** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-K**

 

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**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For thefiscal year ended December 31, 2004**

 

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**CommissionFile Number: 0-11625**

 

**MFIC CORPORATION**

(Exact name of registrant asspecified in its charter)

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

 

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

 

Securities registered pursuantto Section 12(b) of the Act:   **None**

 

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

 

Indicate by check mark whether the registrant; (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes ý  No  o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.   o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act)   Yes o  No  ý

 

The aggregate market value of Common Stock held by non-affiliates ofthe registrant (without admitting that any person whose shares are not includedin determining such value is an affiliate), based upon the closing sale priceof the Common Stock on June 30, 2004 and on March 11, 2005 respectivelyas reported on the NASDAQ Over-the-Counter Bulletin Board was approximately$14,034,000 and $20,294,000.

 

The number of shares outstanding of the registrant’s Common Stock as ofMarch 11, 2005 was 9,677,834 shares.

 

 

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**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.**

 

**MFICCorporation**

**2004 Form 10-KAnnual Report**

**Table ofContents**

 
| **PART I**   | ** **                                                                                  |
|-------------------|---------------------------------------------------------------------------------------------|
| Item 1.           | Business                                                                                    |   |
| Item 2.           | Description of Properties                                                                   |   |
| Item 3.           | Legal Proceedings                                                                           |   |
| Item 4.           | Submission of Matters to a Vote of Security Holders                                         |   |
|              |                                                                                        |   |
| **PART II**  | ** **                                                                                  |
|              |                                                                                        |   |
| Item 5.           | Market for Registrant’s Common Equity and Related Stockholder Matters                  |   |
| Item 6.           | Selected Financial Data                                                                     |   |
| Item 7.           | Management’s Discussion and Analysis of Financial Condition and  Results of Operations |   |
| Item 7A.          | Quantitative and Qualitative Disclosures  about Market Risk                                 |   |
| Item 8.           | Financial Statements and Supplementary Data                                                 |   |
| Item 9.           | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure       |   |
| Item 9A.          | Controls and Procedures                                                                     |   |
|              |                                                                                        |   |
| **PART III** | ** **                                                                                  |
|              |                                                                                        |   |
| Item 13.          | Certain Relationships and Related  Transactions                                             |   |
| Item 14.          | Independent Accountant Fees for Fiscal 2004  and Fiscal 2003                                |   |
| Item 15.          | Exhibits, Financial Statements Schedules  and Reports on Form 8-K                      |   |
|              |                                                                                        |   |
| Signatures        |                                                                                        |   |
|              |                                                                                        |   |
| Certifications    |                                                                                        |   |

 

This Reportcontains “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties,including without limitation those discussed in 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®is a 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 20 years, specializedin manufacturing and marketing a broad line of high shear fluid processingsystems used in numerous applications in the chemical, pharmaceutical, biotech,food and cosmetics industries.  

 

MFIC’s line of high shear fluid processor equipment, marketed under theCompany’s Microfluidizer trade name, are capable of creating nanoparticles(commonly defined as particles having dimensions in the 10-1000 nanometerrange) including nanostructures, microemulsions, and nanosuspensions.  The equipment’s ability to produce commercialquantities of such materials has been important to producers ofpharmaceuticals, coatings and other products.

 

Additionally, the Company is commercializing its proprietary equipment,processes and technology for the continuous creation of nanoparticles.  The Company has announced and undertakencommercialization efforts for its patented MicrofluidizerMixer/Reactor(MMR), which is a high pressure multiple stream mixer/reactor.

 

The Company’s Microfluidizer high shear fluid processing technology isused for formulation of products that are normally very difficult to mix.Microfluidizer processor technology allows manufacturers in the chemical,pharmaceutical, cosmetic, and food processing industries to produce higherquality products with better characteristics on a more consistent basis thanwith other blending, mixing, or homogenizing techniques. Additionally, theequipment is used for cell disruption to harvest the cultivated contents ofbacterial, yeast, mammalian and/or plant cells and for liposomal encapsulationof materials for the cosmetics and biotech/biopharma industries.

 

The Company’s management believes that future commercialization andgrowth of nanotechnology may be, in large part, enabled by the manufacturingcapability of the Company’s materials processor and MMR equipment. Further, theCompany guarantees scaleup of formulations and results on its equipment from100 milliliters per minute on its laboratory and benchtop models to gallons perminute on its pilot and production models.

 

The Company was incorporated in Delaware in 1983. The Company, formerlynamed Biotechnology Development Corporation, changed its name effective June 8,1993 to Microfluidics International Corporation, and again changed its nameeffective July 12, 1999 to MFIC Corporation.  Until its sale on February 9, 2004, theCompany also operated another division, known as the Morehouse-COWLES Division,which manufactured and sold a broad line of mechanical fluid materialsprocessing systems used for a variety of dispersing, milling, and blendingapplications across a variety of industries. The Morehouse-COWLES Division manufactured and distributed high sheardispersers, dissolvers, colloid mills, horizontal media mills, vertical mediamills, and sold grinding media for such equipment.  The Company’s principal executive offices arelocated at 30 Ossipee Road, in Newton, Massachusetts, 02464-9101 and itstelephone number is (617) 969-5452.

 

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The Technologies:

 

Materials Processor 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 microemulsions.  See “Patents and Proprietary RightsProtection.”

 

Microfluidizer high shear fluid processors differ from conventionalmechanical mixing and processing technologies in that they utilize highlypressurized product streams that travel at high velocities in precisely definedmicrochannels producing high shear forces and then collide at ultra-highvelocities in a small, confined space producing high forces of impact. Thereare no moving parts in this mixing and collision zone (“fixed geometry”).  Combined forces of shear and impact which, inthe fixed geometry design, act upon products to consistently create through deagglomeration and particle sizereductionresulting in what the Company believes are smaller, more uniform, highly stable,and reproducible dispersions and emulsions than can be produced by any othermeans. Microfluidizerprocessors also differ from conventional mixing and homogenization equipment inthat Microfluidizer processors permit a linear scaleup from 100 milliliters perminute to gallons per minute with no change in product formulation or equipmentdesign and engineering. The formulations processed may be liquid/liquid orliquid/solid formulations.

 

MMR.  The Company has introduced its patented MicrofluidizerMixer-Reactor (MMR) system as a continuous chemical reactor, which the Companybelieves may become a standard device for conducting chemical reactions, manyof which can be configured to produce nanoparticles. This system producesuniform nanoparticles with phase purity previously unachievable withconventional batch reaction technology. This degree of reaction chemistrycontrol can lead to cost-effective product improvements and the development andmanufacture of new nanomaterials in scalable quantities.

 

#### Commercial Applications: 

 

Microfluidizer processor technology allows manufacturers in thechemical, pharmaceutical, biotechnology, cosmetic, and food processingindustries to produce higher quality products with better characteristics on amore consistent basis than with other blending, mixing, or homogenizingtechniques. Further, the proprietary equipment enables manufacture of uniqueproducts which cannot otherwise be produced. Microfluidizer processor equipment is generally used in the processingof high value-added end-products that require extremely small and uniform particle sizes.

 

Microfluidizer processor equipment can be used to mix and formulatestable emulsions, dispersions and liposomes, and for cell disruption.

 

Emulsions are homogenous mixtures of oil and water components (or othernormally immiscible components), which, if mixed properly, do not readilyseparate.  Emulsions comprise manyproducts, such as food additives, medicines (including injectable drugs),photographic films, and polymers.  TheCompany believes that, generally, an emulsion processed with Microfluidizerprocessor equipment will exhibit improved stability and require reduced

 

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concentrations of costly emulsifying agents that areotherwise needed to enhance product stability.

 

Dispersions are mixtures of fine solids suspended in liquid so that thetwo do not separate readily after processing. Similar to emulsions, dispersions are used in a variety of consumer andindustrial products, including solids for medicines (including injectabledrugs), coatings, pigmented dyes for inkjet inks, phosphorescent coatings forTV screens and fluorescent lamps, barium titanate for capacitors and toners.

 

Liposomes are biodegradable cell-like structures, formed from materialssuch as cholesterol and lecithin, which can be used to encapsulate medicationsor nutrients.  Pharmaceutical andcosmetic manufacturers use liposomes as a delivery system to target activeingredients for specific anatomical sites and to prolong their efficacy.  To date, liposomes have been usedcommercially in two predominant applications: medical diagnostic agents andcosmetics.  Applications include theencapsulation of dye to be used as a marker in medical diagnostic tests and theencapsulation of ingredients for deeper skin penetration, or time-releasecontrol, as well as pharmaceutical, food and specialized agriculturalapplications.

 

In the biotechnology industry, Microfluidizer processor equipment iscurrently used to harvest, by cell rupture, the contents of bacteria, plant or mammaliancells.  The controlled forces of shearand impact produced by Microfluidizer processor equipment allows theencapsulating cell wall to be ruptured without damage to, or contamination of,the cell contents. The Microfluidizer processor equipment eliminates grindingmedia contamination, thus minimizing downstream processing requirements.

 

Microfluidizer processor equipment is generally used in commercialapplications where a scientist, formulator or chemist is trying to develop or improvea product formulation for an expensive, high value-added end product.Microfluidizer processor equipment is initially employed in a researchlaboratory, with the equipment subsequently being used in scaleup to pilotscale production of new or improved products, and ultimately, for fullproduction scale volumes as the improved product comes to market. Fromlaboratory to production the Company guarantees scaleup of formulations andresults on its equipment from 100 milliliters per minute on its laboratory andbenchtop models to gallons per minute on its production models.

 

The Company currentlymanufactures and markets the following lines of equipment:

 

The HC Series: The HC Series, also known as “Homogenizers,” is a laboratory-scaleseries of equipment that is intended to impart moderate levels of energy into acustomer’s product with greater flow rates than the more energy intensiveMicrofluidizer processor devices. Operating pressures of products in theCompany’s HC Series can range from 250 psi to as high as8,000 psi, and will process as much as two liters of fluid per minute.

 

The M-110 Series: The M-110 Series, is a laboratory product line that operates withavailable laboratory air and is designed primarily for research and developmentapplications. Standard models can generate pressures as high as 23,000 psi and havea 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 450ml/min.  It has numerous standardfeatures and options including explosion-proof motors and steam sterilization.

 

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The M-140 Series: The M-140K Series is a laboratory-scaleunit developed for customers in the chemical, biotechnology, pharmaceutical,cosmetic and food processing industries that require elevated operatingpressures and higher shear forces to achieve 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-140K has flow rates up to 500 ml/min.

 

The M-210 Series: The M-210 Series is a pilot unitand is primarily marketed to pharmaceutical, cosmetic and food productmanufacturers who have created a successful new or improved formulation on theM-110 Series unit and would like to increase their productioncapacity.  The M-210 Series unit is typicallyused for testing formulations at greater volume levels before initiatingfull-scale production. For some customers (such as biotechnology andpharmaceutical product manufacturers), the M-210 Series may have thecapacity to function as a production unit.

 

The M-700 Series: The M-700 Series was introduced at the end of fiscal 1998 and wasinitially designed, engineered, and constructed for use in “rugged” industrialenvironments such as coatings, paints and pigments research and manufacturing.This product line was especially designed to withstand such hazards as dust,grease, and water spray.  Through use of ourown proprietary design of an intensifier pump and other components, the systemhas also proven to be more cost-effective in many user applications.

 

More recently, because ofthe market demands of the pharmaceutical, biotech and cosmetic industries, theM-700 product line was upgraded to all stainless steel construction to conformto the U.S. Food and Drug Administration’s current Good Manufacturing Practices(cGMP) requirements. (See discussion under heading “Government Regulations”.)  It also offers steam in place (SIP) and cleanin place (CIP) options.

 

The M-700 Series equipmentis available in a variety of configurations and flow rates depending upon motorsize and the number of intensifier pumps. On the low end of the spectrum is the 15 HP, single intensifier pump M-7115machine with flow rates ranging from 0.9 gpm at 10,000 psi to 0.4 gpm at 30,000psi.  The next size up is the 25 HP,single intensifier pump, M-7125 machine with flow rates ranging from 2.3 gpm at10,000 psi to 0.6 gpm at 30,000 psi. Until September 30, 2003, the largest offering of the M-700 seriesproduct line was the 50 HP, dual intensifier pump M-7250 machine with flowrates ranging from 4.5 gpm at 10,000 psi to 1.2 gpm at 30,000 psi.

 

On September 30,2003, Microfluidics introduced a new addition to the M-700 series product line,the 100 HP, dual intensifier pump, Model M-710 machine with flow rates rangingfrom 16 gpm at 5,000 psi to 3.0 gpm at 30,000 psi. This model has theequivalent throughput of the larger and more expensive M-610-100 HP model.

 

All M-700 series machinesare offered with the capability of operating at 40,000 psi. Additionally,during 2003 the Company introduced several new options and equipment featuresto the M-700 series product offerings including:

 

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(i)         TheM-700 Microfluidizer Containment System, which is utilized for the protectionof personnel engaged in the processing of highly toxic cancer therapeutic drugsand other hazardous materials.

 

(ii)        TheM-700 Microfluidizer 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. Two such systems have beenrecently delivered to a pharmaceutical manufacturer.

 

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

 

The M-610 Series: The M-610 Series consists of custom-built models used forlarge-scale production.  These units haveflow rates of up to 18 gallons per minute and generate operating pressures upto 40,000 psi. Generally, these models are available in 100 HP and 200 HP.

 

MicrofluidizerMixer/Reactor (MMR):The Company has introduced its patented Microfluidizer Mixer/Reactor (MMR)system as a continuous chemical reactor, which the Company believes may becomea standard device for conducting chemical reactions, many of which can beconfigured to produce nanoparticles. This system produces uniform nanoparticleswith phase purity previously unachievable with conventional batch reactiontechnology. This degree of reaction chemistry control can lead tocost-effective product improvements and the development and manufacture of newnanomaterials in scalable quantities. Applications for the new technologyinclude improving the performance of catalysts, planarization polishing media,superconductors, abrasive silica, recording media, photographic media andpigments. It also may be used in the development and production of uniquepharmaceutical products. The Company is proceeding with projects involvingother companies seeking to optimize or enable drug delivery, catalysts andcoatings products, as well as an internal program on nanopolymer creation fordrug delivery and other applications. The Company anticipates either receipt ofan order or making delivery of its first MMR laboratory development systems (inthe $200,000-$250,000 sales price range) in the latter part of 2005, with thesale of production systems (in the $750,000 - $1,500,000 sales price range)anticipated in 2006. The Company believes that the MMR systems and technologymake it a leader in the provision of systems for continuous production ofuniform, reproducible, microparticles, nanoparticles and nanodroplets.

 

Former Company Business Divisions:

 

Morehouse-COWLES Division: On February 9, 2004, pursuant to an Asset Purchase Agreement (theAsset Purchase Agreement) dated February 5, 2004 between MFIC and a whollyowned subsidiary of NuSil Corporation, a California corporation (NuSil), MFICsold substantially all of the assets and selected liabilities of itsMorehouse-COWLES Division (the

 

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Division), to NuSil. Other than NuSil’s prior purchases of products from the Division, therewere no preexisting relationships between MFIC and NuSil.

 

Prior to February 9, 2004, the Company-operated Morehouse-COWLESDivision manufactured grinding and dispersing equipment used in a broad numberof industries including the coatings and ink industries. The products includedhigh-speed single and multi-shaft dissolvers and dispersers, stone mills, andvertical and horizontal media mills. As one of the early inventors ofdispersers, dissolvers, stone mills, and media mills, the one hundred-year-oldCOWLES name is an industry-accepted symbol of quality, reliable products. TheMorehouse-COWLES Division manufactures products that are generally used forblending, mixing, deagglomeration and dispersion of paints and coatings, inks,adhesives, sealants, and pigment dispersions. These applications are moreconventional whereby the formulations are less expensive to produce and thevolumes of product produced are large. The Morehouse-COWLES product lines are used in broader, high volume,lower value-added applications requiring less stringent particle sizereduction.

 

Epworth Mill Division:  Prior to October 1,2000, the Company’s Epworth Mill Division products consisted of ball mills andhorizontal media mills. The division was also engaged in the sale anddistribution of grinding media.  Ballmills are used in coarse grinding application of liquid slurries such as orefrom mines or coarse slurries of material that will later be processed into finerslurries.  Ball mills use large media ina horizontal rotating cylindrical vessel to crush and grind the product beingprocessed. The patented Zinger® horizontal media mill utilizes aunique design for grinding and dispersing solid materials in a liquid carryingmedium.  The design is based uponestablished rotating, horizontal shaft technology but adds the uniquecapability of enhanced mechanical activity between the grinding media and theproduct formulation.  The enhancedmechanical activity is achieved through a unique combination of speciallydesigned rotors and containment vessels. In comparison to traditional horizontal media mills, the Zinger mediamill technology has demonstrated significantly improved productivity in termsof greater volumes of product processed at acceptable quality than thecomparably sized and priced horizontal media mills. On July 24, 2000, theCompany announced that it would transfer the manufacturing and sale of itsZinger® horizontal media mills from its Michigan-based Epworth MillDivision to the Morehouse-COWLES Division plant in Fullerton, California. Thetransfer began on October 1, 2000, and was completed in the fourth quarterof fiscal 2000.

