates**

 

The preparation of consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

F-7

----

 

**RevenueRecognition**

 

Revenue from the sale of machines and spare parts is generallyrecognized upon shipment of the product or when the earnings process iscomplete.  Rental income for the leaseof equipment is recognized on a straight-line basis over the term of the leaseagreement.  Rental income and equipmentsales are classified in revenues in the consolidated statement of operations.

 

The Company has adopted Securities and Exchange Commission (SEC) StaffAccounting Bulletin (SAB) No. 101, *Revenue Recognition in Financial Statements*.The Company recognizes sales at the time of shipment of the system to thecustomer. Management believes the customer’s post-delivery acceptanceprovisions and installation are routine. The Company has never failed tosuccessfully complete a system installation. Should an installation not besuccessfully completed, the contractual provisions do not provide forforfeiture or refund. Installation costs are predictable and insignificant tothe total purchase price. The Company has demonstrated a history of customeracceptance subsequent to shipment and installation of these systems.

 

 

**Cashand Cash Equivalents**

 

The Company considers all highly liquid securities with initialmaturities of 90 days or less, at the time of acquisition, to be cashequivalents.

 

**Allowance for Doubtful Accounts**

 

The Company maintains an allowance for estimated losses resulting fromthe inability of its customers to make required payments.  An estimate of uncollectable amounts is madeby management based upon historical bad debts, current customer receivable balances,age of customer receivable balances, the customer’s financial condition andcurrent economic trends.  If the actualuncollected amounts significantly exceed the estimated allowance, then theCompany’s operating results would be significantly adversely affected.

 

**Inventories**

 

Inventories consist of material, labor and manufacturing overhead andare stated at the lower of cost or net realizable value. Cost is determined ona first-in, first-out basis.  (FIFO)

 

The Company periodically reviews quantities of inventory on hand andcompares these amounts to expected usage of each particular product line.  Reserves are established to recordprovisions for slow moving inventories in the period in which it becomesreasonably evident that the item is not useable, salable or the net realizablevalue is less than cost.

 

**Propertyand Equipment**

 

The Company’s property and equipment is recorded at cost. Depreciationis computed using the straight-line method, based upon useful lives of 3 to 7years.  Leasehold improvements areamortized using the straight-line method based upon the shorter of theestimated useful lives or remaining life of the lease. Expenditures formaintenance and repairs are expensed as incurred.  Upon retirement or sale of property and equipment, the cost ofthe disposed asset and the related accumulated depreciation are removed fromthe accounts and any resulting gain, or loss is credited or charged tooperations.

 

F-8

----

 

 

**Patents,Licenses, and Other Intangible Assets**

 

In accordance with Statements of Financial Accounting Standards (“SFAS”)No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*(“SFAS No. 144”), the Company reviewslong-lived assets and all amortizing intangible assets for impairment wheneverevents or changes in circumstances indicate the carrying amount of such assetsmay not be recoverable.  Recoverabilityof these assets is determined by comparing the forecasted undiscounted net cashflows of the operation to which the assets relate, to the carrying amount.  If the operation is determined to be unableto recover the carrying amount of its assets, then intangible assets arewritten down first, followed by the other long-lived assets of the operation,to fair value.  Fair value is determinedbased on discounted cash flows or appraised values, depending upon the natureof the assets.

 

Patents, patent applications and rights, are stated at acquisitioncost.  Amortization is recorded usingthe straight-line method over the shorter of the legal lives or useful life ofthe patents.  Patents, licenses and otherintangible assets are being amortized over a period of 3 to 17 years.

 

**Goodwill**

 

Goodwill represents the excess of cost over the fair value of netassets of a business acquired.  TheCompany adopted SFAS No. 141, *BusinessCombinations*(“SFAS No. 141”) in fiscal 2001 and SFAS No. 142, *Goodwill and Other Intangible Assets*(“SFAS No. 142”) in fiscal year 2002. SFAS No. 141 requires that the purchase method of accounting be used forall business combinations initiated after June 30, 2001.  SFAS No. 141 also specifies the criteriathat intangible assets acquired in a purchase method business combination mustmeet in order to be recognized and reported apart from goodwill.

 

SFAS No. 142 requires that goodwill and intangible assets withindefinite lives no longer be amortized, but instead be tested for impairment,at least annually.  SFAS No. 142 alsorequires that the intangible assets with definite lives be amortized over theirrespective estimated useful lives to their residual value and reviewed forimpairment in accordance with SFAS No. 144.

 

**Researchand Development Expenses**

 

The Company charges research and development expenses to operations asincurred.

 

**Earnings(Loss) per Share**

 

Basic and diluted net loss per share is presented inconformity with SFAS No. 128, *Earnings per Share,* for all periodspresented.  In accordance with SFAS No.128, basic and diluted net loss per common share was determined by dividing netincome or loss applicable to common stockholders by the weighted average numberof common shares outstanding during the period.  Options to purchase 1,929,662, 2,010,650, and 1,612,980 shares ofcommon stock were outstanding for the years ended 2003, 2002, and 2001,respectively. Basic and diluted net loss per share are $(.44) per share for2003.  Although there were dilutiveshares of common stock for 2002, the basic and diluted net loss per share werethe same.

** **

**FairValue of Financial Instruments**

 

The carrying amount of cash and cash equivalents, accounts receivable,accounts payable and accrued liabilities approximates fair value due to theshort term nature of these accounts. The Company’s bank debt, because itcarries a variable interest rate, is stated at its approximate fair marketvalue. The Company’s subordinated debt bears interest at 10%, whichapproximates fair market value.

 

F-9

----

 

**Income Taxes**

 

The Company accounts for income taxes under SFAS No. 109, *Accountingfor Income Taxes. *Under SFASNo. 109, deferred tax assets or liabilities are computed based on thedifferences between the financial statement and income tax bases of assets andliabilities using the effective tax rates. Deferred income tax expense or credits are based on changes in the assetor liability from period to period. The Company records a valuation allowanceagainst any net deferred tax assets if it is more likely than not that theywill not be realized.

 

**Stock Based Compensation**

 

As allowed bySFAS No. 123, *Accounting for Stock-Based Compensation*, the Company haselected to account for stock-based compensation at intrinsic value with disclosure of the effects of fairvalue accounting on net income and earnings per share on a pro formabasis.  At December 31, 2003, theCompany had one stock incentive plan, which is described more fully in Note10.  The Company accounts for awardsissued to employees under the plan under the recognition and measurementprinciples of Accounting Principles Board (APB) Opinion No. 25, *Accountingfor Stock Issued to Employees,* and the related interpretations.  No stock-based employee compensation cost isreflected in net income, as all options granted under the plan had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant.  The following table illustratesthe effect on net income and earnings per share if the Company had applied thefair value recognition provisions of SFAS No. 123:

 

|                                                                                                                                                |   | **2003** |       | **2002** |   | **2001**   |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|------------|----------|--------|------------|--------|
| Net loss, as Reported                                                                                                                               |   | $        | (3,450,434 | )        | $      | (2,513,974 | )      | $ | (525,186 | ) |
| Deduct:  Total stock-based employee compensation  expense determined under fair value based method for all  awards, net of related tax effects |   | (113,509 | )          | (340,178 | )      | (318,438   | )      |
| Pro forma net loss                                                                                                                                  |   | $        | (3,563,943 | )        | $      | (2,854,152 | )      | $ | (843,264 | ) |
| Net loss per share:                                                                                                                                 |   |     |       |     |   |       |   |
| Basic -as reported                                                                                                                                  |   | $        | (0.44      | )        | $      | (0.34      | )      | $ | (0.07 | ) |
| Diluted-as reported                                                                                                                                 |   | $        | (0.44      | )        | $      | (0.34      | )      | $ | (0.07 | ) |
| Basic - pro forma                                                                                                                                   |   | $        | (0.46      | )        | $      | (0.38      | )      | $ | (0.11 | ) |
| Diluted – pro forma                                                                                                                            |   | $        | (0.46      | )        | $      | (0.38      | )      | $ | (0.11 | ) |

 

F-10

----

 

Stock options granted to non-employees are accounted forin accordance with SFAS No. 123 and the Emerging Issues Task Force (EITF)Abstract No. 96-18, *Accounting for Equity Instruments That Are Issued toOther Than Employees for Acquiring, or in**Conjunction with Selling, Goods orServices*, and the related interpretations, which generally requiresthe value of options to be periodically remeasured and charged to expense asthey are earned over the performance period. Compensation related to stock appreciation rights and other variablestock option or award plans should be measured at the end of each period.  The Company did not grant any stock optionsto non-employees, excluding board members, during 2003, 2002, or 2001.

