##### Table of Contents









U.S. SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-KSB

|  |  |                                                                                       
|- |  | --------------------------------------------------------------------------------------
|þ |  | ANNUAL REPORT UNDER SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
| 
|  |  | For the fiscal year ended January 3,
    2004                                         
| 
|o |  | TRANSITION REPORT UNDER SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT of 1934
| 
|  |  | For the transition period
    from           to                                       

Commission file number: 0-26226

Microfield Group, Inc.

(Name of small business issuer in its
charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Oregon                                                             |  | 93-0935149                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)

1631 NW Thurman St., Suite 200

Portland, Oregon 97209


(Address of principal executive offices and
zip code)


(503) 419-3580

(Issuers telephone number)


Securities registered under Section 12(b)
of the Exchange Act:

None


Securities registered under Section 12(g)
of the Exchange Act:

Common Stock


Check whether the issuer (1) filed all
reports required to be filed by Section 13 or 15(d) of the
Exchange Act during the past 12 months (or for such shorter
period that the Registrant was required to file such reports),
and (2) has been subject to such filing requirements for
the past
90 days:     Yes o          No þ

Check if disclosure of delinquent filers in
response to Item 405 of Regulation S-B is not
contained in this form, and no disclosure will be contained, to
the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of the Form 10-KSB or any amendment to this
Form 10-KSB.     o

Issuers revenues for its most recent fiscal
year were $10,342,000.

The aggregate market value of voting stock held
by non-affiliates of the registrant at March 1, 2004 was
$5,222,000 computed by reference to the average bid and asked
prices as reported on the Nasdaq Bulletin Board Market.

The number of shares outstanding of the
Registrants Common Stock as of March 1, 2004 was
16,772,570 shares.

The index to exhibits appears on page 52 of
this document.

Transitional Small Business Disclosure Format
(check
one):     Yes o          No þ



---






---










MICROFIELD GROUP, INC.

FORM 10-KSB INDEX

|             |  |                                                                                                                         |  |      |    | 
|------------ |  | ----------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|             |  |                                                                                                                         |  | Page
|             |  |                                                                                                                         |  |     
|PART I      
|Item 1.      |  | Description of Business                                                                                                 |  |      | 2  | 
|Item 2.      |  | Description of Property                                                                                                 |  |      | 7  | 
|Item 3.      |  | Legal Proceedings                                                                                                       |  |      | 7  | 
|Item 4.      |  | Submission of Matters to a
    Vote of Security Holders                                                                 |  |      | 8  | 
|            
|PART II     
|Item 5.      |  | Market for Common Equity and
    Related Stockholder Matters                                                            |  |      | 8  | 
|Item 6.      |  | Managements Discussion
    and Analysis of Financial Condition or Plan of Operation                                    |  |      | 10 | 
|Item 7.      |  | Financial Statements                                                                                                    |  |      | 25 | 
|Item 8.      |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure                                |  |      | 57 | 
|Item 8A.     |  | Controls and Procedures                                                                                                 |  |      | 57 | 
|            
|PART III    
|Item 9.      |  | Directors, Executive
    Officers, Promoters and Control Persons; Compliance with
    Section 16(a) of the Exchange Act |  |      | 58 | 
|Item 10.     |  | Executive Compensation                                                                                                  |  |      | 61 | 
|Item 11.     |  | Security Ownership of
    Certain Beneficial Owners and Management                                                      |  |      | 62 | 
|Item 12.     |  | Certain Relationships and
    Related Transactions                                                                      |  |      | 64 | 
|Item 13.     |  | Exhibits and Reports on
    Form 8-K                                                                                    |  |      | 68 | 
|Item 14.     |  | Principal Accountant Fees
    and Services                                                                              |  |      | 71 | 
|EXHIBIT 23.1
|EXHIBIT 31.1
|EXHIBIT 31.2
|EXHIBIT 32.1
|EXHIBIT 32.2



1



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##### Table of Contents



This filing includes statements that may
constitute forward-looking statements. These
statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995.
Forward-looking statements inherently involve risks and
uncertainties that could cause or contribute to such differences
that include, but are not limited to, competitive factors, the
success of new products and services in the marketplace,
dependence upon third party vendors, and the ability to obtain
financing. By making these forward-looking statements, the
Company undertakes no obligation to update these statements for
revisions or changes after the date of this filing.




PART I






|        |                        
|------- | -----------------------
|Item 1. | Description of Business

General

Microfield Group, Inc. (the Company)
specializes in the installation of electrical products and
services. The Companys objective is to leverage its assets
and value to successfully build a viable, profitable electrical
services and technology infrastructure business.

The Company completed its first purchase
transaction in September 2002, with the acquisition, via merger,
of Innovative Safety Technologies, LLC (IST). This acquisition
established a new direction for the Company since it had
previously sold substantially all of the assets used in its
prior business, in October 2000 (see below). The acquisition of
IST was completed on September 17, 2002. As of December
2002, IST was the only operating entity owned by the Company.