 

On September 30, 2000, the Company ceased operations of the BallMill repair business and decided to sell its Ball Mill operation conducted atthe Epworth Mill Division through a broker. On April 13, 2001 the Company concluded the sale of the assets ofthe division’s operation for $200,000 in cash and a promissory note, which resultedin a loss on the sale of these assets of approximately $53,000.

 

#### Marketing and Sales:

 

The Company’s marketing and sales activities are conducted through acorporate marketing and sales group that is responsible for the worldwidemarketing and sales of all products.

 

Marketing programs include media advertising, a website, direct mail,seminars, trade shows and telemarketing. In addition, the Company has an activeprogram of field demonstrations, as well as demonstrations to potential usersin the Company’s laboratories

 

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located in Newton, Massachusetts, Irvine, California,and Lampertheim, Germany.  Distributorsand sales agents worldwide are supported with trade advertising, collateralliterature and trade show materials.  Thedistributors and sales agents also advertise directly on their own behalf andattend regional and international trade shows. As an aid to the marketing and sales activity for the equipment, theCompany provides prospective customers with access to its applicationslaboratories. These laboratories provide free processing and particle sizeand distribution 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.

 

The Company sells its equipment in the United States through a networkof independent manufacturer’s representative firms that are managed by theCompany’s regional sales managers. In Canada, the Company has an exclusivedistributor for the Company’s product line. In Europe, the Company sells itsequipment through a network of independent regional sales agents who aremanaged by the Company’s European Sales organization.  In Asia and the Pacific Rim, the Companysells through a network of distributors and independent manufacturer’srepresentative firms. Customers in other geographical regions are assisteddirectly by Company sales staff.

 

Customers:  

 

The users of the Company’s systems are in various industries, includingthe chemical, pharmaceuticals, food, cosmetic and biotechnology industries.Mizuho Industrial Co. Ltd. (Mizuho) and a wholly owned subsidiary of Teva Pharmaceuticals Industries Ltd.(Teva) accounted for 20% and 13% of the Company’s revenues from continuingoperations in 2004, respectively; 21% and 11%, respectively, in 2003; and 16%and 18%, respectively, in 2002.  Mizuho, theCompany’s Japanese distributor of Microfluidizer processor equipment and spareparts, resells the Company’s equipment to numerous end-users in Japan, none ofwhich individually represents 10% or more of the Company’s revenues.  Three customers accounted for 15%, 15%, and13% of the trade accounts receivable from continuing operations as of December 31,2004, respectively.  Two customersaccounted for 17% and 10% of the trade accounts receivable from continuingoperations as of December 31, 2003, respectively, and one customeraccounted for 13% of the trade accounts receivable as of December 31,2002.  A reduction or delay in ordersfrom any of the Company’s significant customers could have a material adverseeffect on the Company’s results of operations. 

 

#### Competition:

 

The patented Microfluidizer processor equipment product line of highshear fluid processors has direct competition in its major markets, includingpharmaceutical and coatings/chemical applications, but management believes thatthe Company’s products have larger installed bases and competitive performanceadvantages over products of our competitors. The Company believes that the Microfluidizer processor equipment productline offers the highest shear forces available in the process equipment markettoday. It has been proven in many instances that for critical formulations Microfluidizerprocessors produce better quality products for our customers.

 

The M-700 Series of fluid processors, together with the M-210 andM-610 product lines, provide high shear fluid processing capabilities forsanitary, sterile, and industrial applications. The Company believes that the Microfluidizer processor product lineprovides a distinct

 

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advantage over the product lines of our competitorswith respect to the processing of abrasive slurries or solids dispersed inliquids in large part because of the Company’s unique, wear-resistant, diamondinteraction chamber and the special design of the intensifier pumpingsystem.  Further, recent incorporation ofMFIC-developed components has reduced the cost of these units, and they arepriced competitively with lesser capability processing equipment.

 

The MMR systems may encounter significant competition and there areother companies that possess patents and claims to equipment or processes thatclaim to make production quantities of nanoparticles. At least one of thesecompanies, Five Star Technologies Inc. (Five Star), has raised significantinvestment capital from venture capital sources ($4.5 million in its secondround in October 2003) for its patented technology. Five Star claims theuse of hydrodynamic cavitation to achieve production of nano and micromaterials. Five Star also claims that its process is inherently scalable.Although the Company believes that its MMR system is superior in design and functionthere can be no assurance that Five Star, or others, will not pose acompetitive impediment to sales of the Company’s MMR system.

 

The Company faces, and will continue to face, intense competition fromother companies who manufacture and sell materials processing systems. TheCompany is subject to significant competition from organizations that arepursuing technologies and products that are similar to the Company’s technologyand products. The Company’s future success will depend in large part on itsmaintaining its current technologically superior product line and competitiveposition in the fluid processing systems field. 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.  Products offered by the Company could be madeobsolete by less expensive or more effective technologies.  There can be no assurance that the Companywill be able to make the enhancements to its technology necessary to competesuccessfully with newly emerging technologies. The Company expects competition to intensify in the materials processingsystems field as technical advances are made and become more widely known.

 

Research andDevelopment:

 

The Company’s research and development efforts are focused on: (i) developingnew processing applications for the process industries; (ii) furtherenhancements to the functionality, reliability and performance of existing products,and (iii) development of the Microfluidizer 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 variety ofnanomaterials. There can be no assurance that the Company will be able to meetthe enhancement challenges posed by applications of its core Microfluidizerprocessor business. Likewise there can be no assurance that the Company will beable to design and manufacture reaction chambers for its MMR applications thatwill deliver the desired result for specific applications. Research anddevelopment costs for continuing operations were $1,033,978, $785,849, and $583,683in 2004, 2003, and 2002, 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.

 

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CooperativeResearch Arrangements:

 

The Company subsidizes research and development activities centeredaround Microfluidizer processor technology at a number of research centers anduniversities.  The Company’s subsidy ofthese activities takes the form of substantial reduction or elimination of thecustomary rental charges for Microfluidizer processor equipment provided foruse. The Company has, in past years, subsidized research and development in thefollowing 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 their research activities, theseuniversities provide the Company with contacts at industrial companies that mayutilize Microfluidizer processor technology. Additionally, on occasion, research reports, technical papers, anddoctoral theses may be published, which document the use of Microfluidizerprocessor technology. Finally, the Company engages in many informalco-operative development efforts with its customers.

 

Patents and Proprietary Rights Protection:

 

To protect its proprietary rights, the Company relies on a combinationof U.S. patent and trademark laws, trade secrets, confidentiality agreements,contractual provisions and technical means. In the event of patent infringementor breach of confidentiality, there can be no assurance that these measureswill be adequate or that the Company will have sufficient resources toprosecute or prevail in an action against a third party.  In addition, the Company has not soughtpatent or trademark protection for its Microfluidizer processor equipment’sinteraction chamber in any country other than the United States and, as such,its proprietary rights are not subject to the protection of patent or trademarklaws of foreign countries where the Company’s equipment is sold. The Company’sMicrofluidizer processor equipment method patent expires on March 13, 2007and its device patent expired on August 6, 2002.  The Company does not believe that theexpiration of its device patent will result in any material detriment to theCompany since the Company has made many alterations, improvements and advancesto its equipment over the years with such modification and innovations havingbeen treated by the Company as trade secrets.

 

In 1997 the Company completed development of a novel adaptation of itsMicrofluidizer processor equipment – 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 Cooperation Treaty(PCT) application on May 5, 1998. In July and November, 2000, theUSPTO issued to the Company notices of allowances of utility

 

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patent claims regarding the MMR and the use thereof.On September 18, 2002, the European Patent Office advised the Company itwould grant its MMR patent substantially as applied for, including its deviceand process claims.  The Company is inthe process of pursuing national entry in France, Germany, Italy, TheNetherlands, and the United Kingdom.  TheCompany is currently prosecuting its MMR patent in Canada.

 

The Companymaintains confidentiality 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 thatenforcement of the provisions of such agreements should adequately protect theCompany’s proprietary information. However, in the event of a material breach of such agreements certain ofthe Company’s valuable intellectual property may be disclosed to third parties(including competitors). In such event, despite provisions for equitable reliefand damages, in the event of any such breach the Company may suffercompetitively and be materially impacted negatively as a result of any unauthorizeddisclosure.

 

Manufacturing:

 

At present, the Company subcontracts the manufacture and/or machiningand finishing of many of the components of its equipment to third parties, withthe Company undertaking the remaining fabrication, assembly and performancetesting.  The Company has selectedcertain primary suppliers based upon pricing terms, quality of their products,and the vendor’s performance record.

 

The loss of any primary supplier could have a material, adverse effecton the Company’s business, financial condition, or results of operations.  Therefore, the Company has identifiedalternative suppliers for its most critical components of its equipment(Alternative Sources). There can be no assurance that a transition to suchAlternative Sources will not entail transitional delays, quality assurance andquality control difficulties, on time delivery problems, any or all of whichwould likely have an impact on the Company’s production of equipment and mayhave a material adverse effect on the Company’s business, financial condition,or results of operations.

 

Key Management /Personnel:

 

The Company’s continued operation, innovation and growth are to somesignificant degree reliant on the continued services of its key executiveofficers and leading technical personnel. The Company does not maintainemployment contracts with its key management or leading technical personnel.Though the Company believes that it can identify and recruit replacement keymanagement and technical personnel, there can be no assurance as to suchavailability, the length of time required to obtain such replacement managementand technical personnel, the salary level that may have to be paid to obtaintheir respective services, or the impact on operations that may be experiencedthrough the interim absence of such key management and technicalpersonnel.  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.

 

12

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GovernmentRegulation:

 

Certain of the Company’s customers utilize the Company’s products inprocesses and production that are subject to governmental regulation. Forexample, the manufacturing and marketing of pharmaceutical products may requirethe approval of the U.S. Food and Drug Administration (FDA) within the UnitedStates and of comparable agencies 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 process of seeking and obtaining FDAapproval of a new product often takes a number of years and often involves theexpenditure of substantial resources by the Company’s customers.  The FDA approval process can result in longlead times that are attendant to manufacturing equipment orders for theseapplications.

 

Further, in addition to product approvals, the FDA imposes requirementsas to manufacturing practices, record keeping and reporting (current GoodManufacturing Practices or cGMP). cGMP-regulated companies are subject toinspections by the FDA (inclusive of Microfluidizer processor equipment) andproduct approvals may be withdrawn if cGMP are not met.

 

At present, the Company’s customers include companies who are makingFDA approved drugs, preparations, and products (example: x-ray film) forexternal use and companies who utilize Microfluidizer processor equipment forthe formulation or production of FDA approved parenteral (injectable) drugs orcompounds.

 

For the Company’s equipment entering Europe, CE compliance (RegulatoryCompliance with European Safety Standards) is required. All productsmanufactured for European customers (and for any others who may request it) bythe Company are CE compliant.

 

Various laws, regulations and recommendations relating to safe workingconditions, laboratory practices and the purchase, storage, movement, importand export, use and disposal of harmful or potentially harmful substances thatmay be used in connection with the Company’s research work are, or may, beapplicable to its activities.  These lawsinclude, among others, the United States Atomic Energy Act, the Clean Air Act,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.  Theextent of adverse governmental regulation, which might result from futurelegislation or administrative action, cannot be accurately predicted.  Certain agreements that may be entered intoby the Company involving exclusive license rights may also be subject tonational or supranational antitrust regulatory control, the effect of whichcannot be predicted.

 

To date the Company has not been affected by any United Statesgovernmental restrictions on technology transfer, import, export and customsregulations and other present local, state or Federal regulation.  The extent of adverse governmentalregulation, which might result from future legislation or administrativeaction, cannot be accurately predicted. In particular, H.R. 3162 enacted on October 21,2001 (the Patriot Act) and other governmental regulation may impose exportrestrictions on sale of equipment or transfer of technology to certaincountries 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

 

13

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for trade restriction such action could have amaterial adverse effect on the Company’s business, financial condition, orresults of operations.  Also, certain agreementsthat may be entered into by the Company involving exclusive license rights mayalso be subject to national or supranational antitrust regulatory control, theeffect of which cannot be predicted.

 

Backlog:

 

The Company’ssales order backlog related to continuing operations of accepted and unfilledorders at March 11, 2005, and March 24, 2004 was approximately $3,072,000and $2,226,000, respectively. Backlog as of any particular date should not berelied upon as indicative of the Company’s net revenues for any future period.

 

Employees:

 

The Companyhas approximately 48 full-time employees as of March 11, 2005.  None of the Company’s employees are coveredby a collective bargaining agreement, and the Company considers its relationswith its employees to be satisfactory. The Company believes that its future success will depend in large parton its ability to attract and retain highly skilled employees.

 

**Item 2****.                    PROPERTIES**

 

The Company’scorporate headquarters are in Newton, Massachusetts.  The Company also maintains a sales office andlaboratory facility in Lampertheim, Germany and a sales office in Irvine,California. The Company rents approximately 47,200 square feet of offices,production and research and development facilities at these locations foradministrative, development and production activities. The Company has theoption to extend the leases for up to three additional years.  A portion of the space at the Newton,Massachusetts facility is sublet to a non-affiliated company for a total of $12,000per annum under a tenant-at-will arrangement. The lease terms expire at varioustimes through April 2007. The Company believes these facilities will beadequate for operations for the next several years.

 

**Item 3****.                    LEGAL PROCEEDINGS**

 

The Company isnot a party to any material legal proceedings.

 

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

 

No matterswere submitted to a vote of the Company’s security holders during the quarterended December 31, 2004.

 

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

 

Market:

 

The Company’sCommon Stock is traded on the Over-the-Counter Bulletin Board under the symbolMFIC.  The following table sets forth therange of quarterly high and low bid quotations

 

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for the last two fiscal years, as furnished by the National Associationof Securities Dealers Automated Quotation System. The quotations representinterdealer quotations without adjustment for retail markups, markdowns, orcommissions, and may not necessarily represent actual transactions.

 
| **Quarters  Ended** | ** ** | **12/31  2004** | ** ** | **9/30  2004** | ** ** | **6/30  2004** | ** ** | **3/31  2004** | ** ** | **12/31  2003** | ** ** | **9/30  2003** | ** ** | **6/30  2003** | ** ** | **3/31  2003** | ** ** |
|---------------------|------------|-----------------|------------|----------------|------------|----------------|------------|----------------|------------|-----------------|------------|----------------|------------|----------------|------------|----------------|------------|
| **Low**             |       | $               | 1.57       |           | $          | 1.10           |       | $              | 1.50       |            | $          | 2.25           |       | $              | 0.85       |           | $          | 0.57 |   | $ | 0.20 |   | $ | 0.23 |   |
| **High**            |       | $               | 3.90       |           | $          | 2.34           |       | $              | 3.11       |            | $          | 4.30           |       | $              | 2.70       |           | $          | 1.90 |   | $ | 0.73 |   | $ | 0.47 |   |

 

Holders:

 

As of March 11,2005, there were approximately 380 holders of record of the Company’s CommonStock.

 

Issuance of Warrants:

 

On November 17,2004, the Company entered into a general financial and advisory servicesagreement with Maxim Group LLC pursuant to which Maxim Group LLC was granted athree (3) year warrant to purchase 100,000 shares of the Company’s commonstock at an exercise price of $3.20 per share. The securities were issuedpursuant to the exemption to the registration requirements of the SecuritiesAct of 1933, as amended, available under Section 4(2) of that Act.

 

Dividends:

 

The Companyhas never paid any cash dividends on its Common Stock and presently anticipatesthat no dividends on its Common Stock will be declared in the foreseeablefuture. The Company’s current policy is to retain all of its earnings tofinance future growth.

 

Equity Compensation Plan Information:

 

Theinformation in the table below is as of December 31, 2004.  See also the Consolidated FinancialStatements – Note 10.

 
| **Plan category**                                           | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                             | ** ** | **(b)**                                                                            | ** ** | **(c)**                                                                                                                                               | ** ** |
| Equity  compensation plans Approved by security holders     |       | 1,788,213                                                                                           |       | $                                                                                  | 1.14       |                                                                                                                                                  | 907,815    |   |
| Equity  compensation plans not approved by security holders |       | —                                                                                              |       | —                                                                             |       | —                                                                                                                                                |       |
| Total                                                       |       | 1,788,213                                                                                           |       | $                                                                                  | 1.14       |                                                                                                                                                  | 907,815    |   |

 

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**Item 6****.                    SELECTED FINANCIAL DATA**

 

The selectedfinancial information presented below is derived from the audited consolidatedfinancial statements of the Company for each of the five year period ended December 31,2004. 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.  Allfiscal years noted below have been restated to reflect the discontinuedoperations of MFIC Corporation.