** **

**RecentAccounting Pronouncements**

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidationof Variable Interest Entities, an Interpretation of Accounting ResearchBulletin No 51, Consolidated Financial Statements” (FIN 46).  FIN 46 establishes accounting guidance forconsolidation of variable interest entities that function to support the activitiesof the primary beneficiary.  FIN 46applies to any business enterprise, both public and private, that has acontrolling interest, contractual relationship or other business relationshipwith a variable interest entity.  TheCompany does not have any investments in or contractual relationships or otherbusiness relationships with any variable interest entity and therefore, basedon present facts and circumstances, the adoption of FIN 46 is not expected tohave a material impact on the Company’s consolidated financial position orresults of its operations.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity”(SFAS 150).  SFAS 150 establishesstandards for classifying and measuring as liabilities certain financialinstruments that embody obligations of the issuer and have characteristics ofboth liabilities and equity.  SFAS 150represents a significant change in practice in the accounting for a number offinancial instruments, including mandatorily redeemable equity instruments andcertain equity derivatives that frequently are used in connection with sharerepurchase programs.  The Company doesnot use such instruments in its share repurchase program.  SFAS 150 is effective for all financialinstruments created or modified after May 31, 2003.  Adoption of SFAS 150, based on present facts and circumstances,is not expected to have a material effect on the Company’s consolidatedfinancial position or results of its operations.

 

F-11

----

 

**Note2****                                                             INDUSTRYSEGMENT, GEOGRAPHIC AND ENTERPRISE-WIDE REPORTING**

 

SFAS No. 131, *Disclosuresabout Segments of an Enterprise and RelatedInformation*(“SFAS No. 131”), requirescompanies to report selected information about operating segments, as well asenterprise-wide disclosures about products, services, geographic areas andmajor customers.  Operating segments aredetermined based on the way management organizes its business for makingoperating decisions and assessing performance. The Company’s chief decision-maker, as defined under SFAS No. 131, isthe chairman and chief executive officer. The Company has determined that itconducts its operations in one business segment: the development, manufacture,marketing and sale of process and formulation equipment.  The Company’s sales are primarily tocompanies with processing needs in the chemical, pharmaceutical, food,cosmetic, and biotechnology industries. The Company conducts its business primarily in the United States ofAmerica. The Company has less than 1% of total assets overseas.  As a result, the financial informationdisclosed herein represents all of the material financial information relatedto the Company’s principal operating segment.

 

Approximate sales to customers from continuing operations outside NorthAmerica are broken out, by geographic foreign markets, as follows:

** **
|          |   | **2003**  |           | **2002** |   | **2001**      |       |
|---------------|--------|-----------|----------------|----------|--------|---------------|------------|
| North America |   | $         | 5,337,000      |     | $      | 6,462,000     |       | $ | 7,444,000 |   |
| Asia          |   |      | 3,204,000      |     |   | 2,350,000     |       |   | 2,480,000 |   |
| Europe        |   | 1,919,000 |           | 702,000  |   | 1,286,000     |       |
|          |   | **$**     | **10,460,000** |     | **$**  | **9,514,000** | ** ** | **$** | **11,210,000** | ** ** |

 

Two customersaccounted for 21% and 11% of the revenues from continuing operations,respectively, in 2003.  Two customersaccounted for 18% and 16% of the revenues from continuing operations in 2002,respectively, and one customer accounted for 13% of the trade accountsreceivable as of December 31, 2002.  Nocustomer accounted for more than 10% of the Company’s revenues in 2001.  A reduction or delay in orders from these orother significant customers could have a material adverse effect on theCompany’s results of operations.

 

F-12

----

 

**Note3****                                                             INVENTORIES**

 

The components of inventories are as follows at December 31:

 
|                                    |   | **2003**  |          | **2002**   |   |
|-----------------------------------------|--------|-----------|---------------|------------|--------|
| Raw materials                           |   | $         | 1,580,991     |       | $      | 1,670,891 |   |
| Work in progress                        |   | 80,439    |          | 298,649    |   |
| Finished goods                          |   | 132,273   |          | 146,922    |   |
|                                    |   | 1,793,703 |          | 2,116,462  |   |
| Less : Provision for obsolete inventory |   | 110,000   |          | 50,000     |   |
| **TOTAL**                               |   | **$**     | **1,683,703** | ** ** | **$**  | **2,066,462** | ** ** |

 

**Note 4                    ASSETS AVAILABLE FOR SALE**

 

In the fourth quarter of 2003 the company determined that itsMorehouse-COWLES Division was not strategic to the Company’s on-goingobjectives and in December 2003, management committed to a plan to sellsubstantially all the assets and associated liabilities of the division.  Accordingly, the Company reported thedivision as a discontinued operation in accordance with SFAS 144.  The Consolidated financial statements havebeen reclassified to segregate the assets and associated liabilities availablefor sale and operating results of these discontinued operations for all periodspresented.

 

Assets and Liabilities of discontinuedoperations are as follows:

 
| **December 31**                                        |   | **2003**   |    | **2002**  |   |
|--------------------------------------------------------|--------|------------|---------|-----------|--------|
| Assets available for sale                              |   |       |    |      |   |
| Accounts receivable-trade                              |   | $          | 472,573 |      | $      | 922,157 |   |
| Inventory                                              |   | 2,204,128  |    | 1,831,636 |   |
| Prepaid expense                                        |   | 35,517     |    | 34,808    |   |
| Net property and equipment                             |   | 93,615     |    | 242,863   |   |
| Goodwill                                               |   | —     |    | 2,100,000 |   |
| Total assets available for sale                        |   | 2,805,833  |    | 5,131,464 |   |
| Less:   Provision for loss on disposal            |   | (1,422,715 | )       | —    |   |
| Net assets available for sale                          |   | 1,383,118  |    | 5,131,464 |   |
|                                                   |   |       |    |      |   |
| Liabilities associated with assets  available for sale |   |       |    |      |   |
| Accounts payable and accrued expenses                  |   | 457,139    |    | 563,824   |   |
| Customer deposits                                      |   | 203,956    |    | 88,189    |   |
| Liabilities associated with assets held for  sale      |   | $          | 661,095 |      | $      | 652,013 |   |

 

Summary Operating Results of the Discontinued Operations ofMorehouse-COWLES are as follows:

 
|                                                                                                       |   | **2003**   |       | **2002**   |   | **2001**   |   |
|------------------------------------------------------------------------------------------------------------|--------|------------|------------|------------|--------|------------|--------|
| Revenues                                                                                                   |   | $          | 3,655,237  |       | $      | 5,059,202  |   | $ | 4,300,639 |   |
| Cost of Sales                                                                                              |   | 2,601,957  |       | 3,626,407  |   | 3,268,271  |   |
| Gross Income                                                                                               |   | 1,053,280  |       | 1,432,795  |   | 1,032,368  |   |
| Total Operating Expenses                                                                                   |   | 3,740,490  |       | 1,754,837  |   | 1,525,163  |   |
|                                                                                                       |   |       |       |       |   |       |   |
| Loss from Discontinued Operations before  cumulative effect of change in accounting principle and disposal |   | (2,687,210 | )          | (322,042   | )      | (492,795   | )      |
| Loss on disposal of Discontinued Operations                                                                |   | (1,422,715 | )          |       |   |       |   |
| Cumulative effect of change in accounting  principle                                                       |   | —     |       | (2,661,409 | )      | —     |   |
| Loss from Discontinued Operations                                                                          |   | $          | (4,109,925 | )          | $      | (2,983,451 | )      | $ | (492,795 | ) |

 

Upon adoption of SFAS No. 142 in the firstquarter of 2002, the Company recorded a one-time, noncash charge of $2,661,409to reduce the carrying value of its goodwill. Such charge is nonoperational in nature and is reflected as a cumulativeeffect of an accounting change pursuant to the SFAS No. 142 transition rules.

 

In December 2003, in conjunction with theestablishment of management’s plan to sell the Morehouse-COWLES Division, theCompany determined that the remaining goodwill of $2,100,000 was fully impairedand accordingly charged to Discontinued Operations.

 

On February 9, 2004, pursuant to an AssetPurchase Agreement (the “Asset Purchase Agreement”) dated February 5, 2004between MFIC Corporation (“MFIC”) and a wholly owned subsidiary of NuSilCorporation (“NuSil”), MFIC sold substantially all of the assets and selectedliabilities of its Morehouse-COWLES Division (the “Division”), to NuSil.  Other than NuSil’s prior purchases ofproducts from the Division, there were no preexisting relationships betweenMFIC and NuSil.