During 2003, the Company completed two additional
acquisitions. In September 2003, the Company acquired privately
held Velagio, Inc. (Velagio) and Christenson Technology
Services, Inc. (CTS). In December, 2003 the service and
technology teams of Velagio and CTS were consolidated into one
subsidiary under the name Christenson Velagio, Inc.
(CVI) in order to take full advantage of potential
synergies within the subsidiaries. The newly formed organization
conducts business in the electrical services and technology
infrastructure sectors. CVI has the ability to deliver the
following products and services:



| |   |                                                            
| | - | -----------------------------------------------------------
| |  | Computer Telephony Integration                             
|
| |  | Digital Video CCTV Systems and Infrastructure              
|
| |  | Telecommunications Systems and Infrastructure              
|
| |  | Enterprise Security Systems                                
|
| |  | Wireless Networking Solutions                              
|
| |  | Fire Alarm/ Life Safety Systems Design and
    Installation
|
| |  | Information Technology Network Design &
    Engineering    
|
| |  | Voice/ Data Systems and Infrastructure                     
|
| |  | Electrical Design & Engineering                            
|
| |  | Electrical Construction Services                           
|
| |  | Lighting Services                                          
|
| |  | Electrical System Audits                                   

During the fourth quarter of 2003, shortly after
the acquisitions of Velagio and CTS, the Company made the
decision to discontinue the operations of IST and Velagio. This
decision was made based on the declining sales in these two
entities, and the fact that many of the employees whose focus
was in sales of these products and services were no longer with
the Company. As of January 3, 2004 (Fiscal Year End for FY
2003), Microfield Group, Inc. has one wholly-owned subsidiary,
Christenson Velagio, Inc. In the remainder of this document,
reference to the Company refers to either or both
Microfield Group, Inc. and Christenson Velagio, Inc.

2



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Prior to October 24, 2000 the Company
developed, manufactured, and marketed computer conferencing and
telecommunications products designed to enhance and facilitate
group communications. The Companys product lines consisted
of a series of digital whiteboards, interactive rear projection
systems, and interactive plasma display systems sold under the
brand name SoftBoard, along with a variety of application
software packages, supplies and accessories. On October 24,
2000 the assets of the Company that were utilized in operating
the SoftBoard business were sold to Greensteel, Inc., a
wholly-owned subsidiary of PolyVision Corporation. Prior to
September 2002, the Company had not been engaged in continuing
operations since the date of the sale of its SoftBoard assets to
Greensteel. The Company currently receives royalties from
PolyVision, based on sales of SoftBoard products. These
royalties are listed in the income statement under
discontinued operations.

The Company was incorporated in Oregon in 1986.
The Companys executive offices are located at 1631 NW
Thurman St., Suite 200, Portland, OR 97209

Products and Services

The Company conducts business with the goal of
providing organizations with electrical and technology
infrastructure products and services. The Companys main
products and services include:



| |                                              
| | ---------------------------------------------
| | Electrical Design & Construction
    Services

Since its inception in 1945, the electrical
services group that was acquired by the Company established its
business and the value of its name based on the quality and
reliability of their work. The Companys services include
installation of lighting systems, wiring of high-rise buildings,
design-build on complex institutional or industrial locations,
building control systems and installation of emergency power
systems. The Companys engineers, project managers and
field technicians take projects from concept through
implementation.



| |                                                  
| | -------------------------------------------------
| | Digital Video CCTV Systems and
    Infrastructure

Surveillance systems have quickly emerged as a
high priority for facilities of all sizes in the private and
public sectors due to a number of environmental and social
concerns. CVIs knowledge in the design as well as
implementation of sophisticated digital systems including
cameras, multiplexers, monitoring centers, switching devices and
network infrastructure allows the Company to provide a complete,
turnkey source for systems of all sizes and levels of
complexity. CVIs engineers and technicians have the
capability to design and install state-of-the-art fiber optic
networks and switching gear, IP Video Local Area Network
(LAN) and Wide Area Network (WAN) architectures, as
well as highly sophisticated monitoring stations.



| |                                                  
| | -------------------------------------------------
| | Telecommunications Systems and
    Infrastructure

Increasing levels of need and flexibility have
continued to fuel growth in the area of facilities telephony and
IP Telephony systems. Competencies with most major
manufacturers systems and architectures allows the Company
to provide correct scale and functionality in designs and
provide reliability through the installation and maintenance
programs.



| |                                                
| | -----------------------------------------------
| | Enterprise Security and Life Safety
    Systems

The Companys extensive knowledge of access
control systems, intrusion alarm systems and fire protection
systems, allows CVI to provide the highest level of protection
available for most sizes of enterprises. Providing a safe
working environment, protection of company assets including
intellectual property, and reducing liability exposure are
critical business needs that are met with the Companys
systems. CVIs ability to perform facility audits assists
its customers in evaluating site requirements or weaknesses in
their existing systems and provides a basis for recommendations.
Included in this category of service (beyond physical site
security) is our ability to provide IT Network security
including firewalls and VPN/ Remote access security functions.

3



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##### Table of Contents





| |                              
| | -----------------------------
| | Wireless Networking Solutions

Wireless networking solutions is one of the
fastest growing segments of communications technology. The
Companys experience with WI-FI Networks, wireless
telephony and its capability for on-site assessments enables CVI
to provide complete design and implementation services. The
Pacific Northwest has taken a leading position in the
implementation of wireless hot spots both in the
private and public sector. As this high growth area expands, the
Companys knowledge and real world experience will assist
customers in providing this level of capability to their
locations.



| |                                                             
| | ------------------------------------------------------------
| | Information Technology (IT) Network
    Design & Engineering

From designing of systems and infrastructure to
implementation and maintenance, CVI has years of field
experience in the design and installation of complex IT network
configurations. Whether it is in the form of LANS, WANS, or
MANS, switching and routing hardware or high speed Internet
access, CVIs employees have the knowledge and expertise
in-house to handle any requirement. The Companys technical
support staff capability is well established and has an
excellent reputation for technical competency during system
installation as well as subsequent service and repair.

Sales and Distribution

CVI generates sales through the relationships it
has cultivated and the quality work product it has maintained
over its 58 year history. Prior to its acquisition by the
Company, Christenson Technology Services, in various forms since
its inception, has primarily served the Northwest market since
1945. The Christenson name has been a key component
in building a well established, loyal customer base. Much of the
Companys sales are generated by word of mouth or through
repeat customer projects. Growth throughout its existence has
been achieved by entering into additional markets within the
electrical services industry.