 

**SelectedStatement of Operations Data**

 
| ** **                                                                                                                | ** ** | **Year Ended  December 31,  2004** | ** ** | **Year Ended  December 31,  2003** | ** ** | **Year Ended  December 31,  2002** | ** ** | **Year Ended  December 31,  2001** | ** ** | **Year Ended  December 31,  2000** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| Total  revenues                                                                                                           |       | $                                       | 12,158,919 |                                    | $          | 10,459,631                              |       | $                                       | 9,514,180  |                                    | $          | 11,210,375 |   | $ | 10,034,585 |   |
| Total costs  and expenses                                                                                                 |       | 11,461,749                              |       | 9,693,551                               |       | 8,872,465                               |       | 10,934,902                              |       | 10,449,756                              |       |
| Income  (loss) from continuing operations                                                                                 |       | 697,170                                 |       | 766,080                                 |       | 641,715                                 |       | 275,473                                 |       | (415,171                                | )          |
| Interest  expense                                                                                                         |       | (69,383                                 | )          | (116,097                                | )          | (179,429                                | )          | (261,754                                | )          | (350,486                                | )          |
| Other  expense                                                                                                            |       | —                                  |       | —                                  |       | —                                  |       | (53,142                                 | )          | (250,000                                | )          |
| Interest  income                                                                                                          |       | 27,965                                  |       | 9,508                                   |       | 7,191                                   |       | 7,032                                   |       | 248                                     |       |
| Net income  (loss) from continuing operations before income taxes and extraordinary item                                  |       | 655,752                                 |       | 659,491                                 |       | 469,477                                 |       | (32,391                                 | )          | (1,015,409                              | )          |
| Income tax  benefit                                                                                                       |       | 450,000                                 |       | —                                  |       | —                                  |       | —                                  |       | —                                  |       |
| Net income  (loss) from continuing operations before discontinued operations and  extraordinary item                      |       | 1,105,752                               |       | 659,491                                 |       | 469,477                                 |       | (32,391                                 | )          | (1,015,409                              | )          |
| (Loss)  income 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                                | )          | 347,801                                 |       |
| Gain on  subordinated debt restructuring                                                                                  |       | —                                  |       | —                                  |       | —                                  |       | —                                  |       | 194,500                                 |       |
| Net income  (loss)                                                                                                        |       | 874,372                                 |       | (3,450,434                              | )          | (2,513,974                              | )          | (525,186                                | )          | (473,108                                | )          |
| Weighted-average  shares outstanding:                                                                                     |       |                                    |       |                                    |       |                                    |       |                                    |       |                                    |       |
| Basic                                                                                                                     |       | 9,345,560                               |       | 7,767,712                               |       | 7,426,586                               |       | 7,375,102                               |       | 7,086,058                               |       |
| Diluted                                                                                                                   |       | 10,329,313                              |       | 8,501,110                               |       | 7,470,090                               |       | 7,375,102                               |       | 7,086,058                               |       |
| Basic  amounts per common share:                                                                                          |       |                                    |       |                                    |       |                                    |       |                                    |       |                                    |       |
| Net income  (loss) per share from continuing operations before extraordinary gain                                         |       | $                                       | .11        |                                    | $          | .08                                     |       | $                                       | .06        |                                    | $          | (.00 | ) | $ | (.14 | ) |
| Extraordinary  gain per share:                                                                                            |       | —                                  |       | —                                  |       | —                                  |       | —                                  |       | $                                       | .03        |   |
| Net income  (loss) per share from continuing operations                                                                   |       | $                                       | .11        |                                    | $          | .08                                     |       | $                                       | .06        |                                    | $          | (.00 | ) | $ | (.11 | ) |
| Basic net  (loss) income per share from discontinued operations                                                           |       | $                                       | (.02       | )                                       | $          | (.52                                    | )          | $                                       | (.40       | )                                       | $          | (.07 | ) | $ | .05 |   |
| Basic, as  reported                                                                                                       |       | $                                       | .09        |                                    | $          | (.44                                    | )          | $                                       | (.34       | )                                       | $          | (.07 | ) | $ | (.06 | ) |
| Diluted  amounts per common share:                                                                                        |       |                                    |       |                                    |       |                                    |       |                                    |       |                                    |       |
| Net income  (loss) per share from continuing operations before extraordinary gain                                         |       | $                                       | .10        |                                    | $          | .08                                     |       | $                                       | .06        |                                    | $          | (.00 | ) | $ | (.14 | ) |
| Extraordinary  gain per share:                                                                                            |       | —                                  |       | —                                  |       | —                                  |       | —                                  |       | $                                       | .03        |   |
| Diluted net  income (loss) per share from continuing operations                                                           |       | $                                       | .10        |                                    | $          | .08                                     |       | $                                       | .06        |                                    | $          | (.00 | ) | $ | (.11 | ) |
| Diluted net  (loss) income per share from discontinued operations                                                         |       | $                                       | (.02       | )                                       | $          | (.52                                    | )          | $                                       | (.40       | )                                       | $          | (.07 | ) | $ | .05 |   |
| Diluted, as  reported                                                                                                     |       | $                                       | .08        |                                    | $          | (.44                                    | )          | $                                       | (.34       | )                                       | $          | (.07 | ) | $ | (.06 | ) |

 

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

 

# **Certain Factors And CautionaryStatement Regarding Forward-Looking Statements**

 

Managementbelieves that this report contains forward-looking statements that are subjectto certain risks and uncertainties including statements relating to the Company’splan to achieve, maintain and/or increase revenue growth, and/or operatingprofitability, and to maintain net operating profitability. Such statements arebased on management’s current expectations and are subject to a number offactors and uncertainties that could cause actual results achieved by theCompany to differ materially from those described in the forward-lookingstatements.  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 orderswill significantly affect the size of quarter to quarter revenues and resultingnet income results for a particular quarter, (iii) whether the Companywill have access to sufficient working capital through continued and improvingcash flow from sales and ongoing borrowing availability, the latter beingsubject to the Company’s ability to comply with the covenants and terms of theCompany’s loan agreement with its senior lender, (iv) whether the Company’sexpectation that the benefits of nanotechnology will, in part, be realized bythe ability of the MMR to produce innovative materials in large quantities, and(v) whether the Company is able to increase the number of prototype MMRplacements and then manufacture and introduce commercial production MMRequipment.

 

# **Critical Accounting Policies**

 

The Companyconsiders certain accounting policies related to revenue recognition andrelated receivables as well as the valuation of inventories to be criticalpolicies due to the estimation processes involved in each.

 

Revenue Recognition.**** ****The Company’spolicy is to recognize revenue from sales of machines and spare parts uponshipment to our customers and the fulfillment of all contractual terms andconditions, pursuant to the guidance provided by Staff Accounting Bulletin No. 101,Revenue Recognition in Financial Statements (SAB 104), issued by the Securitiesand Exchange Commission.

 

****Rental income from the lease of equipment is recognized on astraight-line basis over the term of the lease agreement.****

 

****Judgments are required in evaluating the creditworthiness of ourcustomers.  In all instances, revenue isnot recognized until the Company has determined that collection is reasonablyassured.****

 

****Should changes in conditions cause management to determine the aforementionedcriteria are not met for certain future transactions, revenue recognized forany reporting period could be adversely affected.****

 

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Allowance for Doubtful Accounts****.  The Company’s policy is to maintainallowances for estimated losses resulting from the inability of our customersto make scheduled payments. The Company regularly evaluates the collectibilityof our trade receivable balances based on a combination of factors. When acustomer’s account balance becomes past due, we initiate dialogue with thecustomer to determine the cause. If it is determined that the customer will beunable to meet its financial obligation to us we record a specific allowance toreduce the related receivable to the amount we expect to recover given allinformation presently available.****

 

****We believe our reported allowances areadequate as of December 31, 2004 and 2003. If the financial condition of our customers were to deteriorate,however, resulting in their inability to make payments, the Company may need torecord additional allowances, which would result in additional expenses beingrecorded for the period in which such determination was made.****

 

Inventory Valuation.**** ********The Company values itsinventory at the lower of cost or net realizable value on a first-in-first-outmethod.  Management regularly evaluatesinventory quantities on hand and records a provision for obsolete or excessinventory levels greater than those of anticipated usage in the subsequent twoyears. There are external factors that may require an adjustment to theanticipated demand including, but not limited to, technological changes in ourmarkets, our ability to meet changing customer requirements, competitivepressures in products and prices, and the availability of key components fromour suppliers. Purchasing requirements and alternative usage avenues areexplored within these processes to mitigate inventory exposure. When recorded,our reserves are intended to reduce the carrying value of our inventory to itsnet realizable value.****

 

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

 

Product Warranties****.  Ourproducts are generally sold with a twelve month warranty provision that requireus to remedy deficiencies in quality or performance of our products at no costto our customers only after it has been determined that the cause of thedeficiency is not due to the actions of the machine operator or product used inthe machine.****

 

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**Fiscal 2004 Compared to Fiscal 2003**

 

In 1998, theCompany purchased the assets and liabilities 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 thattime, the direction of the core business of the Company changed significantlyfrom coatings to other areas, in particular the health care sector.  The Company determined that it could nolonger support the previous strategic plan and the Company, therefore, prepareda plan to divest the Morehouse-COWLES Division.

 

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

 

During thefourth quarter of 2003, management committed to a plan to sell substantiallyall the assets and associated liabilities of Morehouse-COWLES.  Accordingly, at 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 Asset Purchase Agreement (the Asset Purchase Agreement)dated February 5, 2004 between MFIC and a wholly owned subsidiary ofNuSil, MFIC sold substantially all of the assets and selected liabilities ofits Morehouse-COWLES Division (the Division), to NuSil. Other than NuSil’sprior purchases of products from the Division, there were no preexistingrelationships between MFIC and NuSil.

 

The assets ofthe Division that were sold included accounts receivable, furniture, fixturesand equipment, inventory and supplies, books and records, bids, contracts,prepaid expenses, leases, intellectual property, goodwill, domain names andclaims, all as described in the Asset Purchase Agreement (collectively, theAssets).  In addition, certain rights andobligations arising after February 9, 2004 under the Division’s PacifiCareGroup Health Insurance Policy were assigned. The Division’s cash or cash equivalents on hand on February 9, 2004were excluded from the assets being sold. Under the Asset Purchase Agreement, the Division’s executory obligationsunder certain contracts and bids, and the Division’s accounts payable as of February 9,2004 in the amount of $623,240, were assumed by NuSil.

 

The purchaseprice (other than the assumption of accounts payable described in the precedingparagraph) paid under the Asset Purchase Agreement was $918,238.  Of the purchase price, $768,238 (the 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 afuture date subject to any purchase price adjustments and offsets, as providedfor in the Asset Purchase Agreement.

 

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

 

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

 

Pursuant tothe Asset Purchase Agreement, MFIC entered into a Noncompetition andNonsolicitation Agreement, dated February 5, 2004, which limits MFIC’sability to compete with the business of the Division for a period of fiveyears.

 

The salegenerated a loss of approximately $1,420,000. Due to the sale of the Morehouse-COWLES Division, goodwill associatedwith the 1998 purchase of this division in the amount of $2,100,000 has beenimpaired in 2003.

 

**Results ofContinuing Operations**

 

Total revenuesfor 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 increase of $1,699,288, or 16%.

 

North Americansales for the year ended December 31, 2004 were approximately $6,212,000,a 16% increase as compared to North American sales of approximately $5,337,000for 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 were approximately $5,947,000for the year ended December 31, 2004 compared to $5,123,000 for the yearended December 31, 2003, an increase of $824,000, or 16%.  The increase in foreign sales was principallydue to an increase in the sale of spare parts of approximately $977,000compared to 2003.

 

Total cost ofgoods sold for 2004 was $5,607,755 or 46% of revenue, as compared to $4,988,226or 48% of revenue for 2003.  The increasein cost of goods sold in absolute dollars reflects principally the increase insales generated by the Company compared to the previous year. The Company’smajor product lines have different profit margins, as well as multiple profitmargins within each product line.  In thecourse of the periods compared, there may be significant changes in the cost ofrevenues as a percentage of revenue depending on the mix of product sold.  Also, the cost of sales as a percentage ofrevenue will differ between laboratory and pilot plant units sold, due to thedifference in costs between air driven and electric-hydraulic units.

 

Totaloperating expenses for 2004 were $5,853,994, or 48% of revenue, as compared to$4,705,325, or 45% of revenue, for 2003, which is an increase of $1,148,669, or24%.

 

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Research anddevelopment expenses for 2004 were $1,033,978 compared to $785,849 for 2003, anincrease of $248,129, or 32%.  Theincrease in research and development expenses is principally due to an increasein payroll costs, as a result of both an increase in headcount and payincreases of approximately $253,000, an increase in consultants ofapproximately $41,000, an increase in travel and related costs of approximately$10,000, partially offset by a decrease in testing materials of approximately $79,000.

 

Sellingexpenses for 2004 increased approximately $400,000, or 18%, from $2,187,389 to$2,587,658.  The increase was dueprincipally to an increase in outside commissions of approximately $194,000, anincrease in advertising costs of approximately $115,000, an increase in payrollcosts of approximately $91,000, an increase in public relations costs ofapproximately $36,000, partially offset by a decrease in travel and relatedcosts of approximately $38,000.

 

For the yearended December 31, 2004, general and administrative expenses increased byapproximately $500,000, or 29%, from $1,732,087 for the year ended December 31,2003, to $2,232,358.  The increase ingeneral and administrative expenses was principally due to an increase inpayroll and related costs of approximately $241,000, professional fees ofapproximately $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.

 

Interestexpense for 2004 decreased to $69,383 from $116,097 for 2003, a decrease of$46,714, or 40%.  The decrease was dueprimarily to the reduction in the line of credit caused by the paydown of thedebt from proceeds received from the sale of the Morehouse-COWLES Division.

 

Interestincome for 2004 increased to $27,965 from $9,508 in 2003, an increase of $18,457,or 194%.  The increase is due toavailable cash being invested in money markets and certificates of deposit.

 

**Results of Discontinued Operations**

 

Total revenuesfor 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 decreasein revenue is due to the sale of the discontinued operation to NuSilCorporation (NuSil) on February 9, 2004.

 

Total cost ofgoods 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.

 

Totaloperating expenses for 2004 were $238,760, or 74% of revenue, as compared to$1,640,490, or 45% of revenue, for 2003, which is a decrease of $1,401,730, or85%.

 

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Research anddevelopment expenses for 2004 were $37,413 compared to $318,105 for 2003, adecrease of $280,692, or 88%.  Thedecrease in research and development expenses was due to the sale of the discontinuedoperation to NuSil Corporation (NuSil) on February 9, 2004.

 

Sellingexpenses for 2004 decreased approximately $729,243, or 84%, from $863,337 to$134,094.  The decrease in sellingexpenses is due to the sale of the discontinued operation to NuSil Corporation(NuSil) on February 9, 2004.

 

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

 

**Fiscal 2003 Compared to Fiscal 2002**

 

**Results of Continuing Operations**

 

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

 

North American sales for the year ended December 31, 2003decreased to approximately $5,337,000, or 17%, as compared to North Americansales of approximately $6,462,000 for the year ended December 31,2002.  This decrease in North Americansales was principally due to a decrease in the sale of machines ofapproximately $754,000, and a decrease in the sale of spare parts ofapproximately $371,000.  Foreign saleswere approximately $5,123,000 for the year ended December 31, 2003compared to $3,052,000 for the year ended December 31, 2002, an increaseof $2,071,000, or 68%. This increase in foreign sales was principally due to anincrease in the sale of machines of approximately $1,323,000, and an increasein the sale of spare parts of approximately $748,000.

 

Total cost ofgoods sold for 2003 from continuing operations was $4,988,226, or 48% ofrevenue, as compared to $4,438,351, or 47% of revenue for 2002.  The increase in cost of goods sold reflectsprimarily the increase in sales generated by the Company.  The Company’s major product lines havedifferent profit margins, as well as multiple profit margins within each productline.  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 of sales as a percentage ofrevenue will differ between laboratory and pilot plant units sold, due to thedifference in costs between air driven and electric-hydraulic units.

 

Total operating expenses from continuing operations for 2003 were$4,705,325 or 45% of revenue, as compared to $4,434,114 or 47% of revenue for2002, which is an increase of $271,211 or 6%.

 

Research and development expenses for 2003 were $785,849 compared to$583,683 for 2002, an increase of $202,166 or 35%.  The increase in research and developmentexpenses is primarily due to an increase in research costs of approximately$131,000, and an increase in payroll and related costs of approximately$96,000, partially offset by a decrease in amortization

 

22

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costs of approximately $12,000, and a decrease inoutside contract services of approximately $13,000.

 

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

 

General and administrative expenses for 2003 decreased by approximately$32,000, from $1,763,884 for the year ended December 31, 2002, to$1,732,087, or 2%.  The decrease ingeneral and administrative expenses is primarily due to a decrease in payrollcosts of approximately $87,000, a decrease in professional fees ofapproximately $58,000 and a decrease in corporate expenses of approximately$37,000, offset by increases in bad debt expense of approximately $101,000 andoverhead costs of approximately $48,000.

 

Interest expense for 2003 decreased from $179,429 in 2003 to $116,097,a decrease of $63,332, or 35%.  Thedecrease was due principally to a reduction in the interest rate paid, and areduction in the amount of debt borrowed.

