**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.20549**

**FORM 10-K**

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**ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

**Forthe fiscal year ended December 31, 2005**

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**CommissionFile Number: 0-11625**

**MFIC CORPORATION**

(Exact name of registrant as specified in its charter)

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

 

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

**Securitiesregistered pursuant to Section 12(b) of the Act:   None**

**Securitiesregistered pursuant to Section 12(g) of the Act:   Common Stock,$.01 par value**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.   Yes o   No þ

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. o

Indicate by check markwhether the registrant; (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.   Yes þ   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K. o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act)   Large Accelerated Filer o   AcceleratedFiler o   Non-Accelerated Filer þ

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Act) Yes o   No þ

The aggregate market valueof Common Stock held by non-affiliates of the registrant (without admittingthat any person whose shares are not included in determining such value is anaffiliate), based upon the closing sale price of the Common Stock on June 30,2005 and on March 28, 2006 respectively as reported on the NASDAQOver-the-Counter Bulletin Board was approximately $19,993,000 and $11,407,000.

The number of sharesoutstanding of the registrant’s Common Stock as of March 28, 2006 was 9,963,845shares.

**Portions of the definitiveProxy Statement to be delivered to shareholders in connection with the Company’sAnnual Meeting of Stockholders are incorporated by reference into Part III.**

 

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**MFIC Corporation2005 Form 10-K Annual ReportTable of Contents**

|                | ** ** | ** **                                                                                  | ** ** | **Page**   |
|----------------|------------|---------------------------------------------------------------------------------------------|------------|------------|
| ** **     |       | **PART I**                                                                             | ** ** | ** ** |
| Item 1.        |       | Business                                                                                    |       | 1          |
| Item 1A.       |       | Risk Factors                                                                                |       | 11         |
| Item 1B.       |       | Unresolved Staff Comments                                                                   |       | 16         |
| Item 2.        |       | Description of Properties                                                                   |       | 16         |
| Item 3.        |       | Legal Proceedings                                                                           |       | 17         |
| Item 4.        |       | Submission of Matters to a Vote of Security Holders                                         |       | 17         |
|           |       | **PART II**                                                                            |       |       |
| Item 5.        |       | Market for Registrant’s Common Equity and Related  Stockholder Matters                 |       | 17         |
| Item  6.       |       | Selected  Financial Data                                                                    |       | 19         |
| Item 7.        |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |       | 20         |
| Item 7A.       |       | Quantitative and Qualitative Disclosures about Market  Risk                                 |       | 30         |
| Item 8.        |       | Financial Statements and Supplementary Data                                                 |       | 31         |
| Item 9.        |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure       |       | 31         |
| Item 9A.       |       | Controls and Procedures                                                                     |       | 31         |
| Item  9B.      |       | Other  Information                                                                          |       | 31         |
| Item 10.       |       | Directors and Executive Officers of the Registrant                                          |       | 31         |
| Item 11.       |       | Executive Compensation                                                                      |       | 32         |
| Item 12.       |       | Security Ownership of Certain Beneficial Owners and  Management                             |       | 32         |
|           |       | **PART III**                                                                           |       |       |
| Item 14.       |       | Independent Accountant Fees for Fiscal 2005 and Fiscal  2004                                |       | 32         |
| Item 15.       |       | Exhibits, Financial Statements Schedules and Reports  on Form 8-K                      |       | 33         |
| Signatures     |       |                                                                                        |
| Certifications |       |                                                                                        |

 

This Report contains “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of 1995. Suchstatements are subject to certain risks and uncertainties, including without limitationthose discussed in Item 1A “Risks Factors” and Item 7 under the heading “CertainFactors and Cautionary Statement Regarding Forward-Looking Statements.”  Such forward-looking statements speak only asof the date on which they are made, and the Company cautions readers not toplace undue reliance on such statements.

Microfluidizer® isa trademark of the Company, which has been registered with the United StatesPatent and Trademark Office. All other trademarks or trade names referred toherein are the property of their respective owners.

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**Item 1.**                        BUSINESS:

*Company Overview:*

MFIC Corporation (MFIC or the Company) has, for over20 years, specialized in manufacturing and marketing a broad line of high shearfluid processing systems used in numerous applications in the chemical,pharmaceutical, biotech, food and cosmetics industries. 

MFIC’s line of high shear fluid processor equipment,marketed under the Company’s Microfluidizer® trademark and trade name, create nanoparticles(commonly defined as particles having dimensions less than 100 nanometers)including nanostructures, microemulsions and nanosuspensions. The equipmentproduces commercial quantities of such materials important to producers ofpharmaceuticals, coatings and other products.

Additionally, the Company commercializes its proprietaryequipment, processes and technology for the continuous creation ofnanoparticles. The Company has undertaken commercialization efforts for itspatented MicrofluidizerMixer/Reactor(MMR), which is a high pressure multiple stream mixer/reactor.

The Company’s technology embodied within itsMicrofluidizer high shear fluid processing technology is used for formulationof products that are normally very difficult to mix and stabilize.Microfluidizer processors allow manufacturers in the chemical, pharmaceutical,cosmetic, and food processing industries to produce higher quality productswith better characteristics on a more consistent basis than with otherblending, mixing or homogenizing techniques. Additionally, the equipment isused for cell disruption to harvest the cultivated contents of bacterial,yeast, mammalian and/or plant cells and for liposomal encapsulation ofmaterials for the cosmetics and biotech/biopharma industries.

The Company’s management believes that futurecommercialization and growth of nanotechnology may be, in large part, enabledby the manufacturing capability of the Company’s materials processor and MMRequipment. Further, the Company guarantees scaleup of formulations and resultson its processor equipment from 10 milliliters per minute on its laboratory andbenchtop models to more than 15 gallons per minute on its pilot and productionmodels.

The Company wasincorporated 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 effective July 12,1999 to MFIC Corporation. From August, 1998 until its sale on February 9,2004, the Company also operated another division, known as the Morehouse-COWLESDivision, which manufactured and sold a broad line of mechanical fluidmaterials processing systems used for a variety of dispersing, milling, andmixing applications across a variety of industries. The Company’s principalexecutive offices are located at 30 Ossipee Road, in Newton, Massachusetts02464-9101 and its telephone number is (617) 969-5452.

*The Technologies:*

*FluidProcessing Equipment.*   The Company’sMicrofluidizer high shear fluid processing equipment is based on patents andrelated technology that were licensed by the Company from Arthur D. Little &Co. in 1983 and subsequently purchased by the Company in 1985. The Companyholds one unexpired United States patent related to the method used tointimately mix liquids and disperse particulate solids in micro emulsions. See “Patentsand Proprietary Rights Protection.”

Microfluidizer high shear fluid processors differ fromconventional mechanical mixing and processing technologies in that the Company’sequipment utilizes highly pressurized product streams that travel at highvelocities in precisely defined microchannels producing high shear forces andthen collide at ultra-high velocities in a small, confined space producing highforces of impact. There are no moving parts in this mixing and collision zone (“fixedgeometry”). Combined forces of shear and impact in the fixed 

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geometry design act uponproducts to cause deagglomeration and particle size reduction. These forcesresult in what the Company believes are smaller, more uniform, highly stable,and reproducible dispersions and emulsions than can be produced by any othermeans. Microfluidizer processors also differ from conventional mixing andhomogenization equipment in that Microfluidizer processors permit a linearscaleup from 10 milliliters per minute to more than 15 gallons per minute withno basic change in product formulation or equipment design and engineering. Theformulations processed may be liquid/liquid or liquid/solid combinations.

*MMR.*   TheCompany has introduced its patented Microfluidizer 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.

*CommercialApplications:*

Microfluidizer processor technology allowsmanufacturers in the chemical, pharmaceutical, biotechnology, cosmetic, andfood processing industries to produce higher quality products with bettercharacteristics on a more consistent basis than with other blending, mixing orhomogenizing techniques. Further, the proprietary equipment enables manufactureof unique products which cannot otherwise be produced. Microfluidizer processorequipment is generally used in the processing of high value-added end-productsthat require extremely small and uniform particle sizes. New applicationsinclude deagglomeration of carbon nanotubes for subsequent formatting oralignment for specific uses.

Microfluidizer processor equipment can be used to mixand formulate stable emulsions, dispersions and liposomes, and for celldisruption.

Emulsions are homogenous mixtures of oil and watercomponents (or other normally immiscible components), which, if mixed properly,do not readily separate. Emulsions comprise many products, such as foodadditives, medicines (including injectable drugs), photographic films, andpolymers. The Company believes that, generally, an emulsion processed withMicrofluidizer processor equipment will exhibit improved stability and requirereduced concentrations of costly emulsifying agents that are otherwise neededto create and/or maintain product stability.

Dispersions are mixtures of fine solids suspended inliquid so that the two do not separate readily after processing. Similar toemulsions, dispersions are used in a variety of consumer and industrialproducts, including pharmaceutical products (including injectable drugs),coatings, pigment dispersions for inkjet inks and toners, phosphorescentcoatings for TV screens and fluorescent lamps, and barium titanate forcapacitors and toners.

Liposomes are biodegradable cell-like structures,formed from materials such as cholesterol and lecithin, which can be used toencapsulate 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 beenused commercially in two predominant applications: medical diagnostic agentsand cosmetics. Applications include the encapsulation of dye to be used as amarker in medical diagnostic tests and the encapsulation of ingredients fordeeper skin penetration, or time-release control, as well as pharmaceutical,food and specialized agricultural applications.

In the biotechnology industry, Microfluidizerprocessor equipment is currently used to harvest, by cell rupture, proteingrown in bacteria, plant or mammalian cells. The controlled forces of shear andimpact produced by Microfluidizer processor equipment allow the cell wall to beruptured without damage to, or 

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contamination of, the cellcontents. The Microfluidizer processor equipment eliminates grinding mediacontamination, thus minimizing downstream processing requirements.

Microfluidizer processor equipment is generally usedin commercial applications where a scientist, formulator or chemist is tryingto develop or improve a product formulation for a high value-added end product.The Company believes that its laboratory equipment uniquely facilitates modernformulation development and production capability. Microfluidizer processorequipment is initially employed in a research laboratory, with the equipmentsubsequently being used in scale-up to pilot scale production of new orimproved products, and ultimately, for production scale volumes as the improvedproduct comes to market. From laboratory to production, the Company guaranteesscale-up of formulations and results on its equipment from 10 milliliters perminute on its laboratory and benchtop models up to more than 15 gallons perminute on its pilot and production models.

The Company currently manufactures and markets thefollowing lines of equipment:

*TheHC Series:*   The HC Series, also known as “Homogenizers,”is a laboratory-scale series of equipment that is intended to impart moderatelevels of energy into a customer’s product with greater flow rates than themore energy intensive Microfluidizer processor devices. Operating pressures ofproducts in the Company’s HC Series can range from 250 psi to as highas 8,000 psi, and will process as much as two liters of fluid per minute.

*The M-110Series:*   The M-110 Series is alaboratory product line that is designed primarily for research and developmentapplications. Standard models can generate pressures as high as 23,000 psi andhave a product flow rate on the order of one-half liter per minute. The M-110EHincludes an on-board hydraulic pump system for high performance “lab scale”micro-mixing at processing pressures up to 30,000 psi and flow rates up to 320ml/min. It has numerous standard features including ceramic plungers, diamondinteraction chambers, and options including explosion-proof motors, and steamsterilization.

*The M-140Series:*   The M-140K Series is alaboratory-scale unit developed forcustomersin the chemical, biotechnology, pharmaceutical, cosmetic and food processingindustries that require elevated operating pressures and higher shear forces toachieve better performance. The M-140K can achieve operating pressures upto 40,000 psi. The M-140K has a built-in hydraulic system and utilizes abi-directional intensifier pump that provides a highly uniform pressureprofile. It has been designed with many accessories and options including anexplosion proof motor, control package and solvent seal quench. The M-140Khas flow rates up to 500 ml/min.

*The M-210Series:*   The M-210 Series is a pilotunit and is primarily marketed to pharmaceutical, cosmetic and food productmanufacturers who have successfully created a new or improved formulation onthe M-110 Series unit and would like to increase their productioncapacity. The M-210 Series unit is typically used for testingformulations at greater volume levels before initiating full-scale production.For some customers (such as biotechnology and pharmaceutical productmanufacturers), the M-210 Series may have the capacity to functionas a production unit.

*The M-700Series:*   The M-700 Series wasintroduced at the end of fiscal 1998 and was initially designed, engineered,and constructed for use in “rugged” industrial environments such as coatings,paints and pigments research and manufacturing. This product line was especiallydesigned to withstand such hazards as dust, grease, and water spray. Throughuse of our own proprietary design of an intensifier pump and other components,the system has also proven to be more cost-effective in many user applications.

More recently, because of the market demands of thepharmaceutical, biotech and cosmetic industries, the M-700 product linewas upgraded to all stainless steel construction to conform to the U.S. Foodand Drug Administration’s current Good Manufacturing Practices (cGMP) requirements.

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(See discussion underheading “Government Regulations”.) It also offers steam in place (SIP) andultra clean in place (UCIP) options.

The M-700 Series equipment is available ina variety of configurations and flow rates depending upon motor size and thenumber of intensifier pumps. The M-700 series equipment can achieveoperating pressures up to 40,000 psi. On the low end of the spectrum is the 15HP, single intensifier pump M-7115 machine with flow rates ranging from0.9 gpm at 10,000 psi to 0.4 gpm at 30,000 psi. The next size up is the 25 HP,single intensifier pump, M-7125 machine with flow rates ranging from 2.3gpm at 10,000 psi to 0.6 gpm at 30,000 psi. The largest offering of the M-700series product line is the 50 HP, dual intensifier pump M-7250 machinewith flow rates ranging from 4.5 gpm at 10,000 psi to 1.2 gpm at 30,000 psi.The M-7250 machine is available with a recently introduced “constantpressure” option in which operating pressure is maintained to within 5% of peakoperating pressure resulting in lengthened component life, reduced operatingcosts, and quieter operation.

In September 2003, Microfluidics introduced a newaddition to the M-700 series product line, the 100 HP, a dual intensifierpump, Model M-710 machine with flow rates ranging from 15 gpm at 5,000psi to 3.0 gpm at 30,000 psi. This model has the equivalent throughput of thelarger and more expensive M-610-100 HP model.

Additionally,during 2003 the Company introduced several new options and equipment featuresto the M-700 series product offerings including:

(i)    The M-700Microfluidizer Containment System, which is utilized for the protection ofpersonnel engaged in the processing of highly toxic cancer therapeutic drugsand other hazardous materials.

(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.

(iii)  UltraClean in Place (UCIP) option, which provides 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.

(iv)  Constantpressure is now an available feature that eliminates virtually all processpressure variations which dramatically improves the overall reliability of allM7250 and 710 machines.

*The M-610Series:*   The M-610 Series consists ofcustom-built models used for large-scale production. These units have flowrates of up to 18 gallons per minute and generate operating pressures up to40,000 psi. Generally, these models are available in 100 HP and 200 HP.

*MicrofluidizerMixer/Reactor (MMR):*   The Company has introducedits patented Microfluidizer Mixer/Reactor (MMR) system as a continuous chemicalreactor, which the Company believes may become a standard device for conductingchemical reactions, many of which can be configured to produce nanoparticles.This system produces uniform nanoparticles with phase purity previouslyunachievable with conventional batch reaction technology. This degree ofreaction chemistry control can lead to cost-effective product improvements andthe development and manufacture of new nanomaterials in scalable quantities. Applicationsfor the new technology include improving the performance of catalysts,planarization polishing media, superconductors, abrasive silica, recording 

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media, photographicmedia and pigments. It also may be used in the development and production ofunique pharmaceutical products. The Company is proceeding with projectsinvolving other companies seeking to optimize or enable drug delivery,catalysts and coatings products, as well as an internal program on nanopolymercreation for drug delivery and other applications. The Company believes that itcannot accurately assess or anticipate either the timing of receipt of an orderor the delivery of its first MMR laboratory development systems. However,management believes that such event will occur in the foreseeable future. TheCompany believes that the MMR systems and technology make it a leader in theprovision of systems for continuous production of uniform, reproducible,microparticles, nanoparticles and nanodroplets.

*Former CompanyBusiness Division:*

*Morehouse-COWLESDivision:*   On February 9, 2004, pursuant toan Asset Purchase Agreement (the Asset Purchase Agreement) dated February 5,2004 between MFIC and a wholly owned subsidiary of NuSil Corporation, aCalifornia corporation (NuSil), MFIC sold substantially all of the assets andselected liabilities of its Morehouse-COWLES Division (the Division), to NuSil.Other than NuSil’s prior purchases of products from the Division, there were nopreexisting relationships between MFIC and NuSil.

Prior to February 9,2004, the Company-operated Morehouse-COWLES Division manufactured grinding anddispersing equipment used in a broad number of industries including thecoatings and ink industries. The products included high-speed single andmulti-shaft dissolvers and dispersers, stone mills, and vertical and horizontalmedia mills. As one of the early inventors of dispersers, dissolvers, stonemills, and media mills, the one hundred-year-old COWLES name is anindustry-accepted symbol of quality, reliable products. The Morehouse-COWLESDivision manufactures products that are generally used for blending, mixing,deagglomeration and dispersion of paints and coatings, inks, adhesives,sealants, and pigment dispersions. These applications are more conventionalwhereby the formulations are less expensive to produce and the volumes ofproduct produced are large. The Morehouse-COWLES product lines are used inbroader, high volume, lower value-added applications requiring less stringentparticle size reduction.

*Marketing andSales:*

The Company’s marketing and sales activities areconducted through a corporate marketing and sales group that is responsible forthe worldwide marketing and sales of all products.

Marketing programs include media advertising, awebsite, direct mail, seminars, trade shows and telemarketing. In addition, theCompany has an active program of field demonstrations. As an aid to themarketing and sales activity for the equipment, the Company providesprospective customers with access to its applications laboratories. Theselaboratories, located in Newton, Massachusetts, Irvine, California, andLampertheim, Germany, provide free processing and particle size anddistribution analysis of a prospective customer’s sample formulation.Additionally, a prospective customer may pay for subsequent laboratory time andservices on a fee for services basis, which includes equipment rentals.Typically, about one third of such trials result in equipment orders withintwelve months. Finally, the Company has an active domestic and foreignequipment rental program designed to allow customers to use Microfluidizerprocessor equipment at their own locations to experiment with and developproduct formulations and processes. A rental period may last from weeks toseveral months. The Company has a rental pool of equipment to service the needsof customers, including laboratory and pilot machines. A significant percentageof customers who rent the Company’s equipment elect to purchase rentalequipment or to purchase new equipment.

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Distributors and salesagents worldwide are supported with trade advertising, collateral literatureand trade show materials. The distributors and sales agents also advertisedirectly on their own behalf and attend regional and international trade shows.

The Company sells itsequipment in the United States through a network of independent manufacturers’representative firms that are managed by the Company’s regional sales managers.In a portion of Canada, the Company has an exclusive distributor for the Company’sproduct line. In Europe, the Company sells its equipment through a network ofindependent regional sales agents who are managed by the Company’s EuropeanSales organization. In Asia and the Pacific Rim, the Company sells through anetwork of distributors and independent manufacturer’s representative firms.Customers in other geographical regions are assisted directly by Company salesstaff. In November 2005, the Company appointed a vice-president of salesand marketing, who oversees all regional sales managers, independentmanufacturers’ representatives, and distributors.

*Customers:*

The users of the Company’ssystems are in various industries, including the chemical, pharmaceuticals,food, cosmetic and biotechnology industries. Two companies each accounted formore than 10% of 2005 revenues. Mizuho Industrial Co. Ltd. (Mizuho) adistributor for the Company, and a customer who is a wholly owned subsidiary ofTeva Pharmaceuticals Industries Ltd. (Teva) accounted respectively for 19.5%and 18.9% of the Company’s revenues from continuing operations in 2005,respectively; 20.5% and 12.8%, respectively, in 2004; and 20.6% and 10.6%,respectively, in 2003. Mizuho, the Company’s Japanese distributor ofMicrofluidizer processor equipment and spare parts, resells the Company’sequipment to numerous end-users in Japan, none of which individually represents10% or more of the Company’s revenues. Two customers accounted for 10.8% and10.7% of the trade accounts receivable from continuing operations as of December 31,2005, respectively. Three customers accounted for 15.1%, 14.7%, and 13.4% ofthe trade accounts receivable from continuing operations as of December 31,2004, respectively. One customer accounted for 16.7% of the trade accountsreceivable from continuing operations as of December 31, 2003. A reductionor delay in orders from any of the Company’s significant customers could have amaterial adverse effect on the Company’s results of operations.

The Company sells itsproducts in various countries. The Company’s sales in North America, includingthe United States, Canada, and Mexico, accounted for approximately 51.8% of theCompany’s revenues from continuing operations in 2005; approximately 51.1% ofthe Company’s revenues from continuing operations in 2004; and approximately51.0% of the Company’s revenues from continuing operations in 2003, with almostall of those sales coming from United States and Canada. Sales to the rest ofthe world accounted for approximately 48.2% of the Company’s revenues fromcontinuing operations in 2005; approximately 48.9% of the revenues fromcontinuing operations in 2004; and approximately 49.0% of the revenues fromcontinuing operations in 2003. Sales through the Company’s exclusivedistributors in Japan accounted for approximately 19.5% of the Company revenuesfrom continuing operations in 2005; 20.5% of the Company’s revenues fromcontinuing operations in 2004; and 20.6% of the Company’s revenues fromcontinuing operations in 2003. Sales through the Company’s representative in Koreaaccounted for approximately 12.1% of the Company’s revenues from continuingoperations in 2005; 4.8% of the Company’s revenues from continuing operationsin 2004; and 5.1% of the Company’s revenues from continuing operations in 2003.