 

The assets ofthe division that were sold included accounts receivable, furniture, fixturesand equipment, inventory and supplies, books and records, bids, contracts,prepaid expenses, leases, intellectual property, goodwill, domain names andclaims, all as described in the Asset Purchase Agreement (collectively, the “Assets”).  In addition, certain rights and obligationsarising after February 9, 2004 under the division’s PacifiCare Group HealthInsurance Policy were assigned.  Thedivision’s cash or cash equivalents on hand on February 9, 2004 were excludedfrom the assets being sold.  Under theAsset Purchase Agreement, the division’s executory obligations under certaincontracts and bids, and the division’s accounts payable as of February 9, 2004in the amount of $623,240, were assumed by NuSil.

 

The purchaseprice (other than the assumption of accounts payable described in the precedingparagraph) paid under the Asset Purchase Agreement was $918,238.  Of the purchase price, $768,238 (the“Closing Cash”) was paid in cash, $100,000 was paid in the form of a PromissoryNote (the “Purchase Note”) and $50,000 (the “Holdback Payment”) was withheldfor payment at a future date subject to any purchase price adjustments andoffsets, as provided for in the Asset Purchase Agreement.

 

The ClosingCash was paid directly to PNC Bank, National Association (“PNC”), to be appliedto MFIC’s outstanding balance under MFIC’s Revolving Credit Loan with PNC (the“Revolving Credit Loan”).

 

Theaforementioned Purchase Note bears interest at 5 percent per annum, is securedby the Assets pursuant to a Security Agreement dated February 5, 2004 (the“Security Agreement”) between the parties and is subject to certain offsets asprovided in the Asset Purchase Agreement. Principal and interest on the Purchase Note are payable on February 9,2005, unless there is a claim for an offset as allowed for under the AssetPurchase Agreement, which claim might delay final payment of amounts due underthe Purchase Note until final resolution of any such claim under the proceduresoutlined in the Asset Purchase Agreement.

 

Pursuant tothe Asset Purchase Agreement, MFIC entered into a Noncompetition andNonsolicitation Agreement, dated February 5, 2004, which limits MFIC’s abilityto compete with the business of the division for a period of five years.

 

F-13

----

 

**Note5****                                                             INTANGIBLESAND OTHER ASSETS**

 

The Company purchased the rights and title ofcertain liposome and microemulsion technology devices from Arthur D. Little in1985.  The unamortized license fee andpatent are included in intangible assets and are being amortized using thestraight-line method over the useful life of the patent, which is 17 years. In1995, the Company capitalized $96,680 of patent costs related to a cooperativeresearch venture.  Amortization of theseassets charged to expense was $0 in 2003, $14,896 in 2002, and $24,576 in2001.  In 2001, the Company capitalized$64,528 of costs related to the Multi-Stream Mixer Reactor patent, which isbeing amortized over a 17-year period, beginning in the last quarter of2001.  Amortization of these costs was$3,800 in both 2003 and 2002, and $950 in 2001.

 

Costs incurred in connection with the debtrefinancing that occurred on February 28, 2000 are being amortized over threeyears, the initial term of the line of credit. The total of such costs was approximately $207,000.  Amortization of these costs amounted to$11,534 in 2003, and $69,204 in both 2002 and 2001, respectively.

 

**Note 6****                                                             GOODWILL**

 

In 1998, MFIC purchased substantially all ofthe assets and assumed certain liabilities of Epworth Manufacturing CompanyInc. of South Haven, Michigan (Epworth) and Morehouse-COWLES, Inc. ofFullerton, California (Morehouse COWLES) pursuant to an Asset PurchaseAgreement (The Agreement).

 

In accordance with the Agreement, MFIC paidthe following as consideration for the purchase price: (i) $5,508,480 in cash,(ii) two subordinated promissory notes in the aggregate principal amount of$800,000 (the Promissory Notes) and (iii) 900,000 shares of MFIC’s restrictedcommon stock, $0.01 par value per share, subject to the restrictions asdefined.  MFIC also incurredapproximately $500,000 in expenses.  Inaddition, MFIC assumed approximately $1,930,000 in accounts payable and accruedliabilities. The acquisition had been accounted for under the purchase methodof accounting, and the Company recognized goodwill of $6,194,459 which wasfully allocated to Morehouse-COWLES.

 

On January 1, 2002, the Company adopted SFASNo. 142, *Goodwilland Other Intangible Assets*, which requires companies to discontinuethe amortization of goodwill and certain intangible assets with an indefiniteuseful life. Instead, SFAS No. 142 requires that goodwill and intangible assetsdeemed to have an indefinite useful life be reviewed for impairment uponadoption of SFAS No. 142 and annually thereafter. 

 

Under SFAS No. 142, goodwill impairment isdeemed to exist if the net book value of a reporting unit exceeds its estimatedfair value.  Upon adoption of SFAS No.142 in the first quarter of 2002, the Company recorded a one-time, noncashcharge of $2,661,409 to reduce the carrying value of its

 

F-14

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goodwill. Such charge is nonoperational innature and is reflected as a cumulative effect of an accounting change in theaccompanying consolidated statement of operations pursuant to the SFAS No. 142transition rules.  The Company performedits annual impairment review during the fourth quarter of 2002, and determinedthat no impairment of goodwill had occurred since it had recorded a one-time,non-cash charge of $2,661,409 in the first quarter of 2002.

 

In December 2003, in conjuction with theestablishment of management’s plan to sell the Morehouse-COWLES Division, theCompany determined that the remaining goodwill of $2,100,000 was fully impairedand accordingly charged to operations.

 

Pursuant to SFAS 142, the goodwill impairmentcharges of $2,661,409 and $2,100,000 have been classified in discontinuedoperations in the accompanying consolidated statements of operations.

 

**Note 7****                                                            ****DEBT**

 

Long-term debt as of the following dates consisted of:

 
|                                            |   | **December  31,** |      |
|-------------------------------------------------|--------|-------------------|-----------|
|                                            |   | **2003**          |      | **2002** |   |
| Line of credit                                  |   | $                 | 2,425,613 |   | $ | 2,681,987 |   |
| 10% subordinated note payable to related  party |   | 81,250            |      | 156,250 |   |
| Term note payable                               |   | 58,735            |      | 153,739 |   |
|                                            |   | 2,565,598         |      | 2,991,976 |   |
| Less current portion                            |   | (2,559,348        | )         | (2,851,991 | ) |
| Long term debt, net of current portion          |   | **$**             | **6,250** | ** ** | **$** | **139,985** | ** ** |

 

**SubordinatedNote Payable**

 

The subordinated note is payable to Lake Shore Industries Inc, arelated party is defined and disclosed in note 13 of the financial statements.

 

F-15

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**NotesPayable**

 

In October, 2000, the Company entered into a settlement agreementrelated to a warranty claim dating back to 1998 for the Epworth Mill Divisionpursuant to which the Company paid $100,000 upon execution of the agreement,and executed a promissory note for $350,000 payable two years from theexecution date, with interest payable quarterly in arrears at 10% perannum.  The Company paid off the balanceof this note in December, 2002.

 

**CreditFacility**

 

On February 28, 2000, the Company entered into a revolving credit andterm loan agreement with National Bank of Canada providing the Company with a$4,475,000 three-year revolving credit and term loan facility.  The Credit Facility was comprised of: (i) a$4 million three year revolving line of credit (Revolving Credit Line) withadvances thereunder bearing interest at an interest rate equal to the primerate (the Prime Rate for United States borrowings from the National Bank ofCanada as publicly announced from time to time) plus one-half percent (0.50%).  All borrowings under the Revolving CreditLine were evidenced by a $4 million promissory note having a maturity date ofFebruary 28, 2003 (the Revolving Note), and (ii) a $475,000 term promissorynote, amortized over a five-year period but having a maturity date of February28, 2003 and bearing interest at an interest rate equal to the Prime Rate(4.75% at December 31, 2001) plus three quarters of one percent (0.75%).  Loans under the Credit Facility were securedby a collateral pledge to the Lender of substantially all the assets of theCompany and its subsidiaries. The Company’s Microfluidics Corporationsubsidiary guaranteed the Company’s obligations to the Lender under the CreditFacility. The Company also pledged to the Lender all shares of MicrofluidicsCorporation owned by the Company.

 

After review of the results as of and for the quarter ended March 31,2001, the Company notified the National Bank of Canada that it was in violationof the tangible net worth and liabilities to worth ratio covenants contained inthe Credit Facility for the quarter ended March 31, 2001.  On April 13, 2001, the Company received awaiver of these violations from the National Bank of Canada, but is required tomeet all covenant requirements thereafter. As a result of the waiver and management’s expectations of futurecompliance, the non-current portion of the term Promissory Note was classifiedas a non-current liability, as of December 31, 2000.