The Companys staff regularly installs
products and designs product configurations for customer sites
based on the products and/or services ordered by the customer,
or according to plans specified by the customer or general
contractor. The Company may also enlist the assistance of
various subcontractors to provide specific services relative to
the contract the Company has with its customer.

The Company normally delivers products or has
products delivered directly to its customers, and then installs
those products as a part of the services provided to the
customer. The Company does not sell any products through
distributors, dealers or other resellers as a part of its
business.

Customers

With the acquisition of CTS, the Company now
provides electrical and technology products and services for a
wide range of end use customers in the western United States.
The Companys customer base changed materially with the
acquisition of CTS in September 2003. Revenues of the
consolidated group (consisting of Microfield and IST) in the
eight and a half month period prior to the current year
acquisitions, were less than $500,000. Revenues attained in the
three and a half months after the current year acquisitions were
completed, were in excess of $10 million.

Approximately half of the Companys current
revenue base comes as subcontracting work through general
contractors. CVIs customers span all major industries,
including: government, education, retail, entertainment,
finance, health care, manufacturing and transportation. Major
end user customers include Boeing, General Electric, KPMG,
Kaiser Permanente, the Portland Trailblazers, the City of
Portland, Evergreen School District and Lake Oswego School
District. For the year ended January 3, 2004, no single
customer accounted for more than 10% of the Companys
revenue. For the year ended December 28, 2002, one customer
accounted for approximately 68% of the Companys $233,000
in sales. The Company made the decision in November 2003 to
discontinue the operations of IST, and it no longer actively
markets those products.

4



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##### Table of Contents



Acquisitions and Investments

Microfields strategy was one that focused
on the acquisition and deployment of products and services with
strong intellectual property asset value and the potential for
significant growth. In the latest two fiscal years, the Company
completed the acquisitions of three companies, in line with this
strategy.

The Company completed its first purchase
transaction in September 2002, with the acquisition, via merger,
of Innovative Safety Technologies, LLC (IST). This acquisition
established a new direction for the Company since it had
previously sold substantially all of the assets used in its
prior business, in October 2000 (see below). The acquisition of
IST was completed on September 17, 2002. As of December
2002, IST was the only operating entity owned by the Company.

During 2003, the Company completed two additional
acquisitions. In September 2003, the Company merged with
privately held Velagio, Inc. (Velagio) and Christenson
Technology Services, Inc. (CTS). Velagio was a consulting firm
that provided outsourced services for the development and
implementation of software packages. CTS was an electrical
technology and electrical services firm.

In December, 2003 the service and technology
teams of Velagio and CTS were consolidated into one subsidiary
under the name Christenson Velagio, Inc. (CVI) in order to take
advantage of potential synergies within the subsidiaries. In
conjunction with this business rationalization, a new branding
campaign for this consolidated structure was launched. A new
logo and hallmarks were developed to facilitate a cohesive
message to the marketplace that leverages the equity and
reputation of the Christenson name in regional markets as well
as to communicate the broader array of service and capabilities
brought to customers.

During the fourth quarter of 2003, shortly after
the acquisitions of Velagio and CTS, the Company made the
decision to discontinue the operations of IST and Velagio. The
remaining assets and liabilities were merged into CVI in
December in conjunction with the combination of Velagio, IST and
CTS. As of January 3, 2004, Microfield Group, Inc. has one
wholly-owned subsidiary, Christenson Velagio, Inc.

The Companys current acquisition strategy
is to evaluate potential merger opportunities as they develop.

Competition

The Company, through its CVI subsidiary, competes
in the electrical services, communications, networking and
energy management services markets. The principal competitive
factors in the markets in which the Company competes include
price, service, product performance, the ability to provide a
broad range of products and services, conformance to industry
standards, union representation of the Companys workforce,
market presence, and the ability to design and implement cost
beneficial and technologically advanced customer solutions.

The electrical services industry is well
established, and the Company competes mainly on the basis of its
excellent reputation for providing reliable, timely, cost
effective, first class products and services. A portion of this
business is done through the bidding process either directly
with the customer or in a subcontracting role with a general
contractor. Winning projects depends on several factors
including size of the jobs, price, customer service and
reputation from prior work completed. The Companys
electricians and technicians are members of the local electrical
union. Union representation of the Companys workforce is
also a factor in whether the Company is successful in obtaining
work in competitive situations.

In the technology side of the business, the
markets that the Company competes in are constantly changing.
While the services provided in bringing new technology to
customers remain fairly constant, the technology of the products
sold or installed changes continually. This requires that the
Companys engineers and technicians remain in touch with
new product introductions, and advancing or emerging
technologies. The Companys engineers and technicians are
regularly trained regarding safety, new products and
technologies, and how to adapt or configure their
customers applications to take advantage of the new
technologies.

The Company has dozens of competitors in the
electrical services and technology services markets. Some of the
Companys major competitors include, Capitol Electric
Company, Dynalectric, Electrical Construction Company, Hughes
Electrical Contractors, LH Morris, Oregon Electric Group and
Tice Electric Company. Some of these companies compete with CVI
across many of its product lines and service offerings in both
the electric services and technology services markets.

5



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The barriers to entry in the markets that the
Company currently serves are relatively low and new companies
may be created that compete with CVI in various segments of its
markets. Several of the Companys competitors may have
greater financial, engineering and technical resources, may be
able to compete for non-union only work, and may be
able to provide a broader range of products and services than
the Company. The Companys success in competing in these
markets depends on its ability to provide timely service and
creative technology offerings that provide its customers
long-term, cost effective solutions to their electrical and
technology service requirements. Any inability to effectively
control and manage these competitive factors could have a
material adverse effect on the Companys business,
operating results and the financial condition of the Company.