*Competition:*

The patentedMicrofluidizer processor equipment product line of high shear fluid processorshas direct competition in its major markets, including pharmaceutical andcoatings/chemical applications, but management believes that the Company’sproducts have a larger installed base and performance advantages over productsof our competitors. The Company also believes that its “fixed-geometry” systemswhich permit a linear scale up for drops per minute to gallons per minute offera unique equipment 

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advantage.The Company further believes that the Microfluidizer processor equipmentproduct line offers the highest shear forces available in the process equipmentmarket today. It has been proven in many instances that for criticalformulations, Microfluidizer processors have produced better quality productsfor our customers.

The M-700 Series offluid processors, together with the M-210 and M-610 product lines,provide high shear fluid processing capabilities for sanitary, sterile, andindustrial applications. The Company believes that the Microfluidizer processorproduct line provides a distinct advantage over the product lines of ourcompetitors with respect to the processing of abrasive slurries or solidsdispersed in liquids in large part because of the Company’s unique,wear-resistant, diamond interaction chamber and the special design of theintensifier pumping system. Further, recent incorporation of Company developedcomponents in the M-700 series equipment has reduced the cost of theseunits, and they are priced competitively with lesser capability processingequipment.

The MMR systems mayencounter significant competition and there are other companies that possesspatents and claims to equipment or processes that claim to make productionquantities of nanoparticles. At least one of these companies, Five StarTechnologies Inc. (Five Star), has raised significant investment capital fromventure capital sources ($4.5 million in its second round in October 2003)for its patented technology. Five Star claims the use of hydrodynamiccavitation to achieve production of nano and micro materials. Five Star alsoclaims that its process is inherently scalable. Although the Company believesthat its MMR system is superior in design and function there can be noassurance that Five Star, or others, will not pose a competitive impediment tosales of the Company’s MMR system.

The Company faces, andwill continue to face, intense competition from other companies who manufactureand sell materials processing systems. The Company is subject to significantcompetition from organizations that are pursuing technologies and products thatare similar to the Company’s technology and products. The Company’s futuresuccess will depend in large part on maintaining its current technologicallysuperior product line and competitive position in the fluid processing systemsfield. Rapid technological development by the Company or others may result inthe Company’s products or technologies becoming obsolete before the Companyrecovers the expenses it incurs in connection with their development. Productsoffered by the Company could be made obsolete by less expensive or moreeffective technologies. There can be no assurance that the Company will be ableto make the enhancements to its technology necessary to compete successfullywith newly emerging technologies. The Company expects competition to intensifyin the materials processing systems field as technical advances are made andbecome more widely known.

*Research and Development:*

It is the Company’s positionthat a greater proportion of its sales in the future will be for more advancedprocessor production systems that will incorporate features not currentlyincluded in many of the current production machines. In order to meet such achallenge going forward, it became necessary to hire additional research anddevelopment personnel. It also became necessary, as a result of this decision,to increase spending in research and development. Additional resources in bothpersonnel and spending may be required in the future.

The Company’s research anddevelopment efforts are focused on: (i) developing new processingapplications for the process industries; (ii) further enhancements to thefunctionality, reliability and performance of existing products, and (iii) developmentof the Microfluidizer Mixer/Reactor (MMR) by: (a) working with customerswho assist in the development of the system with both application knowledge andfinancial support, and (b) internal development program relating toreaction chamber design and creation of a variety of nanomaterials. There canbe no assurance that the Company will be able to meet the enhancementchallenges posed by applications of its core Microfluidizer processor business.Likewise there can be no assurance that the Company will be able to design andmanufacture reaction chambers for 

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its MMRapplications that will deliver the desired result for specific applications.Research and developmentcosts for continuing operations were $1,701,870, $1,033,978, and $785,849, in2005, 2004, and 2003, respectively. Patent coverage for the MMR has beenobtained both in the United States and in Europe (with national entry inprocess) and the Company is prosecuting the patent application in Canada.

*Cooperative Research Arrangements:*

The Companysubsidizes research and development activities centered around Microfluidizerprocessor technology at a number of research centers and universities. TheCompany’s subsidy of these activities takes the form of substantial reductionor elimination of the customary rental charges for Microfluidizer processorequipment provided for use. The Company has, in past years, subsidized researchand development in the following fields at the following universities:

| **University**                         | ** ** | ** **                                 | ** ** | **Field of Research/Development** |
|----------------------------------------|------------|--------------------------------------------|------------|-----------------------------------|
| University of  Massachusetts, Lowell   |       | biotechnology and  nanotechnology          |
| Massachusetts Institute  of Technology |       | nanoemulsions for  biomedical applications |
| Marine Biological  Laboratory          |       | cell disruption                            |
| Lehigh University                      |       | polymer chemistry                          |
| Université Laval  (Quebec)        |       | food science                               |
| Worcester Polytechnic  Institute       |       | catalytic chemistry                        |
| Purdue University                      |       | pharmaceuticals                            |
| University of Toronto                  |       | genomic research and expression            |

 

In addition to theirresearch activities, these universities provide the Company with contacts atindustrial companies that may utilize Microfluidizer processor technology. Mostrecently, the Company entered into a Research Collaboration Agreement with theUniversity of Massachusetts, Lowell (UML) in September 2005 to develop newapplications, processes and products in the area of nanomaterials utilizingMFIC’s leading-edge materials processing and MMR equipment. Additionally, onoccasion, research reports, technical papers, and doctoral theses may bepublished, which document the use of Microfluidizer processor technology.Finally, the Company engages in many informal co-operative development effortswith its customers.

*Patents and Proprietary Rights Protection:*

To protect its proprietaryrights, the Company relies on a combination of U.S. patent and trademark laws,trade secrets, confidentiality agreements, contractual provisions and technicalmeans. In the event of patent infringement or breach of confidentiality, therecan be no assurance that these measures will be adequate or that the Companywill have sufficient resources to prosecute or prevail in an action against athird party. In addition, the Company neither applied for nor obtained patentor trademark protection for its Microfluidizer processor equipment’sinteraction chamber in any country other than the United States and, as aresult, its proprietary rights are not subject to the protection of patent ortrademark laws of foreign countries where the Company’s equipment is sold. TheCompany’s Microfluidizer processor equipment method patent expires on March 13,2007 and its device patent expired on August 6, 2002. The Company does notbelieve that the expiration of its device patent resulted in any materialdetriment to the Company since the Company has made many alterations, improvementsand advances to its equipment over the years with such modification andinnovations having been treated by the Company as trade secrets.

In 1997 the Companycompleted development of a novel adaptation of its Microfluidizer processorequipment—a “Multiple Stream High Pressure****Mixer/Reactor”, commercially designated as theMicrofluidizer Mixer/Reactor (MMR). In August 1997, the Company filed apatent application for the device and its processes with the United StatesPatent and Trademark Office (USPTO), and filed a Patent 

8

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CooperationTreaty (PCT) application on May 5, 1998. In July and November, 2000,the USPTO issued to the Company notices of allowances of utility patent claimsregarding the MMR and the use thereof. On September 18, 2002, the EuropeanPatent Office advised the Company it would grant its MMR patent substantiallyas applied for, including its device and process claims. The Company is in theprocess of pursuing national entry in France, Germany, Italy, The Netherlands,and the United Kingdom. The Company is currently prosecuting its MMR patent inCanada.

The Company maintainsconfidentiality agreements with its employees and also maintainsconfidentiality agreements and non-competition agreements with those thirdparties to whom it discloses non-public technical information relating to itsequipment. The Company believes that enforcement of the provisions of suchagreements should adequately protect the Company’s proprietary information. However,in the 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, the Company may suffer competitively and be materially and negativelyimpacted as a result of any unauthorized disclosure.

*Manufacturing:*

At present, the Companysubcontracts the manufacture and/or machining and finishing of many of thecomponents of its equipment to third parties, with the Company undertaking the remainingfabrication, assembly and performance testing. The Company has selected certainprimary suppliers based upon pricing terms, quality of their products, and thevendor’s performance record.

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 hasidentified alternative suppliers for its most critical components (AlternativeSources). There can be no assurance that a transition to such AlternativeSources will not entail transitional delays, quality assurance and qualitycontrol difficulties, delivery problems, any or all of which would likely havean impact on the Company’s production of equipment and could have a materialadverse effect on the Company’s business, financial condition, or results ofoperations.

*Key Management / Personnel:*

The Company’s continuedoperation, innovation and growth are to some significant degree reliant on thecontinued services of its key executive officers and leading technicalpersonnel. The Company does not maintain employment contracts with its keymanagement or leading technical personnel. Though the Company believes that itcan identify and recruit replacement key management and technical personnel, therecan be no assurance as to such availability, the length of time required toobtain such replacement management and technical personnel, the salary levelthat may have to be paid to obtain their respective services, or the impact onoperations that may be experienced through the interim absence of such keymanagement and technical personnel. The loss of key management or leadingtechnical personnel could, therefore, have a material adverse effect on theCompany’s business, financial condition, or results of operations.

*Government Regulation:*

Certain of the Company’scustomers utilize the Company’s products in processes and production that aresubject to governmental regulation. For example, the manufacturing andmarketing of pharmaceutical products may require the approval of the U.S. Foodand Drug Administration (FDA) within the United States and of comparableagencies in foreign countries. The FDA has established mandatory procedures,safety standards and protocols that apply to the manufacture, clinical testingand marketing of new pharmaceutical products in the United States. The processof seeking and obtaining FDA approval of a new product often takes a number ofyears and often involves the expenditure of substantial resources by 

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theCompany’s customers. The FDA approval process can result in long lead timesthat are attendant to manufacturing equipment orders for these applications.

Further, in addition toproduct approvals, the FDA imposes requirements as to manufacturing practices,record keeping and reporting (current Good Manufacturing Practices or cGMP).cGMP-regulated companies are subject to inspections by the FDA (inclusive ofMicrofluidizer processor equipment) and product approvals may be withdrawn ifcGMP are not met.

At present, the Company’scustomers include companies who are making FDA approved drugs, preparations,and products, including sunscreens and cosmetic lotions for external use andcompanies who utilize Microfluidizer processor equipment for the formulation orproduction of FDA approved parenteral (injectable) drugs or compounds includingvaccines and anesthesia.

For the Company’sequipment entering Europe, CE compliance (Regulatory Compliance with EuropeanSafety Standards) is required. All products manufactured for European customers(and for any others who may request it) by the Company are CE compliant.

Various laws, regulationsand recommendations relating to safe working conditions, laboratory practicesand the purchase, storage, movement, import and export, use and disposal ofharmful or potentially harmful substances that may be used in connection withthe Company’s research work are, or may be, applicable to its activities. Theselaws include, among others, the United States Atomic Energy Act, the Clean AirAct, the Clean Water Act, the Occupational Safety and Health Act, the NationalEnvironmental Policy Act, the Toxic Substances Control Act, the ResourceConservation and Recovery Act, national restrictions on technology transfer,import, export and customs regulations and other present and possible futurelocal, state or Federal regulation. The extent of adverse governmentalregulation, which might result from future legislation or administrativeaction, cannot be accurately predicted. Certain agreements that may be enteredinto by the Company involving exclusive license rights may also be subject toantitrust regulatory control, the effect of which cannot be predicted.

To date the Company hasnot been affected by any United States governmental restrictions on technologytransfer, import, export and customs regulations and other present local, stateor Federal regulation. The extent of adverse governmental regulation, whichmight result from future legislation or administrative action, cannot beaccurately predicted. In particular, the USA Patriot Act of 2001 and othergovernmental regulations may impose export restrictions on sale of equipment ortransfer of technology to certain countries or groups. There can be noassurance that sale of the Company’s equipment will not be impacted by suchlegislation or designation. Depending upon which countries and sales may bedesignated for trade restriction such action could have a material adverseeffect on the Company’s business, financial condition, or results ofoperations.

*Backlog:*

The Company’s sales orderbacklog related to continuing operations of accepted and unfilled orders at March 28,2006, and March 11, 2005, was approximately $3,646,238 and $3,072,000,respectively. Backlog as of any particular date should not be relied upon asindicative of the Company’s net revenues for any future period.

*Employees:*

The Company hasapproximately 47 full-time employees as of March 28, 2006. None of theCompany’s employees are covered by a collective bargaining agreement, and the Companyconsiders its relations with its employees to be satisfactory. The Companybelieves that its future success will depend in large part on its ability toattract and retain highly skilled employees.

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**Item 1A.**                RISKFACTORS

In addition to the certain risks described in othersections in this annual report and our other filings with the Securities andExchange Commission, prospective investors should consider the following beforemaking any investment decision.

The Company faces a numberof risks and uncertainties that could cause actual results or events to differmaterially from those contained in any forward looking statement. Additionalrisks and uncertainties not presently known to the Company or that arecurrently deemed to be immaterial may also impair the Company’s businessoperations. Factors that could cause or contribute to such differences include,but are not limited to, the following:

**The Company facesintense competition in many of our markets.**

Our Microfluidizer® product line of high-shear fluid processorshas direct competition in its major markets, including its most importantmarkets in the pharmaceutical, biotechnology and coatings/chemical industries. Thereare a few small, direct competitors in geographical areas where our patents arenot protected. The Company does not believe that these competitors, however,offer product lines of comparable breadth or scope as our products and theCompany does not believe that they possess high-pressure engineering experienceto the extent that the Company does. The Company does not regard the presenceof these competitors as an impediment to our growth.

In addition, the Companyfaces, and will continue to face, intense competition from other companies whomanufacture and sell fluid processing systems used in particle size reduction,mixing, milling, dispersing, homogenizing, cell disruption and liposomalencapsulation applications. The Company expects competition to intensify in thefluid processing systems field as technical advances are made and become morewidely known, and such increased competition may have a material adverse effectupon our business.

**The Company issubject to significant competition from companies that are pursuingtechnologies and products that are similar to the Company’s technology andproducts.**

Our future success willdepend in large part on the Company’s ability to maintain a technologicallysuperior product line. Rapid technological development by the Company or othersmay result in our products or technologies becoming obsolete before the Companyrecovers the expenses the Company incurs in connection with their development. Productsoffered by the Company could be made obsolete by less expensive or moreeffective technologies. There can be no assurance that the Company will be ableto make the enhancements to our technology necessary to compete successfullywith newly emerging technologies.

**TheCompany relies on suppliers, vendors and subcontractors.**

The Company does not manufacturemost of the components contained in its Microfluidizer® materials processor equipment but rathersubcontracts the manufacture of most components. Based on quality, price, andperformance, the Company has selected certain suppliers, vendors, and subcontractorsthat provide parts, subassemblies, machining and finishing of components thatare assembled by the Company’s production staff. Although the Company hasidentified alternate sources for such parts, components, machining andfinishing, there can be no assurance that a transition to such alternativesources will not entail quality assurance and quality control difficulties,on-time delivery problems, or other transitional problems, any or all of whichwould likely have an impact on the Company’s production of equipment and couldhave a material adverse effect on the Company’s business, financial condition,or results of operations.

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**TheCompany has only one manufacturing facility**

The Company has only onemanufacturing facility located in Newton, Massachusetts. Our success depends onthe efficient and uninterrupted operation of our manufacturing facility.Whether as a result of a fire, terrorist attack, natural disaster or othercauses, any significant disruption, up to and including substantial destruction,would disrupt our manufacturing operations and significantly impair our abilityto operate our business on a day-to-day basis. Although the Company maintainsbusiness interruption insurance, our business would be injured by any extendedinterruption of the operations of our manufacturing facility. Further, althoughthe Company carries property and business interruption insurance, our coveragemay not be adequate to compensate us for all losses that may occur. Thisinsurance may not continue to be available to the Company. Finally, if theCompany seeks to replicate our manufacturing operations at another location,the Company will face a number of technical as well as financial challenges,which the Company may not be able to address successfully.

**The Companyrelies on patents and trade secrets to protect our technology.**

To protect its proprietary rights, the Company relieson a combination of U.S. patent and trademark laws, trade secrets,confidentiality agreements, contractual provisions and technical means. In theevent of patent infringement or breach of confidentiality, there can be noassurance that these measures will be adequate or that the Company will havesufficient resources to prosecute or prevail in an action against a thirdparty.

The Company’s Microfluidizer® equipment process patent expires on March 13,2007 and its device patent expired on August 6, 2002. In addition, theCompany has neither sought patent protection for its Microfluidizer® interaction chamber nor trademark protectionof its Microfluidizer® trade name in any country other than theUnited States. As such, its proprietary rights are not subject to theprotection of patent or trademark laws of foreign countries where the Company’sequipment is sold. Although the Company has made many alterations, improvementsand advances to its equipment over the years and continues to make suchadvancements with such modification and innovations having been and beingtreated by the Company as trade secrets, the lack or limited nature of our patentprotections will expose the Company to potential competition that would likelyhave a material adverse effect on the Company.

To protect its other proprietary rights, the Companyrelies on a combination of trademark laws, trade secrets, confidentialityagreements, contractual provisions and technical means. In the event of abreach of these protections, there can be no assurance that these measures willprove to have been adequate to protect the Company’s interests, or that theCompany will have sufficient resources to prosecute or prevail in an actionagainst a third party. The Company maintains confidentiality andnon-competition agreements with those parties to whom it discloses non-publictechnical information relating to its equipment. The Company believes thatenforcement of the provisions of such agreements should adequately protect theCompany’s proprietary information. However, in the event of a material breachof such agreements, certain of the Company’s valuable intellectual property maybe disclosed to third parties (including competitors). In such event, despiteprovisions for equitable relief and damages in the event of such breaches, theCompany may suffer competitively and be materially impacted as a result of suchunauthorized disclosure.

In 1997, the Companycompleted development of a novel adaptation of its Microfluidizer® equipment—a Multiple Stream High PressureMixer/Reactor (MMR). In August 1997, the Company filed a patentapplication for the device and its processes with the United States Patent andTrademark Office (USPTO), and filed a Patent Cooperation Treaty (PCT)application on May 5, 1998. In July and November 2000, the USPTOissued to the Company notices of allowances of utility patent claims regardingthe MMR and the use thereof. On September 18, 2002, the European PatentOffice advised the Company it would grant its MMR patent substantially asapplied for, including its device and process 

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claims. TheCompany is in the process of pursuing national entry in France, Germany, Italy,The Netherlands, and the United Kingdom.

**TheCompany must continue its research and development efforts to maintaincompetitive.**

The Company’s research anddevelopment efforts are focused on: (i) developing new processingapplications for the process industries and further enhancing thefunctionality, reliability and performance of existing products, and (ii) developmentof the Multiple-Stream High Pressure Mixer/Reactor (MMR) by: (a) workingwith customers who assist in the development of the system with bothapplication knowledge and financial support, and (b) internal developmentprogram relating to interaction chamber design and creation of a varietynanomaterials. There can be no assurance that the Company will be able to meetthe enhancement challenges posed by applications of its core Microfluidizer® processor business. 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 specific applications.The inability to meet the enhancement challenges or design and manufacturechambers for its MMR applications may have a material adverse effect on theCompany.

**TheCompany’s ability to continue planned operations is dependent upon access tofinancing under a credit facility with its commercial lender.**

The Company’s credit facility is comprised of arevolving line of credit in the maximum principal amount of $1,000,000 and aterm loan note in a face amount of $1,000,000 under which the Company currentlyowes approximately $563,000 at December 31, 2005. Under the terms of thecredit facility, the Company is subject to a number of restrictions that impactthe Company’s use of funds. The Company is limited in ability to acquireproperty and pay dividends, and it must maintain certain financial covenants asdefined. The Company’s ability to operate is potentially impacted by theCompany’s ability to achieve future compliance with the financial covenants ofthe credit facility. The obligations due the lender are essentially demandobligations and under certain circumstances, including the lender’sdetermination that the Company’s prospect of payment of all or any part of theobligations due the lender are impaired, the lender may declare a default andaccelerate payment of the obligations. Loans under the credit facility aresecured by a collateral pledge to the lender of substantially all the assets ofthe Company and its subsidiary. In the event of a breach of the covenants orevents of default under the credit facility there can be no assurance that theCompany can obtain a waiver of such breach or default from its lender.Likewise, in the event of that the Company cannot effect a cure or obtain awaiver of a breach or default under the credit facility there can be noassurance either that the lender will not terminate the credit facility or thatthe Company will be able to obtain alternate financing, or that it can obtainalternate financing on terms that are favorable to the Company. Either eventcould have a material adverse effect on the Company’s business, financialcondition, or results of operations.

Pursuant to its agreements with the lender, theCompany may not issue, create or incur additional debt in excess of itsobligations to lender, except in the ordinary course of business.

There can be no assurancethat 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.

**TheCompany may become subject to increased government regulation which couldaffect our ability to sell our products outside of the United States.**

Although the Company hasnot historically been significantly affected by any United Sates governmentalrestrictions on technology transfer, import, export and customs regulations andother 

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presentlocal, state or federal regulation, any future legislation or administrativeaction restricting our ability to sell our products to certain countriesoutside the United States could significantly affect our ability to makecertain foreign sales. The extent of adverse governmental regulation, whichmight result from future legislation or administrative action, cannot beaccurately predicted. In particular, the USA Patriot Act and other governmentalregulation may impose export restrictions on sale of equipment or transfer oftechnology to certain countries or groups. There can be no assurance that saleof the Company’s equipment will not be impacted by any such legislation ordesignation. Depending upon which countries and sales may be designated fortrade restriction such action could have a material adverse effect on the Company’sbusiness, financial condition, or results of operations. Also, certainagreements that may be entered into by the Company involving exclusive licenserights may also be subject to national or supranational antitrust regulatorycontrol, the effect of which cannot be predicted.