 

On January 16, 2002, the United States portion of National Bank ofCanada’s operations and its loan portfolio was sold to PNC Bank, N.A. OnFebruary 19, 2003, the Company and PNC Bank. N.A. entered into an extension ofthe loan for an additional year, until February 28, 2004.

 

At December 31, 2002, the Company was in violation of the net incomeand debt service coverage covenants.  AtDecember 31, 2001, the Company was not in compliance with the tangible networth, liabilities to worth ratio, net income covenants, and the debt servicecovenant. The Company received a waiver of these violations from the Lender forboth years, but is required to meet all covenant requirements thereafter.  On March 29, 2002, the Company

 

F-16

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and the Lender agreed on a revised set of covenants for fiscal 2002under a second amendment to the original agreement.  On February 19, 2003, the Company and the Lender entered into athird amendment to the original agreement extending the credit facility for anadditional year until February 28, 2004, with no change to the revisedcovenants agreed upon under the agreement of March 29, 2002.

 

On February 6, 2004 theCompany and PNC Bank, N.A (“PNC”) entered into a Fourth Amendment and Waiver toRevolving Credit and Term Loan Agreement permitting the sale of the assets ofthe Company’s Morehouse-COWLES Division in exchange for payment to PNC of allmonies received by the Company in connection with such sale and assignment toPNC of deferred payments and a promissory note from the purchase issued as partof the purchase price. On March 3, 2004, the outstanding loan balance was repaidfrom the proceeds of a new senior debt financing from Banknorth, N.A.

 

Due to the subjective acceleration clause, and the lock-boxarrangement, the revolving credit line was classified as a current liability inthe consolidated balance sheet. At December 31, 2003, the outstanding balanceon the Revolving Credit Line was $2,425,613, having an interest rate of 5.5%.The balance outstanding on the term loan was $58,735, at an interest rate of5.75%.

 

At December 31, 2003, the Company did not meet the net income covenantwhich, according to the terms of the lending agreement, would have required awaiver from its previous lender, PNC. However, in conjunction with the subsequent credit facility it obtainedfrom the new lender, Banknorth, N.A., no waiver was required from the previouslender.

 

On March 3, 2004, the Company and its Microfluidics Corporationsubsidiary, as co-borrowers, entered into a revolving credit and term loanagreement with Banknorth, N.A. (the “Lender”) providing the Company with a$2,000,000 demand revolving credit and four year term loan facility (the“Credit Facility”).  The Credit Facilitywas comprised of (i) a $1 million demand revolving line of credit (RevolvingCredit Line) with advances thereunder bearing interest at an interest rateequal to the prime rate (the Prime Rate for United States borrowings fromBanknorth, N.A. as publicly announced from time to time).  All borrowings under the Revolving CreditLine were evidenced by a $1 million demand promissory note (the “Revolving Note”),and (ii) a $1,000,000 term promissory note, amortized over a four year periodbut having a maturity date of March 3, 2008 and bearing interest at an interestrate equal to the Federal Home Loan Bank Classic Rate at March 4, 2004 plus twoand one-half percent (2.50%).  Loansunder the Credit Facility are secured by a collateral pledge to the Lender ofsubstantially all the assets of the Company and its subsidiaries.  The Company’s Microfluidics Corporationsubsidiary guaranteed the Company’s obligations to the Lender under the CreditFacility.  The Company also pledged tothe Lender all shares of Microfluidics Corporation owned by the Company.  The Company is required to meet twocovenants on an annual (calendar) basis as of December 31 of a given year.  (i) The Company’s senior debt may not be morethan four times the amount of its tangible capital base, and (ii) its debtservice coverage ratio may not be less than 1.20 to 1.

 

F-17

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**Note8****                    EMPLOYEEBENEFIT PLANS**

 

The Company offers a 401(k) profit-sharing plan (the 401K Plan), to itsemployees.  All Company and relatedentity employees who are eighteen years of age and have completed one hour ofservice are eligible to participate in the 401K Plan.  Employees may contribute from 1% to 20% of their compensation.  The Company’s contribution is discretionary,with contributions made from time to time as management deems advisable. TheCompany has made no matching contributions during 2003, 2002, and 2001.  The Company also instituted a cafeteria planin 1992, giving the employees certain pre-tax advantages on specific payrolldeductions.

 

**Note9****                                                             INCOMETAXES**

 

At December 31, 2003, the Company had netoperating loss and research tax credit carryforwards of approximately$4,650,000 and $171,000, respectively, for financial reporting purposes, whichmay be used to offset future taxable income.

 

The components of the net deferred tax assetwith the approximate income tax effect of each type of carryforward, credit andtemporary difference are as follows:

 

|                          |   | **December 31,** |      |
|-------------------------------|--------|------------------|-----------|
|                          |   | **2003**         |      | **2002** |   |
|                          |   |             |      |   |   |
| Operating loss carryforwards  |   | $                | 1,757,000 |   | $ | 2,048,000 |   |
| Tax credit carryforwards      |   | 171,000          |      | 171,000 |   |
| Temporary differences         |   | 2,332,000        |      | (22,000 | ) |
|                          |   | 4,260,000        |      | 2,197,000 |   |
| Less—Valuation allowance |   | (4,260,000       | )         | (2,197,000 | ) |
|                          |   |             |      |   |   |
| Net deferred tax asset        |   | $                | —    |   | $ | — |   |

 

F-18

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The Company has recorded a full valuationallowance against its deferred tax assets because, based on the weight ofavailable evidence, the Company believes it is more likely than not that thedeferred tax assets will not be realized in the near future.  The carryforwards expire from 2003 through2021 and are subject to review and possible adjustment by the Internal RevenueService.  The Internal Revenue Codecontains provisions that may limit the net operating loss and research taxcredit carryforwards in the event of certain changes in the ownership interestsof significant stockholders.

** **

**Note10****                                                      STOCKHOLDERS’EQUITY**

 

The Company adopted the 1988 Stock Plan (the Plan) as the successorplan to the 1987 Stock Plan, which, as amended at the 2002 stockholders’meeting, authorizes the grant of Stock Options for up to 3,500,000 shares ofcommon stock and the 1989 Non-Employee Director Stock Option Plan which, asamended at the 1996 stockholders’ meeting, authorizes the grant of nonqualifiedstock options for up to 500,000 shares of common stock.

 

 

**Stock OptionPlans**

 

Options granted under the Plans vest over athree-to-five-year period and expire 5 - 10 years from the grant date.  At December 31, 2003, 1,206,898 shares wereavailable for future grant under the Plans. Information with respect toactivity under the Plans are as follows:

 
|                           |   | **Number of Shares** |   | **Weighted Average  Exercise Price** |   |
|--------------------------------|--------|----------------------|--------|--------------------------------------|--------|
|                           |   |                 |   |                                 |   |
| Outstanding, December 31, 2000 |   | 1,761,575            |   | $                                    | 0.94   |   |
| Granted                        |   | 328,500              |   | 0.81                                 |   |
| Exercised                      |   | (24,375              | )      | 0.31                                 |   |
| Canceled                       |   | (452,720             | )      | 0.98                                 |   |
| Outstanding, December 31, 2001 |   | 1,612,980            |   | 0.88                                 |   |
| Granted                        |   | 532,045              |   | 0.52                                 |   |
| Exercised                      |   | (19,375              | )      | 0.31                                 |   |
| Canceled                       |   | (115,000             | )      | 0.60                                 |   |
| Outstanding, December 31, 2002 |   | 2,010,650            |   | $                                    | 0.90   |   |
| Granted                        |   | 257,409              |   | 0.47                                 |   |
| Exercised                      |   | (186,377             | )      | 0.78                                 |   |
| Canceled                       |   | (152,020             | )      | 1.13                                 |   |
| Outstanding, December 31, 2003 |   | 1,929,662            |   | $                                    | 0.74   |   |
|                           |   |                 |   |                                 |   |
| Exercisable, December 31, 2001 |   | 878,803              |   | $                                    | 1.06   |   |
|                           |   |                 |   |                                 |   |
| Exercisable, December 31, 2002 |   | 1,093,972            |   | $                                    | 1.01   |   |
|                           |   |                 |   |                                 |   |
| Exercisable, December 31, 2003 |   | 1,102,020            |   | $                                    | 0.96   |   |
|                                |        |                      |        |                                      |        |  |  |

 

F-19

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The following table summarizes informationrelating to outstanding and exercisable stock options as of December 31, 2003:

 
| **Outstanding**     |   | **Exercisable**       |   |
|---------------------|--------|-----------------------|--------|
| **Exercise  Price** |   | **Number of  Shares** |   | **Weighted  Average  Remaining  Contractual  Life (Years)** |   | **Weighted  Average  Exercise  Price** |   | **Number of  Shares** |   | **Weighted  Average  Exercise  Price** |   |
|                |   |                  |   |   |   |   |   |   |   |   |   |
| $0.31 to 1.24       |   | 1,929,662             |   | 6.5 |   | $ | 0.74 |   | 1,102,020 |   | $ | 0.96 |   |
|                     |        |                       |        |  |  |  |  |  |  |  |  |  |  |

 

 

**Accounting forStock-Based Compensation**

 

SFAS No. 123, *Accounting for Stock-Based Compensation*,requires the measurement of the fair value of stock options to be included inthe statement of income or disclosed in the notes to the financialstatements.  The Company has determinedthat it will continue to account for stock-based compensation for employeesunder APB Opinion No. 25, *Accounting for Stock issued to Employees*,and elect the disclosure-only alternative under No. SFAS 123.