 

Interest income for 2003 increased to $9,508 from $7,191 for 2003, anincrease of $2,317.  The increase is dueto interest earned on the note and accounts receivable arising from the sale ofthe Ball Mill operation.

 

**Results of Discontinued Operations**

 

Total revenuesfor the year ended December 31, 2003 from discontinued operations of theMorehouse-COWLES Division (the Division) were $3,655,237 as compared torevenues of $5,059,202 for the year ended December 31, 2002, representinga decrease of $1,403,965, or 28%.  Thedecrease in revenues is due primarily to a decrease in machine sales ofapproximately $930,000, and a decrease in the sale of spare parts ofapproximately $496,000.

 

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

 

Total cost ofgoods sold for 2003 was $2,601,957, or 71% of revenue, as compared to$3,626,407 or 72% of revenue, for 2002. The decrease in cost of goods sold reflects primarily the decrease insales generated by the Division.  TheDivision’s major product lines have different profit margins, as well asmultiple profit margins within each product line.  In the course of the periods compared, theremay be significant changes in the cost of revenues as a percentage of revenuedepending on the mix of product sold.

 

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

 

23

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

 

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

 

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

 

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

 

24

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**QUARTERLY RESULTS OF OPERATIONS**

 

The following table sets forth, for theperiods presented, certain data from our consolidated statements ofoperations.  In the opinion of ourmanagement, the unaudited quarterly consolidated statement of operations data havebeen prepared on substantially the same basis as our audited consolidatedfinancial statements and include all adjustments, consisting only of normalrecurring adjustments, necessary for a fair presentation of the financialinformation for the periods presented. This information should be read in conjunction with the consolidatedfinancial statements and related notes included elsewhere in this Annual Reporton Form 10-K.  The operating resultsin any quarter are not necessarily indicative of the results that may beexpected for any future period.  Fiscalyears 2004 and 2003 quarters have been restated to reflect the discontinuedoperations of the Company.

 

Summarized unaudited quarterly financial dataare as follows

 
| ** **                                                              | ** ** | **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 |   |
| Basis 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 |   |

 

25

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

 

26

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**LIQUIDITY AND CAPITAL RESOURCES**

 

On March 3, 2004, the Company enteredinto a Revolving Credit and Term Loan Agreement with a new lender, Banknorth,N.A. (the New Lender), providing the Company with a $2 million creditfacility.  The proceeds drawn down fromthe New Lender under the credit facility were used to pay off both the line ofcredit and term loan owed PNC Bank N.A. (the Previous Lender).

 

Under the terms of agreement with the NewLender, the Company has two covenants that it must meet on an annualbasis.  The Company borrows funds on theRevolving Credit Line at the prime rate. The $1 million Term Loan is payable ratablyover a four year period at the fixed rate calculated equal to the Federal HomeLoan Bank Classic Rate plus 2.5%.  Seediscussion of New Credit Facility in the notes to the financial statements.

 

On March 31, 2004, the Company completeda private placement offering of investment units (each unit consisting of oneshare of common stock and a 3-year warrant to purchase an additional one-halfshare of common stock).  A total of1,426,616 units were sold, yielding gross proceeds of $3,566,536.  The units were priced at $2.50 and theassociated warrants totaling 713,308 units are exercisable at $3.05.  Additionally, the placement agent for theoffering received 5-year warrants to purchase 213,992 shares of common stock atan exercise price of $3.20 per share.  Thevalue of the warrants granted to the placement agent was approximately $351,000.

 

The Company used cash of $142,299 in 2004from operations and generated cash of $236,292 in 2003, and $398,748 in2002.  In 2004, the Company’s principaloperating cash requirements were to fund its increase in inventories, trade andother receivables, prepaid expenses, and a decrease in current liabilities,partially offset by net income. In 2003, the Company’s principal operating cashrequirements were to fund its net loss, its increase in prepaid expenses,inventory, and a decrease in current liabilities, offset by a decrease in tradeand other receivables, and other current assets. In 2002, the Company’sprincipal operating cash requirements were to fund its decrease in currentliabilities, and increase in other current assets and prepaid expenses, offsetby net income from operations, and a decrease in receivables and inventory.

 

The Company generated cash of $513,083 andused cash of $53,172, and $38,706 for investing activities in 2004, 2003, and2002, respectively.  Net cash provided byinvesting activities in 2004 was generated through the sale of theMorehouse-COWLES Division, partially offset by the purchase of capital equipment.  Net cash used in investing activities forboth 2003 and 2002 included the proceeds from the sale of assets, net of thepurchase of capital equipment. The Company’s sale of assets principally relatedto used equipment. As of December 31, 2004, the Company had no materialcommitments for capital expenditures.

 

For financingactivities, the Company generated cash of $1,607,060 in 2004, and used cash of$217,806 in 2003, and $362,472 in 2002. In 2004, cash was generated from the net proceeds from the privateplacement offering, the issuance of common stock for options exercised,proceeds from stock issued from the employee stock purchase plan, and netproceeds from a new term loan and line of credit from the New Lender, offset bypayments on the previous line of credit, the term note and subordinateddebt.  In 2003, cash was used to pay downthe line of credit, subordinated debt, and the line of credit term note,partially offset by the issuance of common stock.  In 2002 cash was used to pay a note payablearising from a settlement agreement

 

27

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(see Note 7 – Debt), to paydown the term note, and the subordinated debt, and was partially offset byproceeds from the line of credit, and the issuance of common stock.

 

The cash and cash equivalents balance at December 31,2004 was $2,028,114, an increase of $1,977,844 from the December 31, 2003balance of $50,270. At December 31, 2003, the Company maintained a line ofcredit and a term loan (collectively the Credit Facility) with the PreviousLender. The line of credit facility provided for a maximum borrowing of$4,000,000. On March 3, 2004, the Company received a new line of creditfrom the New Lender.  The proceeds of thenew line of credit and term note were used to pay off the balance due the PreviousLender.  As of December 31, 2004 andMarch 11, 2005, the Company had borrowings of $812,503 and $994,504outstanding under its loan facility, respectively.

 

Under the terms of the line of credit withthe Previous Lender, the Company was subject to a number of restrictions thatimpacted the Company’s use of funds.  TheCompany was limited to acquisition of property of $250,000 per year or less,could not pay dividends, and maintained certain financial covenants asdefined.  In addition, the Company was requiredto maintain a lockbox arrangement with the Previous Lender, and all cashreceipts were included in the lockbox and were applied against the outstandingline of credit.  Borrowings outstandingunder the Credit Facility were secured by a collateral pledge to the PreviousLender of substantially all of the assets of the Company.  On February 19, 2003, the Company andthe Previous Lender signed a third amendment to the original agreementextending the credit facility for one year until February 28, 2004.  On February 6, 2004, the Company and thePrevious Lender entered into a Fourth Amendment and Waiver in connection withthe Company’s sale of the assets of the Morehouse-COWLES Division. At December 31,2003, the Company did not meet the net income covenant and would have requireda waiver from its Previous Lender. However, in conjunction with the new credit facility it obtained fromthe New Lender, no waiver was required from the Previous Lender.

 

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

 

Assuming that there is no significant changein the Company’s business, the Company believes that cash flows fromoperations, together with existing cash balances, will be sufficient to meetits working capital and debt service requirements for at least the next twelvemonths.

 

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

 

**Recent Accounting Pronouncements**

 

In November 2004, the FASB issued FASBStatement No. 151, “Inventory Costs – an amendment of ARB No. 43” (“SFAS151”), which is the result of its efforts to converge U.S.

 

28

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accounting standards for inventories with international AccountingStandards.  SFAS No. 151 requiresidle facility expenses, freight, handling costs, and wasted material (spoilage)costs to be recognized as current-period charges.  It also requires that allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities.  SFAS No. 151will be effective for inventory costs incurred during fiscal years beginningafter June 15, 2005.  The company isevaluating the impact of this standard on our consolidated financialstatements.

 

In December 2004, the FASB issued SFAS No. 123(Revised 2004) “Share-Based Payment” (“SFAS No. 123R”).  SFAS No. 123R addresses all forms ofshare-based payment (“SBP”) awards, including shares issued under employeestock purchase plans, stock options, restricted stock and stock appreciationrights.  SFAS No. 123R will requirethe Company to expense SBP awards with compensation cost for SBP transactionsmeasured at fair value.  The FASBoriginally stated a preference for a lattice model because it believed that alattice model more fully captures the unique characteristics of employee stockoptions in the estimate of fair value, as compared to the Black-Scholes modelwhich the Company currently uses for its disclosure.  The FASB decided to remove its explicitpreference for a lattice model and not require a single valuationmethodology.  SFAS No. 123R requiresthe Company to adopt the new accounting provisions beginning in our fiscal year2006.  The Company is evaluating theimpact of this standard and expects that it could have a material effect on itsconsolidated financial statements.

 

**Item 7A****.  QUANTITATIVE AND QUALITIVEDISCLOSURES 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 theinstruments.  The Company’s fixed ratedebt is not exposed to cash flow or interest rate changes but is exposed tofair market value changes in the event of refinancing this fixed ratedebt.  The Company does not havesignificant exposure to fluctuations in foreign exchange rates.

 

The Company had no variable rate borrowingsoutstanding under its revolving credit agreement at December 31,2004.  Therefore, an adverse change ininterest rates for this variable rate debt would have had no material effect onthe Company’s earnings and cash flows on an annual basis.

 

For additional information about the Company’sfinancial instruments, see Note 7 to the Financial Statements.

 

29

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**Item 8****.**                    **FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

The following Consolidated FinancialStatements of the Company and its Subsidiaries appear at the end of this reportstarting on Page F-1 and include:

 
| Report Independent Auditors                                                                                                 |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                        |   |
| Consolidated Balance Sheets as of December 31, 2004 and 2003                                                           |   |
|                                                                                                                        |   |
| Consolidated Statements of Operations for  the years ended December 31, 2004, 2003 and 2002                            |   |
|                                                                                                                        |   |
| Consolidated Statements of Cash Flows for  the years ended December 31, 2004, 2003 and 2002                            |   |
|                                                                                                                        |   |
| Consolidated Statements of Changes in  Stockholders’ Equity for the years ended December 31, 2004, 2003 and  2002 |   |
|                                                                                                                        |   |
| Notes to Consolidated Financial Statements                                                                                  |   |

 

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

 

None.

 

# **Item 9A**.                 CONTROLSAND PROCEDURES

 

(a)             *Evaluation of disclosure controls and procedures*.  Based on his evaluation as of the end of the fiscal quarter ended December 31, 2004, each of our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) are effective to ensure that material information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

 

(b)             *Changes in internal control over financial reporting*.  There were no significant changes in ourinternal control over financial reporting during the fiscal quarter ended December 31,2004 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**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 ofEthics by sending a request for the Code of Ethics to MFIC Corp., 30 OssipeeRoad, Newton, MA 02464-9101, ATTN: Investor Relations. The Code of Ethics is also viewable on the Company’swebsite at the following URL: http://www.mficcorp.com/nethics.html

 

The information required by thisItem 10 will be incorporated by reference from the Company’s definitive proxystatement or will be filed as an amendment to the Company’s Form 10-Kwithin 120 days of the Company’s fiscal year end.

 

**Item 11****.****                 EXECUTIVECOMPENSATION**

 

The information required by this Item 11 willbe incorporated by reference from the Company’s definitive proxy statement orwill be filed as an amendment to the Company’s Form 10-K within 120 daysof the Company’s fiscal year end.

 

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

 

The information required by this Item 12 willbe incorporated by reference from the Company’s definitive proxy statement orwill be filed as an amendment to the Company’s Form 10-K within 120 daysof the Company’s fiscal year end.

 

**Item 13****.**  **CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

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

 

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**Item 14****.  INDEPENDENT ACCOUNTANT FEES FOR FISCAL 2004AND FISCAL 2003**

 

*Audit-RelatedFees*

 

During the years ended December 31, 2004and December 31, 2003, Brown & Brown LLP was paid approximately $139,000and $70,000 respectively for assurance and related services reasonably relatedto the performance of audit or review of the Company’s financial statements andare not reported under Item 9(e) of the Company’s definitive proxystatement.****All services were approved by theAudit Committee.

 

*Tax Fees*

 

During the years ended December 31, 2004and December 31, 2003, Brown & Brown LLP was paid approximately $14,000and $16,000 respectively for tax compliance, tax advice and tax planningservices.  All tax services were approvedby the Audit Committee.

 

*All Other Fees*

 

During the years ended December 31, 2004and December 31, 2003, Brown & Brown LLP was paid approximately $56,000and $0, respectively, for non-audit services. All of these services were approved by the Audit Committee.

 

The Audit Committee has considered whetherthe provision of non-core audit services to the Company by the Company’sprincipal auditor is compatible with maintaining independence, and haveaffirmed, in each instance, that the provision of such service was compatiblewith the principal auditor’s independent role.

 

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

 

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

 

The following Consolidated FinancialStatements are included in Item 8:

 
| Reports of Independent Auditors                                                                                              |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                         |   |
| Consolidated Balance Sheets as of December 31, 2004 and 2003                                                            |   |
|                                                                                                                         |   |
| Consolidated Statements of Operations for  the years ended December 31, 2004, 2003, and 2002                            |   |
|                                                                                                                         |   |
| Consolidated Statements of Cash Flows for  the years ended December 31, 2004, 2003, and 2002                            |   |
|                                                                                                                         |   |
| Consolidated Statements of Changes in  Stockholders’ Equity for the years ended December 31, 2004, 2003, and  2002 |   |
|                                                                                                                         |   |
| Notes to Consolidated Financial Statements                                                                                   |   |

 

**(b)****           Exhibits.**

 

The Company hereby files as part of this Form 10-Kthe Exhibits listed below

 

**(c)****           FinancialStatement Schedules.**

 

The following Consolidated FinancialStatement Schedule of the Registrant is filed as part of this report:

 

Schedule II– Valuation and Qualifying Accounts and Reserves

 

33

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**INDEPENDENT AUDITORS REPORT**

 

The Board of Directors and Stockholders of MFIC Corporation:

 

We have audited the accompanying consolidatedbalance sheets of MFIC Corporation and subsidiaries as of December 31,2004 and 2003 and the related consolidated statements of operations,stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2004. Our audits also included the financial statement schedule listedin the Index at Item 15(c).  Thesefinancial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements and schedule based on our audits.

 

Weconducted our audits in accordance with auditing standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audits to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting 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, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated financial positionof MFIC Corporation and subsidiaries at December 31, 2004 and 2003 and theconsolidated results of their operations and their cash flows for the threeyears in the period ended December 31, 2004, in conformity with accountingprinciples generally accepted in the United States of America.  Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects theinformation set forth therein.