Manufacturing and Supply

CVI purchases telecommunication equipment,
networking equipment, cabling and wiring and various other
equipment and supplies that it uses in customer applications, or
that it sells and installs at customer sites. The Company relies
on various vendors for these products, and does not manufacture
any of the products that it sells or installs.

The electrical services industry is a mature
industry. As such, there are numerous vendors that supply the
products that CVI uses in this market. CVI purchases supplies
from several of these vendors, and has secondary sources for all
products that it buys. CVI has had negative operating cash flows
in its business since it was acquired by Microfield. While this
negative cash flow has not had a measurable impact on the
operations of the Company, there is no assurance that the supply
of products and materials will continue to be available if the
Companys working capital position further deteriorates.

The Companys goal is to keep its inventory
of parts and supplies to a minimum. A fleet of vehicles is
leased by the Company for use by technicians and electricians in
servicing customers. Each vehicle has a stock of parts and/or
tools used by CVI employees in their work. The inventory on
board the vehicles is kept at a fairly constant level, to match
the work flow throughout the year. Each technician and
electrician has the authority to order and pick up parts as
needed to fulfill job requirements. CVI also maintains a stock
of inventory and supplies at its main plant.

The technology services business is subject to
rapid technological developments, evolving industry standards
changes in customer requirements, and new product introductions
and enhancements. The Companys future success in this
industry depends on its ability to keep pace with these new
developments and requirements, and to provide customer solutions
using current technology, on a cost-effective and timely basis.
Failure to keep pace with these customer requirements, industry
standards and technological developments could have a material
adverse effect on the Companys results of operations and
financial condition.

The Companys principal suppliers include
Graybar Electric Co., Inc., Anixter, Inc., Platt Electric
Supply, Inc., Ronco Communications, Inc., Crescent Electric
Supply, Inc., and North Coast Electric, Inc. The Company
generally believes it has good relationships with its current
principal vendor base.

The Company buys products and supplies on both
open account and job accounts, up to various limits, specified
by each particular vendor. Job accounts can be set up by a
vendor for products or supplies used on specific projects. The
vendor is protected from the Companys non payment by lien
rights. Lien rights give vendors the legal ability to receive
payment directly from their creditors customer. The
Company does not have a history of having lien rights filed
against its jobs. Should the Companys cash situation
worsen, vendors could exercise their lien rights against the
Company, which could harm the Companys reputation in the
markets where it does business. This could have a material
adverse effect on the Companys business, its operating
results and financial condition.

The Company does not have any long-term contracts
for the purchase of products or supplies with any of its
material vendors.

Intellectual Property

As a part of the purchase of IST, the Company
owns United States Patent No. 5,288,945. This patent covers
the No Tug PlugTM and was issued in February 1994.
The patent was purchased by Innovative Safety Technologies, LLC
in July 2002 from the original inventor. IST was granted the
Trademark for the mark No

6



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##### Table of Contents



Tug Plug, in November, 2002. In November
2003, the Company made the decision to discontinue the
operations of IST. The Company still owns the above mentioned
patent and trademark.


In September 2003, through the acquisition of
CTS, the Company shares ownership of the Christenson
trade name. The previous owners of CTS own a separate entity
that continues to do business under the name Christenson Power
Services (CPS). CPS uses the same branding and trade dress of
the Christenson name as does CVI, but with their separate name.
CPS focuses on the utility segment of this industry, which is
not a major market for the Company. The Companys joint
ownership of the Christenson name and trade dress is not limited
in any way. The owners of CPS also maintain a significant
ownership position in Microfield Group, Inc.

Also in September 2003 through the acquisition of
Velagio, the Company acquired the rights to the Velagio name,
which it now uses in its subsidiary Christenson Velagio,
Inc.

The Company protects its intellectual property
rights through a combination of patent, trademark, trade secret
and other intellectual property law, nondisclosure agreements
and other measures. The Company believes, however, that its
financial performance will depend more upon the service
excellence, technical knowledge and innovative design abilities
of its employees, than upon such protection.

Government Approval or Regulations

The Company is subject to certain local
government regulations regarding Uniform Commercial Building
Codes. Many projects require inspection by local government
building code inspectors. There are no federal regulations
related to the business.

Employees

As of January 3, 2004, the Company employed
approximately 285 persons. The Companys workforce
fluctuates based on the project work flow at any specific point
in time. Approximately 213 of the Companys employees are
covered by collective bargaining agreements, and the Company
believes its relations with its employees are good.






|        |           
|------- | ----------
|Item 2. | Properties

The Company leased seven facilities in Portland,
Eugene and Bend, Oregon, during 2003. These facilities consist
of approximately 11,000 square feet of office space. The
Company vacated the facility in Bend at the expiration of the
lease on December 31, 2003. The remaining facilities are
occupied pursuant to both fixed-term, and month-to-month leases.
The Company does not own or lease any manufacturing space.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

The Company was not a party to any legal
proceedings during 2003.

From time to time, claims are made against the
Company in the ordinary course of our business, which could
result in litigation. Claims and associated litigation are
subject to inherent uncertainties and unfavorable outcomes could
occur, such as monetary damages, fines, penalties or injunctions
prohibiting the Company from selling one or more products or
engaging in other activities. The occurrence of an unfavorable
outcome in any specific period could have a material adverse
affect on the Companys results of operations for that
period or future periods.