 

The Company has computed the pro formadisclosures required under SFAS No. 123 for its stock compensation plan foremployees during the years ended December 31, 2003, 2002 and 2001 using theBlack-Scholes option pricing model under the fair value method as prescribed bySFAS No. 123.  The assumptions used forthe years ended December 31, 2003, 2002 and 2001 are as follows:

 

|                     |   | **December 31,** |   |
|--------------------------|--------|------------------|--------|
|                     |   | **2003**         |   | **2002** |   | **2001** |   |
|                     |   |             |   |   |   |   |   |
| Risk-free interest rates |   | 4.75             | %      | 4.36 | % | 5.25 | % |
| Expected lives           |   | 5 years          |   | 5 years |   | 5 years |   |
| Expected volatility      |   | 164              | %      | 75 | % | 197 | % |
| Dividend yield           |   | 0                | %      | 0 | % | 0 | % |

 

Stock or other equity-based compensation for nonemployees must beaccounted for under the fair value method as required by SFAS No, 123 andEmerging Issues Task Force No. 96-18, *Accounting for Equity Instruments That Are Issued ToOther Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices*, and the related interpretations.  Under this method, the equity-based instrument is valued ateither the fair value of the consideration received or the fair value of theequity instruments issued, whichever is more reliably measurable.  The measurement date is generally thevesting date for nonemployees. Compensation related to stock appreciationrights and other variable stock option or award plans should be measured at theend of each period.  The resultingnoncash expense is recorded in the statements of operations over the vestingperiod of the stock.  The Company didnot grant any options to non-employees, excluding board members, in 2003, 2002or 2001.

 

F-20

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**Warrants**

 

On September 23, 1999, the Chief Executive Officer of the Company,Irwin J. Gruverman, was granted warrants to purchase up to 100,000 shares ofthe Company’s common stock at a price of $0.52 per share, having an expirationdate of July 2, 2004.  The warrants wereexercised on November 25, 2003.

 

**Employee Stock Purchase Plan**

 

The Company has an employee stock purchase plan (the Purchase Plan).Under the Purchase Plan, participants are granted options to purchase theCompany’s common stock twice a year at the lower of 85% of market value at thebeginning or end of each period. Calculation of the number of options granted,and subsequent purchase of these shares, is based upon voluntary payrolldeductions during each six-month period. The number of options granted to eachemployee under this plan is limited to a maximum amount of 1,000 shares foreach six-month period. The number of shares issued pursuant to this plantotaled 36,717, 29,207, and 30,658, in 2003, 2002, and 2001, respectively.

 

**Note11****                                                      COMMITMENTS**

 

The Company leases its facilities under non-cancelable operating leasesexpiring through August 2006.  Futureminimum rental payments under the operating leases at December 31, 2003 areapproximately as follows:

 
| 2004                     |   | 341,000 |        |
|--------------------------|--------|---------|-------------|
| 2005                     |   | 327,000 |        |
| 2006                     |   | 138,000 |        |
| **Total Lease Payments** |   | **$**   | **806,000** | ** ** |
|                          |        |         |             |  |

 

Rent expense for 2003, 2002, and 2001 was approximately $439,000,$402,000, and $415,000, respectively.  Aportion of the space is sublet to non-affiliated company under a tenant at willarrangement for a total of $12,000 per annum.

 

**Note12****                                                      RELATEDPARTY TRANSACTIONS**

 

During 2001, the Company and G&G Corporation (G&G), an entitycontrolled by Mr. Gruverman, the Company’s Chairman, entered into anarrangement whereby G&G reimbursed the Company for certain administrativeexpenses incurred for services performed by the Company.  The Company was reimbursed approximately $0,and $30,407 by G&G during 2002 and 2001, respectively. At both December 31,2003 and 2002, G&G owed the Company $0.

 

F-21

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As discussed in Notes 6 and 13, the Company owed the former Principalsof Morehouse and Epworth $81,250, $156,250, and $237,500 at December 31, 2003,2002, and 2001, respectively.  Interestcapitalized on the $300,000 note in connection with the Settlement Agreementdiscussed in Note 13 amounted to $88,750 and is being amortized over 5years.  Total payments in 2003 and 2002were $12,340 and $21,989, respectively.

 

 

**Note 13****                  SETTLEMENTAGREEMENT, DEBT RESTRUCTURING AND REFINANCING**

 

On December 20, 1999 the Company signed an agreement in principle (theAgreement In Principle) with J.B. Jennings and Bret A. Lewis, the former ownersof the Epworth Mill and Morehouse-COWLES businesses (the Sellers), Lake ShoreIndustries, Inc., and JLJ Properties, Inc., entities owned and controlled bythe Sellers.  The Agreement In Principlesets forth understandings among the parties concerning restructuring of theCompany’s subordinated debt and resolution of various disputes.  On January 17, 2000 a definitive settlementagreement incorporating these subject matters was executed between the parties(the Settlement Agreement).  Inconnection with the closing of the Credit Facility, and pursuant to aSettlement Agreement dated January 17, 2000 with the Company’s subordinateddebt holders, the subordinated debt of the Company was restructured in thefollowing manner. The outstanding August 14, 1998 $500,000 subordinatedpromissory note, having a remaining $475,000 principal balance together withaccrued interest at the Closing Date in the approximate amount of $77,500, andaccrued interest on the August 14, 1998 $300,000 subordinated note wereconverted to 500,000 shares of MFIC restricted common stock (the ConversionShares). The fair market value of the Company’s Common Stock on the date of theAgreement In Principle was $0.31 per share. MFIC was granted the right for a three-year period to repurchase theConversion Shares at a purchase price of $1.75 per share.  The August 14, 1998 $300,000 subordinatednote was replaced with a new $300,000 subordinated promissory note datedFebruary 28, 2000 (the 2000 Subordinated Note).  The 2000 Subordinated Note has a maturity date of February 28,2005 and bears interest at a rate of ten percent (10%) per annum. The note ispayable interest only in its first year and then is payable in equal quarterlyinstallments of principal together with outstanding interest thereon untilmaturity.

 

F-22

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**Note14****                  QUARTERLYRESULTS OF OPERATIONS**

 

Summarized unaudited quarterly financial data are as follows:

 
|                                                                        |   | **Fiscal  2003 Quarters** |      |
|-----------------------------------------------------------------------------|--------|---------------------------|-----------|
|                                                                        |   | **First**                 |      | **Second** |   | **Third** |   | **Fourth** |   |
| Revenues                                                                    |   | $                         | 2,949,677 |   | $ | 3,119,465 |   | $ | 1,912,738 |   | $ | 2,477,751 |   |
| Gross income                                                                |   | 1,491,923                 |      | 1,666,124 |   | 958,398 |   | 1,354,960 |   |
| Net income (loss) from continuing  operations                               |   | 405,571                   |      | 341,855 |   | (157,266 | ) | 69,331 |   |
| Loss from discontinued operations including  loss on disposal of $1,422,715 |   | (215,899                  | )         | (87,215 | ) | (186,080 | ) | (3,620,731 | ) |
| Net income (loss)                                                           |   | 189,672                   |      | 254,640 |   | (343,346 | ) | (3,551,400 | ) |
| Basic net income (loss) per share from  continuing operations:              |   | $                         | .05       |   | $ | .05 |   | $ | (.02 | ) | $ | .00 |   |
| Basic net loss per share from discontinued  operations                      |   | $                         | (.03      | ) | $ | (.01 | ) | $ | (.02 | ) | $ | (.46 | ) |
| Basic, as reported                                                          |   | $                         | .03       |   | $ | .03 |   | $ | (.05 | ) | $ | (.45 | ) |
| Diluted net income (loss) per share from  continuing operations             |   | $                         | .05       |   | $ | .05 |   | $ | (.02 | ) | $ | .00 |   |
| Diluted net loss per share from  discontinued operations                    |   | $                         | (.03      | ) | $ | (.01 | ) | $ | (.02 | ) | $ | (.46 | ) |
| Diluted, as reported                                                        |   | $                         | .03       |   | $ | .03 |   | $ | (.05 | ) | $ | (.45 | ) |