 

 
|                  | /s/ BROWN & BROWN, LLP |   |
|-----------------------|---------------------------------|--------|
|                  |
|                  |
| Boston, Massachusetts |
| March 2, 2005         |

 

F-1

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**MFIC CORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                         | ** ** | **December 31,** | ** **    |
|--------------------------------------------------------------------------------------------------------------------|------------|-----------------------|---------------|
| **ASSETS**                                                                                                         | ** ** | **2004**              | ** **    | **2003** | ** ** |
| *Current  Assets:*                                                                                                 |       |                  |          |   |   |
| Cash and  cash equivalents                                                                                         |       | $                     | 2,028,114     |   | $ | 50,270 |   |
| Accounts  receivable, less allowance for doubtful accounts of $13,203 and $58,500 in  2004 and 2003, respectively. |       | 2,056,522             |          | 1,814,584 |   |
| Note  receivable - NuSil                                                                                           |       | 100,000               |          | — |   |
| Note  receivable – current                                                                                    |       | 25,000                |          | 16,429 |   |
| Inventories,  net                                                                                                  |       | 1,888,138             |          | 1,683,703 |   |
| Prepaid  expenses                                                                                                  |       | 227,607               |          | 207,210 |   |
| Other  current assets                                                                                              |       | 45,167                |          | 38,749 |   |
| Assets  available for sale                                                                                         |       | —                |          | 1,383,118 |   |
| Deferred  income taxes                                                                                             |       | 450,000               |          | — |   |
| **TOTAL  CURRENT ASSETS**                                                                                          | ** ** | **6,820,548**         | ** **    | **5,194,063** | ** ** |
|                                                                                                               |       |                  |          |   |   |
| *Property  and Equipment, at cost:*                                                                                |       |                  |          |   |   |
| Furniture,  fixtures and office equipment                                                                          |       | 451,341               |          | 330,022 |   |
| Machinery and  equipment                                                                                           |       | 368,374               |          | 219,765 |   |
| Leasehold  improvements                                                                                            |       | 85,795                |          | 50,568 |   |
| ** **                                                                                                         | ** ** | **905,510**           | ** **    | **600,355** | ** ** |
| Less: accumulated  depreciation and amortization                                                                   |       | (511,170              | )             | (418,066 | ) |
| **Net  property and equipment**                                                                                    | ** ** | **394,340**           | ** **    | **182,289** | ** ** |
|                                                                                                               |       |                  |          |   |   |
| Note  receivable – long-term                                                                                  |       | —                |          | 54,761 |   |
| Patents,  licenses and other assets (net of accumulated amortization of $225,885 in  2004 and $216,155 in 2003)    |       | 77,413                |          | 55,978 |   |
|                                                                                                               |       |                  |          |   |   |
| **TOTAL  ASSETS**                                                                                                  | ** ** | **$**                 | **7,292,301** | ** ** | **$** | **5,487,091** | ** ** |

 

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

 

F-2

----

 
| ** **                                                                                                                                                                                                  | ** ** | **December 31,** | ** **    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|---------------|
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                               | ** ** | **2004**              | ** **    | **2003** | ** ** |
| *Current  Liabilities:*                                                                                                                                                                                     | * *   | * *              | * *      | * * | * * |
| Line of  credit                                                                                                                                                                                             |       | $                     | —        |   | $ | 2,425,613 |   |
| Accounts  payable                                                                                                                                                                                           |       | 120,841               |          | 882,091 |   |
| Accrued expenses                                                                                                                                                                                            |       | 355,627               |          | 179,806 |   |
| Accrued  interest- related party                                                                                                                                                                            |       | —                |          | 2,639 |   |
| Accrued  compensation and vacation pay                                                                                                                                                                      |       | 132,970               |          | 111,855 |   |
| Customer  advances                                                                                                                                                                                          |       | 775,327               |          | 223,501 |   |
| Current  portion of term note payable                                                                                                                                                                       |       | 250,000               |          | 58,735 |   |
| Current portion  of long-term debt- related party                                                                                                                                                           |       | 6,250                 |          | 75,000 |   |
| Liabilities  associated with assets available for sale                                                                                                                                                      |       | —                |          | 661,095 |   |
| **TOTAL  CURRENT LIABILITIES**                                                                                                                                                                              | ** ** | **1,641,015**         | ** **    | **4,620,335** | ** ** |
|                                                                                                                                                                                                        |       |                  |          |   |   |
| Long-term  debt, net of current portion- related party                                                                                                                                                      |       | —                |          | 6,250 |   |
| Term note                                                                                                                                                                                                   |       | 562,503               |          | — |   |
| Commitments  (Note 11)                                                                                                                                                                                      |       |                  |          |   |   |
| *Stockholders’  Equity:*                                                                                                                                                                               |       |                  |          |   |   |
| Common  Stock, par value $.01 per share, 20,000,000 shares authorized; 9,921,984 and  8,028,158 shares issued; 9,661,538 and 7,767,712 shares outstanding at December 31,  2004 and 2003, respectively |       | 99,220                |          | 80,281 |   |
| Additional  paid-in capital                                                                                                                                                                                 |       | 16,485,828            |          | 13,150,862 |   |
| Accumulated  deficit                                                                                                                                                                                        |       | (10,808,564           | )             | (11,682,936 | ) |
| Less:  Treasury Stock, at cost, 260,446 shares at December 31, 2004 and 2003,  respectively                                                                                                            |       | (687,701              | )             | (687,701 | ) |
|                                                                                                                                                                                                        |       |                  |          |   |   |
| **TOTAL  STOCKHOLDERS’ EQUITY**                                                                                                                                                                        | ** ** | **5,088,783**         | ** **    | **860,506** | ** ** |
|                                                                                                                                                                                                        |       |                  |          |   |   |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                        | ** ** | **$**                 | **7,292,301** | ** ** | **$** | **5,487,091** | ** ** |

 

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

 

F-3

----

 

**MFIC CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                                                                       | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                       | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues                                                                                                         |       | $                                 | 12,158,919 |   | $ | 10,459,631 |   | $ | 9,514,180 |   |
| Cost of  goods sold                                                                                              |       | 5,607,755                         |       | 4,988,226 |   | 4,438,351 |   |
| Gross profit                                                                                                     |       | 6,551,164                         |       | 5,471,405 |   | 5,075,829 |   |
| Operating  expenses:                                                                                             |       |                              |       |   |   |   |   |
| Research and  development                                                                                        |       | 1,033,978                         |       | 785,849 |   | 583,683 |   |
| Selling                                                                                                          |       | 2,587,658                         |       | 2,187,389 |   | 2,086,547 |   |
| General and  administrative                                                                                      |       | 2,232,358                         |       | 1,732,087 |   | 1,763,884 |   |
| Total  operating expenses                                                                                        |       | 5,853,994                         |       | 4,705,325 |   | 4,434,114 |   |
| Income from  continuing operations                                                                               |       | 697,170                           |       | 766,080 |   | 641,715 |   |
|                                                                                                             |       |                              |       |   |   |   |   |
| Interest  expense                                                                                                |       | (69,383                           | )          | (116,097 | ) | (179,429 | ) |
| Interest  income                                                                                                 |       | 27,965                            |       | 9,508 |   | 7,191 |   |
| Net income  from continuing operations before income tax benefit                                                 |       | 655,752                           |       | 659,491 |   | 469,477 |   |
| Income tax  benefit                                                                                              |       | 450,000                           |       | — |   | — |   |
| Net income  from continuing operations                                                                           |       | 1,105,752                         |       | 659,491 |   | 469,477 |   |
| 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 | ) |
| Net income  (loss)                                                                                               |       | $                                 | 874,372    |   | $ | (3,450,434 | ) | $ | (2,513,974 | ) |
|                                                                                                             |       |                              |       |   |   |   |   |
| Weighted  average number of common and common equivalent shares outstanding:                                     |       |                              |       |   |   |   |   |
| Basic                                                                                                            |       | 9,345,560                         |       | 7,767,712 |   | 7,426,586 |   |
| Diluted                                                                                                          |       | 10,329,313                        |       | 8,501,110 |   | 7,470,090 |   |
| Basic  amounts per common share:                                                                                 |       |                              |       |   |   |   |   |
| Net income  per share from continuing operations                                                                 |       | $                                 | .11        |   | $ | .08 |   | $ | .06 |   |
| Basic net  (loss) per share from discontinued operations                                                         |       | $                                 | (.02       | ) | $ | (.52 | ) | $ | (.40 | ) |
| Basic, as  reported                                                                                              |       | $                                 | .09        |   | $ | (.44 | ) | $ | (.34 | ) |
|                                                                                                             |       |                              |       |   |   |   |   |
| Diluted  amounts per common share:                                                                               |       |                              |       |   |   |   |   |
| Net income  per share from continuing operations                                                                 |       | $                                 | .10        |   | $ | .08 |   | $ | .06 |   |
| Diluted net  (loss) per share from discontinued operations                                                       |       | $                                 | (.02       | ) | $ | (.52 | ) | (.40 | ) |
| Diluted, as  reported                                                                                            |       | $                                 | .08        |   | $ | (.44 | ) | $ | (.34 | ) |

 

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

 

F-4

----

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                            | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                            | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| *Cash  flows from operating activities:*                                              | * *   | * *                     | * *   | * * | * * | * * | * * |
| Net income  (loss)                                                                    |       | $                            | 874,372    |   | $ | (3,450,434 | ) | $ | (2,513,974 | ) |
| Adjustments  to reconcile net income (loss) to net cash used in operating activities: |       |                         |       |   |   |   |   |
| Change in  accounting principle                                                       |       |                         |       | — |   | 2,661,409 |   |
| Impairment  of goodwill                                                               |       | —                       |       | 2,100,000 |   | — |   |
| Income tax  benefit                                                                   |       | (450,000                     | )          |   |   |   |   |
| Provision  for disposal of discontinued operations                                    |       |                         |       | 1,422,715 |   | — |   |
| Depreciation  and amortization                                                        |       | 111,829                      |       | 264,101 |   | 308,131 |   |
| Provision  for loss on trade receivables                                              |       | (45,297                      | )          | 24,378 |   | 6,985 |   |
| Provision  for other receivables                                                      |       | 46,190                       |       | 76,000 |   | — |   |
| Provision  for excess inventory                                                       |       | 53,000                       |       | 60,000 |   | — |   |
| Gain on sale  of assets                                                               |       | —                       |       | (26,931 | ) | (42,268 | ) |
| Issuance of  restricted common stock to consultants                                   |       | —                       |       | — |   | 11,668 |   |
| *Changes  in assets and liabilities:*                                                 | * *   | * *                     | * *   | * * | * * | * * | * * |
| Receivables                                                                           |       | (196,641                     | )          | 146,573 |   | 242,043 |   |
| Inventories                                                                           |       | (257,435                     | )          | (49,733 | ) | 64,647 |   |
| Prepaid  expenses                                                                     |       | (20,397                      | )          | (50,209 | ) | (11,831 | ) |
| Other  current assets                                                                 |       | (46,578                      | )          | 51,281 |   | (40,229 | ) |
| Current  liabilities                                                                  |       | (15,127                      | )          | (331,449 | ) | (287,833 | ) |
| Assets and  liabilities available for sale                                            |       | (196,215                     | )          | — |   | — |   |
| Net cash  (used in) provided by operating activities                                  |       | (142,299                     | )          | 236,292 |   | 398,748 |   |
|                                                                                  |       |                         |       |   |   |   |   |
| *Cash  flows from investing activities:*                                              | * *   | * *                     | * *   | * * | * * | * * | * * |
| Proceeds  from sale of fixed assets                                                   |       | —                       |       | 26,931 |   | 105,991 |   |
| Purchase of  fixed assets                                                             |       | (305,155                     | )          | (96,532 | ) | (163,864 | ) |
| Proceeds  from note receivable                                                        |       |                         |       | 16,429 |   | 19,167 |   |
| Proceeds  from sale of assets available for sale                                      |       | 818,238                      |       | — |   | — |   |
| Net cash  provided by (used in) investing activities                                  |       | 513,083                      |       | (53,172 | ) | (38,706 | ) |
|                                                                                  |       |                         |       |   |   |   |   |
| *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                    |       | — |   | 146,195 |   |
| Principal payments  on term note – PNC                                           |       | (58,735                      | )          | (95,004 | ) | (95,004 | ) |
| Principal payments  on term loan – Banknorth                                     |       | (187,497                     | )          |   |   |   |   |
| Principal payments  on note payable                                                   |       | —                       |       | — |   | (350,000 | ) |
| Issuance of  common stock under employee stock purchase plan                          |       | 20,993                       |       | 11,713 |   | 11,581 |   |
| Issuance of  common stock under employee stock option plan                            |       | 343,973                      |       | 144,859 |   | 6,006 |   |
| Issuance of  common stock purchased through warrants                                  |       | —                       |       | 52,000 |   | — |   |
| Proceeds  from private placement (net of closing costs of $577,601)                   |       | 2,988,939                    |       | — |   | — |   |
| Payments on  subordinated debt-related party                                          |       | (75,000                      | )          | (75,000 | ) | (81,250 | ) |
| Net cash  provided by (used in) financing activities                                  |       | 1,607,060                    |       | (217,806 | ) | (362,472 | ) |
|                                                                                  |       |                         |       |   |   |   |   |
| Net increase  (decrease) in cash and cash equivalents                                 |       | 1,977,844                    |       | (34,686 | ) | (2,430 | ) |
| Cash and  cash equivalents, beginning of year                                         |       | 50,270                       |       | 84,956 |   | 87,386 |   |
| Cash and  cash equivalents, end of year                                               |       | $                            | 2,028,114  |   | $ | 50,270 |   | $ | 84,956 |   |
|                                                                                  |       |                         |       |   |   |   |   |
| Supplemental  disclosure of cash flow information:                                    |       |                         |       |   |   |   |   |
|                                                                                  |       |                         |       |   |   |   |   |
| Cash paid  for interest                                                               |       | $                            | 67,942     |   | $ | 130,967 |   | $ | 204,977 |   |

 

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

 

F-5

----

 

**MFIC****CORPORATION**

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

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

 

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

 

F-6

----

 

**MFICCORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1****                    ORGANIZATIONAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Organization**

 

MFIC Corporation (MFIC or the Company), throughits wholly-owned subsidiary, Microfluidics Corporation (Microfluidics), itsoperating division, operates in one segment, specializing in producing andmarketing a broad line of proprietary fluid materials processing systems usedfor a variety of grinding, mixing, milling, and blending applications across avariety of industries and for use in numerous applications within thoseindustries. Microfluidizer materials processor systems are produced atMicrofluidics.

 

**Principles of Consolidation**

 

The consolidated financial statements of theCompany include the accounts of the Company and its wholly owned subsidiaries.All significant intercompany transactions and balances have been eliminated inconsolidation.

 

**Use of Estimates**

 

The preparation of consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America (“Generally Accepted Accounting Principles”) requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ from those estimates.

 

**Reclassifications**

 

As described in Note 4, in December 2003,the Company committed to a plan to sell substantially all the assets andassociated liabilities of its Morehouse-COWLES Division.  As such, in accordance with generallyaccepted accounting principles, results of operations have been reclassified toreflect Morehouse-COWLES’ operating results, net of income taxes, asDiscontinued Operations.  Further,certain prior period balances have been reclassified to conform to the currentperiod presentation.

 

 

F-7

----

 

**Revenue Recognition**

 

Revenue from the sale of machines and spareparts is generally recognized upon shipment of the product or when the earningsprocess is complete.  Rental income forthe lease of equipment is recognized on a straight-line basis over the term ofthe lease agreement. Rental income and equipment sales are classified inrevenues in the consolidated statement of operations.

 

The Company has adopted Securities andExchange Commission (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.

 

**Cash and Cash Equivalents**

 

The Company considers all highly liquidsecurities with initial maturities of 90 days or less, at the time of acquisition,to be cash equivalents.

 

**Allowance for Doubtful Accounts**

 

The Company maintains an allowance forestimated losses resulting from the inability of its customers to make requiredpayments.  An estimate of uncollectibleamounts is made by management based upon historical bad debts, current customerreceivable balances, age of customer receivable balances, customer’s financialcondition and current economic trends. If the actual uncollected amounts significantly exceed the estimatedallowance, the Company’s operating results would be significantly adverselyaffected.

 

**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 periodically reviews quantitiesof inventory on hand and compares these amounts to expected usage of eachparticular product line.  Reserves areestablished to record provisions for slow moving inventories in the period inwhich it becomes reasonably evident that the item is not useable, salable orthe market value is less than cost.

 

F-8

----

 

**Property and Equipment**

 

The Company’s property and equipment isrecorded at cost. Depreciation is computed using the straight-line method,based upon estimated useful lives of 3 to 7 years.  Leasehold improvements are amortized usingthe straight-line method based upon the shorter of the estimated useful livesor remaining life of the lease. Expenditures for maintenance and repairs areexpensed as incurred. Upon retirement or sale of property and equipment, thecost of the disposed asset and the related accumulated depreciation are removedfrom the accounts and any resulting gain, or loss is credited or charged tooperations.

 

**Long-Lived Assets**

 

In accordance with Statements of FinancialAccounting Standards (“SFAS”) No.144, *Accounting for theImpairment or Disposal of Long-Lived Assets* (“SFAS No. 144”),the Company reviews long-lived assets and all amortizing intangible assets forimpairment whenever events or changes in circumstances indicate the carryingamount of such assets may not be recoverable. Recoverability of these assets is determined by comparing the forecastedundiscounted net cash flows of the operation to which the assets relate, to thecarrying amount.  If the operation isdetermined to be unable to recover the carrying amount of its assets, thenintangible assets are written down first, followed by the other long-livedassets of the operation, to fair value. Fair value is determined based on discounted cash flows or appraisedvalues, depending upon the nature of the assets.

 

**Patents, Licenses, and Other IntangibleAssets**

 

Patents, patent applications and rights arestated at acquisition cost.  Amortizationis recorded using the straight-line method over the shorter of the legal livesor useful life of the patents.  Patents,licenses and other intangible assets are being amortized over a period of 3 to17 years.

 

**Goodwill**

 

Goodwill represents the excess of cost overthe fair value of net assets of a business acquired.  The Company adopted SFAS No. 141, *Business Combinations* (“SFAS No. 141”) in fiscal 2001and SFAS No. 142, *Goodwill and OtherIntangible Assets*(“SFAS No. 142”) in fiscal year 2002.  SFAS No. 141 requires that the purchasemethod of accounting be used for all business combinations initiated after June 30,2001.  SFAS No. 141 also specifiesthe criteria that intangible assets acquired in a purchase method businesscombination must meet in order to be recognized and reported apart fromgoodwill.

 

SFAS No. 142 requires that goodwill andintangible assets with indefinite lives no longer be amortized, but instead betested for impairment, at least annually. SFAS No. 142 also requires that the intangible assets with definitelives be amortized over their respective estimated useful lives to theirresidual value and reviewed for impairment in accordance with SFAS No. 144.

 

F-9

----

 

**Research and Development Expenses**

 

The Company charges research and developmentexpenses to operations as incurred.

 

**Earnings (Loss) per Share**

 

Basic anddiluted net loss per 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 percommon share was determined by dividing net income or loss applicable to commonstockholders by the weighted average number of common shares outstanding duringthe period. Options to purchase 1,782,713, 1,929,662 and 2,010,650 shares ofcommon stock were outstanding for the years ended 2004, 2003, and 2002,respectively. Basic and diluted net income per share are $.09 and $.08,respectively, per share for 2004.  Basicand diluted net loss per share are $(.44) per share for 2003.  Basic and diluted net loss per share are$(.34) per share for 2002.