**TheCompany relies on our key management and technical personnel.**

The Company’s continuedoperation, innovation and growth are to some significant degree reliant on thecontinued services of its key executive officers and leading technicalpersonnel. The Company does not maintain employment contracts with its keymanagement or leading technical personnel. There can be no assurance that theCompany will be able to retain such key management and technical personnel ifemployment is offered by other companies better able to pay highercompensation, provide more and better benefits, or willing to offer longer termjob security by entering into employment contracts with the Company’semployees. Further, there can be no assurance that key executive officers andleading technical personnel will not either die or become disabled to an extentthat they cannot render their services to the Company. Though the Companybelieves that 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 orleading technical personnel could, therefore, have a material adverse effect onthe Company’s business, financial condition, or results of operations.

**TheCompany’s stock is listed on the OTC Bulletin Board and stockholders may havelimited liquidity.**

The Company’s common stock is quoted on the OTC Bulletin Board,which provides significantly less liquidity than a securities exchange (such asthe American or New York Stock Exchanges or The Nasdaq Stock Market LLC). Ingeneral, over the past two years, fewer than 100,000 shares of our common stockhave traded on a daily basis. Management expects, when and if the Companyqualifies, to seek a listing on a securities exchange, which may increasestockholders liquidity. There is uncertainty that the Company will ever beaccepted for a listing on a securities exchange.

**The Company anticipates that shipments ofour products to relatively few customers will continue to account for asignificant portion of our business.**

Sales to ourJapanese distributor accounted for 19.5% of our net revenues in 2005 and 20.5%of our revenues in 2004 and sales to a wholly owned subsidiary of TevaPharmaceuticals accounted for 18.9% of our revenues in 2005 and 12.8% of ourrevenues in 2004. The Company expects that a limited number of customers maycontinue to account for a substantial portion of our net revenues for theforeseeable future. If our current customers delay or cancel their orders, orfind other sources for our products, our resulting net income may be impacted.

Although the Company attempts to maintain good relationships withour current customers, the Company cannot be certain that our current customerswill continue to place orders with us or that those orders will be significant.The Company continuously seeks out new customers, but there can be no 

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certainty that the Company will receiveorders from new customers or that those new customers will continue to orderfrom us.

**Our quarterly revenues and stockperformance are variable.**

The timing of orders and subsequent shipment will significantlyaffect quarterly revenues and resulting net income results for particularquarters which may cause increased volatility in both the Company’s revenuesand stock price.

**The Company allows customers to lease someof our products and those leases may not turn into sales.**

We sometimes lease our products to our customers prior to orinstead of selling a product to a customer. The Company’s products areexpensive, and customers frequently want to test out a product’s capabilitiesprior to purchase. We have had reasonable success in converting leases intosubsequent sales of the same or a newer product, however there is no guaranteethat we will continue to be able to convert any of our leases into sales.

**The Company may be subject to productliability claims from our customers or by persons harmed by our customers’products.**

The Company maintains what it deems to be reasonable levels ofproduct liability coverage through insurance policies with a reasonably smalldeductible. Nonetheless, inasmuch as the Company sells its equipment to anumber of customers who make pharmaceutical preparations and consumercosmetics, there can be no assurance that if a consumer of end products isinjured or dies from such product that a suit by an injured party (or a classof similar situated plaintiffs) will not sue the Company as well as the makerof the drug or cosmetic. Although the Company may have no control over themanufacture of end-products made on its equipments, it may not be able to bar aplaintiff’s claims against all parties who products and equipment were ininvolved in the manufacturing process under a variety of legal theories ofliability. The Company may be required to present a vigorous and costly defenseif it cannot be dismissed from such an action. The cost of such legal defensemay significantly impact the cash flow of the Company.

**TheCompany’s international business operations expose us to a variety of risks.**

For the year ended December 31, 2005, shipmentsoutside of North America accounted for approximately 48.2% of the Company’stotal net revenues as compared to 48.9% in the prior year. In particular,approximately 19.5% and 20.5% of our net revenues in 2005 and 2004 resultedfrom sales to Japan and approximately 12.1% and 4.8% of our net revenues in2005 and 2004 resulted from sales to Korea. In addition, approximately 13.0%and 17.9% of our net revenues resulted from sales to Europe in 2005 and 2004respectively. We expect that shipments outside of North America will continueto account for a significant portion of our total net product revenues.

We attempt to reduce some of our risk related to salesand shipments outside of the United States by requiring that our contractsgenerally be paid in United States Dollars. Nevertheless, a downturn in theeconomies of Japan, Korea or across Europe might reduce investment in newtechnology or products while a weakening of foreign currency against the UnitedStates Dollar would make our products more expensive, each of which could havea substantial impact on our operating results.

In addition, a significantportion of our total net revenue is subject to the risks associated withshipping to foreign markets in general, including unexpected changes in legaland regulatory requirements; changes in tariffs; political and economicinstability; risk of terrorism; difficulties in managing distributors and representatives;difficulties in protecting our intellectual property overseas; and naturaldisasters, any of which could have a negative impact on our operating results.

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**Changes inaccounting treatment of stock options could adversely affect our operatingresults.**

The Financial Accounting Standards Board has announcedits decision to require companies to expense employee stock options inaccordance with SFAS 123R, *Accounting for Stock-BasedCompensation*, or SFAS 123R, for financial reporting purposes. Suchstock option expensing would require us to value our employee stock optiongrants pursuant to an option valuation model, then amortize that value againstour reported earnings over the vesting period in effect for those options.

Prior to January 1,2006, the Company elected to accelerate all outstanding employee stock options(except those employee stock options held by employees who chose not toparticipate) to minimize the impact of SFAS 123R on its operating results**.**The Company estimated that by accelerating the vesting ofthe employee options, it would not incur approximately $400,000 of futurecompensation expense, net of taxes. In general, the Company issues stock optionsto certain of its employees (except for senior management) every two years anddoes not anticipate issuing options to a large number of employees until 2008.Nevertheless, all options issued on or after January 1, 2006 must beexpensed in accordance with SFAS 123R. The impact of SFAS 123R on our financialresults will depend on a variety of factors, including the number of optionsissued, the length of time until vesting and the amount required to beexpensed. The Company has determined that there will be a non-cash charge ofapproximately $129,000 in 2006 as a result of this requirement.

**Compliancewith internal controls reporting requirements could increase our costs.**

As directed by Section 404 of the Sarbanes-OxleyAct of 2002, the Securities and Exchange Commission adopted rules requiring publiccompanies to include a report of management on the company’s internal controlover financial reporting in their annual reports on Form 10-K. This reportis required to contain an assessment by management of the effectiveness of suchcompany’s internal controls over financial reporting. In addition, the publicaccounting firm auditing a public company’s financial statements must attest toand report on management’s assessment of the effectiveness of the company’sinternal controls over financial reporting. We intend to expend resources indeveloping the necessary documentation and testing procedures required bySection 404. Going forward, there is a risk that we will not comply withall of the requirements imposed by Section 404. If the Company fails toimplement required new or improved controls, we may be unable to comply withthe requirements of Section 404 in a timely manner. This could result inan adverse reaction in the financial markets due to a loss of confidence in thereliability of the Company’s financial statements, which could cause the marketprice of the Company’s common stock to decline and make it more difficult for theCompany to finance its operations.

Under current rules, theCompany is required to comply with the requirements of Section 404 by itsfirst fiscal year ending on or after July 15, 2007.

**Item1B.**               UNRESOLVED STAFFCOMMENTS

**None.**

**Item 2.**                        DESCRIPTIONOF PROPERTIES

The Company’s corporateheadquarters are in Newton, Massachusetts. The Company also maintains a salesoffice and laboratory facility in Lampertheim, Germany and a sales office inIrvine, California. The Company rents approximately 34,000 square feet ofoffices, production and research and development facilities at these locationsfor administrative, development and production activities. A portion of thespace at the Newton, Massachusetts facility is sublet to a non-affiliatedcompany for a total of $21,600 per annum under a tenant-at-will arrangement.The lease terms expire at various times through May 2007 (with an optionunder which the Company can extend the lease at the Newton facility through May 31,2008). The Company believes these facilities will be adequate for operationsfor the next two years. 

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**Item 3.**                        LEGALPROCEEDINGS

The Company is not a partyto any material legal proceedings.

**Item 4.**                        SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submittedto a vote of the Company’s security holders during the quarter ended December 31,2005.

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

*Market:*

TheCompany’s Common Stock is traded on the Over-the-Counter Bulletin Board underthe symbol MFIC. The following table sets forth the range of quarterly high andlow bid quotations for the last two fiscal years, as furnished by the NationalAssociation of Securities Dealers Automated Quotation System. The quotationsrepresent interdealer quotations without adjustment for retail markups,markdowns, or commissions, and may not necessarily represent actualtransactions.

| **Quarters Ended** | ** ** | ** ** | ** ** | **12/31  2005** | ** ** | **9/30  2005** | ** ** | **6/30  2005** | ** ** | **3/31  2005** | ** ** | **12/31  2004** | ** ** | **9/30  2004** | ** ** | **6/30  2004** | ** ** | **3/31  2004** | ** ** |
|-------------------------|------------|------------|------------|-----------------|------------|----------------|------------|----------------|------------|----------------|------------|-----------------|------------|----------------|------------|----------------|------------|----------------|------------|
| **Low**                 |       | $          | 1.26       |            | $          | 1.58           |       | $              | 1.50       |           | $          | 1.90            |       | $              | 1.57       |           | $          | 1.10           |       | $ | 1.50 |   | $ | 2.25 |   |
| **High**                |       | $          | 1.95       |            | $          | 2.78           |       | $              | 2.90       |           | $          | 3.99            |       | $              | 3.90       |           | $          | 2.34           |       | $ | 3.11 |   | $ | 4.30 |   |

 

*Holders:*

As of March 28, 2006,there were approximately 377 holders of record of the Company’s Common Stock.

*Issuance ofWarrants:*

On November 17, 2004,the Company entered into a general financial and advisory services agreementwith Maxim Group LLC pursuant to which Maxim Group LLC was granted, on April,1, 2005, a three (3) year warrant to purchase 100,000 shares of theCompany’s common stock at an exercise price of $3.20 per share. These warrantswere issued pursuant to the exemption to the registration requirements of theSecurities Act of 1933, as amended, available under Section 4(2) ofthat Act. The Company expects to file a registration statement for purposes ofregistering the shares of common stock underlying the warrants byApril 15, 2006.

*Dividends:*

The Company has never paidany cash dividends on its Common Stock and presently anticipates that nodividends on its Common Stock will be declared in the foreseeable future. TheCompany’s current policy is to retain all of its earnings to finance futuregrowth. 

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*Equity CompensationPlan Information:*

Theinformation in the table below is as of December 31, 2005. See also theConsolidated Financial Statements—Note 9.

| ** **                                                  | ** ** | **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 of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected  in column (a)** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan category**                                      | ** ** | ** **                                                                                                                                       | ** ** | **(a)**                                                                                                 | ** ** | **(b)**                                                                                                                                                                                                     | ** ** | **(c)** | ** ** |
| Equity  compensation plans Approved by security holders     |       |                                                                                                                                             | 1,718,925  |                                                                                                    |       |                                                                                                                                                                                                        | $          | 1.39 |   |   |   | 757,946 |   |   |
| Equity  compensation plans not approved by security holders |       |                                                                                                                                             | 958,970    |                                                                                                    |       |                                                                                                                                                                                                        | 3.09       |   |   |   | N/A |   |   |
| Total                                                       |       |                                                                                                                                             | 2,677,895  |                                                                                                    |       |                                                                                                                                                                                                        | $          | 2.00 |   |   |   | 757,946 |   |   |
|                                                             |            |                                                                                                                                                  |            |                                                                                                         |            |                                                                                                                                                                                                             |            |  |  |  |  |  |  |  |  |  |

 

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**Item 6.**                        SELECTEDFINANCIAL DATA

The selected financialinformation presented below is derived from the audited consolidated financialstatements of the Company for each of the five years in the period ended December 31,2005. The information set forth below should be read in conjunction withManagement’s Discussion and Analysis of Financial Condition and Results ofOperations and the Consolidated Financial Statements and related Notes includedelsewhere in this Form 10-K. All fiscal years noted below have beenrestated to reflect discontinued operations. 

**SelectedStatement of Operations Data**

| ** **                                                                                                        | ** ** | **Year Ended  December 31,  2005** | ** ** | **Year Ended  December 31,  2004** | ** ** | **Year Ended  December 31,  2003** | ** ** | **Year Ended  December 31,  2002** | ** ** | **Year Ended  December 31,  2001** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| Total revenues                                                                                                    |       | $                                            | 11,645,481 |                                         | $          | 12,158,919                                   |       | $                                            | 10,459,631 |                                         |       | $ | 9,514,180 |   |   | $ | 11,210,375 |   |
| Total costs and expenses                                                                                          |       | 12,416,631                                   |       | 11,461,749                                   |       | 9,693,551                                    |       |                                         | 8,872,465  |                                         |       | 10,934,902 |   |
| (Loss) income from continuing operations                                                                          |       | (771,150                                     | )          | 697,170                                      |       | 766,080                                      |       |                                         | 641,715    |                                         |       | 275,473 |   |
| Interest expense                                                                                                  |       | (58,510                                      | )          | (69,383                                      | )          | (116,097                                     | )          |                                         | (179,429   | )                                            |       | (261,754 | ) |
| Other expense                                                                                                     |       | —                                       |       | —                                       |       | —                                       |       |                                         | —     |                                         |       | (53,142 | ) |
| Interest income                                                                                                   |       | 26,124                                       |       | 27,965                                       |       | 9,508                                        |       |                                         | 7,191      |                                         |       | 7,032 |   |
| Net (loss) income from continuing operations before  income taxes and extraordinary item                          |       | (803,536                                     | )          | 655,752                                      |       | 659,491                                      |       |                                         | 469,477    |                                         |       | (32,391 | ) |
| Income tax (expense) benefit                                                                                      |       | (185,000                                     | )          | 450,000                                      |       | —                                       |       |                                         | —     |                                         |       | — |   |
| Net (loss) income from continuing operations before  discontinued operations and extraordinary item               |       | (988,536                                     | )          | 1,105,752                                    |       | 659,491                                      |       |                                         | 469,477    |                                         |       | (32,391 | ) |
| (Loss) from discontinued operations (net of loss from  disposal of discontinued operations of $1,422,715 in 2003) |       | —                                       |       | (231,380                                     | )          | (4,109,925                                   | )          |                                         | (2,983,451 | )                                            |       | (492,795 | ) |
| Net (loss) income                                                                                                 |       | (988,536                                     | )          | 874,372                                      |       | (3,450,434                                   | )          |                                         | (2,513,974 | )                                            |       | (525,186 | ) |
| Weighted-average shares  outstanding:                                                                             |       |                                         |       |                                         |       |                                         |       |                                         |       |                                         |       |   |   |
| Basic                                                                                                             |       | 9,756,221                                    |       | 9,345,560                                    |       | 7,767,712                                    |       |                                         | 7,426,586  |                                         |       | 7,375,102 |   |
| Diluted                                                                                                           |       | 9,756,221                                    |       | 10,329,313                                   |       | 8,501,110                                    |       |                                         | 7,470,090  |                                         |       | 7,375,102 |   |
| Basic amounts per common  share:                                                                                  |       |                                         |       |                                         |       |                                         |       |                                         |       |                                         |       |   |   |
| Net (loss) income per share from continuing  operations                                                           |       | $                                            | (.10       | )                                            | $          | .11                                          |       | $                                            | .08        |                                         |       | $ | .06 |   |   | $ | (.00 | ) |
| Basic net (loss) income per share from discontinued  operations                                                   |       | —                                       |       | $                                            | (.02       | )                                            | $          | (.52                                         | )          |                                         | $          | (.40 | ) |   | $ | (.07 | ) |
| Basic, as reported                                                                                                |       | $                                            | (.10       | )                                            | $          | .09                                          |       | $                                            | (.44       | )                                            |       | $ | (.34 | ) |   | $ | (.07 | ) |
| Diluted amounts per  common share:                                                                                |       |                                         |       |                                         |       |                                         |       |                                         |       |                                         |       |   |   |
| Diluted net (loss) income per share from continuing  operations                                                   |       | $                                            | (.10       | )                                            | $          | .10                                          |       | $                                            | .08        |                                         |       | $ | .06 |   |   | $ | (.00 | ) |
| Diluted net (loss) income per share from discontinued  operations                                                 |       | —                                       |       | $                                            | (.02       | )                                            | $          | (.52                                         | )          |                                         | $          | (.40 | ) |   | $ | (.07 | ) |
| Diluted, as  reported                                                                                             |       | $                                            | (.10       | )                                            | $          | .08                                          |       | $                                            | (.44       | )                                            |       | $ | (.34 | ) |   | $ | (.07 | ) |

 

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**Item 7.**                        MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

*Certain Factors AndCautionary Statement Regarding Forward-Looking Statements*

Management believes thatthis report contains forward-looking statements that are subject to certainrisks and uncertainties including statements relating to the Company’s plan toachieve, maintain and/or increase revenue growth, and/or operatingprofitability, and to achieve, maintain, and/or increase net operatingprofitability. Such statements are based on management’s current expectationsand are subject to a number of factors and uncertainties that could causeactual results achieved by the Company to differ materially from thosedescribed in the forward-looking statements. The Company cautions investorsthat there can be no assurance that the actual results or business conditionswill not differ materially from those projected or suggested in suchforward-looking statements as a result of various factors, including but notlimited to, the following risks and uncertainties: (i) whether theperformance advantages of the Company’s Microfluidizer materials processingequipment will be realized commercially or that a commercial market for theequipment will continue to develop, (ii)  whether the timing of orders will significantlyaffect quarter to quarter revenues and resulting net income results for aparticular quarter, (iii) whether the Company will haveaccess to sufficient working capital through continued and improving cash flowfrom sales and ongoing borrowing availability, the latter being subject to theCompany’s ability to comply with the covenants and terms of the Company’s loanagreement with its senior lender, (iv) whether the Company’s technologywill be adopted by customers as a means of producing MMR innovative materialsin large quantities, (v) whether the Company is able to deploy prototypeMMR placements and then manufacture and introduce commercial production MMRequipment as well as those risks set forth in Item 1A, “Risk Factors”, and(vi) whether the Company will achieve a greater proportion of its sales inthe future through the sale of advanced processor production systems.

*Critical AccountingPolicies*

The Company considerscertain accounting policies related to revenue recognition and relatedreceivables as well as the valuation of inventories to be critical policies dueto the estimation processes involved in each.

**Revenue Recognition**

Revenue from the sale of machines and spare parts isgenerally recognized upon shipment of the product or when the earnings processis complete. Rental income for the lease of equipment is recognized on astraight-line basis over the term of the lease agreement. Rental income andequipment sales are classified as revenues in the consolidated statement ofoperations.

The Company has adopted Securities and ExchangeCommission (SEC) Staff Accounting Bulletin (SAB) No. 104, *Revenue Recognition in Financial Statements*. The Companyrecognizes sales at the time of shipment of the system to the customer.Management believes the customer’s post-delivery acceptance provisions andinstallation are routine. The Company has never failed to successfully completea system installation. With few exceptions, the Company limits its liability tothe return of the equipment sold. Installation costs are predictable andinsignificant to the total purchase price. The Company has demonstrated ahistory of customer acceptance subsequent to shipment and installation of thesesystems.

Judgments are required in evaluating thecreditworthiness of our customers. In all instances, revenue is not recognizeduntil the Company has determined that collection is reasonably assured. Shouldchanges in conditions cause management to determine the aforementioned criteriaare not met for certain future transactions, revenue recognized for anyreporting period could be adversely affected.

20

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*Allowancefor Doubtful Accounts.**  *TheCompany’s policy is to maintain allowances for estimated losses resulting fromthe inability of our customers to make scheduled payments. The Companyregularly evaluates the collectibility of our trade receivable balances basedon a combination of factors. When a customer’s account balance becomes pastdue, we initiate dialogue with the customer to determine the cause. If it isdetermined that the customer will be unable to meet its financial obligation tous we record a specific allowance to reduce the related receivable to theamount we expect to recover given all information presently available. Webelieve our reported allowances are adequate as of December 31, 2005 and2004.

*InventoryValuation.**  *The Company valuesits inventory at the lower of cost or net realizable value on afirst-in-first-out method. Management regularly evaluates inventory quantitieson hand and records a provision for obsolete or excess inventory levels greaterthan those of anticipated usage in the subsequent two years. There are externalfactors that may require an adjustment to the anticipated demand including, butnot limited to, technological changes in our markets, our ability to meetchanging customer requirements, competitive pressures in products and prices,and the availability of key components from our suppliers. Purchasingrequirements and alternative usage avenues are explored within these processesto mitigate inventory exposure. When recorded, our reserves are intended toreduce the carrying value of our inventory to its net realizable value.

*Impairment.*   Ithas been the Company’s policy to review the carrying values of long-livedassets and amortizable intangibles for impairment under Statement of FinancialAccounting Standards (“SFAS”) No. 144 whenever an event or changes incircumstances indicated that the carrying amount of an asset may not berecoverable.

*Product Warranties.*   Our productsare generally sold with a twelve month warranty provision that requires us toremedy deficiencies in quality or performance of our products at no cost to ourcustomers only after it has been determined that the cause of the deficiency isnot due to the actions of the machine operator or product used in themachine.The Company has established a policy for replacing parts that wear outor break prematurely. The policy calls for replacing the parts or repairing amachine within one year of the sale. The Company is now selling more advancedprocessor production systems than past years that may require more costlyparts. A reserve balance has now been established. We believe the reservebalance in the amount of $58,000 to be adequate as of December 31, 2005.