 

F-23

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|                                                              |   | **Fiscal  2002 Quarters** |      |
|-------------------------------------------------------------------|--------|---------------------------|-----------|
|                                                              |   | **First**                 |      | **Second** |   | **Third** |   | **Fourth** |   |
| Revenues                                                          |   | $                         | 2,739,707 |   | $ | 2,286,564 |   | $ | 2,003,723 |   | $ | 2,484,186 |   |
| Gross income                                                      |   | 1,442,428                 |      | 1,083,213 |   | 1,154,685 |   | 1,395,503 |   |
| Net income (loss) continuing operations                           |   | 235,659                   |      | (67,603 | ) | (19,056 | ) | 320,477 |   |
| (Loss) income from discontinued operations                        |   | (2,796,821                | )         | 123,034 |   | 32,742 |   | (342,406 | ) |
| Net (loss) income                                                 |   | (2,561,162                | )         | 55,431 |   | 13,686 |   | (21,929 | ) |
| Basis net income (loss) per share:                                |   |                      |      |   |   |   |   |   |   |
| Net income (loss) per share from continuing  operations           |   | $                         | .03       |   | $ | (.01 | ) | $ | (.00 | ) | $ | .04 |   |
| Basic net (loss) income per share from  discontinued operations   |   | $                         | (.38      | ) | $ | .02 |   | $ | .00 |   | $ | (.04 | ) |
| Basic, as reported                                                |   | $                         | (.33      | ) | $ | .01 |   | $ | .00 |   | $ | (.02 | ) |
| Diluted net income (loss) per share:                              |   |                      |      |   |   |   |   |   |   |
| Net income (loss) per share from continuing  operations           |   | $                         | .03       |   | $ | (.01 | ) | $ | .00 |   | $ | .04 |   |
| Diluted net (loss) income per share from  discontinued operations |   | $                         | (.38      | ) | $ | .02 |   | .00 |   | $ | (.04 | ) |
| Diluted, as reported                                              |   | $                         | (.33      | ) | $ | .01 |   | $ | .00 |   | $ | (.02 | ) |

 

**Note15****                                                      SUBSEQUENTEVENTS**

 

On March 31, 2004, the Company completed a private placement offeringof investment units (each unit consisting of one share of common stock and a3-year warrant to purchase an additional 1/2 share of common stock).  A total of 1,426,616 units were sold,yielding gross proceeds of $3,566,540. The units were priced at $2.50 and the associated warrants areexercisable at $3.05.  Additionally, theplacement agent for the offering received 5 year warrants to purchase 142,662share of common stock at an exercise price of $3.20 per share.

 

F-24

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**Listof Exhibits**

 
| **Exhibit  Number** |   | **Description of Exhibit** |
|---------------------|--------|----------------------------|
|                |   |                       |
| 3(a)                |   |                       | Certificate  of Incorporation for the Company, as amended (filed as Exhibit 2A to  Registration Statement No. 0-11625 on Form 8-A and as Exhibit 3.1(a) to the  Company’s Report on Form 10-Q for the quarterly period ended  September 30, 1999 and incorporated herein by reference). |
|                |   |                       |   |
| 3(b)                |   |                       | Amended and  Restated By-Laws for the Company (filed as Exhibit 3.3(b) to the Company’s  Annual Report on Form 10-K for the fiscal year ended December 31, 1996  and incorporated herein by reference). |
|                |   |                       |   |
| *4.2                |   |                       | Form of  Warrant issued to placement agent under the Placement Agent Agreement  attached as Exhibit 10.62 |
|                |   |                       |   |
| *4.3                |   |                       | Form of  Warrant issued to investors in the private placement described in the  Placement Agency Agreement attached as Exhibit 10.62 |
|                |   |                       |   |
| 10.1                |   |                       | 1987 Stock  Plan (filed as Exhibit 10(g) to the Company’s Annual Report on Form 10-K for  the fiscal year ended December 31, 1987 and incorporated herein by  reference). |
|                |   |                       |   |
| 10.2                |   |                       | 1988 Stock Plan (filed as Exhibit 10(g) to the Company’s Annual  Report on Form 10-K for the fiscal year ended December 31, 1988 and  incorporated herein by reference). |
|                |   |                       |   |
| 10.3                |   |                       | 1989 Non-Employee Directors Stock Option Plan (filed as Exhibit 10.1  to the Company’s  registration  statement on Form S-8 filed October 22,1996 and incorporated herein by  reference). |
|                |   |                       |   |
| 10.4                |   |                       | Lease for 30 Ossipee Road, Newton, Massachusetts dated May 23, 1997  between Microfluidics International Corporation and J. Frank Gerrity, Trustee  of 1238 Chestnut Street Trust under Declaration of Trust dated May 23, 1969,  recorded with Middlesex South Registry of Deeds in Book 11682, Page 384  (filed as Exhibit 3.10(a) to the Company’s form 10-Q for the quarterly period  ended June 30, 1997 and incorporated herein by reference). |
|                |   |                       |   |
| 10.5                |   |                       | Letter of Understanding between Microfluidics International  Corporation and Worcester Polytechnic Institute dated as of April 3,  1992 (filed as Exhibit 3.10(f) to the Company’s Form 10-K for the  fiscal year ended December 31, 1993 and incorporated herein by  reference). |
|                |   |                       |   |
| 10.6                |   |                       | Agreement between Microfluidics International Corporation and  Catalytica, Inc. dated as of October 18, 1993 (filed as  Exhibit 3.10(g) to the Company’s Form 10-K for the fiscal year  ended December 31, 1993 and incorporated herein by reference) with  amendments dated September 1, 1994 and March 31, 1995. |
|                |   |                       |   |
| 10.7                |   |                       | Amendment to agreement dated September 1, 1994 between  Microfluidics International Corporation and Catalytica, Inc. dated as of  October 18, 1993 (filed as Exhibit 3.10(g) to the Company’s Form 10-K  for the fiscal year ended December 31, 1993, and incorporated herein by  reference). |
|                     |        |                            |  |  |

 

 

----

 
| 10.8   |   |   | Amendment to agreement dated March 31, 1995 between  Microfluidics International Corporation and Catalytica, Inc. dated as of  October 18, 1993 (filed as Exhibit 3.10(g) to the Company’s Form 10-K  for the fiscal year ended December 31, 1993, and incorporated herein by  reference)                                          |
|--------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.9   |   |   | License Agreement among Microfluidics International Corporation,  Worcester Polytechnic Institute and Catalytica, Inc. dated as of  October 18, 1993 (filed as Exhibit 3.10(h) to the Company’s  Form 10-K for the fiscal year ended   December 31, 1993 and incorporated herein by reference).                          |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.10  |   |   | Amendment to agreement dated September 1, 1994 between  Microfluidics International Corporation and Catalytica, Inc. dated as of  October 18, 1993 (filed as Exhibit 3.10(g) to the Company’s Form 10-K  for the fiscal year ended December 31, 1993, and incorporated herein by  reference).                                      |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.11  |   |   | Letter, dated August 15, 1995, from Microfluidics International  Corporation to Michael T. Rumley. (filed as Exhibit 3.10(j) to the  Company’s Form 10-K for fiscal year ended December 31, 1995 and  incorporated herein by reference).                                                                                           |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.12  |   |   | Letter, dated December 31, 1995 from Microfluidics International  Corporation to Irwin J. Gruverman. (filed as Exhibit 3.10(k) to the Company’s  Form 10-K for fiscal year ended December 31, 1996 and incorporated  herein by reference).                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.13  |   |   | Warrant for the Purchase of Shares of Common Stock, dated  July 14, 1993, in favor of Ladenburg, Thalmann & Co. Inc. (filed as  Exhibit 3.10(l) to the Company’s Form   10-K or fiscal year ended December 31, 1996 and incorporated  herein by reference).                                                                    |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.14  |   |   | Letter, dated December 31, 1996, from Microfluidics  International Corporation to Irwin J. Gruverman. (filed as Exhibit  3.10(o) to the Company’s Form 10-K for fiscal year ended December 31, 1996  and incorporated herein by reference).                                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.15  |   |   | Agreement between Microfluidics International Corporation and  Catalytica, Inc. dated January 1, 1995 regarding participation in and  management of the Advanced  Technology  Program (ATP). (filed as Exhibit 3.10(p) to the Company’s Form 10-K for  fiscal year ended December 31, 1996 and incorporated herein by  reference). |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.16  |   |   | Consulting Agreement with James Little. (filed as Exhibit 3.10(q) to  the Company’s Form 10-K for fiscal year ended December 31, 1996 and  incorporated herein by reference).                                                                                                                                                                |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.17  |   |   | Supplemental Agreement between Catalytica Advanced Technologies, Inc.  and Microfluidics International Corporation dated December 31, 1997.  (filed as Exhibit 3.10(r) to the Company’s Form 10-k for fiscal year ended  December 31, 1997, and incorporated herein by reference)                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.18  |   |   | Letter dated December 31, 1997, from Microfluidics International  Corporation to Irwin J. Gruverman and G & G Diagnostics Corp. (filed as  Exhibit 3.10(s) to the Company’s Form 10-K for fiscal year ended  December 31, 1997, and incorporated herein by reference).                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                   |
| 10.19  |   |   | 1988 Stock Plan as amended (filed as Exhibit 10(a) to the Company’s  Form 10-Q for the quarterly period ended March 31, 1997 and incorporated  herein by reference.                                                                                                                                                                          |