In March, 2004, Kurt Underwood (former President/
CEO of Microfield Group, Inc.) filed a lawsuit in Multnomah
County Circuit Court, Portland, Oregon under case number
0403-02370 against Robert J. Jesenik, JMW Capital Partners,
Inc., Destination Capital, LLC, Microfield Group, Inc.,
Christenson Electric, Inc., Steven M. Wright, Andrew S. Craig,
Thomas A. Sidley, R. Patrick Hanlin, Michael Stansell, Brian A.
Oliver, Brian N. Christopher, Kevin D. Robertson, Christenson
Group, LLC, and Christenson Velagio, Inc. The lawsuit alleges
that the Defendants violated Oregon securities law and Oregon
common law in connection with the following transactions (which
closed simultaneously in September 2003): (1) the merger of
CTS Acquisition Co. (a wholly-owned subsidiary of the Company)
with and into Christenson Technology Services, Inc.; and
(2) the merger of VSI Acquisition Co. (A wholly-owned
subsidiary of the Company) with and into

7



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##### Table of Contents



Velagio, Inc. In addition, the lawsuit alleges
that Mr. Underwood was terminated as an employee entitling
him to severance pay. The lawsuit seeks damages of approximately
$1.4 million. The Company intends to vigorously defend the
lawsuit, however, at the date of this filing, the outcome of
this matter is uncertain.







|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters of a Vote of Security
    Holders

No matters were submitted to a vote of the
Companys shareholders during the quarter ended
January 3, 2004.




PART II






|        |                                                             
|------- | ------------------------------------------------------------
|Item 5. | Market for Common Equity and Related
    Stockholder Matters

The Companys common stock is quoted on the
Nasdaq Bulletin Board Market under the symbol
MICG.OB. The following table sets forth the high and
low sales prices as reported by the Nasdaq Bulletin Board Market
for the periods indicated.

|               |  |     |      |      |  |   |      | 
|-------------- |  | --- | ---- | ---- |  | - | ---- | 
|               |  | Low |      | High
|               |  |     |      |     
|Fiscal 2002    |  |     |      |      |  |   |      | 
|First Quarter  |  | $   | 0.05 |      |  | $ | 0.07 | 
|Second Quarter |  |     | 0.04 |      |  |   | 0.06 | 
|Third Quarter  |  |     | 0.05 |      |  |   | 0.15 | 
|Fourth Quarter |  |     | 0.19 |      |  |   | 0.78 | 
|              
|Fiscal 2003    |  |     |      |      |  |   |      | 
|First Quarter  |  | $   | 0.16 |      |  | $ | 0.44 | 
|Second Quarter |  |     | 0.20 |      |  |   | 0.57 | 
|Third Quarter  |  |     | 0.23 |      |  |   | 0.80 | 
|Fourth Quarter |  |     | 0.36 |      |  |   | 0.73 | 

There were 180 shareholders of record and
the Company believes approximately 1000 beneficial shareholders
at March 1, 2004. There were no cash dividends declared or
paid in fiscal years 2003 or 2002. In November 2003, 3,333,333
preferred shares were issued in exchange for the conversion of a
previously existing $1.4 million debt owed by the Company.
This conversion was completed in conjunction with a $750,000
Series 2 preferred stock private placement subscribed to on
September 26, and a conversion of $765,000 of existing debt
into shares of Series 2 preferred stock, also on
September 26, 2003. Under the terms of the private
placement and the debt conversions, a 6.5% dividend based on the
value converted and issued, is due to those preferred
shareholders when declared by the board of directors. Dividends
on those preferred shares can only be declared if, in the
discretion of the board of directors, the Company is in a cash
flow position sufficient to pay a dividend. The Company does not
anticipate declaring such dividends on that converted amount
before there are legally available funds to pay that dividend.
The Company does not anticipate declaring any dividends on
common stock.

8



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##### Table of Contents



Securities Authorized for Issuance Under
Equity Compensation Plans

The following equity compensation information, as
of January 3, 2004, is presented in compliance with SEC
regulation S-B Item 201(d).

|                                                               |  |                     |           |                     |  |                      |      |  |  |  |         | 
|-------------------------------------------------------------- |  | ------------------- | --------- | ------------------- |  | -------------------- | ---- |  |  |  | ------- | 
|                                                               |  |                     |           |                     |  | Number of           
|                                                               |  |                     |           |                     |  | Securities          
|                                                               |  |                     |           |                     |  | Remaining Available 
|                                                               |  | Number of           |           |                     |  | for Future Issuance 
|                                                               |  | Securities to be    |           |                     |  | Under Equity        
|                                                               |  | Issued Upon         |           | Weighted Average    |  | Compensation Plans  
|                                                               |  | Exercise of         |           | Exercise Price of   |  | (Excluding          
|                                                               |  | Outstanding Options |           | Outstanding Options |  | Securities Reflected
|                                                               |  | and Warrants        |           | and Warrants        |  | in Column (a))      
|Plan Category                                                  |  | (a)                 |           | (b)                 |  | (c)                 
|                                                               |  |                     |           |                     |  |                     
|Equity compensation plans approved by security
    holders     |  |                     | 688,936   |                     |  | $                    | 0.84 |  |  |  | 222,252 | 
|Equity compensation plans not approved by
    security holders |  |                     | 2,510,643 |                     |  | $                    | 0.44 |  |  |  | -0-     | 
|Total                                                          |  |                     | 3,199,579 |                     |  | $                    | 0.53 |  |  |  | -0-     | 

The Company has an Incentive Stock Option Plan.
At January 3, 2004, 688,936 shares of common stock
were reserved for issuance to employees, officers and directors
to whom options have been granted. Under the Plan, options may
be granted to purchase shares of the Companys common stock
at fair market value, as determined by the Companys Board
of Directors, at the date of grant. The options are exercisable
over a period of up to five years from the date of grant or such
shorter term as provided for in the Plans. The options become
exercisable over four years.