***Fiscal 2005 Compared to Fiscal 2004***

**Results of Continuing Operations**

Total revenues for the year ended December 31,2005 from continuing operations were $11,645,481 as compared to revenues of$12,158,919 for the year ended December 31, 2004, representing decrease of$513,438, or 4.2%.

North American sales for the year ended December 31,2005 decreased to approximately $6,028,000, or 3.0%, as compared to NorthAmerican sales of approximately $6,212,000 for the year ended December 31,2004. This decrease in North American sales was principally due to a decreasein the sale of machines of approximately $1,478,000, and an increase in thesale of spare parts of approximately $1,294,000. Foreign sales wereapproximately $5,618,000 for the year ended December 31, 2005, compared to$5,947,000 for the year ended December 31, 2004, a decrease of $329,000,or 5.5%. This decrease in foreign sales was principally due to an increase inthe sale of machines of approximately $1,044,000, and a decrease in the sale ofspare parts of approximately $1,373,000. The decline in the sale of machines isa result, in part, of longer lead times associated with the increasedcomplexity of manufactured automated operating controls, data acquisitionsystems, and sterilization features of systems orders received from biopharmacustomers. The decline is also the result of increased competition from severalcompanies that sell laboratory units. The Company believes its laboratorymachines are superior in terms of technology, 

21

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and that, with relativelyminor modifications to these units that are currently in development, theCompany hopes to regain market share.

Total cost of goods sold for 2005 was $5,917,994, or50.8% of revenue, as compared to $5,607,755, or 46.1% of revenue for 2004. Theincrease in cost of goods sold reflects primarily the increased costs resultingfrom the manufacture and sales of production units, as opposed to manufacturinglaboratory machines. Production units have a higher cost to manufacture, andcorrespondingly, a lower gross profit margin than laboratory machines. Asubstantial contributor to the increased cost of goods sold in 2005 was theCompany’s production of a highly customized production system for the KoreanInstitute of Industrial Technology (KITECH). This customized production machineaccounted for 2.8% of the total revenues for 2005 or approximately $324,000,and 5.2% of the total costs of goods sold for the year ended December 31,2005 or approximately  $308,000.

The Company believes that the construction and designof this customized production system  forKITECH enhanced the Company’s knowledge and skills in producing advancedsystems, and will allow the Company to quote other significant equipment ordersat higher profit margins in the future. The Company also believes that, becauseKITECH provides high visibility for its equipment to companies that work withKITECH, it may lead those companies to consider purchasing our equipment toscale up the production of products developed on this system.

The Company’s major product lines have differentprofit margins, as well as multiple profit margins within each product line. Inthe course of the periods compared, there may be significant changes in thecost of revenues as a percentage of revenue depending on the mix of productsold. Also, the cost of sales as a percentage of revenue will differ betweenlaboratory and pilot plant units sold, due to the difference in costs betweenair driven and electric-hydraulic units.

Total operating expenses for 2005 were $6,498,637 or55.8% of revenue, as compared to $5,853,994 or 48.1% of revenue for 2004, whichis an increase of $644,643 or 11.0%.

It is the Company’s position that a greater proportionof its sales in the future will be for more advanced processor productionsystems that will incorporate features not currently included in many of thecurrent production machines. In order to meet that challenge going forward, itbecame necessary to hire additional research and development personnel, andalso to increase spending in research and development.

Research and development expenses for 2005 were $1,701,870compared to $1,033,978 for 2004, an increase of $667,892 or 64.6%. The increasein research and development expenses is primarily due to a planned increase inpayroll and related costs of approximately $419,000, an increase in consultingcosts of approximately $134,000, and an increase in development costs ofapproximately $101,000. The development costs were primarily for outsidecontractors and supplies.

Selling expenses for 2005 decreased approximately$175,000, from $2,587,658 in 2004 to $2,412,550 or 6.8%. The decreases were dueprincipally to a decrease in commission expense of approximately $136,000, adecrease of approximately $35,000 in delivery costs, a decrease ofapproximately $33,000 in payroll and related costs, a decrease in advertisingexpenses of approximately $19,000, partially offset by an increase in facilityoperating costs of approximately $40,000, and an increase in printing costs ofapproximately $20,000. The decrease in commission costs was caused by adecrease in direct sales. Sales made in Asia, where the Company’s products aresold primarily through distributors, were 35.2% of sales for the year ended December 31,2005, compared to 31.0% of sales for the year ended December 31, 2004.Sales made to distributors are sold net of a discount, but without acommission. Accordingly, these sales generally reflect a lower gross marginoffset by lower selling costs. The decrease in payroll was due to a reductionin personnel. The decrease in delivery costs was principally due to a change invendors.  The increase in 

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printing costs was due toincreased purchases of general brochures and cost data sheets compared to theprevious year.

General and administrative expenses for 2005 increasedby approximately $152,000, from $2,232,358 for the year ended December 31,2004, to $2,384,217, or 6.8%. The increase in general and administrativeexpenses is primarily due to an increase in consultants costs of approximately$166,000, an increase in facility operating costs of approximately $74,000, anincrease in corporate expenses of approximately $53,000, and an increase inprofessional fees of approximately $17,000, offset in part by a decrease inpayroll costs of approximately $114,000. The increase in consultant costs wascaused by the use of outside consultants that included a non-cash charge forwarrants issued in the amount of $119,000, and a recruiting placement fee of$41,000. The increases in facility operating costs were primarily rent andenergy related. The increase in corporate costs is due to the expense incurredin accelerating employees’ stock options of approximately $65,000.  The decrease in payroll is a result of aplanned decrease in payroll costs, including both a reduction in personnel andno bonuses paid employees for 2005, due to the loss from operations.

Interest expense for 2005 decreased from $69,383 in2004 to $58,510, a decrease of $10,873, or 15.7%. The decrease was principallydue to a reduction in the term debt outstanding.

Interest income for 2005decreased to $26,124 from $27,965 for 2004, a decrease of $1,841. The decreaseis due to less cash available for investing.

***Results of Discontinued Operations***

In 1998, the Company purchased the assets andliabilities of Morehouse-COWLES, Inc. (Morehouse-COWLES). This was done tocomplete a strategic combination with Microfluidics, in order to enhance theCompany’s position in the coatings market, which, at the time, was the dominantpart of the Company’s business.

Since that time, the direction of the core business ofthe Company changed significantly from coatings to other areas, in particularthe health care sector. The Company determined that it could no longer supportthe previous strategic plan and the Company, therefore, prepared a plan todivest the Morehouse-COWLES Division.

It was expected that the sale would positively impactthe Company’s cash flow, and would allow the Company to focus on the corebusiness, and expand its sales and marketing resources for the Company’sMicrofluidizer processor systems line, and promote its new MMR nanoparticleproduction systems.

During the fourth quarter of 2003, managementcommitted to a plan to sell substantially all the assets and associatedliabilities of Morehouse-COWLES. Accordingly, at fiscal year end 2003, theCompany reported the division as discontinued operations and reclassified theassets and 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 AssetPurchase Agreement (the Asset Purchase Agreement) dated February 5, 2004between MFIC and a wholly owned subsidiary of NuSil, MFIC sold substantiallyall of the assets and selected liabilities of its Morehouse-COWLES Division(the Division), to NuSil. Other than NuSil’s prior purchases of products fromthe Division, there were no preexisting relationships between MFIC and NuSil.

The assets of the Division that were sold includedaccounts receivable, furniture, fixtures and equipment, inventory and supplies,books and records, bids, contracts, prepaid expenses, leases, intellectualproperty, goodwill, domain names and claims, all as described in the AssetPurchase Agreement (collectively, the Assets). In addition, certain rights andobligations arising after February 9, 

23

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2004 under the Division’sPacifiCare Group Health Insurance Policy were assigned. The Division’s cash orcash equivalents on hand on February 9, 2004 were excluded from the assetsbeing sold. Under the Asset Purchase Agreement, the Division’s executoryobligations under certain contracts and bids, and the Division’s accountspayable as of February 9, 2004 in the amount of $623,240, were assumed byNuSil.

The purchase price (other than the assumption ofaccounts payable described in the preceding paragraph) paid under the AssetPurchase Agreement was $918,238. Of the purchase price, $768,238 (the ClosingCash) was paid in cash, $100,000 was paid in the form of a Promissory Note (thePurchase Note) and $50,000 (the Holdback Payment) was withheld for payment at a****future date subject to any purchase price adjustments andoffsets, as provided for in the Asset Purchase Agreement.

The Closing Cash was paid directly to PNC Bank,National Association (PNC), to be applied to MFIC’s outstanding balance underMFIC’s Revolving Credit Loan with PNC (the Revolving Credit Loan).

The aforementioned Purchase Note bore interest at 5percent per annum, was secured by the Assets pursuant to a Security Agreementdated February 5, 2004 (the Security Agreement) between the parties andwas subject to certain offsets as provided in the Asset Purchase Agreement. Principaland interest on the Purchase Note were payable on February 9, 2005. NuSilforwarded a payment to the Company on that date which, in conjunction with anallowable offset of approximately $8,300 paid by NuSil for the benefit of theCompany, satisfied the claim.

Pursuant to the Asset Purchase Agreement, MFIC enteredinto a Noncompetition and Nonsolicitation Agreement, dated February 5,2004, which limits MFIC’s ability to compete with the business of the Divisionfor a period of five years.

The sale generated a loss of approximately $1,420,000.Due to the sale of the Morehouse-COWLES Division, goodwill associated with the1998 purchase of this division in the amount of $2,100,000 was impaired in2003.

In the three months ended March 31, 2004, theCompany sold the assets and selected liabilities of the Division to NuSil.During the year ended December 31, 2005, the Company had no discontinuedoperations. Thus, all items of discontinued operations decreased 100% whencompared to the comparable periods for the prior year.

Total Company revenues for the year ended December 31,2005 from discontinued operations were $0, as compared to revenues of $323,635for the comparable period for the prior year. The decrease during this periodis due to the sale of the Division to NuSil on February 9, 2004.

Cost of goods sold for the year ended December 31,2005 were $0, compared to $308,548 for the year ended December 31, 2004. Thedecrease in cost of goods sold is attributable to the sale of the Division toNuSil on February 9, 2004.

Total operating expensesfor the year ended December 31, 2005, which include research anddevelopment, selling, and general administrative expenses, were $0, compared to$238,760 for the year ended December 31, 2004. The decrease in operatingexpenses is due to the sale of the Division to NuSil on February 9, 2004.

***Fiscal 2004 Compared to Fiscal 2003***

**Results of Continuing Operations**

Total revenues for the year ended December 31,2004 from continuing operations were $12,158,919 as compared to revenues of$10,459,631 for the year ended December 31, 2003, representing an increaseof $1,699,288, or 16%.

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North American sales for the year ended December 31,2004 were approximately $6,212,000, a 16% increase as compared to NorthAmerican sales of approximately $5,337,000 for the year ended December 31,2003. This increase in North American sales was principally due to an increasein the sale of machines of approximately $680,000. Foreign sales wereapproximately $5,947,000 for the year ended December 31, 2004 compared to$5,123,000 for the year ended December 31, 2003, an increase of $824,000,or 16%. The increase in foreign sales was principally due to an increase in thesale of spare parts of approximately $977,000 compared to 2003.

Total cost of goods sold for 2004 was $5,607,755 or46% of revenue, as compared to $4,988,226 or 48% of revenue for 2003. Theincrease in cost of goods sold in absolute dollars reflects principally theincrease in sales generated by the Company compared to the previous year. TheCompany’s major product lines have different profit margins, as well asmultiple profit margins within each product line. In the course of the periodscompared, there may be significant changes in the cost of revenues as apercentage of revenue depending on the mix of product sold. Also, the cost ofsales as a percentage of revenue will differ between laboratory and pilot plantunits sold, due to the difference in costs between air driven andelectric-hydraulic units.

Total operating expenses for 2004 were $5,853,994, or48% of revenue, as compared to $4,705,325, or 45% of revenue, for 2003, whichis an increase of $1,148,669, or 24%.

Research and development expenses for 2004 were$1,033,978 compared to $785,849 for 2003, an increase of $248,129, or 32%. The increasein research and development expenses is principally due to an increase inpayroll costs, as a result of both an increase in headcount and pay increasesof approximately $253,000, an increase in consultants of approximately $41,000,an increase in travel and related costs of approximately $10,000, partiallyoffset by a decrease in testing materials of approximately $79,000.

Selling expenses for 2004 increased approximately$400,000, or 18%, from $2,187,389 to $2,587,658. The increase was due principallyto an increase in outside commissions of approximately $194,000, an increase inadvertising costs of approximately $115,000, an increase in payroll costs ofapproximately $91,000, an increase in public relations costs of approximately$36,000, partially offset by a decrease in travel and related costs ofapproximately $38,000.

For the year ended December 31, 2004, general andadministrative expenses increased by approximately $500,000, or 29%, from$1,732,087 for the year ended December 31, 2003, to $2,232,358. Theincrease in general and administrative expenses was principally due to anincrease in payroll and related costs of approximately $241,000, professionalfees of approximately $148,000, and investor relation expenses of approximately$73,000, general overhead costs of approximately $71,000, partially offset by adecrease in bad debt expense of approximately $76,000.

Interest expense for 2004 decreased to $69,383 from$116,097 for 2003, a decrease of $46,714, or 40%. The decrease was due primarilyto the reduction in the line of credit caused by the paydown of the debt fromproceeds received from the sale of the Morehouse-COWLES Division.

Interest income for 2004increased to $27,965 from $9,508 in 2003, an increase of $18,457, or 194%. Theincrease is due to available cash being invested in money markets andcertificates of deposit.

**Results of Discontinued Operations**

Total revenues for the year ended December 31,2004 were $323,635 as compared to revenues of $3,655,237 for the year ended December 31,2003, representing a decrease of $3,331,602, or 91%.

The decrease in revenue is due to the sale of thediscontinued operation to NuSil Corporation (NuSil) on February 9, 2004.

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Total cost of goods sold for 2004 was $308,548, or 95%of revenue, as compared to $2,601,957, or 71% of revenue for 2003. The decreasein cost of goods sold in absolute dollars is due to the sale of thediscontinued operation to NuSil Corporation (NuSil) on February 9, 2004.

Total operating expenses for 2004 were $238,760, or74% of revenue, as compared to $1,640,490, or 45% of revenue, for 2003, whichis a decrease of $1,401,730, or 85%.

Research and developmentexpenses for 2004 were $37,413 compared to $318,105 for 2003, a decrease of$280,692, or 88%. The decrease in research and development expenses was due tothe sale of the discontinued operation to NuSil Corporation (NuSil) on February 9,2004.

Selling expenses for 2004decreased approximately $729,243, or 84%, from $863,337 to $134,094. Thedecrease in selling expenses is due to the sale of the discontinued operationto NuSil Corporation (NuSil) on February 9, 2004.

For the year ended December 31,2004, general and administrative expenses decreased by $391,795 from $459,048for the year ended December 31, 2003, to $67,253, or 85%. The decrease ingeneral and administrative expenses is due to the sale of the discontinuedoperation to NuSil Corporation (NuSil) on February 9, 2004.

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**QUARTERLYRESULTS OF OPERATIONS**

The following table setsforth, for the periods presented, certain data from our consolidated statementsof operations. In the opinion of our management, the unaudited quarterlyconsolidated statement of operations data have been prepared on substantiallythe same basis as our audited consolidated financial statements and include alladjustments, consisting only of normal recurring adjustments, necessary for afair presentation of the financial information for the periods presented. Thisinformation should be read in conjunction with the consolidated financialstatements and related notes included elsewhere in this Annual Report on Form 10-K.The operating results in any quarter are not necessarily indicative of theresults that may be expected for any future period.

Summarizedunaudited quarterly financial data are as follows 

| ** **                                                                 | ** ** | **Fiscal 2005 Quarters** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                 | ** ** | **First**                          | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenues                                                                   |       | $                                  | 2,536,469  |   | $ | 3,163,645 |   | $ | 2,881,267 |   | $ | 3,064,100 |   |
| Gross profit                                                               |       | 1,387,540                          |       | 1,556,366 |   | 1,354,132 |   | 1,429,449 |   |
| Net (loss) from  continuing operations before income tax benefit (expense) |       | (193,066                           | )          | (36,193 | ) | (297,291 | ) | (276,986 | ) |
| Income tax  benefit (expense)                                              |       | 77,000                             |       | — |   | — |   | (262,000 | ) |
| Net (loss)                                                                 |       | (116,066                           | )          | (36,193 | ) | (297,291 | ) | (538,986 | ) |
| Basic net (loss)  income per share from continuing operations:             |       | $                                  | (0.01      | ) | $ | (0.00 | ) | $ | (0.03 | ) | $ | (0.06 | ) |
| Diluted net (loss) income per share from continuing  operations       |       | $                                  | (0.01      | ) | $ | (0.00 | ) | $ | (0.03 | ) | $ | (0.06 | ) |

 

| ** **                                                              | ** ** | **Fiscal 2004 Quarters** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                              | ** ** | **First**                          | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenues                                                                |       | $                                  | 2,251,452  |   | $ | 3,081,977 |   | $ | 3,163,785 |   | $ | 3,661,705 |   |
| Gross profit                                                            |       | 1,238,579                          |       | 1,675,974 |   | 1,813,584 |   | 1,823,027 |   |
| Net (loss) income  from continuing operations before income tax benefit |       | (55,183                            | )          | 256,495 |   | 282,050 |   | 172,390 |   |
| Income tax benefit                                                      |       | —                             |       | — |   | — |   | 450,000 |   |
| Net (loss) income  from continuing operations                           |       | (55,183                            | )          | 256,495 |   | 282,050 |   | 622,390 |   |
| (Loss) from  discontinued operations                                    |       | (231,380                           | )          | — |   | — |   | — |   |
| Net (loss) income                                                       |       | (286,563                           | )          | 256,495 |   | 282,050 |   | 622,390 |   |
| Basic net (loss) income  per share:                                     |       |                               |       |   |   |   |   |   |   |
| Net (loss) income  per share from continuing operations                 |       | $                                  | (.01       | ) | $ | .03 |   | $ | .03 |   | $ | .06 |   |
| Basic net (loss)  income per share from discontinued operations         |       | $                                  | (.02       | ) | $ | .00 |   | $ | .00 |   | $ | .00 |   |
| Basic, as  reported                                                     |       | $                                  | (.03       | ) | $ | .03 |   | $ | .03 |   | $ | .06 |   |
| Diluted net income  (loss) per share:                                   |       |                               |       |   |   |   |   |   |   |
| Net (loss) income  per share from continuing operations                 |       | $                                  | (.01       | ) | $ | .02 |   | $ | .03 |   | $ | .06 |   |
| Diluted net loss  per share from discontinued operations                |       | $                                  | (.02       | ) | $ | .00 |   | $ | .00 |   | $ | .00 |   |
| Diluted, as reported                                                    |       | $                                  | (.03       | ) | $ | .02 |   | $ | .03 |   | $ | .06 |   |

 

27

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**LIQUIDITYAND CAPITAL RESOURCES**

On March 31, 2004,the Company completed a private placement offering of investment units (eachunit consisting of one share of common stock and a 3-year warrant topurchase an additional one-half share of common stock). A total of 1,426,616units were sold, yielding gross proceeds of $3,566,536. The units were pricedat $2.50 and the associated warrants totaling 713,308 units are exercisable at$3.05. Additionally, the placement agent for the offering received 5-yearwarrants to purchase 142,662 shares of common stock at an exercise price of$3.20 per share. The value of the warrants granted to the placement agent wasapproximately $351,000. The shares of common stock underlying these warrantshave been registered with the Securities and Exchange Commission.

The Company used cash of$396,456 and $142,299 in 2005 and 2004 respectively from operations andgenerated cash of $236,292 in 2003. In 2005, the Company’s principal operatingcash requirements were to fund its net loss, its decrease in currentliabilities, and an increase in prepaid expenses, offset by a decrease inreceivables, inventories, and other current assets. In 2004, the Company’sprincipal operating cash requirements were to fund its increase in inventories,trade and other receivables, prepaid expenses, and a decrease in currentliabilities, partially offset by net income. In 2003, the Company’s principaloperating cash requirements were to fund its net loss, its increase in prepaidexpenses, inventory, and a decrease in current liabilities, offset by adecrease in trade and other receivables, and other current assets.

The Company used cash of$96,048 generated cash of $513,083, and used cash of $53,172 for investingactivities in 2005, 2004, and 2003, respectively. Net cash used in investingactivities for 2005 was used for the purchase of capital equipment. Net cashprovided by investing activities in 2004 was generated through the sale of theMorehouse-COWLES Division, partially offset by the purchase of capitalequipment. Net cash used in investing activities for 2003 included the proceedsfrom the sale of assets, net of the purchase of capital equipment. The Company’ssale of assets principally related to used equipment. As of December 31,2005, the Company had no material commitments for capital expenditures.

For financing activities,the Company used cash of $83,252 in 2005, generated cash of $1,607,060 in 2004,and used cash of $217,806 in 2003. In 2005, cash was generated from theissuance of common stock for options exercised, from proceeds from stock issuedfrom the employee stock purchase plan, and the collection of a note receivable,offset by payments on a term note and subordinated debt to a related party. In2004, cash was generated from the net proceeds from the private placementoffering, the issuance of common stock for options exercised, proceeds fromstock issued from the employee stock purchase plan, and net proceeds from a newterm loan and line of credit from the New Lender, offset by payments on theprevious line of credit, the term note and subordinated debt. In 2003, cash wasused to pay down the line of credit, subordinated debt, and the line of creditterm note, partially offset by the issuance of common stock.