 

 

----

 
| 10.20  |   |   | Asset Purchase Agreement, dated as of June 19, 1998, by and  among the Company, Epworth Manufacturing Company and Morehouse-COWLES,  Inc.(filed as Exhibit 2.1 to Schedule 13D of Bret A. Lewis, File No.  005-35850, and incorporated herein by Reference).                                            |
|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.21  |   |   | Stockholders Agreement, dated August 14, 1998, by and among the  Company and J.B. Jennings and Bret A. Lewis (filed as exhibit 2.2 to  Schedule 13D of Bret A. Lewis, File No. 005-35850, and incorporated  herein by reference.                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.22  |   |   | $500,000 Subordinated Promissory Note issued by the Company to  Epworth Manufacturing Company (filed as exhibit 99.2 to the Company’s Form  8-K on August 27, 1998, File No. 000-11625, and incorporated herein by  reference).                                                                         |
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.23  |   |   | $300,000 Subordinated Promissory Note issued by the Company to  Epworth Manufacturing Company (filed as exhibit 99.2 to the Company’s Form  8-K on August 27, 1998, File No. 000-11625, and incorporated herein by  reference).                                                                         |
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.24  |   |   | Revolving credit loan between Comerica Bank and the Company dated  August 12, 1998 (filed as Exhibit 10.1 to the Company’s form 10-Q for  the quarterly period ended September 30, 1998 and incorporated herein by  reference).                                                                    |
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.25  |   |   | Letter dated December 31, 1998 from Microfluidics International  Corporation To Irwin J. Gruverman.   (Filed as exhibit 3.10(2) to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 1998 and incorporated herein by  reference.)                                  |
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.26  |   |   | Revolving Credit and Term Loan Agreement among MFIC Corporation and  National Bank of Canada dated February 28, 2000. (Filed as exhibit 10.26  to the Company’s Annual Report on Form 10-K for fiscal year ended  December 31, 2000, and incorporated herein by reference.)                        |
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.27  |   |   | Revolving Credit Note of the Company in favor of National Bank of  Canada in the amount of $4,000,000.00 dated February 28, 2000.  (Filed as exhibit 10.27 to the Company’s  Annual Report on Form 10-K for fiscal year ended December 31, 2000, and  incorporated herein by reference.)      |
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.28  |   |   | Term Note of the Company in favor of National Bank of Canada in the  amount of $475,000.00 dated February 28, 2000.  (Filed as exhibit 10.28 to the Company’s Annual Report on Form  10-K for fiscal year ended December 31, 2000, and incorporated herein by  reference.)                    |
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.29  |   |   | Security Agreement of the Company in favor of National Bank of Canada  dated February 28, 2000. (Filed as exhibit 10.29 to the Company’s Annual  Report on Form 10-K for fiscal year ended December 31, 2000, and incorporated  herein by reference.)                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                              |
| 10.30  |   |   | Trademark and Trademark Applications Security Agreement of the  Company in favor of National Bank of Canada, dated February 28,  2000.  (Filed as exhibit 10.30 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.) |

 

 

----

 
| 10.31  |   |   | Patent and Patent Applications Security Agreement of the Company in  favor of National Bank of Canada, dated February 28, 2000. (Filed as  exhibit 10.31 to the Company’s Annual Report on Form 10-K for fiscal year  ended December 31, 2000, and incorporated herein by reference.)                                                                                                                                                                                                                 |
|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.32  |   |   | Unlimited Guaranty of Microfluidics Corporation in favor of National  Bank of Canada  Dated  February 28, 2000.  (Filed as  exhibit 10.32 to the Company’s Annual Report on Form 10-K for fiscal year  ended December 31, 2000, and incorporated herein by reference.)                                                                                                                                                                                                                      |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.33  |   |   | Stock Pledge Agreement between the Company and National Bank of  Canada dated  February 28,  2000.  (Filed as exhibit 10.33 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.34  |   |   | Subordination Agreement among the Company, Lake Shore Industries,  Inc. and National Bank of Canada dated as of February 28, 2000.  (Filed as exhibit 10.34 to the Company’s  Annual Report on Form 10-K for fiscal year ended December 31, 2000, and  incorporated herein by reference.)                                                                                                                                                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.35  |   |   | Subordinated Promissory Note on the Company in favor of Lake Shore  Industries, Inc. in the amount of $300,000.00 dated February 28,  2000.  (Filed as exhibit 10.35 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                               |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.36  |   |   | Forbearance Agreements with Comerica. (Filed as exhibit 10.36 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                                                                                                                |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.37  |   |   | Settlement Agreement, dated January 17, 2000 by and among the  Company, Bret A. Lewis, J. B. Jennings, Lake Shore Industries, Inc., and JLJ  Properties, Inc., with $300,000 Subordinated Promissory Note dated  February 28, 2000, issued by the Company to Lake Shore Industries, Inc.  (FKA Epworth Manufacturing Company, Inc).   (Filed as exhibit 10.37 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.) |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.38  |   |   | Letter, dated December 31, 1999, from MFIC Corporation to Irwin  J. Gruverman and G&G Diagnostics Corp. (Filed as exhibit 10.38 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.39  |   |   | Letter, dated December 31, 1999, from MFIC Corporation to Irwin  J. Gruverman. (Filed as exhibit 10.39 to the Company’s Annual Report on Form  10-K for fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                                                                  |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.40  |   |   | First Amendment to Revolving Credit and Term Loan Agreement between  the Company and National Bank of Canada dated March 30, 2000. (Filed as  exhibit 10.40 to the Company’s Annual Report on Form 10-K for fiscal year  ended December 31, 2000, and incorporated herein by reference.)                                                                                                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.41  |   |   | Lease between ABB and Microfluidics dated April 14, 2000 for  space at Lampertheim, Germany. (Filed as exhibit 10.41 to the Company’s  Annual Report on Form 10-K for fiscal year                                                                                                                                                                                                                                                                                                                          |

 

 

----

 
|   |   |   | ended December 31, 2000, and incorporated herein by reference.)                                                                                                                                                                                                                                                                                                                                                                                                                               |
|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.42  |   |   | Security Agreement between MFIC Corporation and J.M. Huber  Corporation dated October 18, 2000. (Filed as exhibit 10.42 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                               |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.43  |   |   | Settlement agreement between MFIC Corporation and J.M. Huber  Corporation dated December 18, 2000. (Filed as exhibit 10.43 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.44  |   |   | Letter, dated December 31, 2000, from MFIC Corporation to Irwin  J. Gruverman and G&G Diagnostics Corporation. (Filed as exhibit 10.45 to  the Company’s Annual Report on Form 10-K for fiscal year ended  December 31, 2000, and incorporated herein by reference.)                                                                                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.45  |   |   | Letter, dated December 31, 2000, from MFIC Corporation to Irwin  J. Gruverman. (Filed as exhibit 10.46 to the Company’s Annual Report on Form  10-K for fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                                                |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.46  |   |   | Lease for 30 Ossipee Road, Newton, Massachusetts dated  October 19, 2001, between Microfluidics International Corporation and  King Real Estate Corp., Trustee of 1238 Chestnut Street Trust under  Declaration of Trust dated May 23, 1969, recorded with Middlesex South  Registry of Deeds in Book 11682, Page 384.   (Filed as Exhibit 10.47 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 21, 2001, and incorporated herein by  reference.) |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.47  |   |   | Consulting agreement with Vincent Cortina dated January 2,  2002.  (Filed as Exhibit 10.48 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2001, and incorporated herein by reference.)                                                                                                                                                                                                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.48  |   |   | Letter dated December 31, 2001 from MFIC Corporation to Irwin J.  Gruverman.  (Filed as Exhibit 10.49 to  the Company’s Annual Report on Form 10-K for fiscal year ended  December 31, 2001, and incorporated herein by reference.)                                                                                                                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.49  |   |   | Second Amendment to Revolving Credit and Term Loan Agreement between  the Company and PNC Bank, N.A. dated March 29, 2002.  (Filed as Exhibit 10.50 to the Company’s  Annual Report on Form 10-K for fiscal year ended December 31, 2001, and  incorporated herein by reference.)                                                                                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.50  |   |   | 1986 Employee Stock Purchase Plan as Amended.  (Filed as Exhibit 10.51 to the Company’s  Annual Report on Form 10-K for fiscal year ended December 31, 2001, and  incorporated herein by reference.)                                                                                                                                                                                                                                                                                |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.51  |   |   | 1988 Stock Plan as Amended.   (Filed as Exhibit 10.52 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2001, and incorporated herein by  reference.)                                                                                                                                                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.52  |   |   | Letter dated December 31, 2002 from MFIC Corporation to Irwin J.  Gruverman. (Filed as Exhibit 10.53 to the Company’s Annual Report on Form  10-K for fiscal year ended December 31, 2002, and incorporated herein by  reference.)                                                                                                                                                                                                                                                  |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.53  |   |   | Third Amendment to Revolving Credit and Term Loan Agreement between  the Company and                                                                                                                                                                                                                                                                                                                                                                                                               |