In September 2003, in connection with a preferred
stock private placement, the Company issued 333,334 warrants to
purchase common stock. Each warrant is exercisable into one
share of common stock at $0.42 per share and will expire in
2008. Subsequent to this private placement, the Company
exercised an option to convert $1,400,000 of outstanding debt
into preferred stock that is convertible into shares of common
stock. This exercise, when aggregated with all other outstanding
equity arrangements, resulted in the total number of common
shares that could be required to be delivered to exceed the
number of authorized common shares. In accordance with
EITF 00-19, the fair value of the warrants issued in the
private placement must be recorded as a liability in the
financial statements using the Black-Scholes model, and any
subsequent changes in the Companys stock price to be
recorded in earnings. Accordingly, the fair value of these
warrants at the date of issuance was determined to be $64,902.
At January 3, 2004, the fair value was determined to be
$135,667 and the increase from the initial amount was recorded
in earnings.

In connection with an April 2003 common stock
private placement, the Company issued 111,308 warrants to
purchase common stock. Each warrant is exercisable into one
share of common stock at $0.40 per share and will expire in
2008. Subsequent to this private placement, the Company
exercised an option to convert $1,400,000 of outstanding debt
into preferred stock that is convertible into shares of common
stock. This exercise, when aggregated with all other outstanding
equity arrangements, resulted in the total number of common
shares that could be required to be delivered to exceed the
number of authorized common shares. In accordance with
EITF 00-19, the fair value of the warrants issued in the
private placement must be recorded as a liability in the
financial statements using the Black-Scholes model, and any
subsequent changes in the Companys stock price to be
recorded in earnings. Accordingly, the fair value of these
warrants at the date of issuance was determined to be $19,832.
At January 3, 2004, the fair value was determined to be
$47,195 and the increase from the initial amount was recorded in
earnings.

In connection with debt financing entered into
during fiscal year 2000, the Company issued 2,066,000 detachable
warrants to purchase common stock. The warrants had an initial
term of 3 years and were to expire in June 30, 2005.
Proceeds from the debt were allocated between the debt and
warrants based on the fair value of the warrants issued using
the Black-Scholes model. The combined value assigned to the
warrants when they were issued was approximately $357,000 and
was initially recorded as debt discount and recognized as
interest expense over the life of the debt. On
September 15, 2003, the Company extended the life of
1,239,600 of these warrants until June 30, 2007 as partial
consideration to satisfy a $150,000 promissory note between CTS
and JMW Capital Partners, Inc. In accordance with FIN 44,
the fair value of the warrants on the date of the

9



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settlement of the $150,000 promissory note
between CTS and JMW Capital Partners, Inc was determined to be
$468,000. The difference between the initial fair value and the
fair value at the date of the extension was recorded as equity
and a loss on debt extinguishment.


On October 15, 1999 the Company issued a
warrant to certain of its debt holders to
purchase 20,000 shares of the Companys common
stock at an exercise price of $0.75 per share. In
accordance with the terms of the warrant, the holder, in lieu of
exercising the warrant, has the option to convert the warrant
into a number of shares to be determined based on a formula
which considers the difference between the fair market value of
the Companys common stock at the time of conversion and
the exercise price of the warrant. The warrant expired,
unexercised, in October 2003.






|        |                                                                                     
|------- | ------------------------------------------------------------------------------------
|Item 6. | Managements Discussion and Analysis
    of Financial Condition or Plan of Operation

Overview

Microfield Group, Inc. (the Company)
specializes in the installation of electrical products and
services. The Companys objective is to leverage its assets
and value to successfully build a viable, profitable electrical
services and technology infrastructure business.

In September 2003, the Company acquired privately
held Velagio, Inc. (Velagio) and Christenson Technology
Services, Inc. (CTS). In December, 2003 the service and
technology teams of Velagio and CTS were consolidated into one
subsidiary under the name Christenson Velagio, Inc.
(CVI) in order to take full advantage of inherent synergies
within the subsidiaries, as well as capture competitive
advantage. The newly formed organization conducts business in
the electrical services and technology infrastructure sectors.
CVI has the ability to deliver the following products and
services:



| |   |                                                            
| | - | -----------------------------------------------------------
| |  | Computer Telephony Integration                             
|
| |  | Digital Video CCTV Systems and Infrastructure              
|
| |  | Telecommunications Systems and Infrastructure              
|
| |  | Enterprise Security Systems                                
|
| |  | Wireless Networking Solutions                              
|
| |  | Fire Alarm/ Life Safety Systems Design and
    Installation
|
| |  | Information Technology Network Design &
    Engineering    
|
| |  | Voice/ Data Systems and Infrastructure                     
|
| |  | Electrical Design & Engineering                            
|
| |  | Electrical Construction Services                           
|
| |  | Lighting Services                                          
|
| |  | Electrical System Audits                                   

These services and capabilities are expected to
provide the substantial majority of the Companys sales in
the foreseeable future. The Companys results will
therefore depend on continued and increased market acceptance of
these products and the Companys ability to install and
service them to meet the needs of its customers. Any reduction
in demand for, or increase in competition with respect to these
products could have a material adverse effect on the
Companys financial condition and results of operations.

During the fourth quarter of 2003, shortly after
the acquisitions of Velagio and CTS, the Company made the
decision to discontinue the operations of IST and Velagio. This
decision was made based on the declining sales in these two
entities, and the fact that many of the employees whose focus
was in sales of these products and services were no longer with
the Company. The remaining assets and liabilities were merged
into CVI in December in conjunction with the combination of
Velagio, IST and CTS. As of January 3, 2004, Microfield
Group, Inc. has one wholly-owned subsidiary, Christenson
Velagio, Inc.