The cash and cashequivalents at December 31, 2005 was $1,452,358, a decrease of $575,756from the December 31, 2004 balance of $2,028,114.

On March 3, 2004, theCompany entered into a Revolving Credit and Term Loan Agreement with a newlender, Banknorth, N.A. (the New Lender), providing the Company with a $2million credit facility. The proceeds drawn down from the New Lender under thecredit facility were used to pay off both the line of credit and term loan owedPNC Bank N.A. (the Previous Lender).

The Credit Facility wascomprised of (i) a $1 million dollar four-year revolving line of credit,(Revolving Credit Line) and (ii) a $1 million dollar four year termpromissory note (Term Loan). The Company borrows funds on the Revolving CreditLine at the prime rate. The $1 million Term Loan is payable ratably over a fouryear period at the fixed rate calculated equal to the Federal Home Loan BankClassic Rate plus 2.5%, or 5.7%. See discussion of New Credit Facility in thenotes to the Consolidated Financial Statements.

28

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Under the terms ofagreement with the New Lender, the Company has two covenants that it must meeton an annual basis. As of December 31, 2005, the Company was not incompliance with the debt service coverage ratio covenant of its Credit Facilitywith the New Lender. On March 23, 2006 the Company obtained a waiver fromthe New Lender for this covenant as of December 31, 2005. The Companyexpects to be in full compliance with both debt covenants related to the debtwith the New Lender at December 31, 2006. As of December 31, 2005,the Company had no balance due and additional availability of up to $1,000,000under its Revolving Credit Line, and a balance of $562,507 under its Term Loanfacility.

The proceeds of the newline of credit and term note were used to pay off the balance due the PreviousLender. As of December 31, 2005 and March 21, 2006, the Company hadborrowings of $562,507 and $500,008 outstanding under its Term Loan facility,respectively.

The Company’s ability tocontinue planned operations is dependent upon access to financing which ispotentially impacted by the Company’s ability to achieve future compliance withthe financial covenants.

Additionally, although theCompany raised approximately $3.6 million in a private placement offering whichclosed in March 2004, the Company may, from time to time, seek to raiseadditional capital for various initiatives that management believes advance theinterests of the Company. The terms upon which the Company may raise suchadditional capital may include private placements of its stock, whichplacements are usually priced at discount to the then-current market price ofthe Company’s stock (in order to compensate for the fact that the stock beingsold is not freely-tradable) or upon other terms that management believesappropriate under the circumstances.

Assuming that there is nosignificant change in the Company’s business, the Company believes that cashflows from operations, together with existing cash balances, will be sufficientto meet its working capital and debt service requirements for at least the nexttwelve months.

**TheCompany’s contractual obligations as of December 31, 2005 are as follows:**

| **Contractual Obligations** | ** ** | ** ** | ** ** | **At December 31,  2005** | ** ** | **Fiscal Year  2006** | ** ** | **Fiscal Year  2007** | ** ** | **Fiscal Year  2008** | ** ** |
|----------------------------------|------------|------------|------------|-------------------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| Long term debt                   |       |       | $          | 562,507                             |       |                       |       | $                          | 250,000    |                       |       |   | $ | 250,000 |   |   |   | $ | 62,507 |   |   |
| Operating leases                 |       |       | 503,565    |                                |       |                       | 355,189    |                       |       |                       | 148,376    |   |   |   | — |   |   |
| Capital leases                   |       |       | 50,546     |                                |       |                       | 38,507     |                       |       |                       | 12,039     |   |   |   | — |   |   |
| Total contractual  obligations   |       |       | $          | 1,166,618                           |       |                       |       | $                          | 643,696    |                       |       |   | $ | 410,415 |   |   |   | $ | 62,507 |   |   |

 

**RecentAccounting Pronouncements**

In November 2004, theFASB issued FASB Statement No. 151, “Inventory Costs—an amendment of ARB No. 43”(“SFAS 151”), which is the result of its efforts to converge U.S. accountingstandards for inventories with international Accounting Standards. SFAS No. 151requires idle facility expenses, freight, handling costs, and wasted material(spoilage) costs to be recognized as current-period charges. It also requiresthat allocation of fixed production overheads to the costs of conversion bebased on the normal capacity of the production facilities. SFAS No. 151will be effective for inventory costs incurred during fiscal years beginningafter June 15, 2005. The Company believes there is no impact from this standardon our consolidated financial statements.

In December 2004, theFASB issued SFAS No. 123 (Revised 2004) “Share-Based Payment” (“SFAS No. 123R”).SFAS No. 123R addresses all forms of share-based payment (“SBP”) awards,including shares issued under employee stock purchase plans, stock options,restricted stock and stock appreciation rights. SFAS No. 123R will requirethe Company to expense SBP awards with compensation cost for SBP transactionsmeasured at fair value. The FASB originally stated a preference for a latticemodel because it believed that a lattice model more fully captures the uniquecharacteristics of employee stock options in the estimate of fair value, ascompared to the Black-Scholes model which the Company currently uses for 

29

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itsdisclosure. The FASB decided to remove its explicit preference for a latticemodel and not require a single valuation methodology. SFAS No. 123Rrequires the Company to adopt the new accounting provisions beginning in ourfiscal year 2006. The Company has evaluated the impact of this standard andexpects that there will be a non-cash charge of approximately $129,000 on itsconsolidated financial statements.

In May 2005, the FASBissued FASB statement No. 154, Accounting Changes and Corrections. SFAS No. 154addressed the accounting and reporting for changes in accounting principles. Itreplaces APB 20  and FIN 20, and iseffective for all fiscal years beginning after December 15, 2005. Itrequires that the cumulative effect of a change in accounting principle be recordeddirectly in the opening retained earnings balance. The Company has evaluatedthis standard, and has determined there is no impact from this standard on ourconsolidated financial statements.

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

The Company’s financialinstruments are generally not subjected to changes in market value as a resultof changes in interest rates due to the short maturities of the instruments. TheCompany’s fixed rate debt is not exposed to cash flow or interest rate changesbut is exposed to fair market value changes in the event of refinancing thisfixed rate debt. The Company does not have significant exposure to fluctuationsin foreign exchange rates.

The Company had novariable rate borrowings outstanding under its revolving credit agreement at December 31,2005. Therefore, until the Company decides to borrow under its revolving creditagreement, an adverse change in interest rates for this variable rate debtwould have no material effect on the Company’s earnings and cash flows on anannual basis.

For additional information about the Company’sfinancial instruments, see Note 6 to the Consolidated Financial Statements.

30

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**Item 8.**                        FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

Thefollowing Consolidated Financial Statements of the Company and its Subsidiariesappear at the end of this report starting on Page F-1 and include:

|                                                                                                                             | ** ** | **Page** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm                                                                    |       |     | F-1        |   |   |
| Consolidated Balance Sheets as of December 31,  2005 and 2004                                                          |       |     | F-2        |   |   |
| Consolidated Statements of Operations for the years  ended December 31, 2005, 2004, and 2003                           |       |     | F-3        |   |   |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2005, 2004, and 2003                           |       |     | F-4        |   |   |
| Consolidated Statements of Changes in Stockholders’  Equity for the years ended December 31, 2005, 2004, and 2003 |       |     | F-5        |   |   |
| Notes to Consolidated Financial Statements                                                                                  |       |     | F-6        |   |   |

 

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

None.

**Item 9A.**                CONTROLSAND PROCEDURES

(a)   Evaluationof disclosure controls and procedures. Based on their evaluation as of the endof the fiscal quarter ended December 31, 2005, each of our principalexecutive officer and principal financial officer have concluded that ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended) areeffective to ensure that material information required to be disclosed by us inreports that we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in Securities andExchange Commission rules and forms.

(b)   Changes in internal control over financial reporting. There wereno significant changes in our internal control over financial reporting duringthe fiscal quarter ended December 31, 2005 that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

**Item 9B.**               OTHERINFORMATION

None.

**Item 10.**                 DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

*Code of Ethics*

The Company has adopted a Code of Ethics that appliesto all of the Company’s employees, officers and directors, and which isattached to this Report as Exhibit 14. Any person may receive a copy,without charge, of the Company’s Code of Ethics by sending a request for theCode of Ethics to MFIC Corporation., 30 Ossipee Road, Newton, MA 02464-9101,ATTN:  Investor Relations. The Code ofEthics is also viewable on the Company’s website at the following URL: *http://www.mficcorp.com/nethics.html*

The information requiredby this Item 10 will be incorporated by reference from the Company’s definitiveproxy statement or will be filed as an amendment to the Company’s Form 10-Kwithin 120 days of the Company’s fiscal year end.

31

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**Item 11.**                 EXECUTIVECOMPENSATION

The information requiredby this Item 11 will be incorporated by reference from the Company’s definitiveproxy statement or will be filed as an amendment to the Company’s Form 10-Kwithin 120 days of the Company’s fiscal year end.

**Item 12.**                 SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information requiredby this Item 12 will be incorporated by reference from the Company’s definitiveproxy statement or will be filed as an amendment to the Company’s Form 10-Kwithin 120 days of the Company’s fiscal year end.

**Item 14.**                 INDEPENDENTACCOUNTANT FEES FOR FISCAL 2005 AND FISCAL 2004

*Audit Fees*

During the years ended December 31,2005 and December 31, 2004, Brown & Brown, LLP was paidapproximately $87,000, and $139,000 respectively for services rendered for theaudit of the Company’s financial statements and review of financial statementsincluded in the Company’s reports on Form 10-Q or services that arenormally provided by Brown & Brown, LLP in connection with statutoryand regulatory filings or engagements for those fiscal years. All services wereapproved by the Audit Committee.

*Audit-Related Fees*

During the years ended December 31,2005 and December 31, 2004, Brown & Brown, LLP was paidapproximately $0, and $0 respectively for assurance and related services reasonablyrelated to the performance of audit or review of the Company’s financialstatements and are not reported under Item 9(e) of the Company’sdefinitive proxy statement.****All serviceswere approved by the Audit Committee.

*Tax Fees*

During the years ended December 31,2005 and December 31, 2004, Brown & Brown LLP was paidapproximately $16,000 and $14,000 respectively for tax compliance, tax adviceand tax planning services. All tax services were approved by the AuditCommittee.

*All Other Fees*

During the years ended December 31, 2005 and December 31,2004, Brown & Brown LLP was paid approximately $27,000 and $56,000respectively, for non-audit services. All of these services were approved bythe Audit Committee.

The Audit Committee pre-approves audit and non-auditservices provided to the Company by the independent auditors (or subsequentlyapproves non-audit services in those circumstances where a subsequent approvalis necessary and permissible).

The Audit Committee hasconsidered whether the provision of non-core audit services to the Company bythe Company’s principal auditor is compatible with maintaining independence,and have affirmed, in each instance, that the provision of such service wascompatible with the principal auditor’s independent role.

32

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

**(a)   ConsolidatedFinancial Statements.**

Thefollowing Consolidated Financial Statements are included in Item 8:

|                                                                                                                              | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Reports of  Independent Registered Public Accounting Firm                                                                    |       |     | F-1        |   |   |
| Consolidated  Balance Sheets as of December 31, 2005 and 2004                                                           |       |     | F-2        |   |   |
| Consolidated  Statements of Operations for the years ended December 31, 2005, 2004,  and 2003                           |       |     | F-3        |   |   |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2005, 2004,  and 2003                           |       |     | F-4        |   |   |
| Consolidated  Statements of Changes in Stockholders’ Equity for the years ended  December 31, 2005, 2004, and 2003 |       |     | F-5        |   |   |
| Notes to Consolidated  Financial Statements                                                                                  |       |     | F-6        |   |   |

 

**(b)   Exhibits.**

The Company hereby filesas part of this Form 10-K the Exhibits listed below.

**(c)   FinancialStatement Schedules.**

The following Consolidated Financial StatementSchedule of the Registrant is filed as part of this report:

Schedule II—Valuation andQualifying Accounts and Reserves

33

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**Reportof Independent Registered Public Accounting Firm**

The Board of Directors and Stockholders of MFICCorporation:

We have audited the accompanying consolidated balancesheets of MFIC Corporation and subsidiaries as of December 31, 2005 and2004 and the related consolidated statements of operations, stockholders’equity, and cash flows for each of the three years in the period ended December 31,2005. Our audits also included the financial statement schedule listed in theIndex at Item 15(c). These financial statements and schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements and schedule based on ouraudits.

We conducted our audits in accordance with theauditing standards of the Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. The Company is not required to have, nor were we engagedto perform, an audit of its internal control over financial reporting. An auditincludes consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstance, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’ internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of MFIC Corporation andsubsidiaries at December 31, 2005 and 2004 and the consolidated results oftheir operations and their cash flows for the three years in the period ended December 31,2005, in conformity with accounting principles generally accepted in the UnitedStates of America. Also, in our opinion, the related financial statementschedule, when considered in relation to the basic financial statements takenas a whole, presents fairly in all material respects the information set forththerein.

/s/ BROWN & BROWN, LLP

Boston, MassachusettsMarch 1, 2006, except for Note 6,as to which the date is March 23, 2006

F-1

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**MFICCORPORATIONCONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                                                                                                   | ** ** | **December 31,** | ** **    |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|---------------|
| ** **                                                                                                                                                                                                   | ** ** | **2005**              | ** **    | **2004** | ** ** |
| **ASSETS**                                                                                                                                                                                                   | ** ** | ** **            | ** **    | ** ** | ** ** |
| *Current Assets:*                                                                                                                                                                                            |       |                  |          |   |   |
| Cash and cash  equivalents                                                                                                                                                                                   |       | $                     | 1,452,358     |   | $ | 2,028,114 |   |
| Accounts  receivable, less allowance for doubtful accounts of $43,175 and $13,203 in  2005 and 2004, respectively.                                                                                           |       | 1,864,451             |          | 2,056,522 |   |
| Note  receivable—NuSil                                                                                                                                                                                  |       | —                |          | 100,000 |   |
| Note  receivable—current                                                                                                                                                                                |       | —                |          | 25,000 |   |
| Inventories, net                                                                                                                                                                                             |       | 1,849,446             |          | 1,888,138 |   |
| Prepaid expenses                                                                                                                                                                                             |       | 269,370               |          | 227,607 |   |
| Other current  assets                                                                                                                                                                                        |       | 32,949                |          | 45,167 |   |
| Deferred income  taxes                                                                                                                                                                                       |       | 265,000               |          | 450,000 |   |
| **TOTAL  CURRENT ASSETS**                                                                                                                                                                                    | ** ** | **5,733,574**         | ** **    | **6,820,548** | ** ** |
| *Property and Equipment, at cost:*                                                                                                                                                                           |       |                  |          |   |   |
| Furniture,  fixtures and office equipment                                                                                                                                                                    |       | 507,852               |          | 451,341 |   |
| Machinery and  equipment                                                                                                                                                                                     |       | 420,172               |          | 368,374 |   |
| Leasehold  improvements                                                                                                                                                                                      |       | 89,935                |          | 85,795 |   |
|                                                                                                                                                                                                         | ** ** | **1,017,959**         | ** **    | **905,510** | ** ** |
| Less: accumulated  depreciation and amortization                                                                                                                                                             |       | (611,589              | )             | (511,170 | ) |
| **Net  property and equipment**                                                                                                                                                                              | ** ** | **406,370**           | ** **    | **394,340** | ** ** |
| Patents, licenses  and other assets (net of accumulated amortization of $231,515 in 2005 and  $225,885 in 2004)                                                                                              |       | 71,783                |          | 77,413 |   |
| **TOTAL  ASSETS**                                                                                                                                                                                            | ** ** | **$**                 | **6,211,727** | ** ** | **$** | **7,292,301** | ** ** |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                               | ** ** | ** **            | ** **    | ** ** | ** ** |
| *Current Liabilities:*                                                                                                                                                                                       | * *   | * *              | * *      | * * | * * |
| Accounts payable                                                                                                                                                                                             |       | $                     | 115,461       |   | $ | 120,841 |   |
| Accrued expenses                                                                                                                                                                                             |       | 148,609               |          | 162,554 |   |
| Accrued  commissions                                                                                                                                                                                         |       | 160,491               |          | 193,073 |   |
| Accrued  compensation and vacation pay                                                                                                                                                                       |       | 74,313                |          | 132,970 |   |
| Accrued warranty                                                                                                                                                                                             |       | 58,000                |          | — |   |
| Customer advances                                                                                                                                                                                            |       | 615,929               |          | 775,327 |   |
| Current portion of  term note payable                                                                                                                                                                        |       | 250,000               |          | 250,000 |   |
| Current portion of  long-term debt- related party                                                                                                                                                            |       | —                |          | 6,250 |   |
| Current  portion—capital leases                                                                                                                                                                         |       | 38,507                |          | — |   |
| **TOTAL  CURRENT LIABILITIES**                                                                                                                                                                               | ** ** | **1,461,310**         | ** **    | **1,641,015** | ** ** |
| Capital leases  payable                                                                                                                                                                                      |       | 12,039                |          | — |   |
| Term note                                                                                                                                                                                                    |       | 312,507               |          | 562,503 |   |
| Commitments (Note 10)                                                                                                                                                                                        |       |                  |          |   |   |
| *Stockholders’ Equity:*                                                                                                                                                                                 |       |                  |          |   |   |
| Common Stock, par  value $.01 per share, 20,000,000 shares authorized; 10,166,430 and 9,921,984  shares issued; 9,905,984 and 9,661,538 shares outstanding at  December 31, 2005 and 2004, respectively |       | 101,665               |          | 99,220 |   |
| Additional paid-in  capital                                                                                                                                                                                  |       | 16,809,007            |          | 16,485,828 |   |
| Accumulated  deficit                                                                                                                                                                                         |       | (11,797,100           | )             | (10,808,564 | ) |
| Less: Treasury  Stock, at cost, 260,446 shares at December 31, 2005 and 2004,  respectively                                                                                                             |       | (687,701              | )             | (687,701 | ) |
| **TOTAL  STOCKHOLDERS’ EQUITY**                                                                                                                                                                         | ** ** | **4,425,871**         | ** **    | **5,088,783** | ** ** |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                         | ** ** | **$**                 | **6,211,727** | ** ** | **$** | **7,292,301** | ** ** |

 

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

F-2

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**MFICCORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS**

| ** **                                                                                                       | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues                                                                                                         |       | $                                           | 11,645,481 |   | $ | 12,158,919 |   | $ | 10,459,631 |   |
| Cost of goods  sold                                                                                              |       | 5,917,994                                   |       | 5,607,755 |   | 4,988,226 |   |
| Gross profit                                                                                                     |       | 5,727,487                                   |       | 6,551,164 |   | 5,471,405 |   |
| Operating expenses:                                                                                              |       |                                        |       |   |   |   |   |
| Research and development                                                                                         |       | 1,701,870                                   |       | 1,033,978 |   | 785,849 |   |
| Selling                                                                                                          |       | 2,412,550                                   |       | 2,587,658 |   | 2,187,389 |   |
| General and administrative                                                                                       |       | 2,384,217                                   |       | 2,232,358 |   | 1,732,087 |   |
| Total operating  expenses                                                                                        |       | 6,498,637                                   |       | 5,853,994 |   | 4,705,325 |   |
| (Loss) income  from continuing operations                                                                        |       | (771,150                                    | )          | 697,170 |   | 766,080 |   |
| Interest expense                                                                                                 |       | (58,510                                     | )          | (69,383 | ) | (116,097 | ) |
| Interest income                                                                                                  |       | 26,124                                      |       | 27,965 |   | 9,508 |   |
| Net (loss) income  from continuing operations before income tax (expense) benefit                                |       | (803,536                                    | )          | 655,752 |   | 659,491 |   |
| Income tax  (expense) benefit                                                                                    |       | (185,000                                    | )          | 450,000 |   | — |   |
| Net (loss) income  from continuing operations                                                                    |       | (988,536                                    | )          | 1,105,752 |   | 659,491 |   |
| Loss from  discontinued operations (net of loss from disposal of discontinued operations  of $1,422,715 in 2003) |       | —                                      |       | (231,380 | ) | (4,109,925 | ) |
| Net (loss) income                                                                                                |       | $                                           | (988,536   | ) | $ | 874,372 |   | $ | (3,450,434 | ) |
| Weighted average  number of common and common equivalent shares outstanding:                                     |       |                                        |       |   |   |   |   |
| Basic                                                                                                            |       | 9,756,221                                   |       | 9,345,560 |   | 7,767,712 |   |
| Diluted                                                                                                          |       | 9,756,221                                   |       | 10,329,313 |   | 8,501,110 |   |
| Basic amounts per common  share:                                                                                 |       |                                        |       |   |   |   |   |
| Net (loss) income  per share from continuing operations                                                          |       | $                                           | (0.10      | ) | $ | .11 |   | $ | .08 |   |
| Basic net (loss)  per share from discontinued operations                                                         |       | $                                           | —     |   | $ | (.02 | ) | $ | (.52 | ) |
| Basic, as  reported                                                                                              |       | $                                           | (0.10      | ) | $ | .09 |   | $ | (.44 | ) |
| Diluted amounts  per common share:                                                                               |       |                                        |       |   |   |   |   |
| Net (loss) income  per share from continuing operations                                                          |       | $                                           | (0.10      | ) | $ | .10 |   | $ | .08 |   |
| Diluted net  (loss) per share from discontinued operations                                                       |       | $                                           | —     |   | $ | (.02 | ) | $ | (.52 | ) |
| Diluted, as reported                                                                                             |       | $                                           | (0.10      | ) | $ | .08 |   | $ | (.44 | ) |