 

**Fair Value of Financial Instruments**

 

The carrying amount of cash and cashequivalents, accounts receivable, accounts payable and accrued liabilitiesapproximates fair value due to the short term nature of these accounts. TheCompany’s bank debt, because it carries a variable interest rate, is stated atits approximate fair market value. The Company’s subordinated debt bearsinterest at 10%, which approximates fair market value.

 

**Income Taxes**

 

The Company accounts for income taxes under SFAS No. 109, *Accounting for Income Taxes (“SFAS No. 109”). *Under SFAS No. 109, deferredtax assets or liabilities are computed based on the differences between thefinancial statement and income tax bases of assets and liabilities using theeffective tax rates.  Deferred income taxexpense or credits are based on changes in the asset or liability from periodto period. The Company records a valuation allowance against any net deferredtax assets if it is more likely than not that they will not be realized.

 

F-10

----

 

**Stock Based Compensation**

 

As allowed by SFAS No. 123, *Accounting for Stock-BasedCompensation*, the Company has elected to account for stock-basedcompensation at intrinsic value with disclosure of the effects of fair valueaccounting on net income and earnings per share on a pro forma basis.  At December 31, 2004, the Company hadone stock incentive plan, which is described more fully in Note 10.  The Company accounts for awards issued toemployees under its stock incentive plan pursuant to the recognition andmeasurement principles of Accounting Principles Board (APB) Opinion No. 25,*Accounting for Stock Issued to Employees,*and related interpretations.  Nostock-based employee compensation cost is reflected in net income, as alloptions granted under the plan had an exercise price equal to the market valueof the underlying common stock on the date of grant.  The following table illustrates the effect onnet income (loss) and earnings (loss) per share if the Company had applied thefair value recognition provisions of SFAS No. 123:

 

| ** **                                                                                                                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Net income (loss), as reported                                                                                                               |       | $        | 874,372    |     | $          | (3,450,434 | )          | $ | (2,513,974 | ) |
| Deduct: total stock-based employee compensation expense determined  under fair value based method for all awards, net of related tax effects |       | (231,886 | )          | (113,509 | )          | (340,178   | )          |
| Pro forma net income (loss)                                                                                                                  |       | $        | 642,486    |     | $          | (3,563,943 | )          | $ | (2,854,152 | ) |
| Net income (loss) per share:                                                                                                                 |       |     |       |     |       |       |       |
| Basic - as reported                                                                                                                          |       | $        | .09        |     | $          | (0.44      | )          | $ | (0.34 | ) |
| Diluted - as reported                                                                                                                        |       | $        | .08        |     | $          | (0.44      | )          | $ | (0.34 | ) |
| Basic - pro forma                                                                                                                            |       | $        | .07        |     | $          | (0.46      | )          | $ | (0.38 | ) |
| Diluted – pro forma                                                                                                                     |       | $        | .06        |     | $          | (0.46      | )          | $ | (0.38 | ) |

 

F-11

----

 

Stock optionsgranted to non-employees are accounted for in accordance with SFAS No. 123and the Emerging Issues Task Force (EITF) Abstract No. 96-18, *Accounting for Equity Instruments That Are Issued to Other ThanEmployees for Acquiring, or in**Conjunction with Selling,Goods or Services*, and related interpretations, which generallyrequires the value of options to be periodically remeasured and charged toexpense as they are earned over the performance period.  Compensation related to stock appreciationrights and other variable stock option or award plans should be measured at theend of each period.  The Company did notgrant any stock options to non-employees, during 2004, 2003, or 2002.

 

**Recent Accounting Pronouncements**

 

In November 2004, the FASB issued FASBStatement No. 151, “Inventory Costs – an amendment of ARB No. 43” (“SFASNo. 151”), which is the result of its efforts to converge U.S. accountingstandards for inventories with international Accounting Standards.  SFAS No. 151 requires idle facilityexpenses, freight, handling costs, and wasted material (spoilage) costs to berecognized as current-period charges.  Italso requires that allocation of fixed production overheads to the costs of conversionbe based on the normal capacity of the production facilities.  SFAS No. 151 will be effective forinventory costs incurred during fiscal years beginning after June 15,2005.  The Company is evaluating theimpact of this standard on its consolidated financial statements.

 

In December 2004, the FASB issued SFAS No. 123(Revised 2004) “Share-Based Payment” (“SFAS No. 123R”).  SFAS No. 123R addresses all forms ofshare-based payment (“SBP”) awards, including shares issued under employeestock purchase plans, stock options, restricted stock and stock appreciationrights.  SFAS No. 123R will requirethe Company to expense SBP awards with compensation cost for SBP transactionsmeasured at fair value.  The FASBoriginally stated a preference for a lattice model because it believed that alattice model more fully captures the unique characteristics of employee stockoptions in the estimate of fair value, as compared to the Black-Scholes modelwhich the Company currently uses for its disclosure.  The FASB decided to remove its explicitpreference for a lattice model and not require a single valuationmethodology.  SFAS No. 123R requiresthe Company to adopt the new accounting provisions beginning in our fiscal year2006.  The Company is evaluating theimpact of this standard and expects that it could have a material effect on itsconsolidated financial statements.

 

**Note 2****                    INDUSTRYSEGMENT, GEORGRAPHIC AND ENTERPRISE-WIDE REPORTING**

 

SFAS No. 131, *Disclosures about Segments of an Enterprise and Related Information*,(“SFAS No. 131”), requires companies to report selected information aboutoperating segments, as well as enterprise-wide disclosures about products,services, geographic areas and major customers. Operating segments are determined based on the way management organizesits business for making operating decisions and assessing

 

F-12

----

 

performance.  The Company’s chief decision-maker, asdefined under SFAS No. 131, is the chairman and chief executive officer.The Company has determined that it conducts its operations in one businesssegment: the development, manufacture, marketing and sale of process andformulation equipment.  The Company’ssales are primarily to companies with processing needs in 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 informationdisclosed herein represents all of the material financial information relatedto the Company’s principal operating segment.

 

Approximate sales to customers fromcontinuing operations by geographic markets, are as follows:

 
| ** **     | ** ** | **2004**  | ** **     | **2003**   | ** ** | **2002**       | ** ** |
|----------------|------------|-----------|----------------|------------|------------|----------------|------------|
| North  America |       | $         | 6,212,000      |       | $          | 5,337,000      |       | $ | 6,462,000 |   |
| Asia           |       | 3,774,000 |           | 3,204,000  |       | 2,350,000      |       |
| Europe         |       | 2,173,000 |           | 1,919,000  |       | 702,000        |       |
| ** **     | ** ** | **$**     | **12,159,000** | ** ** | **$**      | **10,460,000** | ** ** | **$** | **9,514,000** | ** ** |

 

Customers:

 

The users ofthe Company’s systems are in various industries, including the chemical,pharmaceuticals, food, cosmetic and biotechnology industries. Mizuho IndustrialCo. Ltd., the Company’s exclusive Japanese distributor of our Microfluidizerprocessor equipment and spare parts (Mizuho) and a wholly owned subsidiary ofTeva Pharmaceuticals Industries Ltd. (Teva) accounted for 20% and 13% respectivelyof the Company’s revenues from continuing operations in 2004. Two customers,Mizuho and Teva accounted for 21% and 11%, respectively, of the revenues fromcontinuing operations in 2003.  Teva andMizuho, respectively, accounted for 18% and 16% of the revenues from continuingoperations in 2002, respectively. Three customers accounted for 15%, 15%, and13% of the trade accounts receivable from continuing operations as of December 31,2004, respectively.  Two customersaccounted for 17% and 10% of the trade accounts receivable from continuingoperations as of December 31, 2003, respectively, and one customeraccounted for 13% of the trade accounts receivable as of December 31,2002.  Mizuho, as a distributor of theCompany’s equipment, sells the Company’s equipment to many of its own customersand therefore there is no actual reliance on a single customer.  It accounted for 20% of the Company’s 2004revenues and 21% of the Company’s 2003 revenues.  A reduction or delay in orders from others ofthese greater than 10% customers or other significant customers could have amaterial adverse effect on the Company’s results of operations.

 

F-13

----

 

**Note 3****                    INVENTORIES**

 

The components of inventories are as followsat December 31:

 
| ** **                            | ** ** | **2004**  | ** **    | **2003**   | ** ** |
|---------------------------------------|------------|-----------|---------------|------------|------------|
| Raw  materials                        |       | $         | 1,786,427     |       | $          | 1,580,991 |   |
| Work in  progress                     |       | 147,376   |          | 80,439     |       |
| Finished  goods                       |       | 117,335   |          | 132,273    |       |
|                                  |       | 2,051,138 |          | 1,793,703  |       |
| Less: provision  for excess inventory |       | 163,000   |          | 110,000    |       |
| **TOTAL**                             | ** ** | **$**     | **1,888,138** | ** ** | **$**      | **1,683,703** | ** ** |

 

F-14

----

 

**Note 4****                    ASSETSAVAILABLE FOR SALE**

 

In the fourthquarter of 2003 the Company determined that its Morehouse-COWLES Division (the “Division”)was not strategic to the Company’s on-going objectives and in December 2003,management committed to a plan to sell substantially all the assets andassociated liabilities of the Division. Accordingly, the Company reported the Division as a discontinuedoperation in accordance with SFAS No. 144. The Consolidated financial statements have been reclassified tosegregate the assets and associated liabilities available for sale andoperating results of these discontinued operations for all periods presented.

 

Assets and liabilities of discontinuedoperations are as follows:

 

| ** **                                        | ** ** | **December 31** | ** ** |
|---------------------------------------------------|------------|----------------------|------------|
| ** **                                        | ** ** | **2004**             | ** ** | **2003** | ** ** |
| Assets  available for sale                        | ** ** | ** **           | ** ** | ** ** | ** ** |
| Accounts  receivable-trade                        |       | $                    | —     |   | $ | 472,573 |   |
| Inventory                                         |       | —               |       | 2,204,128 |   |
| Prepaid  expense                                  |       | —               |       | 35,517 |   |
| Net property  and equipment                       |       | —               |       | 93,615 |   |
| Goodwill                                          |       | —               |       | — |   |
| Total assets  available for sale                  |       | —               |       | 2,805,833 |   |
| Less: provision  for loss on disposal             |       | —               |       | (1,422,715 | ) |
| Net assets  available for sale                    |       | $                    |       |   | $ | 1,383,118 |   |
|                                              |       |                 |       |   |   |
| Liabilities  associated with assets held for sale |       |                 |       |   |   |
| Accounts  payable and accrued expenses            |       | —               |       | 457,139 |   |
| Customer  deposits                                |       | —               |       | 203,956 |   |
| Liabilities  associated with assets held for sale |       | $                    | —     |   | $ | 661,095 |   |

 

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

 
| ** **                                                                                                  | ** ** | **2004** | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------|------------|------------|------------|------------|------------|
| Revenue                                                                                                     |       | $        | 323,635    |       | $          | 3,655,237  |       | $ | 5,059,202 |   |
| Cost of sales                                                                                               |       | 308,548  |       | 2,601,957  |       | 3,626,407  |       |
| Gross profit                                                                                                |       | 15,087   |       | 1,053,280  |       | 1,432,795  |       |
| Total operating  expenses                                                                                   |       | 238,760  |       | 3,740,490  |       | 1,754,837  |       |
|                                                                                                        |       |     |       |       |       |       |       |
| Loss from discontinued  operations before cumulative effect of change in accounting principle and  disposal |       | (223,673 | )          | (2,687,210 | )          | (322,042   | )          |
| Loss on  disposal of discontinued operations                                                                |       | (7,707   | )          | (1,422,715 | )          | —     |       |
| Cumulative  effect of change in accounting principle                                                        |       | —   |       | —     |       | (2,661,409 | )          |
| Loss from discontinued  operations                                                                          |       | $        | (231,380   | )          | $          | (4,109,925 | )          | $ | (2,983,451 | ) |

 

F-15

----

 

In December 2003, in conjunction withthe establishment of management’s plan to sell the Morehouse-COWLES Division,the Company determined that the remaining goodwill of $2,100,000 was fullyimpaired and accordingly charged to discontinued operations.

 

On February 9, 2004, pursuant to anAsset 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 preexisting relationshipsbetween MFIC and NuSil.

 

The assets of the Division that were soldincluded accounts receivable, furniture, fixtures and equipment, inventory andsupplies, books and records, bids, contracts, prepaid expenses, leases,intellectual property, goodwill, domain names and claims, all as described inthe Asset Purchase Agreement (collectively, the “Assets”). In addition, certainrights and obligations arising after February 9, 2004 under the Division’sPacifiCare Group Health Insurance Policy were assigned.  The Division’s cash on hand on February 9,2004 were excluded from the assets being sold. Under the Asset Purchase Agreement, the Division’s executory obligationsunder certain contracts and bids, and the Division’s accounts payable as of February 9,2004 in the amount of $623,240, were assumed by NuSil.

 

The purchase price (other than the assumptionof accounts 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(the “Purchase Note”) and $50,000 (the “Holdback Payment”) was withheld forpayment subject to any purchase price adjustments and offsets, as provided forin the Asset Purchase Agreement.  Inaccordance with the Asset Purchase Agreement, this Company received theholdback payment on March 26, 2004.

 

The Closing Cash was paid directly to PNCBank, National Association (“PNC”), to be applied to MFIC’s outstanding balanceunder MFIC’s Revolving Credit Loan with PNC (the “Revolving Credit Loan”).

 

The aforementioned Purchase Note bearsinterest at 5 percent per annum, is secured by the Assets pursuant to aSecurity Agreement dated February 5, 2004 (the “Security Agreement”)between the parties and is subject to certain offsets as provided in the AssetPurchase Agreement.  Principal andinterest on the Purchase Note are payable on February 9, 2005, unlessthere is a claim for an offset as allowed for under the Asset Purchase Agreement,which claim might delay final payment of amounts due under the Purchase Noteuntil final resolution of any such claim under the procedures outlined in theAsset Purchase Agreement.

 

Pursuant to the Asset Purchase Agreement,MFIC entered into 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.

 

F-16

----

 

 

**Note 5****                    INTANGIBLESAND OTHER ASSETS**

 

In 2001, theCompany capitalized $64,528 of costs related to the Multiple-Stream HighPressure Mixer Reactor patent, with an additional $28,582 of costs related tothis patent capitalized in 2004.  Thesecosts are being amortized over a 17-year period, beginning in the last quarterof 2001.  Amortization of these costs was$9,747 in 2004, and $3,800 in both 2003 and 2002.

 

In 1995, theCompany capitalized $96,680 of patent costs related to a cooperative researchventure.  Amortization of these assetscharged to expense was $0 in 2004 and 2003, and $14,896 in 2002.

 

Costs incurredin connection with the debt refinancing that occurred on March 3, 2004 arebeing amortized over four years, the initial term of the line of credit.  The total of such costs was approximately$36,533.  Amortization of these costsamounted to $8,978 in 2004.

 

Costs incurredin connection with the debt refinancing that occurred on February 28, 2000were amortized over three years, the initial term of the line of credit.  The total of such costs which are fullyamortized was approximately $207,000. Amortization of these costs amounted to $11,534 in 2003, and $69,204 in2002.

 

**Note 6**                    GOODWILL

 

In 1998, MFICpurchased substantially all of the assets and assumed certain liabilities ofEpworth Manufacturing Company, Inc. of South Haven, Michigan (Epworth) andMorehouse-COWLES, Inc. of Fullerton, California (Morehouse-COWLES)pursuant to an Asset Purchase Agreement.

 

In accordancewith the Agreement, MFIC paid the following as consideration for the purchaseprice: (i) $5,508,480 in cash, (ii) two subordinated promissory notesin the aggregate principal amount of $800,000 (the Promissory Notes) and (iii) 900,000shares of MFIC’s restricted common stock, $0.01 par value per share, subject tothe restrictions as defined.  MFIC alsoincurred approximately $500,000 in expenses. In addition, MFIC assumed approximately $1,930,000 in accounts payableand accrued liabilities. The acquisition had been accounted for under thepurchase method of accounting, and the Company recognized goodwill of$6,194,459 which was fully allocated to Morehouse-COWLES.

 

On January 1, 2002, the Company adopted SFAS No. 142, *Goodwill and Other Intangible Assets*, which requirescompanies to discontinue the amortization of goodwill and certain intangibleassets with an indefinite useful life. Instead, SFAS No. 142 requires thatgoodwill and intangible assets deemed to have an indefinite useful life bereviewed for impairment upon adoption of SFAS No. 142 and annuallythereafter.

 

Upon adoption of SFAS No. 142 in the first quarter of 2002, the Companyrecorded a one-time, noncash charge of $2,661,409 to reduce the carrying valueof its goodwill.  Such charge isnonoperational in nature and is reflected as a cumulative effect of anaccounting change pursuant to the SFAS No. 142 transition rules.