The Companys current acquisition strategy
is to evaluate potential merger opportunities as they develop.

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| |                                                                                    
| | -----------------------------------------------------------------------------------
| | Managements Focus in Evaluating
    Financial Condition and Operating Performance.

Management meets regularly to review the business
along two main divisions. These divisions include Operations,
which consists of customer solicitation and project work
performance, and Finance and Administration, which consists of
the administration and support of the Company. Based on the
kinds of information reviewed, meetings are held daily, weekly
and monthly. Following is a list of the most critical
information which management examines when evaluating the
performance and condition of the Company.

Revenue.Sales
personnel and project managers are responsible for obtaining
work to be performed by the Company. Revenue is booked daily
based on the Companys revenue recognition policy (see
Critical Accounting Policies). These bookings are reviewed the
following day by the Senior Vice President of Operations (SVP),
the Chief Financial Officer (CFO) and several of their direct
reports. Decisions about various aspects of the business are
made, and actions are taken based on the prior days
revenue, and whether or not it met daily and weekly revenue
goals and expectations. Monthly customer revenue is also
examined, in detail, as a part of a review of the Companys
financial statements for the prior month, by the Companys
executive team and its board of directors.

Expense Control.The
Company has various controls in place to monitor spending. These
range from authorization and approvals by the SVP and CFO as
well as review of the periodic check runs by the CFO and reviews
of labor efficiency and utilization by the SVP and his project
managers. The organizational team, which is comprised of the
SVP, CFO, several department heads and key employees, meets
weekly to review reports that monitor expenses and cost
efficiency, among other factors. Additionally, the executive
team, comprised of the Companys Chief Executive Officer
(CEO), CFO and SVP, meets weekly to review operations, and
monthly with the board of directors to review monthly spending
patterns and expenses as a part of the review of the prior
months financial statements.

Cash Requirements.The Company focuses on cash daily, through a series of meetings
that highlight cash received from borrowings on the prior
days billings, cash required to fund daily operating
needs, cash received from customers and several other factors
that impact cash. Management reviews accounts receivable
reports, ineligible receivables and accounts payable reports in
conjunction with preparing a daily cash flow schedule that
projects and tracks all cash sources and uses. Management and
the board of directors use this information in determining cash
requirements.

Customer service.Management considers the Companys reputation as one of its
most valuable assets. Much of the Companys revenue is
based either on repeat business or referrals from its loyal
customer base. The Company reviews service issues and any
customer feedback continually to ensure continued customer
satisfaction through timely and high quality work.

Safety.Safety is of
utmost importance to the Company and its employees. The
Companys engineers, electricians and technicians are
required to undergo regular educational seminars, which include
safety training. The Company has well defined procedures
designed to prevent accidents. Management reviews reports on the
Companys safety record, and examines the facts and
circumstances surrounding specific accidents to ensure that all
procedures were followed, or to modify procedures if needed.



| |                          
| | -------------------------
| | Business Characteristics.

Revenue.The Company
generates revenue by performing electrical service work and
technology infrastructure design and installation. These
projects are obtained by the Companys sales force and
project managers. These projects come from direct solicitation
of work, the bidding process, referrals, regular maintenance
relationships and repeat customer projects.

Cash.The Company
generates cash mainly through operations. Cash is borrowed daily
from an asset based lender under a revolving credit facility.
These borrowings are repaid through collections from
customers accounts. Each day, the Company submits to its
lender, a summary of customer billings, cash collections,
ineligible accounts and the amount of the borrowing requested.
The lender approves the submission and deposits funds directly
into the Companys bank account.

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The Company has also generated cash through debt
issuances and private placements of common and preferred stock.
The board of directors reviews both short and long range
business plans and projections, and implements funding
strategies based on the cash needs produced in the projections.

Opportunities and
Risks.Some of the significant
business risks CVI faces, among others, include interruption in
the flow of materials and supplies, interruption of its work
force through disagreements with its union, business contraction
and expansion caused by the economy in general and its general
lack of liquidity.

As a part of its regular business planning, the
Company anticipates the effect that these risks may potentially
have on its financial condition. Some of the risks are planned
for contractually to minimize the Companys liability in
cases where it is subject to contract performance. Others are
anticipated by forging plans for staff reductions or increases
should the economy move drastically in one direction. The
Company also continually looks for additional funding sources
and cash availability, both by improving operating performance
internally and from external debt and equity sources, should its
cash be strained by certain factors.



| |                          
| | -------------------------
| | Business Goal Attainment.

The Company went through a cost reduction effort
in the fourth quarter of 2003 that continued into the first
quarter of 2004. The Company has been successful in improving
monthly cash flow in its effort to reach profitability. This is
being done through a combination of staff reductions, gross
margin improvements, lease restructurings and general expense
cutbacks. The Company anticipates that this combination of
improvements, if accomplished to its expectations throughout
2004, is expected to result in Q1 2004 net pre tax losses
in the range of $1.0 to $1.5 million, improving toward
monthly breakeven during the years second half.

When entering into the acquisitions of CTS and
Velagio, the Companys goal was to realize certain
synergies within the resulting organization, save costs from
eliminating duplicate processes, and come out of the combination
as a breakeven or slightly profitable company. Due to management
turnover in the months following the acquisition, broader than
anticipated process issues, lower than anticipated sales
achievements and professional costs associated with the
acquisition that were higher than anticipated the Company has
not yet met its interim post-acquisition profitability goals.
Management is continuing to improve internal processes, cut
costs and maximize revenue opportunities.



| |        
| | -------
| | Trends.