 

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

F-3

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**MFICCORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS**

| ** **                                                                            | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| *Cash flows from operating activities:*                                               | * *   | * *                                    | * *   | * * | * * | * * | * * |
| Net (loss) income                                                                     |       | $                                           | (988,536   | ) | $ | 874,372 |   | $ | (3,450,434 | ) |
| Adjustments to reconcile net (loss) income to net  cash used in operating activities: |       |                                        |       |   |   |   |   |
| Impairment of  goodwill                                                               |       | —                                      |       | — |   | 2,100,000 |   |
| Income tax expense  (benefit)                                                         |       | 185,000                                     |       | (450,000 | ) | — |   |
| Disposal of  discontinued operations                                                  |       | —                                      |       | — |   | 1,422,715 |   |
| Depreciation and  amortization                                                        |       | 186,126                                     |       | 111,829 |   | 264,101 |   |
| Provision for loss  on trade receivables                                              |       | 29,972                                      |       | (45,297 | ) | 24,378 |   |
| Provision for  other receivables                                                      |       | —                                      |       | 46,190 |   | 76,000 |   |
| Provision for  obsolete and excess inventory                                          |       | 22,000                                      |       | 53,000 |   | 60,000 |   |
| Provision for  warranty expense                                                       |       | 58,000                                      |       | — |   | — |   |
| Gain on sale of  assets                                                               |       | —                                      |       | — |   | (26,931 | ) |
| Share based  payments consultants                                                     |       | 119,000                                     |       | — |   | — |   |
| Acceleration—stock  options                                                      |       | 65,129                                      |       | — |   | — |   |
| Share based  compensation                                                             |       | 21,987                                      |       | — |   | — |   |
| *Changes in assets and liabilities:*                                                  |       |                                        |       |   |   |   |   |
| Receivables                                                                           |       | 162,099                                     |       | (196,641 | ) | 146,573 |   |
| Inventories                                                                           |       | 16,692                                      |       | (257,435 | ) | (49,733 | ) |
| Prepaid expenses                                                                      |       | (49,530                                     | )          | (20,397 | ) | (50,209 | ) |
| Other current  assets                                                                 |       | 45,567                                      |       | (46,578 | ) | 51,281 |   |
| Current  liabilities                                                                  |       | (269,962                                    | )          | (15,127 | ) | (331,449 | ) |
| Assets and  liabilities available for sale                                            |       | —                                      |       | (196,215 | ) | — |   |
| Net cash (used in)  provided by operating activities                                  |       | (396,456                                    | )          | (142,299 | ) | 236,292 |   |
| *Cash flows from investing activities:*                                               |       |                                        |       |   |   |   |   |
| Proceeds from sale  of fixed assets                                                   |       | —                                      |       | — |   | 26,931 |   |
| Purchase of fixed  assets                                                             |       | (96,048                                     | )          | (305,155 | ) | (96,532 | ) |
| Proceeds from note  receivable                                                        |       | —                                      |       | — |   | 16,429 |   |
| Proceeds from sale  of assets available for sale                                      |       | —                                      |       | 818,238 |   | — |   |
| Net cash (used in)  provided by investing activities                                  |       | (96,048                                     | )          | 513,083 |   | (53,172 | ) |
| *Cash flows from financing activities:*                                               | * *   | * *                                    | * *   | * * | * * | * * | * * |
| Principal payments  on bank line of credit—PNC                                   |       | —                                      |       | (2,425,613 | ) | (256,374 | ) |
| Proceeds from term  loan—Banknorth                                               |       | —                                      |       | 1,000,000 |   | — |   |
| Principal payments  on term note—PNC                                             |       | —                                      |       | (58,735 | ) | (95,004 | ) |
| Principal payments  on term loan—Banknorth                                       |       | (249,996                                    | )          | (187,497 | ) | — |   |
| Principal payments-  notes payable—capital leases                                |       | (38,165                                     | )          | — |   | — |   |
| Issuance of common  stock under employee stock purchase plan                          |       | 42,688                                      |       | 20,993 |   | 11,713 |   |
| Issuance of common  stock under employee stock option plan                            |       | 76,820                                      |       | 343,973 |   | 144,859 |   |
| Issuance of common  stock purchased through warrants                                  |       | —                                      |       | — |   | 52,000 |   |
| Proceeds from  private placement (net of closing costs of $577,601)                   |       | —                                      |       | 2,988,939 |   | — |   |
| Proceeds from  notes receivable—NuSil                                            |       | 91,651                                      |       | — |   | — |   |
| Payments on  subordinated debt-related party                                          |       | (6,250                                      | )          | (75,000 | ) | (75,000 | ) |
| Net cash (used in)  provided by financing activities                                  |       | (83,252                                     | )          | 1,607,060 |   | (217,806 | ) |
| Net (decrease)  increase in cash and cash equivalents                                 |       | (575,756                                    | )          | 1,977,844 |   | (34,686 | ) |
| Cash and cash  equivalents, beginning of year                                         |       | 2,028,114                                   |       | 50,270 |   | 84,956 |   |
| Cash and cash  equivalents, end of year                                               |       | $                                           | 1,452,358  |   | $ | 2,028,114 |   | $ | 50,270 |   |
| Supplemental disclosure of cash flow information:                                     |       |                                        |       |   |   |   |   |
| Assets acquired in  exchange for notes                                                |       | $                                           | 88,711     |   | $ | — |   | $ | — |   |
| Cash paid for interest                                                                |       | $                                           | 60,666     |   | $ | 67,942 |   | $ | 130,967 |   |

 

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

F-4

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**MFICCORPORATIONCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

| ** **                                                   | ** ** | **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, 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 |   |   |
| Stock options exercised                                      |       | 440,532                |       |                      | 4,406      |                             |       | 339,567                  |       | —                     |       |                     | —      |                                  |       | — |   |   | 343,973 |   |   |
| Issuance of common  stock from private placement             |       | 1,426,616              |       |                      | 14,266     |                             |       | 2,974,673                |       | —                     |       |                     | —      |                                  |       | — |   |   | 2,988,939 |   |   |
| Issuance of common stock under employee stock  purchase plan |       | 26,678                 |       |                      | 267        |                             |       | 20,726                   |       | —                     |       |                     | —      |                                  |       | — |   |   | 20,993 |   |   |
| Net income                                                   |       | —                 |       |                      | —     |                             |       | —                   |       | 874,372                    |       |                     | —      |                                  |       | — |   |   | 874,372 |   |   |
| Balance, December 31, 2004                              |       | 9,921,984              |       |                      | 99,220     |                             |       | 16,485,828               |       | (10,808,564                | )          |                     | 260,446     |                                  |       | (687,701 | ) |   | 5,088,783 |   |   |
| Stock options exercised                                      |       | 128,796                |       |                      | 1,288      |                             |       | 75,532                   |       | —                     |       |                     | —      |                                  |       | — |   |   | 76,820 |   |   |
| Issue of common stock under employee stock purchase  plan    |       | 23,289                 |       |                      | 233        |                             |       | 42,455                   |       | —                     |       |                     | —      |                                  |       | — |   |   | 42,688 |   |   |
| Stock warrants issued                                        |       | —                 |       |                      | —     |                             |       | 119,000                  |       | —                     |       |                     | —      |                                  |       | — |   |   | 119,000 |   |   |
| Correction—exercised options                            |       | 70,374                 |       |                      | 704        |                             |       | (704                     | )          | —                     |       |                     | —      |                                  |       | — |   |   | — |   |   |
| Stock based compensation—directors                      |       | 21,987                 |       |                      | 220        |                             |       | 21,767                   |       |                       |       |                     |        |                                  |       |   |   |   | 21,987 |   |   |
| Acceleration of stock options                                |       |                   |       |                      |       |                             |       | 65,129                   |       |                       |       |                     |        |                                  |       |   |   |   | 65,129 |   |   |
| Net loss                                                     | ** ** | **—**             | ** ** | ** **                | **—** |                             | ** ** | **—**               |       | (988,536                   | )          | ** **               | **—**  |                                  | ** ** | **—** |   |   | (986,536 | ) |   |
| Balance,  December 31, 2005                             |       | 10,166,430             |       |                      | $          | 101,665                          |       |                     | $          | 16,809,007                 |       | $                        | (11,797,100 | )                                     |       | 260,446 |   |   | $ | (687,701 | ) |   | $ | 4,425,871 |   |   |

 

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

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**MFICCORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**Note1**           ORGANIZATION ANDSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

**Organization**

MFIC Corporation (MFIC orthe Company), through its wholly-owned subsidiary, Microfluidics Corporation(Microfluidics), its operating division, operates in one segment, specializingin producing and marketing a broad line of proprietary fluid materialsprocessing systems used for a variety of grinding, mixing, milling, andblending applications across a variety of industries and for use in numerousapplications within those industries. Microfluidizer materials processorsystems are produced at Microfluidics.

**Managements Plan**

The Company incurred a netloss before income tax expense from continuing operations of $803,536 for theyear ended December 31, 2005. As of a result of the loss, the Company wasnot in compliance with its debt service coverage ratio covenant of its CreditFacility with Banknorth, N.A. (“the Lender”). The Company was granted a waiverof this covenant as of December 31, 2005, but must meet this covenantrequirement in the future as of December 31, 2006. Assuming the Companydoes not continue to incur substantial operating losses, management believesthat cash flows from operations and available credit from the Credit Facility,along with the existing cash balances, will be sufficient to meet its workingcapital requirements for at least the next twelve months. In the event that theCompany continues to incur significant operating losses, the Company anticipatesthat it would be able to fund its working capital requirements for the next 12months if it sufficiently decreased expenditures to avoid further operatinglosses. Although there can be no assurance of success, the Company’s managementis confident that it could modify the Company’s business  plan and operation to achieve positive cashflows from its base level of operations and thereby have sufficient capitalresources to accommodate its working capital requirements for the next 12months.

**Principles of Consolidation**

The consolidated financialstatements of the Company include the accounts of the Company and its whollyowned subsidiaries. All significant intercompany transactions and balances havebeen eliminated in consolidation.

**Reclassifications**

Morehouse-COWLES Division:On February 9, 2004, pursuant to an Asset Purchase Agreement (the AssetPurchase Agreement) dated February 5, 2004 between MFIC and a wholly ownedsubsidiary of NuSil Corporation, a California corporation (NuSil), MFIC soldsubstantially all of  the assets andselected liabilities of its Morehouse-COWLES Division (the Division), to NuSil.As such, in accordance with Generally Accepted Accounting Principles, resultsof operations have been reclassified to reflect Morehouse-COWLES’ operatingresults, net of income taxes, as Discontinued Operations. Further, certainprior period balances have been reclassified to conform to the current periodpresentation.

**Use of Estimates**

The preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America (“Generally AcceptedAccounting Principles”) requires 

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managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

**Revenue Recognition**

Revenue from the sale of machines and spare parts isgenerally recognized upon shipment of the product or when the earnings processis complete. Rental income for the lease of equipment is recognized on astraight-line basis over the term of the lease agreement. Rental income andequipment sales are classified in revenues in the consolidated statement ofoperations.

The Company has adopted Securities and ExchangeCommission (SEC) Staff Accounting Bulletin (SAB) No. 104, *Revenue Recognition in Financial Statements*. The Companyrecognizes sales at the time of shipment of the system to the customer.Management believes the customer’s post-delivery acceptance provisions andinstallation are routine. The Company has never failed to successfully completea system installation. With few exceptions, the Company limits its liability tothe return of the equipment sold. Installation costs are predictable andinsignificant to the total purchase price. The Company has demonstrated ahistory of customer acceptance subsequent to shipment and installation of thesesystems.

The Company has adoptedFASB Interpretation No. 46R, Consolidation of Variable Interest Entities,(FIN46). The Company has evaluated this interpretation, and has determined thatit has no Variable Interest Entities that would require consolidation withinthe Company’s December 31, 2005 Consolidated Financial Statements.

**Cash and Cash Equivalents**

The Company considers allhighly liquid securities with initial maturities of 90 days or less, at thetime of acquisition, to be cash equivalents.

**Allowance for Doubtful Accounts**

The Company maintains anallowance for estimated losses resulting from the inability of its customers tomake required payments. An estimate of uncollectible amounts is made bymanagement based upon historical bad debts, current customer receivablebalances, age of customer receivable balances, customer’s financial conditionand current economic trends. If the actual uncollected amounts significantlyexceed the estimated allowance, the Company’s operating results would be significantlyadversely affected.

**Inventories**

Inventories consist of material, labor andmanufacturing overhead and are stated at the lower of cost or market. Cost isdetermined on a first-in, first-out basis (FIFO).

The Company periodicallyreviews quantities of inventory on hand and compares these amounts to expectedusage 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 market value isless than cost.

**Property and Equipment**

The Company’s property andequipment is recorded at cost. Depreciation is computed using the straight-linemethod, based upon estimated useful lives of 3 to 7 years. Leasehold improvementsare amortized 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 

F-7

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sale ofproperty and equipment, the cost of the disposed asset and the relatedaccumulated depreciation are removed from the accounts and any resulting gain,or loss is credited or charged to operations.

**Long-Lived Assets**

In accordance withStatements of Financial Accounting Standards (“SFAS”) No.144, *Accounting for the Impairment or Disposal of Long-Lived Assets*(“SFAS No. 144”), the Company reviews long-lived assets and all amortizingintangible assets for impairment whenever events or changes in circumstancesindicate the carrying amount of such assets may 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. Ifthe operation is determined to be unable to recover the carrying amount of itsassets, then intangible assets are written down first, followed by the otherlong-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,Licenses, and Other Intangible Assets**

Patents, patentapplications and rights are stated at acquisition cost. Amortization isrecorded using the straight-line method over the shorter of the legal lives oruseful life of the patents. Patents, licenses and other intangible assets arebeing amortized over a period of 3 to 17 years.

**Reserve for Warranty Expenses**

The Company generallysells its products with a twelve month warranty that requires it to remedydeficiencies or quality on performance not caused by the actions of thecustomer. The Company has established a reserve for these costs, based uponhistorical data.

**Research and Development Expenses**

The Company chargesresearch and development expenses to operations as incurred.

**Earnings (Loss) per Share**

Basic and diluted net lossper share is presented in conformity with SFAS No. 128, *Earnings per Share (“SFAS No. 128”),*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 1,718,925,1,788,213 and 1,929,662 shares of common stock were outstanding for the yearsended 2005, 2004, and 2003, respectively. Basic and diluted net loss per shareare $(.10) for 2005. Basic and diluted net incomes per share are $.09 and $.08respectively per share for 2004. Basic and diluted net loss per share are$(.44) per share for 2003.

**Fair Value of Financial Instruments**

The carrying amount ofcash and cash equivalents, accounts receivable, accounts payable and accruedliabilities approximates fair value due to the short term nature of theseaccounts. The Company’s bank debt, because it carries a variable interest rate,is stated at its approximate fair market value.

**Income Taxes**

TheCompany accounts for income taxes under SFAS No. 109, *Accountingfor Income Taxes (“SFAS No. 109”).*Under SFAS No. 109,deferred tax assets or liabilities are computed based on the differencesbetween the financial statement and income tax bases of assets and liabilitiesusing the effective tax rates. Deferred income tax expense or credits are basedon changes in the asset or liability from period to period. 

F-8

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The Company records a valuation allowance against anynet deferred tax assets if it is more likely than not that they will not berealized.

**Stock Based Compensation**

As allowed by SFAS No. 123,*Accounting for Stock-Based Compensation*,the Company has elected to account for stock-based compensation at intrinsicvalue with disclosure of the effects of fair value accounting on net income andearnings per share on a pro forma basis. At December 31, 2005, the Companyhad one stock incentive plan, which is described more fully in Note 9. TheCompany accounts for awards issued to employees under its stock incentive planpursuant to the recognition and measurement principles of Accounting PrinciplesBoard (APB) Opinion No. 25, *Accounting for Stock Issuedto Employees*, and related interpretations. No stock-based employeecompensation cost is reflected in net income, as all options granted under theplan had an exercise price equal to the market value of the underlying commonstock on the date of grant.

The following table illustrates the effect on net (loss)income and (loss) income per share if the  Company had applied the fair value recognition provisions of SFAS No. 123:

| ** **                                                                                                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net (loss) income, as reported                                                                                             |       | $        | (988,536   | )        | $          | 874,372  |       | $ | (3,450,434 | ) |
| Deduct: total stock-based expense determined under fair value based  method for all awards net, met of related tax effects |       | (130,791 | )          | (231,886 | )          | (113,509 | )          |
| Pro forma net (loss) income                                                                                                |       | $        | (1,119,327 | )        | $          | 642,486  |       | $ | (3,563,943 | ) |
| Net  (loss) income per share:                                                                                              |       |     |       |     |       |     |       |
| Basic—as reported                                                                                                     |       | $        | (0.10      | )        | $          | .09      |       | $ | (0.44 | ) |
| Diluted—as reported                                                                                                   |       | $        | (0.10      | )        | $          | .08      |       | $ | (0.44 | ) |
| Basic—pro forma                                                                                                       |       | $        | (0.11      | )        | $          | .07      |       | $ | (0.46 | ) |
| Diluted—pro  forma                                                                                                    |       | $        | (0.11      | )        | $          | .06      |       | $ | (0.46 | ) |

 

Stockoptions granted to non-employees are accounted for in accordance with SFAS No. 123and the Emerging Issues Task Force (EITF) AbstractNo. 96-18, *Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in**Conjunction with Selling, Goods or Services*,and related interpretations, which generally requires the value of options tobe periodically remeasured and charged to expense as they are earned over theperformance period. Compensation related to stock appreciation rights and othervariable stock option or award plans should be measured at the end of eachperiod. The Company did not grant any stock options to non-employees, with theexception of granting options to non-employee directors, during 2005, 2004, or2003.

**Recent Accounting Pronouncements**

In November 2004, the FASB issued FASB Statement No. 151,“Inventory Costs—an amendment of ARB No. 43” (“SFAS No. 151”), whichis the result of its efforts to converge U.S. accounting standards forinventories with international Accounting Standards. SFAS No. 151 requiresidle facility expenses, freight, handling costs, and wasted material (spoilage)costs to be recognized as current-period charges. It also requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. SFAS No. 151 will beeffective for inventory costs incurred during fiscal years beginning after June 15,2005. The Company believes there is no impact from this standard on itsconsolidated financial statements.

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In December 2004, the FASB issued SFASNo. 123 (Revised 2004) “Share-Based Payment” (“SFAS No. 123R”). SFASNo. 123R addresses all forms of share-based payment (“SBP”) awards,including shares issued under employee stock purchase plans, stock options,restricted stock and stock appreciation rights. SFAS No. 123R requires theCompany to expense SBP awards with compensation cost for SBP transactionsmeasured at fair value. The FASB originally stated a preference for a latticemodel because it believed that a lattice model more fully captures the uniquecharacteristics of employee stock options in the estimate of fair value, ascompared to the Black-Scholes model which the Company currently uses for itsdisclosure. The FASB decided to remove its explicit preference for a latticemodel and not require a single valuation methodology. SFAS No. 123Rrequires the Company to adopt the new accounting provisions beginning in ourfiscal year 2006. The Company is has evaluated the impact of this standard andexpects that there will be a non-cash charge of approximately $129,000 on itsconsolidated financial statements.

In May 2005, the FASBissued FASB statement No. 154, Accounting Changes and Corrections. SFASNo. 154 addressed the accounting and reporting for changes in accountingprinciples. It replaces APB 20 and FIN 20, and is effective for all fiscalyears beginning after December 15, 2005. It requires that the cumulativeeffect of a change in accounting principle be recorded directly in the openingretained earnings balance. The Company has evaluated this standard, and hasdetermined there is no impact on our consolidated financial statements.

**Note2**           INDUSTRY SEGMENT,GEORGRAPHIC AND ENTERPRISE-WIDE REPORTING

SFAS No. 131, *Disclosures about Segmentsof an Enterprise and Related Information,*(“SFAS No. 131”), requires companies toreport selected information about operating segments, as well asenterprise-wide disclosures about products, services, geographic areas andmajor customers. Operating segments are determined based on the way managementorganizes its business for making operating decisions and assessingperformance. The Company’s chief decision-maker, as defined under SFASNo. 131, is the chairman and chief executive officer. The Company hasdetermined that it conducts its operations in one business segment: thedevelopment, manufacture, marketing and sale of process and formulationequipment. The Company’s sales are primarily to companies with processing needsin the chemical, pharmaceutical, food, cosmetic, and biotechnology industries.The Company has less than 1% of total assets in foreign countries. As a result,the financial information disclosed herein represents all of the materialfinancial information related to the Company’s principal operating segment.