 

F-17

----

 

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

 

Long-term debt as of thefollowing dates consisted of:

 
| ** **                                      | ** ** | **December 31,** | ** **  |
|-------------------------------------------------|------------|-----------------------|-------------|
| ** **                                      | ** ** | **2004**              | ** **  | **2003** | ** ** |
| Line of  credit                                 |       | $                     | —      |   | $ | 2,425,613 |   |
| 10%  subordinated note payable to related party |       | 6,250                 |        | 81,250 |   |
| Term note  payable                              |       | 812,503               |        | 58,735 |   |
|                                            |       | 818,753               |        | 2,565,598 |   |
| Less current  portion                           |       | (256,250              | )           | (2,559,348 | ) |
| Long term  debt, net of current portion         | ** ** | **$**                 | **562,503** | ** ** | **$** | **6,250** | ** ** |

 

**Subordinated Note Payable**

 

The subordinated note is payable to LakeShore Industries Inc., a related party as defined and disclosed in Note 13 ofthe financial statements.

 

**Notes Payable**

 

In October, 2000, the Company entered into asettlement agreement related to a warranty claim dating back to 1998 for theEpworth Mill division pursuant to which the Company paid $100,000 uponexecution of the agreement, and executed a promissory note for $350,000 payabletwo years from the execution date, with interest payable quarterly in arrearsat 10% per annum.  The Company paid offthe balance of this note in December 2002.

 

F-18

----

 

**Credit Facility**

 

On February 28, 2000, the Companyentered into a revolving credit and term loan agreement with National Bank ofCanada (together with its successors, the Lender) providing the Company with a$4,475,000 three-year revolving credit and term loan facility.  The Credit Facility was comprised of: (i) a$4 million three year revolving line of credit (Revolving Credit Line) withadvances thereunder bearing interest at an interest rate equal to the primerate (the Prime Rate for United States borrowings from the National Bank ofCanada as publicly announced from time to time) plus one-half percent(0.50%).  All borrowings under theRevolving Credit Line were evidenced by a $4 million promissory note having amaturity date of February 28, 2003 (the Revolving Note), and (ii) a$475,000 term promissory note, amortized over a five-year period but having amaturity date of February 28, 2003 and bearing interest at an interestrate equal to the Prime Rate (4.75% at December 31, 2001) plus threequarters of one percent (0.75%).  Loansunder the Credit Facility were secured by a collateral pledge to the Lender ofsubstantially all the assets of the Company and its subsidiaries. The Company’sMicrofluidics Corporation subsidiary guaranteed the Company’s obligations tothe Lender under the Credit Facility. The Company also pledged to the Lenderall shares of Microfluidics Corporation owned by the Company.

 

On January 16, 2002, the United Statesportion of National Bank of Canada’s operations and its loan portfolio was soldto PNC Bank, N.A. On February 19, 2003, the Company and PNC Bank, N.A.entered into an extension of the loan for an additional year, until February 28,2004.

 

On March 29, 2002, the Company and theLender agreed on a revised set of covenants for fiscal 2002 under a secondamendment to the original agreement. On February 19, 2003, the Company andthe Lender entered into a third amendment to the original agreement extendingthe credit facility for an additional year until February 28, 2004, withno change to the revised covenants agreed upon under a March 29, 2002agreement.

 

On February 6**,**2004 the Company and PNC Bank, N.A (“PNC”) entered into a Fourth Amendment andWaiver to Revolving Credit and Term Loan Agreement permitting the sale of theassets of the Company’s Morehouse-COWLES Division in exchange for payment toPNC of all monies received by the Company in connection with such sale andassignment to PNC of deferred payments and a promissory note from the purchaseissued as part of the purchase price. On March 3, 2004, the outstandingloan balance was repaid from the proceeds of a new senior debt financing fromBanknorth, N.A.

 

Due to the subjective acceleration clause,and the lock-box arrangement, the revolving credit line is classified as acurrent liability in the consolidated balance sheet. At December 31, 2004and 2003, the outstanding balance on the Revolving Credit Line was $0 and$2,425,613, having an interest rate of 5.25%. The balance outstanding on theterm loan was $812,503, at an interest rate of 5.67%.

 

F-19

----

 

At December 31, 2003, the Company wouldnot have met the net income covenant which, according to the terms of thelending agreement, would have required a waiver from its previous lender,PNC.  However, in conjunction with the subsequentcredit facility it obtained from the new lender, Banknorth, N.A., no waiver wasrequired from the previous lender.

 

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 comprised of (i) a $1,000,000 demandrevolving line of credit (“The Revolving Credit Line”) with advances thereunderbearing interest at an interest rate equal to the prime rate (the Prime Ratefor United States borrowings from Banknorth, N.A. as publicly announced fromtime to time).  All borrowings under theRevolving Credit Line were evidenced by a $1,000,000 demand promissory note(the “Revolving Note”), and (ii) a $1,000,000 term promissory note,amortized over a four year period but having a maturity date of March 3,2008 and bearing interest at an interest rate equal to the Federal Home LoanBank Classic Rate at March 4, 2004 plus two and one-half percent(2.50%).  Loans under the Credit Facilityare secured by a collateral pledge to the New Lender of substantially all theassets of the Company and its subsidiaries. The Company’s Microfluidics Corporation subsidiary guaranteed theCompany’s obligations to the New Lender under the Credit Facility.  The Company also pledged to the New Lenderall shares of Microfluidics Corporation owned by the Company.  The Company is required to meet two covenantson an annual (calendar) basis as of December 31 of a given year.  (i) The Company’s senior debt may not bemore than four times the amount of its tangible capital base, and (ii) itsdebt service coverage ratio may not be less than 1.20 to 1. At December 31,2004, the Company was in compliance with both covenants.

 

**Note 8****                    EMPLOYEEBENEFIT PLANS**

 

The Company offers a 401(k) profit-sharingplan (the 401K Plan), to its employees. All Company and related entity employees who are eighteen years of ageand have completed one hour of service are eligible to participate in the 401KPlan.  Employees may contribute from 1%to 20% of their compensation.  TheCompany’s contribution is discretionary, with contributions made from time totime as management deems advisable. The Company made no matching contributionsduring 2004, 2003 or 2002.  The Companyalso instituted a cafeteria plan in 1992, giving the employees certain pre-taxadvantages on specific payroll deductions.

 

F-20

----

 

**Note 9****                    INCOMETAXES**

 

The benefit for income taxes is as follows:

 
| ** ** | ** ** | **Year ended December 31** | ** ** |
|------------|------------|---------------------------------|------------|
| ** ** | ** ** | **2004**                        | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** ** | ** ** | **(In thousands)**              | ** ** |
| Deferred:  |       |                            |       |   |   |   |   |
| Federal    |       | $                               | 345,000    |   | $ | — |   | $ | — |   |
| State      |       | 105,000                         |       | — |   | — |   |
|       |       |                            |       |   |   |   |   |
|       |       | $                               | 450,000    |   | $ | — |   | $ | — |   |

 

The amount reported as income tax benefit in 2004 is theresult of the reversal of tax reserves recorded in prior years.

 

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

 
| ** **                                               | ** ** | **Year ended December 31** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **2004**                        | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                               | ** ** | **(In thousands)**              | ** ** |
| Federal  income tax at statutory rate                    |       | 34.0                            | %          | 34.0 | % | 34.0 | % |
| State income  taxes, net of Federal Benefit              |       | 6.3                             | %          | 6.3 | % | 6.3 | % |
| Net research  and development and other tax credits      |       | —                          |       | — |   | — |   |
| Valuation  allowance                                     |       | (152.6                          | )%         | (40.3 | )% | (40.3 | )% |
| Reversal of valuation  allowance recorded in prior years |       | 6.5                             | %          | — |   | — |   |
| Total income  tax benefit                                |       | (106                            | )%         | 0 | % | 0 | % |

 

F-21

----

 

The following isa summary of the significant components of the Company’s deferred tax assetsand liabilities:

 
| ** **                                                         | ** ** | **Year  ended December 31** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                         | ** ** | **2004**                         | ** ** | **2003** | ** ** |
| ** **                                                         | ** ** | **(In thousands)**               | ** ** |
| Deferred tax  assets:                                              | ** ** | ** **                       | ** ** | ** ** | ** ** |
|                                                               | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Purchased  intangibles                                             |       | $                                | 11,000     |   | $ | — |   |
|                                                               |       |                             |       |   |   |
| Net operating  loss carryforwards                                  |       | 4,683,000                        |       | 1,757,000 |   |
|                                                               |       |                             |       |   |   |
| Research and  development and other credits                        |       | 180,000                          |       | 171,000 |   |
|                                                               |       |                             |       |   |   |
| Accruals and  allowances not currently deductible for tax purposes |       | 129,000                          |       | 2,332,000 |   |
|                                                               |       |                             |       |   |   |
| Depreciation  and other                                            |       | (440,000                         | )          | — |   |
|                                                               |       |                             |       |   |   |
| Valuation  allowance                                               |       | (4,063,000                       | )          | (4,260,000 | ) |
|                                                               |       |                             |       |   |   |
| Total  deferred tax assets                                         |       | $                                | 450,000    |   | $ | — |   |

 

AtDecember 31, 2004, the Company has available net operating losscarryforwards of approximately $11,505,000 expiring at various dates through 2024,federal research and development credit carryforwards of approximately $171,000expiring in varying amounts during the period 2004 through 2019 and state andresearch and development credit carryforwards of approximately $9,000 expiringin varying amounts during the period 2004****through 2019.Ownership changes, as defined in the Internal Revenue Code, may have limitedthe amount of net operating loss carry forwards that can be utilized annuallyto offset future taxable income. Subsequent ownership changes could furtheraffect the limitation in future years.

 

F-22

----

 

**Note 10****                  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 grantedunder the Plans vest over a three-to-five-year period and expire 5 - 10 yearsfrom the grant date.  At December 31,2004, 907,815 shares were available for future grant under the Plans.Information with respect to activity under the Plans are as follows:

 

| ** **                          | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|-------------------------------------|------------|-----------------------|------------|---------------------------------------|------------|
|                                |       |                  |       |                                  |       |
| Outstanding, December 31, 2000 |       | 1,761,575             |       | $                                     | 0.94       |   |
| Granted                             |       | 328,500               |       | 0.81                                  |       |
| Exercised                           |       | (24,375               | )          | 0.31                                  |       |
| Canceled                            |       | (452,720              | )          | 0.98                                  |       |
| Outstanding, December 31, 2001 |       | 1,612,980             |       | 0.88                                  |       |
| Granted                             |       | 532,045               |       | 0.52                                  |       |
| Exercised                           |       | (19,375               | )          | 0.31                                  |       |
| Canceled                            |       | (115,000              | )          | 0.60                                  |       |
| Outstanding, December 31, 2002 |       | 2,010,650             |       | 0.90                                  |       |
| Granted                             |       | 257,409               |       | 0.47                                  |       |
| Exercised                           |       | (186,377              | )          | 0.78                                  |       |
| Canceled                            |       | (152,020              | )          | 1.13                                  |       |
| Outstanding, December 31, 2003 |       | 1,929,662             |       | 0.74                                  |       |
| Granted                             |       | 392,668               |       | 2.27                                  |       |
| Exercised                           |       | (440,532              | )          | 0.79                                  |       |
| Canceled                            |       | (93,585               | )          | 0.67                                  |       |
| Outstanding, December 31, 2004 |       | 1,788,213             |       | $                                     | 1.14       |   |
|                                |       |                  |       |                                  |       |
| Exercisable, December 31, 2002 |       | 1,093,972             |       | $                                     | 1.01       |   |
|                                |       |                  |       |                                  |       |
| Exercisable, December 31, 2003 |       | 1,102,020             |       | $                                     | 0.96       |   |
|                                |       |                  |       |                                  |       |
| Exercisable, December 31, 2004 |       | 979,763               |       | $                                     | 0.79       |   |

 

F-23

----

 

The following tablesummarizes information relating to outstanding and exercisable stock options asof December 31, 2004:

 
| **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 – .90    |       | 919,938               |       | 5.5 |   | $ | .53 |   | 518,013 |   | $ | 0.54 |   |
| .95 – 2.48     |       | 861,423               |       | 7.0 |   | 1.63 |   | 461,750 |   | 1.07 |   |
| 3.12 – 4.25    |       | 6,852                 |       | 9.5 |   | 3.69 |   | 0 |   |   |   |
|                |       | 1,788,213             |       |   |   |   |   | 979,763 |   |   |   |
|                     |            |                       |            |  |  |  |  |  |  |  |  |  |  |

** **

**Accountingfor 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 Company has determined that it willcontinue to account for stock-based compensation for employees under APBOpinion No. 25, *Accounting for Stockissued to Employees*, and elect the disclosure-only alternative underNo. SFAS 123.

 

The Company hascomputed the pro forma disclosures required under SFAS No. 123 for itsstock compensation plan for employees during the years ended December 31,2004, 2003 and 2002 using the Black-Scholes option pricing model under the fairvalue method as prescribed by SFAS No. 123.  The assumptions used for the years ended December 31,2004, 2003 and 2002 are as follows:

 

| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Risk-free interest rates |       | 3.55                  | %          | 4.75 | % | 4.36 | % |
| Expected lives           |       | 5 years               |       | 5 years |   | 5 years |   |
| Expected volatility      |       | 106                   | %          | 164 | % | 75 | % |
| Dividend yield           |       | 0                     | %          | 0 | % | 0 | % |

 

F-24

----

 

**Private Placement**

 

On March 31, 2004, the Company completeda private placement of investment units (each unit consisting of one share ofcommon stock and a 3-year warrant to purchase an additional 1⁄2 share of commonstock).  A total of 1,426,616 units weresold, yielding gross proceeds of $3,566,540. The units were priced at $2.50 and the associated warrants areexercisable at $3.05.  Additionally, theplacement agent for the offering received 5 year warrants to purchase 142,662shares of common stock 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 ChiefExecutive Officer of the Company, Irwin J. Gruverman, was granted warrants topurchase up to 100,000 shares of the Company’s common stock at a price of $0.52per share, having an expiration date of July 2, 2004.  The warrants were exercised on November 25,2003.

 

On November 17, 2004, the Company enteredinto a general financial and advisory services agreement with Maxim Group LLCpursuant to which Maxim Group LLC was granted a three (3) year warrant topurchase 100,000 shares of the Company’s common stock at an exercise price of$3.20 per share.

 

**Employee Stock Purchase Plan**

 

The Company has an employee stock purchaseplan (the Purchase Plan). Under the Purchase Plan, participants are granted optionsto purchase the Company’s common stock twice a year at the lower of 85% ofmarket value at the beginning or end of each period. Calculation of the numberof options granted, and subsequent purchase of these shares, is based uponvoluntary payroll deductions during each six-month period. The number ofoptions granted to each employee under this plan is limited to a maximum amountof 1,000 shares for each six-month period. The number of shares issued pursuantto this plan totaled 26,678, 36,717, and 29,207, in 2004, 2003, and 2002,respectively.

 

**Note 11****                  COMMITMENTS**

 

The Company leases its facilities undernon-cancelable operating leases expiring through August 2006.  Future minimum rental payments under theoperating leases at December 31, 2004 are approximately as follows:

 
| 2005                     |       | $       | 339,000     |       |
|--------------------------|------------|---------|-------------|------------|
| 2006                     |       | 152,000 |        |
| **Total Lease Payments** | ** ** | **$**   | **491,000** | ** ** |

 

F-25

----

 

Rent expense for 2004, 2003, and 2002 wasapproximately $357,000, $439,000, and $402,000, respectively. A portion of thespace is sublet to a non-affiliated company under a tenant-at-will arrangementfor a total of $12,000 per annum.

 

**Note 12****                  RELATEDPARTY TRANSACTIONS**

 

As discussed in Notes 6 and 13, the Companyowed the former principals of Morehouse and Epworth $6,250, $81,250, and$156,250 at December 31, 2004, 2003, and 2002, respectively.  Interest capitalized on the $300,000 note inconnection with the Settlement Agreement discussed in Note 13 amounted to$88,750 and is being amortized over 5 years. Total payments in 2004 and 2003were $4,757 and $12,340, respectively.

 

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

 

On December 20, 1999 the Company signedan agreement in principle (the Agreement In Principle) with J.B. Jennings andBret A. Lewis, the former owners of the Epworth Mill and Morehouse-COWLESbusinesses (the Sellers), Lake Shore Industries, Inc., and JLJ Properties, Inc.,entities owned and controlled by the Sellers. The Agreement In Principle sets forth understandings among the partiesconcerning restructuring of the Company’s subordinated debt and resolution ofvarious disputes.  On January 17,2000, a definitive settlement agreement incorporating these subject matters wasexecuted between the parties (the Settlement Agreement).  In connection with the closing of the CreditFacility, and pursuant to a Settlement Agreement dated January 17, 2000with 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 theapproximate amount of $77,500, and accrued interest on the August 14, 1998$300,000 subordinated note were converted to 500,000 shares of MFIC restrictedcommon stock (the Conversion Shares). The fair market value of the Company’sCommon Stock on the date of the Agreement In Principle was $0.31 pershare.  MFIC was granted the right for athree-year period to repurchase the Conversion Shares at a purchase price of$1.75 per share. The August 14, 1998 $300,000 subordinated note wasreplaced with a new $300,000 subordinated promissory note dated February 28,2000 (the 2000 Subordinated Note). The 2000 Subordinated Note has a maturitydate of February 28, 2005 and bears interest at a rate of ten percent(10%) per annum. The note is payable interest only in its first year and thenis payable in equal quarterly installments of principal together withoutstanding interest thereon until maturity.