 

 

----

 
|   |   |                                                                                                                                                           | PNC Bank N.A. dated February 19, 2003. (Filed as Exhibit 10.54  to the Company’s Annual Report on Form 10-K for fiscal year ended  December 31, 2002, and incorporated herein by reference.)                                                                                |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.54 |   |                                                                                                                                                           | Fourth Amendment and Waiver to Revolving Credit and Term Loan  Agreement between the Company and PNC Bank, N.A. dated February 6, 2004.                                                                                                                                               |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| 10.55  |   |                                                                                                                                                           | Asset Purchase Agreement dated February 5, 2004, by and among  MFIC Corporation and Morehouse-COWLES, Inc.   (Filed as Exhibit 2 to the Company’s Form 8K dated February 13,  2004, and incorporated herein by reference.)                                             |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.56 |   |                                                                                                                                                           | Revolving Line of Credit Note in the amount of $1,000,000 in favor of  Banknorth, N.A. dated March 3, 2004.   (Filed as Exhibit 10.57 to the Company’s Annual Report on Form 10K for  the fiscal year ended December 31, 2003, and incorporated herein by  reference.) |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.57 |   |                                                                                                                                                           | Letter dated December 31, 2003 from MFIC Corporation to Irwin  Gruverman                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.58 |   |                                                                                                                                                           | Secured Term Note in the amount of $1,000,000 in favor of Banknorth,  N.A. dated March 3, 2004.                                                                                                                                                                                       |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.59 |   |                                                                                                                                                           | Loan and Security Agreement between Banknorth, N.A. and the Company  dated March 3, 2004.                                                                                                                                                                                        |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.60 |   |                                                                                                                                                           | Trademark Security Agreement of the Company in favor of Banknorth,  N.A., dated March 3, 2004.                                                                                                                                                                                   |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.61 |   |                                                                                                                                                           | Patent Security Agreement of the Company in favor of Banknorth, N.A.,  dated March 3, 2004.                                                                                                                                                                                      |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.62 |   |                                                                                                                                                           | Placement Agency Agreement between the Company and Casimir Capital  L.P. dated February 13, 2004.                                                                                                                                                                                |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.63 |   |                                                                                                                                                           | First Amendment to Placement Agency Agreement between the Company and  Casimir Capital L.P. dated March 12, 2004.                                                                                                                                                                          |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *10.64 |   |                                                                                                                                                           | Registration Rights Agreement between the Company and Purchasers  dated March 16, 2004.                                                                                                                                                                                                    |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *14.00 |   |                                                                                                                                                           | Code of Ethics, as adopted by the Company                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                           |                                                                                                                                                                                                                                                                                       |
| *23(a) |   | Consent of Brown & Brown, LLP                                                                                                                              |
| *31.1  |   | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2003. |
| *31.2  |   | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2003. |
| *32.1  |   | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| *32.2  |   | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

----

*Filed herewith

 

**Management contracts or compensatory plan or arrangement required tobe filed as an exhibit to this Form 10-K pursuant to of this report.

 

 

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized, in thecity of Newton, Commonwealth of Massachusetts, on the 5th day ofApril 2004.

 

 
|   | By:    | /s/ Irwin J. Gruverman  |   |
|--------|--------|-------------------------|--------|
|   |   | Irwin J. Gruverman      |
|   |   | Chief Executive Officer |

 

Pursuant to the requirements of the Securities and Exchange Act of1934, this report has been signed below by the following persons on behalf ofthe Registrant and in the capacities and on the dates indicated.

 
| **Signature**           |   | **Title**                                                                        |                    | **Date** |
|-------------------------|--------|----------------------------------------------------------------------------------|-------------------------|----------|
|                    |   |                                                                             |                    |     |
|                    |   |                                                                             |                    |     |
| /s/ Irwin J. Gruverman  |   |                                                                             | Chief Executive Officer |     | April 5, 2004 |
| Irwin J. Gruverman      |   | (Principal Executive Officer), Chairman of the Board of Directors and  Secretary |                    |     |
|                    |   |                                                                             |                    |     |
|                    |   |                                                                             |                    |     |
| /s/ James N. Little     |   |                                                                             | Director                |     | April 5, 2004 |
| James N. Little         |   |                                                                             |                    |     |
|                    |   |                                                                             |                    |     |
|                    |   |                                                                             |                    |     |
| /s/ Vincent Cortina     |   |                                                                             | Director                |     | April 5, 2004 |
| Vincent Cortina         |   |                                                                             |                    |     |
|                    |   |                                                                             |                    |     |
|                    |   |                                                                             |                    |     |
| /s/ Leo Pierre Roy      |   |                                                                             | Director                |     | April 5, 2004 |
| Leo Pierre Roy          |   |                                                                             |                    |     |
|                    |   |                                                                             |                    |     |
|                    |   |                                                                             |                    |     |
| /s/ Edward T. Paslawski |   |                                                                             | Director                |     | April 5, 2004 |
| Edward T. Paslawski     |   |                                                                             |                    |     |
|                         |        |                                                                                  |                         |          |  |  |  |  |

 

 

----

 

**SCHEDULE II**

 

**MFICCORPORATION**

 

Valuation and Qualifying Accounts andReservesFor the years ended December 31, 2003, 2002, and 2001

 

 
|                                                                |   | **Balance at  Beginning of  Period** |      | **Additions  Charged to Costs  and Expenses** |   | **Deductions  and  Adjustments** |   | **Balance at  End  of Period** |   |
|---------------------------------------------------------------------|--------|--------------------------------------|-----------|-----------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
| ALLOWANCE FOR DOUBTFUL ACCOUNTS                                     |   |                                 |      |                                          |   |                             |   |                           |   |
| For the year ended December 31, 2003                           |   | $                                    | 33,500    |                                          | $      | 25,000                           |   | $                              |   |   | $ | 58,500 |   |
| For the year ended December 31, 2002                           |   | 48,500                               |      | —                                        |   | 15,000                           |   | 33,500                         |   |
| For the year ended December 31, 2001                           |   | 33,500                               |      | 15,000                                        |   | —                           |   | 48,500                         |   |
|                                                                |   |                                 |      |                                          |   |                             |   |                           |   |
| INVENTORY RESERVE                                                   |   |                                 |      |                                          |   |                             |   |                           |   |
| For the year ended December 31, 2003                           |   | $                                    | 50,000    |                                          | $      | 60,000                           |   | $                              |   |   | $ | 110,000 |   |
| For the year ended December 31, 2002                           |   | 40,000                               |      | 10,000                                        |   | —                           |   | 50,000                         |   |
| For the year ended December 31, 2001                           |   | 65,000                               |      | —                                        |   | 25,000                           |   | 40,000                         |   |
|                                                                |   |                                 |      |                                          |   |                             |   |                           |   |
| ACCUMULATED AMORTIZATION RELATED TO  GOODWILL AND OTHER INTANGIBLES |   |                                 |      |                                          |   |                             |   |                           |   |
| For the year ended December 31, 2003                           |   | $                                    | 4,814,444 |                                          | $      | 2,103,800                        |   | $                              | — |   | $ | 6,918,244 |   |
| For the year ended December 31, 2002                           |   | 2,065,135                            |      | 2,749,309                                     |   | —                           |   | 4,814,444                      |   |
| For the year ended December 31, 2001                           |   | 1,548,371                            |      | 516,764                                       |   | —                           |   | 2,065,135                      |   |

 

 

----