Approximatesales to customers from continuing operations by geographic markets, are asfollows:

| ** **    | ** ** | **2005**  | ** **     | **2004**   | ** ** | **2003**       | ** ** |
|---------------|------------|-----------|----------------|------------|------------|----------------|------------|
| North America |       | $         | 6,028,000      |       | $          | 6,212,000      |       | $ | 5,337,000 |   |
| Asia          |       | 4,100,000 |           | 3,774,000  |       | 3,204,000      |       |
| Europe        |       | 1,518,000 |           | 2,173,000  |       | 1,919,000      |       |
|          | ** ** | **$**     | **11,646,000** | ** ** | **$**      | **12,159,000** | ** ** | **$** | **10,460,000** | ** ** |

 

*Customers:*

The users of the Company’s systems are in variousindustries, including the chemical, pharmaceuticals, food, cosmetic andbiotechnology industries. Mizuho Industrial Co. Ltd. (Mizuho) and a whollyowned subsidiary of Teva Pharmaceuticals Industries Ltd. (Teva) accounted for19.5% and 18.9% of the Company’s revenues from continuing operations in 2005,respectively; 20.5% and 12.8%, respectively, in 2004; and 20.6% and 10.6%,respectively, in 2003. Mizuho, the Company’s Japanese distributor ofMicrofluidizer processor equipment and spare parts, resells the Company’sequipment to numerous end-users in Japan, none of which individually represents10% or more of the Company’s revenues. Two customers accounted for 10.8% and10.7% of the trade accounts receivable from continuing operations as 

F-10

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of December 31, 2005,respectively. Three customers accounted for 15.1%, 14.7%, and 13.4% of thetrade accounts receivable as of December 31, 2004, respectively. One customeraccounted for 16.7% of the trade accounts receivable as of December 31,2003. A reduction or delay in orders from any of the Company’s significantcustomers could have a material adverse effect on the Company’s results ofoperations.

The Company sells itsproducts in various countries. The Company’s sales in North America, includingthe United States, Canada, and Mexico, accounted for approximately 51.8% of theCompany’s revenues from continuing operations in 2005; approximately 51.1% ofthe Company’s revenues from continuing operations in 2004; and approximately51.0 % of the Company’s revenues from continuing operations in 2003, withalmost all of those sales coming from United States and Canada. Sales to therest of the world accounted for approximately 48.2% of the Company’s revenuesfrom continuing operations in 2005; approximately 48.9% of the revenues fromcontinuing operations in 2004; and approximately 49.0% of the revenues fromcontinuing operations in 2003. Sales through the Company’s exclusivedistributors in Japan accounted for approximately 19.5% of the Company revenuesfrom continuing operations in 2005; 20.5% of the Company’s revenues fromcontinuing operations in 2004; and 20.6% of the Company’s revenues fromcontinuing operations in 2003. Sales through the Company’s representative inKorea accounted for approximately 12.1% of the Company’s revenues fromcontinuing operations in 2005; 4.8% of the Company’s revenues from continuingoperations in 2004; and 5.1% of the Company’s revenues from continuingoperations in 2003.

**Note 3**           INVENTORIES

Thecomponents of inventories are as follows at December 31:

| ** **                            | ** ** | **2005**  | ** **    | **2004**   | ** ** |
|---------------------------------------|------------|-----------|---------------|------------|------------|
| Raw materials                         |       | $         | 1,711,661     |       | $          | 1,786,427 |   |
| Work in progress                      |       | 73,844    |          | 147,376    |       |
| Finished goods                        |       | 248,941   |          | 117,335    |       |
|                                  |       | 2,034,446 |          | 2,051,138  |       |
| Less: provision  for excess inventory |       | 185,000   |          | 163,000    |       |
| **TOTAL**                             | ** ** | **$**     | **1,849,446** | ** ** | **$**      | **1,888,138** | ** ** |

 

**Note 4**           ASSETSAVAILABLE FOR SALE

In the fourth quarter of 2003 the Company determinedthat its Morehouse-COWLES Division (the “Division”) was not strategic to theCompany’s on-going objectives and in December 2003, management committedto a plan to sell substantially all the assets and associated liabilities ofthe Division. Accordingly, the Company reported the Division as a discontinuedoperation in accordance with SFAS No. 144. The consolidated financialstatements were reclassified to segregate the assets and associated liabilitiesavailable for sale and operating results of these discontinued operations forall periods presented.

F-11

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Summary OperatingResults of the Discontinued Operations of Morehouse-COWLES are as follows:

| ** **                                                                                                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenue                                                                                                     |       |     | $          | —   |       |     | $          | 323,635 |   | $ | 3,655,237 |   |
| Cost of sales                                                                                               |       |     | —     |     |       | 308,548  |       | 2,601,957 |   |
| Gross profit                                                                                                |       |     | —     |     |       | 15,087   |       | 1,053,280 |   |
| Total operating  expenses                                                                                   |       |     | —     |     |       | 238,760  |       | 3,740,490 |   |
|                                                                                                        |       |     | —     |     |       |     |       |   |   |
| Loss from  discontinued operations before cumulative effect of change in accounting  principle and disposal |       |     | —     |     |       | (223,673 | )          | (2,687,210 | ) |
| Loss on disposal  of discontinued operations                                                                |       |     | —     |     |       | (7,707   | )          | (1,422,715 | ) |
| Cumulative effect  of change in accounting principle                                                        |       |     | —     |     |       | —   |       | — |   |
| Loss from discontinued  operations                                                                          |       |     | —     |     |       | $        | (231,380   | ) | $ | (4,109,925 | ) |

 

In December 2003, inconjunction with the establishment of management’s plan to sell theMorehouse-COWLES Division, the Company determined that the remaining goodwillof $2,100,000 was fully impaired and accordingly charged to DiscontinuedOperations.

On February 9, 2004,pursuant to an Asset Purchase Agreement (the “Asset Purchase Agreement”) dated February 5,2004 between MFIC and a wholly owned subsidiary of NuSil Corporation (“NuSil”),MFIC sold substantially all of the assets and selected liabilities of itsMorehouse-COWLES Division (the “Division”), to NuSil. Other than NuSil’s priorpurchases of products from the Division, there were no preexistingrelationships between MFIC and NuSil.

The assets of the Divisionthat were sold included accounts receivable, furniture, fixtures and equipment,inventory and supplies, books and records, bids, contracts, prepaid expenses,leases, intellectual property, goodwill, domain names and claims, all asdescribed in the Asset Purchase Agreement (collectively, the “Assets”). Inaddition, certain rights and obligations arising after February 9, 2004under the Division’s PacifiCare Group Health Insurance Policy were assigned. TheDivision’s cash on hand on February 9, 2004 were excluded from the assetsbeing sold. Under the Asset Purchase Agreement, the Division’s executoryobligations under certain contracts and bids, and the Division’s accounts payableas of February 9, 2004 in the amount of $623,240, were assumed by NuSil.

The purchase price (otherthan the assumption of accounts payable described in the preceding paragraph)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 formof a Promissory Note (the “Purchase Note”) and $50,000 (the “Holdback Payment”)was withheld for payment subject to any purchase price adjustments and offsets,as provided for in the Asset Purchase Agreement. In accordance with the AssetPurchase Agreement, this Company received the holdback payment on March 26,2004.

The Closing Cash was paiddirectly to PNC Bank, National Association (“PNC”), to be applied to MFIC’soutstanding balance under MFIC’s Revolving Credit Loan with PNC (the “RevolvingCredit Loan”).

The aforementionedPurchase Note bore interest at 5 percent per annum, and was secured by theAssets pursuant to a Security Agreement dated February 5, 2004 (the “SecurityAgreement”) between the parties and was subject to certain offsets as providedin the Asset Purchase Agreement. Principal and interest on the Purchase Notewere payable on February 9, 2005. NuSil forwarded a payment to the Companyon that date which, in conjunction with allowable offset of approximately$8,300 paid by NuSil for the benefit of the Company, satisfied the claim.

Pursuant to the AssetPurchase Agreement, MFIC entered into a Noncompetition and NonsolicitationAgreement, dated February 5, 2004, which limits MFIC’s ability to competewith the business of the Division for a period of five years.

F-12

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**Note 5**           INTANGIBLESAND OTHER ASSETS

In 2001, the Company capitalized $64,528 of costsrelated to the Multiple-Stream Mixer High Pressure Reactor patent, with anadditional $28,582 of costs related to this patent capitalized in 2004. Thesecosts are being amortized over a 17-year period, beginning in the lastquarter of 2001. Amortization of these costs was $5,630 in 2005, $9,747 in2004, and $3,800 in 2003.

Costs incurred in connection with the debt refinancingthat occurred on March 3, 2004 are being amortized over four years, theinitial term of the line of credit. The total of such costs was approximately$36,533. Amortization of these costs amounted to $7,767 in 2005 and $8,978 in2004.

Costs incurred inconnection with the debt refinancing that occurred on February 28, 2000were amortized over three years, the initial term of the line of credit. Thetotal of such costs, which are fully amortized, was approximately $207,000. Amortizationof these costs amounted to $11,534 in 2003.

**Note 6**           DEBT

Long-termdebt as of the following dates consisted of:

| ** **                                      | ** ** | **December 31,** | ** **  |
|-------------------------------------------------|------------|-----------------------|-------------|
| ** **                                      | ** ** | **2005**              | ** **  | **2004** | ** ** |
| 10% subordinated  note payable to related party |       | $                     | —      |   | $ | 6,250 |   |
| Term note payable                               |       | 562,507               |        | 812,503 |   |
| Capital lease  notes payable                    |       | 50,546                |        | — |   |
|                                            |       | 613,053               |        | 818,753 |   |
| Less current  portion                           |       | (288,507              | )           | (256,250 | ) |
| Long term debt, net of  current portion         | ** ** | **$**                 | **324,546** | ** ** | **$** | **562,503** | ** ** |

 

The capital lease notes payable consist of threecapitalized leases with bargain purchase options that the Company is obligatedto pay over a three year period.

Futureminimum capital lease payments required under the capital leases are asfollows:

| 2006                          |   | $       | 40,475 |   |
|-------------------------------|--------|---------|--------|--------|
| 2007                          |   | 12,654  |   |
| Total Capital lease  payments |   | 53,129  |   |
| Less: Interest  expense       |   | 2,583   |   |
| Net                           |   | $50,546 |   |

 

**Subordinated Note Payable**

The subordinated note waspayable to Lake Shore Industries Inc., a related party as defined and disclosedin Note 11 of the financial statements.

**Credit Facility**

On March 3, 2004, the Company and itsMicrofluidics Corporation subsidiary, as co-borrowers, entered into a revolvingcredit and term loan agreement with Banknorth, N.A. (the “New Lender”)providing the Company with a $2,000,000 demand revolving credit and four yearterm loan facility (the “Credit Facility”). The Credit Facility was comprisedof (i) a $1,000,000 demand revolving line of credit (“The Revolving CreditLine”), and (ii) a $1,000,000 four year term promissory note (“The Term Loan”).The Revolving Credit Line obtains advances there under bearing interest at aninterest rate equal to the prime rate (the Prime Rate for United Statesborrowings from Banknorth, N.A. as publicly announced 

F-13

----

from time to time). Allborrowings under the Revolving Credit Line were evidenced by a $1,000,000demand promissory note (the “Revolving Note”), and (ii) a $1,000,000 termpromissory note, amortized over a four year period but having a maturity dateof March 3, 2008 and bearing interest at an interest rate equal to theFederal Home Loan Bank Classic Rate at March 4, 2004 plus two and one-halfpercent (2.50%). Loans under the Credit Facility are secured by a collateralpledge to the New Lender of substantially all the assets of the Company and itssubsidiaries. The Company’s Microfluidics Corporation subsidiary guaranteed theCompany’s obligations to the New Lender under the Credit Facility. The Companyalso pledged to the New Lender all shares of Microfluidics Corporation owned bythe Company. The Company is required to meet two covenants on an annual(calendar) basis as of December 31 of a given year: (i) The Company’ssenior debt may not be more than four times the amount of its tangible capitalbase, and (ii) its debt service coverage ratio may not be less than 1.20to 1. At December 31, 2005, the Company was not in compliance with thedebt service coverage ratio, and required a waiver from the New Lender, whichwas granted on March 23, 2006. The Company will be required to meet bothcovenant requirements at December 31, 2006. The Company expects to be incompliance as of that date.

Due to the subjectiveacceleration clause, and the lock-box arrangement with the New Lender, therevolving credit line is classified as a current liability in the consolidatedbalance sheet. On December 31, 2005 and 2004, there was no outstandingbalance on the Revolving Credit Line. The balance outstanding on the term loanwas $562,507, at an interest rate of 5.67%.

**Note 7**           EMPLOYEEBENEFIT PLANS

The Company offers a 401(k) profit-sharingplan (the 401K Plan) to its employees. All Company and related entity employeeswho are eighteen years of age and have completed one hour of service areeligible to participate in the 401K Plan. Employees may contribute from 1% to20% of their compensation. The Company’s contribution is discretionary, withcontributions made from time to time as management deems advisable. The Companymade no matching contributions during 2005, 2004, or 2003. The Company alsoinstituted a cafeteria plan in 1992, giving the employees certain pre-taxadvantages on specific payroll deductions.

**Note 8**           INCOMETAXES

The(expense) benefit for income taxes is as follows:

| ** ** | ** ** | **Year ended December 31** | ** ** |
|------------|------------|-------------------------------------------|------------|
| ** ** | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| Deferred:  |       |                                      |       |   |   |   |   |   |   |
| Federal    |       | $                                         | (141,000   | ) | $ | 345,000 |   |   | $ | — |   |   |
| State      |       | $                                         | (44,000    | ) | 105,000 |   |   | — |   |   |
|       |       | $                                         | (185,000   | ) | $ | 450,000 |   |   | $ | — |   |   |

 

The amount reported as an incometax expense for 2005 is the result of an increase to the valuation allowancereserve that was recorded against the Company’s deferred tax assets.

The amount reported as an incometax expense in 2004 is the result of the reversal of tax reserves recorded inprior years.

F-14

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The total income tax benefit differs from the income taxat the statutory federal income tax rate due to the following:

| ** **                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal income  tax at statutory rate                    |       | 34.00    | %          | 34.0     | %          | 34.0     | %          |
| State income  taxes, net of federal benefit              |       | 6.3      | %          | 6.3      | %          | 6.3      | %          |
| Permanent  adjustments                                   |       | (6.5     | )%         | 2.6      | %          | —   |       |
| Net research and development  and other tax credits      |       | (11.7    | )%         | —   |       | —   |       |
| Valuation  allowance                                     |       | 25.9     | %          | (42.8    | )%         | (40.3    | )%         |
| Reversal of  valuation allowance recorded in prior years |       | (25.0    | )%         | (68.7    | )%         | —   |       |
| Total income tax expense  (benefit)                      |       | 23.0     | %          | (68.6    | )%         | 0        | %          |

 

The following is a summary of the significant componentsof the Company’s deferred tax assets and liabilities:

| ** **                                                         | ** ** | **Year ended December 31** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Deferred tax assets  (liabilities) :                               |       |                                      |       |   |   |
| Purchased Intangibles                                              |       | $                                         | 0          |   | $ | 11,000 |   |
| Net operating  loss carry forwards                                 |       | 3,958,000                                 |       | 4,683,000 |   |
| Research and  development and other credits                        |       | 93,000                                    |       | 180,000 |   |
| Accruals and  allowances not currently deductible for tax purposes |       | 122,000                                   |       | 129,000 |   |
| Depreciation and  other                                            |       | 7,000                                     |       | (440,000 | ) |
| Valuation  allowance                                               |       | (3,915,000                                | )          | (4,063,000 | ) |
| Total deferred tax  assets                                         |       | $                                         | 265,000    |   | $ | 450,000 |   |

 

At December 31, 2005, the Company has available federalnet operating loss carryforwards for income tax purposes of approximately $10,274,000and state net operating losses of approximately $7,420,000 which expire atvarious dates through 2025, federal research and development credit carryforwards of approximately $84,000 expiring in varying amounts during the periodthrough 2011 and state research and development credit carryforwards ofapproximately $9,000 expiring in varying amounts during the period through2011. Ownership changes, as defined in the Internal Revenue Code, may havelimited the amount of new operating loss carry forwards that can be utilizedannually to offset future taxable income. Subsequent ownership changes couldfurther affect the limitation in future years.

Based on our review of the evidence available, webelieve that the valuation allowance is adequate as of the year ended December 31,2005, based on our projected results for 2006. If there is any significantchange between actual and budgeted results, we would revisit the valuationallowance at the end of June 30, 2006, and make the appropriateadjustment.

F-15

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**Note 9**                          STOCKHOLDERS’EQUITY

The Company adopted the1988 Stock Plan (the Plan) as the successor plan to the 1987 Stock Plan, which,as amended at the 2002 stockholders’ meeting, authorizes the grant of StockRights for up to 3,500,000 shares of common stock, and the 1989 Non-EmployeeDirector Stock Option Plan which, as amended at the 1996 stockholders’ meeting,authorizes the grant of nonqualified stock options for up to 500,000 shares ofcommon stock.

**Stock Option Plans**

Options granted under the plans vest over athree-to-five-year period and expire 5 - 10 years from the grant date. At December 31,2005, 757,946 shares were available for future grants under the plans.Information with respect to activity under the plans is as follows:

| ** **                           | ** ** | **Number of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|--------------------------------------|------------|--------------------------------|------------|------------------------------------------------|------------|
| 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 |   |   |
| Granted                              |       |                           | 392,668    |                                           |       |   | 2.27 |   |   |
| Exercised                            |       |                           | (440,532   | )                                              |       |   | 0.79 |   |   |
| Canceled                             |       |                           | (93,585    | )                                              |       |   | 0.67 |   |   |
| Outstanding, December 31, 2004  |       |                           | 1,788,213  |                                           |       |   | 1.14 |   |   |
| Granted                              |       |                           | 424,900    |                                           |       |   | 2.14 |   |   |
| Exercised                            |       |                           | (221,157   | )                                              |       |   | .57 |   |   |
| Canceled                             |       |                           | (273,031   | )                                              |       |   | 1.07 |   |   |
| Outstanding, December 31, 2005  |       |                           | 1,718,925  |                                           |       |   | $ | 1.37 |   |   |
| Exercisable, December 31, 2003  |       |                           | 1,102,020  |                                           |       |   | $ | 0.96 |   |   |
| Exercisable, December 31, 2004  |       |                           | 979,763    |                                           |       |   | $ | 0.79 |   |   |
| Exercisable,  December 31, 2005 |       |                           | 1,338,954  |                                           |       |   | $ | 1.30 |   |   |

 

The following table summarizes information relating tooutstanding and exercisable stock options as of December 31, 2005:

| **Outstanding**           | ** ** | **Exercisable**            | ** ** |
|---------------------------|------------|----------------------------|------------|
| **Exercise  Price ** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Remaining  Contractual Life  (Years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| $ 0.30-.95           |       | 638,564                    |       |   | 5.5 |   |   |   | $ | .50 |   |   | 530,439 |   |   | $ | .50 |   |   |
| $ 1.00-1.75          |       | 603,215                    |       |   | 7.0 |   |   |   | 1.23 |   |   | 517,715 |   |   | $ | 1.45 |   |   |
| $ 2.06-4.25          |       | 477,146                    |       |   | 9.5 |   |   |   | 2.70 |   |   | 290,800 |   |   | $ | 2.47 |   |   |
|                      |       | 1,718,925                  |       |   |   |   |   |   |   |   |   | 1,338,954 |   |   |   |   |   |

 

F-16

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**Acceleration ofStock Options**

The Company, upon recommendation of its CompensationCommittee, approved the accelerated vesting of all currently outstandingunvested stock options (“Options”) to purchase shares of common stock of theCompany. These Options were previously awarded to officers and employees underthe Company’s 1988 Employee Stock Option Plan. The Company has recognized aone-time compensation expense in accordance with Accounting Principles BoardOpinion No. 25, Accounting for Stock Issued to Employees (“APB No.25”), ofapproximately $65,000 in the fourth quarter of fiscal 2005 with respect to theacceleration of in-the-money options.

Options to purchase 480,915 shares of the Company’scommon stock, which would otherwise have vested from time to time over the nextfive years, became immediately exercisable on December 31, 2005 as aresult of the Board’s actions. The number of shares and exercise prices of theOptions subject to acceleration are unchanged. The remaining terms for each ofthe Options granted remain the same.

The accelerated Options included 139,350 Options heldby executive officers as identified in the Company’s June 3, 2005 proxystatement increased by subsequent grants dated December 6, 2005, and341,565 Options held by other employees. Based on the Company’s closing stockprice of $1.35 per share on the date of accelerated vesting, 48% of the totalaccelerated Options would have an exercise price above the closing market priceat the time of acceleration. All of the accelerated Options have exerciseprices between $.30 and $4.25 per share, with total weighted average exerciseprice per share $1.72.

The decision to acceleratethe vesting of these Options was made primarily to reduce non-cash compensationexpense that would have been recorded in its income statement in the futureperiods upon the adoption of Financial Accounting Standards Board Statement No. 123R(Share-Based Payment) on January 1, 2006. As of December 31, 2005,option holders exercised the opt-out right with respect to 284,971 Options, andthe Company will recognize a one-time non-cash compensation charge ofapproximately $87,000 in 2006 with regard to those Options.

**CorrectionRegarding Exercised Options**

On April 7, 2004, an officer of the Companyexercised 80,000 options that had been granted in 1998 at an exercised price of$1.2375 per share, for a total expenditure of $99,000.

A review of the 1988 employee stock plan occurred in2005. At that time, it was discovered that the employee, due to his degree ofownership in the Company, could not exercise these options after five years, or2003.

Instead of having themoney returned, the employee exercised other options held and exercisable. Thenet result of the transaction was no overall change to equity, but an increaseto Common Stock, and a corresponding decrease to Additional-Paid-In-Capital.

**Accounting for Stock-Based Compensation**

SFAS No. 123, *Accounting for Stock-Based Compensation*, requires themeasurement of the fair value of stock options to be included in the statementof income or disclosed in the notes to the financial statements. The Companyhas determined that it will continue to account for stock-based compensationfor employees under APB Opinion No. 25, *Accountingfor Stock issued to Employees*, and elect the disclosure-only alternativeunder No. SFAS 123.