 

F-26

----

 

**Note 14****                  QUARTERLYRESULTS OF OPERATIONS**

 

Summarized unaudited quarterly financial dataare as follows:

 
| ** **                                                              | ** ** | **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 |   |
| Basis 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-27

----

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

 

F-28

----

 

**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  attached as Exhibit 10.62                                                                                                                                                                                                                                                                                                                                                                       |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 4.3                 |       | Form of  Warrant issued to investors in the private placement described in the  Placement Agency Agreement attached as Exhibit 10.62                                                                                                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.1                |       | 1987 Stock  Plan (filed as Exhibit 10(g) to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 1987 and incorporated herein by  reference).                                                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.2                |       | 1988 Stock  Plan (filed as Exhibit 10(g) to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 1988 and incorporated herein by  reference).                                                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.3                |       | 1989  Non-Employee Directors Stock Option Plan (filed as Exhibit 10.1 to the  Company’s registration statement on Form S-8 filed October 22, 1996  and incorporated herein by reference).                                                                                                                                                                                                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.4                |       | Lease for 30  Ossipee Road, Newton, Massachusetts dated May 23, 1997 between  Microfluidics International Corporation and J. Frank Gerrity, Trustee of 1238  Chestnut Street Trust under Declaration of Trust dated May 23, 1969,  recorded with Middlesex South Registry of Deeds in Book 11682, Page 384  (filed as Exhibit 3.10(a) to the Company’s form 10-Q for the  quarterly period ended June 30, 1997 and incorporated herein by  reference). |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.5                |       | Letter of  Understanding between Microfluidics International Corporation and Worcester  Polytechnic Institute dated as of April 3, 1992 (filed as Exhibit 3.10(f) to  the Company’s Form 10-K for the fiscal year ended December 31, 1993  and incorporated herein by reference).                                                                                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.6                |       | Agreement  between Microfluidics International Corporation and Catalytica, Inc. dated  as of October 18, 1993 (filed as Exhibit 3.10(g) to the  Company’s Form 10-K for the fiscal year ended December 31, 1993 and  incorporated herein by reference) with amendments dated September 1,  1994 and March 31, 1995.                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.7                |       | Amendment to  agreement dated September 1, 1994 between Microfluidics International  Corporation and Catalytica, Inc. dated as of October 18, 1993  (filed as Exhibit 3.10(g) to the Company’s Form 10-K for the  fiscal year ended December 31, 1993, and incorporated herein by reference).                                                                                                                                                     |

 

----

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

 

----

 
| 10.20  |   | Asset Purchase Agreement, dated as of June 19,  1998, by and among the Company, Epworth Manufacturing Company and  Morehouse-COWLES, Inc. (filed as Exhibit 2.1 to Schedule 13D  of Bret A. Lewis, File No. 005-35850, and incorporated herein by  Reference).                               |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                  |
| 10.21  |   | Stockholders Agreement, dated August 14,  1998, by and among the Company and J.B. Jennings and Bret A. Lewis (filed as Exhibit 2.2  to Schedule 13D of Bret A. Lewis, File No. 005-35850, and  incorporated herein by reference).                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                  |
| 10.22  |   | $500,000 Subordinated Promissory Note  issued by the Company to Epworth Manufacturing Company (filed as Exhibit 99.2  to the Company’s Form 8-K on August 27, 1998, File No. 000-11625,  and incorporated herein by reference).                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                  |
| 10.23  |   | $300,000 Subordinated Promissory Note  issued by the Company to Epworth Manufacturing Company (filed as Exhibit 99.2  to the Company’s Form 8-K on August 27, 1998, File No. 000-11625,  and incorporated herein by reference).                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                  |
| 10.26  |   | Revolving Credit and Term Loan Agreement  among MFIC Corporation and National Bank of Canada dated February 28,  2000. (Filed as Exhibit 10.26 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.)                 |
|   |   |                                                                                                                                                                                                                                                                                                                  |
| 10.27  |   | Revolving Credit Note of the Company in  favor of National Bank of Canada in the amount of $4,000,000.00 dated February 28,  2000. (Filed as Exhibit 10.27 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.)     |
|   |   |                                                                                                                                                                                                                                                                                                                  |
| 10.28  |   | Term Note of the Company in favor of  National Bank of Canada in the amount of $475,000.00 dated February 28,  2000. (Filed as Exhibit 10.28 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.)                   |
|   |   |                                                                                                                                                                                                                                                                                                                  |
| 10.29  |   | Security Agreement of the Company in favor  of National Bank of Canada dated February 28, 2000. (Filed as Exhibit 10.29  to the Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                        |
|   |   |                                                                                                                                                                                                                                                                                                                  |
| 10.30  |   | Trademark and Trademark Applications  Security Agreement of the Company in favor of National Bank of Canada, dated February 28,  2000. (Filed as Exhibit 10.30 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.) |
|   |   |                                                                                                                                                                                                                                                                                                                  |
| 10.31  |   | Patent and Patent Applications Security  Agreement of the Company in favor of National Bank of Canada, dated February 28,  2000. (Filed as Exhibit 10.31 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.)       |

 

----

 
| 10.32  |   | Unlimited Guaranty of Microfluidics  Corporation in favor of National Bank of Canada dated February 28, 2000.  (Filed as Exhibit 10.32 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                                           |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.33  |   | Stock Pledge Agreement between the Company  and National Bank of Canada dated February 28, 2000. (Filed as Exhibit 10.33  to the Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.34  |   | Subordination Agreement among the Company,  Lake Shore Industries, Inc. and National Bank of Canada dated as of February 28,  2000. (Filed as Exhibit 10.34 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.35  |   | Subordinated Promissory Note on the Company  in favor of Lake Shore Industries, Inc. in the amount of $300,000.00  dated February 28, 2000. (Filed as Exhibit 10.35 to the Company’s  Annual Report on Form 10-K for fiscal year ended December 31, 2000,  and incorporated herein by reference.)                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.37  |   | Settlement Agreement, dated January 17,  2000 by and among the Company, Bret A. Lewis, J. B. Jennings, Lake Shore  Industries, Inc., and JLJ Properties, Inc., with $300,000  Subordinated Promissory Note dated February 28, 2000, issued by the  Company to Lake Shore Industries, Inc. (FKA Epworth Manufacturing Company,  Inc). (Filed as Exhibit 10.37 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.38  |   | Letter, dated December 31, 1999, from  MFIC Corporation to Irwin J. Gruverman and G&G Diagnostics Corp. (Filed  as Exhibit 10.38 to the Company’s Annual Report on Form 10-K for  fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.39  |   | Letter, dated December 31, 1999, from  MFIC Corporation to Irwin J. Gruverman. (Filed as Exhibit 10.39 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.40  |   | First Amendment to Revolving Credit and  Term Loan Agreement between the Company and National Bank of Canada dated March 30,  2000. (Filed as Exhibit 10.40 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.41  |   | Lease between ABB and Microfluidics dated April 14,  2000 for space at Lampertheim, Germany. (Filed as Exhibit 10.41 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.42  |   | Security Agreement between MFIC Corporation  and J.M. Huber Corporation dated October 18, 2000. (Filed as Exhibit 10.42  to the Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.43  |   | Settlement agreement between MFIC  Corporation and J.M. Huber Corporation dated December 18, 2000. (Filed  as Exhibit 10.43 to the Company’s Annual Report on Form 10-K for  fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                                                                      |

 

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| 10.44  |   | Letter, dated December 31, 2000, from  MFIC Corporation to Irwin J. Gruverman and G&G Diagnostics Corporation.  (Filed as Exhibit 10.45 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2000, and incorporated herein by  reference.)                                                                                                                                                                                                               |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.45  |   | Letter, dated December 31, 2000, from  MFIC Corporation to Irwin J. Gruverman. (Filed as Exhibit 10.46 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2000, and incorporated herein by reference.)                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.46  |   | Lease for 30 Ossipee Road, Newton,  Massachusetts dated October 19, 2001, between Microfluidics  International Corporation and King Real Estate Corp., Trustee of 1238  Chestnut Street Trust under Declaration of Trust dated May 23, 1969,  recorded with Middlesex South Registry of Deeds in Book 11682, Page 384.  (Filed as Exhibit 10.47 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 21, 2001, and incorporated herein by  reference.) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.47  |   | Consulting agreement with Vincent Cortina  dated January 2, 2002. (Filed as Exhibit 10.48 to the Company’s  Annual Report on Form 10-K for fiscal year ended December 31, 2001,  and incorporated herein by reference.)                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.48  |   | Letter dated December 31, 2001 from  MFIC Corporation to Irwin J. Gruverman. (Filed as Exhibit 10.49 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2001, and incorporated herein by reference.)                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.49  |   | Second Amendment to Revolving Credit and  Term Loan Agreement between the Company and PNC Bank, N.A. dated March 29,  2002. (Filed as Exhibit 10.50 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2001, and incorporated herein by  reference.)                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.50  |   | 1986 Employee Stock Purchase Plan as  Amended (Filed as Exhibit 10.51 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2001, and incorporated herein by  reference.)                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.51  |   | 1988 Stock Plan as Amended. (Filed as Exhibit 10.52  to the Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2001, and incorporated herein by reference.)                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.52  |   | Letter dated December 31, 2002 from  MFIC Corporation to Irwin J. Gruverman. (Filed as Exhibit 10.53 to the  Company’s Annual Report on Form 10-K for fiscal year ended December 31,  2002, and incorporated herein by reference)                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.53  |   | Third Amendment to Revolving Credit and  Term Loan Agreement between the Company and PNC Bank N.A. dated February 19,  2003. (Filed as Exhibit 10.54 to the Company’s Annual Report on Form 10-K  for fiscal year ended December 31, 2002, and incorporated herein by  reference)                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.54  |   | Fourth Amendment and Waiver to Revolving  Credit and Term Loan Agreement between the Company and PNC Bank, N.A. dated February 6,  2004 (Filed as Exhibit 10.54 to the Company’s Form 10-K dated December 31,  2003, and incorporated herein by reference).                                                                                                                                                                                                                             |

 

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| 10.55  |   | Asset Purchase Agreement dated February 5,  2004, by and among MFIC Corporation and Morehouse-COWLES, Inc. (Filed as  Exhibit 2 to the Company’s Form 8K dated February 13, 2004,  and incorporated herein by reference.)        |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                           |
| 10.56  |   | Revolving Line of Credit Note in the amount  of $1,000,000 in favor of Banknorth, N.A. dated March 3, 2004 (Filed as Exhibit 10.56  to the Company’s Form 10-K dated December 31, 2003, and  incorporated herein by reference).       |
|   |   |                                                                                                                                                                                                                                                           |
| 10.57  |   | Letter dated December 31, 2003 from  MFIC Corporation to Irwin Gruverman (Filed as Exhibit 10.57 to the  Company’s Form 10-K dated December 31, 2003, and incorporated  herein by reference).                                         |
|   |   |                                                                                                                                                                                                                                                           |
| 10.58  |   | 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 Form 10-K dated December 31, 2003, and  incorporated herein by reference).                   |
|   |   |                                                                                                                                                                                                                                                           |
| 10.59  |   | Loan and Security Agreement between  Banknorth, N.A. and the Company dated March 3, 2004 (Filed as Exhibit 10.59  to the Company’s Form 10-K dated December 31, 2003, and  incorporated herein by reference).                         |
|   |   |                                                                                                                                                                                                                                                           |
| 10.60  |   | 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 Form 10-K dated December 31, 2003, and incorporated  herein by reference).                    |
|   |   |                                                                                                                                                                                                                                                           |
| 10.61  |   | 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 Form 10-K dated December 31, 2003, and  incorporated herein by reference).                       |
|   |   |                                                                                                                                                                                                                                                           |
| 10.62  |   | Placement Agency Agreement between the  Company and Casimir Capital L.P. dated February 13, 2004 (Filed as Exhibit 10.62  to the Company’s Form 10-K dated December 31, 2003, and  incorporated herein by reference).                 |
|   |   |                                                                                                                                                                                                                                                           |
| 10.63  |   | 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 Form 10-K dated December 31,  2004, and incorporated herein by reference). |
|   |   |                                                                                                                                                                                                                                                           |
| 10.64  |   | Registration Rights Agreement between the  Company and Purchasers dated March 16, 2004 (Filed as Exhibit 10.64  to the Company’s Form 10-K dated December 31, 2003, and  incorporated herein by reference).                           |
|   |   |                                                                                                                                                                                                                                                           |
| *10.65 |   | Lease between ABB and MFIC Corporation  dated April 1, 2004 for space at Lampertheim, Germany                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                           |
| *10.66 |   | 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.                                                                             |

 

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| 10.67  |   | Report on Form 8-K regarding  preliminary unaudited fiscal 2003 and fourth quarter sales results dated March 5,  2004.                                                 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                             |
| 10.68  |   | Report on Form 8-K regarding the  commencement of a private placement offering dated February 20, 2004.                                                                |
|   |   |                                                                                                                                                                             |
| 10.69  |   | Report on Form 8-K regarding the  disposition of selected assets and liabilities dated February 13, 2004.                                                              |
|   |   |                                                                                                                                                                             |
| 14.    |   | Code of Ethics, as adopted by the Company (Filed  as Exhibit 14. to the Company’s Form 10-K dated December 31,  2003, and incorporated herein by reference). |
|   |   |                                                                                                                                                                             |
| 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.                   |

 

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*Filedherewith

**Management contracts or compensatory plan or arrangement required tobe filed as an exhibit to this Form 10-K pursuant to Item 14 of thisreport.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized, in thecity of Newton, Commonwealth of Massachusetts, on the 11th day of March 2005.

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

 

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

 
| **Signature**           | ** ** | **Title**                 | ** **              | **Date** |
|-------------------------|------------|---------------------------|-------------------------|----------|
|                    |       |                      |                    |     |
|                    |       |                      |                    |     |
| /s/ Irwin J. Gruverman  |       |                      | Chief Executive Officer |     | March 11, 2005 |
| Irwin J. Gruverman      |       | (Principal Executive      |                    |     |
|                    |       | Officer), Chairman of the |                    |     |
|                    |       | Board of Directors and    |                    |     |
|                    |       | Secretary                 |                    |     |
|                    |       |                      |                    |     |
|                    |       |                      |                    |     |
| /s/ Dennis P.Riordan    |       |                      | Controller              |     | March 11, 2005 |
| Dennis P. Riordan       |       | (Principal Financial and  |                    |     |
|                    |       | Accounting Officer)       |                    |     |
|                    |       |                      |                    |     |
|                    |       |                      |                    |     |
| /s/ James N. Little     |       |                      | Director                |     | March 11, 2005 |
| James N. Little         |       |                      |                    |     |
|                    |       |                      |                    |     |
|                    |       |                      |                    |     |
| /s/ Vincent Cortina     |       |                      | Director                |     | March 11, 2005 |
| Vincent Cortina         |       |                      |                    |     |
|                    |       |                      |                    |     |
|                    |       |                      |                    |     |
| /s/ Leo Pierre Roy      |       |                      | Director                |     | March 11, 2005 |
| Leo Pierre Roy          |       |                      |                    |     |
|                    |       |                      |                    |     |
|                    |       |                      |                    |     |
| /s/ Edward T. Paslawski |       |                      | Director                |     | March 11, 2005 |
| Edward T. Paslawski     |       |                      |                    |     |
|                         |            |                           |                         |          |  |  |  |  |  |

 

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**SCHEDULE II**

 

**MFICCORPORATION**

 

Valuation and QualifyingAccounts and Reserves

For the years ended December 31,2004, 2003, and 2002

 
| ** **                                                          | ** ** | **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, 2004                          |       | $                                    | 58,500     |                                          | $          | 25,447                           |       | $                              | 70,744     |   | $ | 13,203 |   |
| For the year  ended December 31, 2003                          |       | 33,500                               |       | 25,000                                        |       | —                           |       | 58,500                         |       |
| For the year  ended December 31, 2002                          |       | 48,500                               |       | —                                        |       | 15,000                           |       | 33,500                         |       |
|                                                                |       |                                 |       |                                          |       |                             |       |                           |       |
| INVENTORY  RESERVE                                                  |       |                                 |       |                                          |       |                             |       |                           |       |
| 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                        |       |
| For the year  ended December 31, 2002                          |       | 40,000                               |       | 10,000                                        |       | —                           |       | 50,000                         |       |
|                                                                |       |                                 |       |                                          |       |                             |       |                           |       |
| ACCUMULATED  AMORTIZATION RELATED TO GOODWILL AND OTHER INTANGIBLES |       |                                 |       |                                          |       |                             |       |                           |       |
| 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                      |       |
| For the year  ended December 31, 2002                          |       | 2,065,135                            |       | 2,749,309                                     |       | —                           |       | 4,814,444                      |       |

 

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