F-17

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The Company has computed the pro forma disclosuresrequired under SFAS No. 123 for its stock compensation plan for employeesduring the years ended December 31, 2005, 2004 and 2003 using theBlack-Scholes option pricing model under the fair value method as prescribed bySFAS No. 123. The assumptions used for the years ended December 31,2005, 2004 and 2003 are as follows:

| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk-free interest rates |       | 4.35                  | %          | 3.55 | % | 4.75 | % |
| Expected lives           |       | 5  years              |       | 5  years |   | 5  years |   |
| Expected volatility      |       | 129                   | %          | 106 | % | 164 | % |
| Dividend  yield          |       | 0                     | %          | 0 | % | 0 | % |

 

**Private Placement**

On March 31, 2004,the Company completed a private placement of investment units (each unitconsisting of one share of common stock and a 3-year warrant to purchasean 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 theassociated warrants are exercisable at $3.05. Additionally, the placement agentfor the offering received 5 year warrants to purchase 142,662 shares of commonstock at an exercise price of $3.20 per share.  The value of the warrants granted to theplacement agent is approximately $351,000, and was accounted for as a non cashfinancing activity.

**Warrants**

On September 23, 1999, the Chief ExecutiveOfficer of the Company, Irwin J. Gruverman, was granted warrants to purchase upto 100,000 shares of the Company’s common stock at a price of $0.52 per share,having an expiration date of July 2, 2004. The warrants were exercised on November 25,2003.

On November 17, 2004,the Company entered into a twelve month general financial and advisory servicesagreement with Maxim Group LLC (Maxim) pursuant to which Maxim was granted on April 1,2005 a three (3) year warrant to Purchase 100,000 shares of the Company’scommon stock at an exercise price of $3.20 per share. The Company expects tofile a registration statement for purposes of registering the shares of commonstock underlying the warrants by April 15, 2006. The estimated value ofthese warrants, included in general and administrative expense, was amortizedto expense pursuant to the term of the agreement. The Company recognized$119,000 in expenses for the year ended December 31, 2005.

**Employee Stock Purchase Plan**

The Company has anemployee stock purchase plan (the Purchase Plan). Under the Purchase Plan,participants are granted options to purchase the Company’s common stock twice ayear at the lower of 85% of market value at the beginning or end of eachperiod. Calculation of the number of options granted, and subsequent purchaseof these shares, is based upon voluntary payroll deductions during eachsix-month period. The number of options granted to each employee under thisplan is limited to a maximum amount of 1,000 shares for each six-month period.The number of shares issued pursuant to this plan totaled 23,289, 26,678 and36,717, in 2005, 2004, and 2003, respectively.

F-18

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**Note 10**                   COMMITMENTS

TheCompany leases its facilities under non-cancelable operating leases expiringthrough May 2007. Future minimum rental payments under the operatingleases at December 31, 2005 are as follows:

| 2006                     |       | $       | 355,189     |       |
|--------------------------|------------|---------|-------------|------------|
| 2007                     |       | 148,376 |        |
| **Total Lease Payments** | ** ** | **$**   | **503,565** | ** ** |

 

Rent expense for 2005,2004, and 2003, was approximately $468,000, $357,000, $439,000, respectively. Aportion of the space is sublet to a non-affiliated company under atenant-at-will arrangement for a total of $21,600 per annum.

**Note 11**                   RELATEDPARTY TRANSACTIONS

As discussed in Notes 6and 12, the Company owed the former principals of Morehouse and Epworth $0,$6,250, and $81,250, at December 31, 2005, 2004, and 2003, respectively. Interestcapitalized on the $300,000 note in connection with the Settlement Agreement discussedin Note 12 amounted to $88,750 and is being amortized over 5 years. Totalpayments in 2005, 2004 and 2003 were $54, $4,757 and $12,340, respectively.

**Note 12**                   SETTLEMENTAGREEMENT, DEBT RESTRUCTURING AND REFINANCING

On December 20, 1999 the Company signed anagreement in principle (the Agreement In Principle) with J.B. Jennings and BretA. Lewis, the former owners of the Epworth Mill and Morehouse-COWLES businesses(the Sellers), Lake Shore Industries, Inc., and JLJ Properties, Inc.,entities owned and controlled by the Sellers. The Agreement In Principle setsforth understandings among the parties concerning restructuring of the Company’ssubordinated debt and resolution of various disputes. On January 17, 2000,a definitive settlement agreement incorporating these subject matters wasexecuted between the parties (the Settlement Agreement). In connection with theclosing of the Credit Facility, and pursuant to a Settlement Agreement dated January 17,2000 with the Company’s subordinated debt holders, the subordinated debt of theCompany was restructured in the following manner. The outstanding August 14,1998 $500,000 subordinated promissory note, having a remaining $475,000principal balance together with accrued interest at the Closing Date in the approximateamount of $77,500, and accrued interest on the August 14, 1998 $300,000subordinated note were converted to 500,000 shares of MFIC restricted commonstock (the Conversion Shares).

The fair market value ofthe Company’s Common Stock on the date of the Agreement In Principle was $0.31per 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 subordinated note was replaced with a new $300,000 subordinatedpromissory note dated February 28, 2000 (the 2000 Subordinated Note). The2000 Subordinated Note had a maturity date of February 28, 2005 and boreinterest at a rate of ten percent (10%) per annum. The final payment on thenote was made on January 25, 2005 for $6,304 including interest of $54.

F-19

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**Note 13**                   QUARTERLYRESULTS OF OPERATIONS

Summarizedunaudited quarterly financial data are as follows:

| ** **                                                                 | ** ** | **Fiscal 2005 Quarters** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                 | ** ** | **First**                          | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenues                                                                   |       | $                                  | 2,536,469  |   | $ | 3,163,645 |   | $ | 2,881,267 |   | $ | 3,064,100 |   |
| Gross profit                                                               |       | 1,387,540                          |       | 1,556,366 |   | 1,354,132 |   | 1,429,449 |   |
| Net (loss) from  continuing operations before income tax benefit (expense) |       | (193,066                           | )          | (36,193 | ) | (297,291 | ) | (276,986 | ) |
| Income tax benefit  (expense)                                              |       | 77,000                             |       | — |   | — |   | (262,000 | ) |
| Net (loss)                                                                 |       | (116,066                           | )          | (36,193 | ) | (297,291 | ) | (538,986 | ) |
| Basic net (loss) income  per share from continuing operations:             |       | $                                  | (0.01      | ) | $ | (0.00 | ) | $ | (0.03 | ) | ($0.06 | ) |
| Diluted net (loss) income per share from continuing  operations       |       | $                                  | (0.01      | ) | $ | (0.00 | ) | $ | (0.03 | ) | $ | (0.06 | ) |

 

| ** **                                                              | ** ** | **Fiscal 2004 Quarters** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                              | ** ** | **First**                          | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Revenues                                                                |       | $                                  | 2,251,452  |   | $ | 3,081,977 |   | $ | 3,163,785 |   | $ | 3,661,705 |   |
| Gross profit                                                            |       | 1,238,579                          |       | 1,675,974 |   | 1,813,584 |   | 1,823,027 |   |
| Net (loss) income  from continuing operations before income tax benefit |       | (55,183                            | )          | 256,495 |   | 282,050 |   | 172,390 |   |
| Income tax  benefit                                                     |       | —                             |       | — |   | — |   | 450,000 |   |
| Net (loss) income  from continuing operations                           |       | (55,183                            | )          | 256,495 |   | 282,050 |   | 622,390 |   |
| (Loss) from  discontinued operations                                    |       | (231,380                           | )          | — |   | — |   | — |   |
| Net (loss) income                                                       |       | (286,563                           | )          | 256,495 |   | 282,050 |   | 622,390 |   |
| Basic net (loss) income  per share:                                     |       |                               |       |   |   |   |   |   |   |
| Basic net (loss)  income per share from continuing operations           |       | $                                  | (.01       | ) | $ | .03 |   | $ | .03 |   | $ | .06 |   |
| Basic net (loss)  income per share from discontinued operations         |       | $                                  | (.02       | ) | $ | .00 |   | $ | .00 |   | $ | .00 |   |
| Basic, as  reported                                                     |       | $                                  | (.03       | ) | $ | .03 |   | $ | .03 |   | $ | .06 |   |
| Diluted net income  (loss) per share:                                   |       |                               |       |   |   |   |   |   |   |
| Diluted net  (loss) income per share from continuing operations         |       | $                                  | (.01       | ) | $ | .02 |   | $ | .03 |   | $ | .06 |   |
| Diluted net loss  per share from discontinued operations                |       | $                                  | (.02       | ) | $ | .00 |   | $ | .00 |   | $ | .00 |   |
| Diluted, as reported                                                    |       | $                                  | (.03       | ) | $ | .02 |   | $ | .03 |   | $ | .06 |   |

 

F-20

----

**Exhibit Index**
| 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 (filed as  Exhibit 10.62 to the Company’s Annual Report on Form 10-K for  the fiscal year ended December 31, 2004 and incorporated herein by  reference).                                                                                                                                                                                                                                                |
| 4.3              |       | Form of Warrant  issued to investors in the private placement described in the Placement  Agency Agreement (filed as Exhibit 10.62 to the Company’s Annual Report  on Form 10-K for the fiscal year ended December 31, 2004 and  incorporated herein by reference).                                                                                                                                                                                                                     |
| 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 Quarterly Report on Form 10-Q  for the fiscal quarter 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 Annual Report on 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  Annual Report on 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 Annual Report 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 Annual Report on  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 Annual Report on 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 Annual Report on 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  Annual Report on Form 10-K for the 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 Annual  Report on Form 10-K for the 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 Annual Report on  Form  10-K for the 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  Annual Report on Form 10-K for the 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 Annual Report on Form 10-K for the 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 Annual  Report on Form 10-K for the 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 10-K for the fiscal year  ended December 31, 1997, and incorporated herein by reference)                                                                            |
| 10.18 |   | 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)                                                                                                                                                                                             |
| 10.19 |   | 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).                                                                                                        |
| 10.20 |   | 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).                                                                                                                                          |

----

 
| 10.21 |   | $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).                                                                             |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.22 |   | $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).                                                                             |
| 10.23 |   | 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 the fiscal year ended December 31, 2000, and incorporated herein by  reference.)                            |
| 10.24 |   | 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 the fiscal year ended December 31,  2000, and incorporated herein by reference.)                |
| 10.25 |   | 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 the fiscal year ended December 31,  2000, and incorporated herein by reference.)                              |
| 10.26 |   | 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 the fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                  |
| 10.27 |   | 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 the fiscal year ended  December 31, 2000, and incorporated herein by reference.)            |
| 10.28 |   | 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 the fiscal year ended  December 31, 2000, and incorporated herein by reference.)                  |
| 10.29 |   | 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 the fiscal year ended December 31,  2000, and incorporated herein by reference.)                                    |
| 10.30 |   | 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 the fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                 |
| 10.31 |   | 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 the fiscal year ended  December 31, 2000 and incorporated herein by reference.)           |
| 10.32 |   | 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  the fiscal year ended December 31, 2000, and incorporated herein by  reference.) |

----

 
| 10.33 |   | 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 the fiscal year ended  December 31, 2000, and incorporated herein by reference.) |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.34 |   | 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 the fiscal year ended  December 31, 2000, and incorporated herein by reference.)                                                                                                                                                                                                                                             |
| 10.35 |   | 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 the fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                                                                          |
| 10.36 |   | 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 the fiscal year ended  December 31, 2000, and incorporated herein by reference.)                                                                                                                                                                                                                      |
| 10.37 |   | 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 the fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                                                            |
| 10.38 |   | 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 the fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                                                         |
| 10.39 |   | 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 the fiscal year ended December 31, 2000, and  incorporated herein by reference.)                                                                                                                                                                                                                                                      |
| 10.40 |   | 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 the fiscal year ended  December 31, 2000, and incorporated herein by reference.)                                                                                                                                                                                                                                      |
| 10.41 |   | 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 the fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                                                                          |
| 10.42 |   | 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 the fiscal year ended December 21, 2001, and  incorporated herein by reference.)                        |
| 10.43 |   | 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 the fiscal year  ended December 31, 2001, and incorporated herein by reference.)                                                                                                                                                                                                                                                                                        |

----

 
| 10.44 |   | 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  the fiscal year ended December 31, 2001, and incorporated herein by  reference.)                                                           |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.45 |   | 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 the fiscal year ended December 31, 2001, and incorporated herein by  reference.)             |
| 10.46 |   | 1986 Employee Stock  Purchase Plan as Amended (Filed as Exhibit 10.51 to the Company’s Annual  Report on Form 10-K for the fiscal year ended December 31,  2001, and incorporated herein by reference.)                                                                                                |
| 10.47 |   | 1988 Stock Plan as  Amended. (Filed as Exhibit 10.52 to the Company’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2001, and  incorporated herein by reference.)                                                                                                                 |
| 10.48 |   | 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  the fiscal year ended December 31, 2002, and incorporated herein by reference)                                                             |
| 10.49 |   | 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 the fiscal year ended  December 31, 2002, and incorporated herein by reference)             |
| 10.50 |   | Fourth Amendment and  Waiver to Revolving Credit and Term Loan Agreement between the Company and  PNC Bank, N.A. dated February 6, 2004 (filed as Exhibit 10.54 to  the Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2003, and incorporated herein by reference). |
| 10.51 |   | 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).                                                                    |
| 10.52 |   | 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 10.56 to the Company’s Annual  Report on Form 10-K for the fiscal year ended December 31,  2003, and incorporated herein by reference).                             |
| 10.53 |   | Letter dated  December 31, 2003 from MFIC Corporation to Irwin Gruverman (Filed as  Exhibit 10.57 to the Company’s Annual Report on Form 10-K for  the fiscal year ended December 31, 2003, and incorporated herein by  reference).                                                               |
| 10.54 |   | Secured Term Note in the  amount of $1,000,000 in favor of Banknorth, N.A. dated March 3, 2004  (Filed as Exhibit 10.58 to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2003, and incorporated herein by  reference).                                         |
| 10.55 |   | Loan and Security  Agreement between Banknorth, N.A. and the Company dated March 3, 2004  (Filed as Exhibit 10.59 to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2003, and incorporated herein by  reference).                                               |
| 10.56 |   | Trademark Security  Agreement of the Company in favor of Banknorth, N.A., dated March 3,  2004 (Filed as Exhibit 10.60 to the Company’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2003, and  incorporated herein by reference).                                          |
| 10.57 |   | Patent Security  Agreement of the Company in favor of Banknorth, N.A., dated March 3,  2004 (Filed as Exhibit 10.61 to the Company’s Annual Report on  Form 10-K for the fiscal year ended December 31, 2003, and  incorporated herein by reference).                                             |

----

 
| 10.58  |   | Placement Agency  Agreement between the Company and Casimir Capital L.P. dated  February 13, 2004 (Filed as Exhibit 10.62 to the Company’s Annual  Report on Form 10-K for the fiscal year ended December 31,  2003, and incorporated herein by reference).                                                                            |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.59  |   | First Amendment to  Placement Agency Agreement between the Company and Casimir Capital L.P. dated  March 12, 2004 (Filed as Exhibit 10.63 to the Company’s Annual  Report on Form 10-K for the fiscal year ended December 31,  2004, and incorporated herein by reference).                                                            |
| 10.60  |   | Registration Rights  Agreement between the Company and Purchasers dated March 16, 2004 (Filed  as Exhibit 10.64 to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2003, and incorporated herein by  reference).                                                                                      |
| 10.61  |   | Lease between ABB and  MFIC Corporation dated April 1, 2004 for space at Lampertheim, Germany  (filed as Exhibit 10.65 to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2004 and incorporated herein by reference).                                                                                 |
| 10.62  |   | Letter Agreement between  Maxim Group LLC and MFIC Corporation dated November 17, 2004 to provide  general financial advisory and investment banking services to the Company  (filed as Exhibit 10.66 to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2004 and incorporated herein by  reference). |
| *10.63 |   | Research Collaboration  Agreement between University of Massachusetts, Lowell and MFIC Corporation,  dated September 21, 2005.                                                                                                                                                                                                                             |
| *10.64 |   | Warrant issued to Maxim  Group LLC dated April 1, 2005                                                                                                                                                                                                                                                                                                     |
| *14.   |   | Code of Ethics, as  adopted by the Company.                                                                                                                                                                                                                                                                                                                     |
| 21.    |   | Subsidiary of the  Company, Microfluidics Corporation, a Delaware corporation                                                                                                                                                                                                                                                                                   |
| *23(a) |   | Consent of  Brown & Brown, LLP                                                                                                                                                                                                                                                                                                                         |
| *31.1  |   | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2003.                                                                                                                                                                                                                                                      |
| *31.2  |   | Certification of Chief  Financial Officer 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 contractsor compensatory plan or arrangement required to be filed as an exhibit to this Form 10-Kpursuant to Item 15 (b) of this report.

----

**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized, in the city of Newton,Commonwealth of Massachusetts, on the 30th day of March 2006.

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

 

Pursuantto the requirements of the Securities and Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.
|                        | **Signature** | ** **                                    | ** ** |                     | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|------------------------|---------------|-----------------------------------------------|------------|---------------------|-----------|------------|------------|--|----------|------------|
|                   |          |                                          |       |                |
| /s/ IRWIN J. GRUVERMAN |          | Chief Executive Officer                       |       | March 30, 2006 |
| Irwin  J. Gruverman    |          | (Principal Executive Officer),  Chairman of   |       |                |
|                   |          | the Board of Directors  and Secretary         |       |                |
|                   |          |                                          |       |                |
|                   |          |                                          |       |                |
| /s/ DENNIS P. RIORDAN  |          | Controller                                    |       | March 30, 2006 |
| Dennis  P. Riordan     |          | (Principal Financial and  Accounting Officer) |       |                |
|                   |          |                                          |       |                |
|                   |          |                                          |       |                |
| /s/ JAMES N. LITTLE    |          | Director                                      |       | March 30, 2006 |
| James  N. Little       |          |                                          |       |                |
|                   |          |                                          |       |                |
|                   |          |                                          |       |                |
| /s/ VINCENT CORTINA    |          | Director                                      |       | March 30, 2006 |
| Vincent  Cortina       |          |                                          |       |                |
|                   |          |                                          |       |                |
|                   |          |                                          |       |                |
| /s/ LEO PIERRE ROY     |          | Director                                      |       | March 30, 2006 |
| Leo  Pierre Roy        |          |                                          |       |                |
|                   |          |                                          |       |                |
|                   |          |                                          |       |                |
| /s/ GEORGE UVEGES      |          | Director                                      |       | March 30, 2006 |
| George  Uveges         |          |                                          |       |                |
|                   |          |                                          |       |                |
|                   |          |                                          |       |                |
| /s/ ERIC G. WALTERS    |          | Director                                      |       | March 30, 2006 |
| Eric G. Walters        |          |                                          |       |                |

 

 

----

**SCHEDULE II**

**MFIC CORPORATION**

**Valuationand Qualifying Accounts and ReservesFor the years ended December 31, 2005, 2004, and 2003**

| ** **                                                          | ** ** | **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, 2005                          |       | $                                              | 13,203     |                                                         |       | $                                    | 30,015     |                                     |       |   | $ | 43 |   |   | $ | 43,175 |   |
| For the year  ended December 31, 2004                          |       | 58,500                                         |       |                                                         | 25,447     |                                 |       |                                     | 70,744     |   |   | 13.203 |   |
| For the year  ended December 31, 2003                          |       | 33,500                                         |       |                                                         | 25,000     |                                 |       |                                     | —     |   |   | 58,500 |   |
| INVENTORY RESERVE                                                   |       |                                           |       |                                                         |       |                                 |       |                                     |       |   |   |   |   |
| For the year  ended December 31, 2005                          |       | $                                              | 163,000    |                                                         |       | $                                    | 80,000     |                                     |       |   | $ | 58,000 |   |   | $ | 185,000 |   |
| For the year  ended December 31, 2004                          |       | 110,000                                        |       |                                                         | 98,000     |                                 |       |                                     | 45,000     |   |   | 163,000 |   |
| For the year  ended December 31, 2003                          |       | 50,000                                         |       |                                                         | 60,000     |                                 |       |                                     | —     |   |   | 110,000 |   |
| ACCUMULATED  AMORTIZATION RELATED TO GOODWILL AND OTHER INTANGIBLES |       |                                           |       |                                                         |       |                                 |       |                                     |       |   |   |   |   |
| For the year  ended December 31, 2005                          |       | $                                              | 0          |                                                         |       | $                                    | —     |                                     |       |   | $ | — |   |   | $ | 0 |   |
| For the year  ended December 31, 2004                          |       | 6,918,244                                      |       |                                                         | —     |                                 |       |                                     | 6,918,244  |   |   | — |   |
| For the year  ended December 31, 2003                          |       | 4,814,444                                      |       |                                                         | 2,103,800  |                                 |       |                                     | —     |   |   | 6,918,244 |   |
| WARRANTY RESERVE                                                    |       |                                           |       |                                                         |       |                                 |       |                                     |       |   |   |   |   |
| For the year ended  December 31, 2005                          |       | $                                              | 0          |                                                         |       | $                                    | 91,511     |                                     |       |   | $ | 33,511 |   |   | $ | 58,000 |   |
| For the year ended  December 31, 2004                          |       | $                                              | 0          |                                                         |       | $                                    | 52,194     |                                     |       |   | $ | 52,194 |   |   | $ | 0 |   |
| For the year ended  December 31, 2003                          |       | $                                              | 0          |                                                         |       | $                                    | 48,415     |                                     |       |   | $ | 48,415 |   |   | $ | 0 |   |

 

S-1

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