CVIs business is closely tied to the
economy. In a down economy, the Companys work becomes more
dependent on repeat business from ongoing customer
relationships. When the service, manufacturing and retail
industries arent expanding, CVIs service projects
are more focused toward changes, adds, moves, and fixes within
this customer base. Also during these periods, the Company
enhances its revenue through its exclusive license with TEGG,
that provides contractual electrical inspections and maintenance
on an annual basis The Company does not see any significant
movement in the economy either up or down at the current time.
Based on this assessment, the Company continues to work toward
positive cash flow and profitability through increased project
efficiency, cost controls and revenue growth.

In the last three years the Company has seen a
dramatic downturn in spending for technology infrastructure.
This affected the technology side of CTSs business prior
to its acquisition by the Company. It is anticipated that as the
economy improves, CVI will see increasing revenue from the sales
of technology products and services.

Critical Accounting Policies

The discussion and analysis of financial
condition and results of operations is based upon the
Consolidated Financial Statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities. The
Company evaluates, on an on-going basis, its estimates and
judgments, including those related to revenue recognition, sales
returns, bad debts, excess inventory, income taxes,
contingencies and litigation. Its estimates are based on
historical experience and assumptions that we believe

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to be reasonable under the circumstances, the
results of which form the basis for making judgments about the
carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.


The Company believes the following critical
accounting policies, among others, affect its more significant
judgments and estimates used in the preparation of its
consolidated financial statements:



| |   |                                                                                
| | - | -------------------------------------------------------------------------------
| |  | Revenue recognition and allowances; Accruals for
    contingent liabilities;   
|
| |  | Inventories and reserves for shrinkage and
    obsolescence; Bad debt reserves;
|
| |  | Impairment of intangible and long-lived assets;                                

Significant portions of the Companys
revenues are derived from construction and service projects.
Revenues from fixed-price, cost-plus-fee, time and material and
unit-price contracts are recognized using the
percentage-of-completion method of accounting which recognizes
income as work on a contract progresses. Recognition of revenues
and profits generally are related to costs incurred in providing
the services required under the contract. Earned revenue is the
amount of cost incurred on the contract in the period plus the
proportional amount of gross profit earned during the same
period. This method is used because management considers total
cost to be the best available measure of completion of
construction contracts in progress. Provisions for estimated
losses on construction contracts in progress are made in their
entirety in the period in which such losses are determined
without reference to the percentage complete. Changes in job
performance, job conditions and estimated profitability,
including those arising from contract penalty provisions and
final contract settlements, may result in revisions to revenue
and costs, and are recognized in the period in which the
revisions are determined. Claims for additional revenue are not
recognized until the period in which such claims are allowed.
Direct contract costs include all direct labor, direct materials
and some estimating costs and shop and equipment costs. General
and administrative costs are charged to expense as incurred.
Revenue from discontinued operations was recognized when
persuasive evidence of an arrangement existed, the price was
fixed, title had transferred, collection of resulting
receivables was probable, no customer acceptance requirements
existed and there were no remaining significant obligations.

The Company makes estimates of liabilities that
arise from various contingencies for which values are not fully
known at the date of the accrual. These contingencies may
include accruals for reserves for costs and awards involving
legal settlements, costs associated with vacating leased
premises or abandoning leased equipment, and costs involved with
the discontinuance of a segment of a business. Events may occur
that are resolved over a period of time or on a specific future
date. Management makes estimates of the potential cost of these
occurrences, and charges them to expense in the appropriate
periods. If the ultimate resolution of any event is different
than managements estimate, compensating entries to
earnings may be required. For the year ended, January 3,
2004 the Company estimated costs for abandoning leases premises
and the leasehold improvements within those premises. An
estimate of $108,680 for this abandonment is recorded as a
liability and was charged against earnings.

The Company adjusts inventory for estimated
excess and obsolete inventory equal to the difference between
the cost of inventory and the estimated fair value based upon
assumptions about future demand and market conditions. At
January 3, 2004, the allowance for inventory obsolescence
was $157,653 and reflects managements current estimate of
potentially obsolete inventory based on these factors. Any
significant unanticipated changes in demand or competitive
product developments could have a significant impact on the
value of the Companys inventory and its reported results.
If actual market conditions are less favorable than those
projected, additional inventory write-downs and charges against
earnings may be required.

The Company maintains allowances for doubtful
accounts for estimated losses resulting from the inability of
our customers to make required payments. Accounts receivable,
historical bad debts, customer concentrations, customer
creditworthiness, current economic trends, and changes in
customer payment terms and practices are analyzed when
evaluating the adequacy of the allowance for doubtful accounts.
At January 3, 2004, the allowance for doubtful accounts was
$117,650. This allowance was determined by reviewing customer
accounts and considering each customers creditworthiness
as of January 3, 2004, and the potential that some of these
accounts may be uncollectible. If the financial condition of the
Companys customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional
allowances and charges against earnings may be required.

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Intangible and long-lived assets to be held and
used, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amounts of such assets
may not be recoverable. Determination of recoverability is based
on an estimate of discounted future cash flows resulting from
the use of the asset, and its eventual disposition. Measurement
of an impairment loss for intangible and long-lived assets that
management expects to hold and use is based on the fair value of
the asset as estimated using a discounted cash flow model. After
the acquisitions of Velagio and CTS in September 2003,
management decided to discontinue the operations of IST because
that business was not the focus of any of the Companys
future plans. Accordingly, net intangible assets of $255,000
were expensed in Loss for discontinued operations in
the consolidated statement of operations.

The Company measures the carrying value of
goodwill recorded in connection with the acquisitions for
potential impairment in accordance with SFAS No. 142,
Goodwill and Other Intangible Assets. To apply
SFAS 141, a company is divided into separate
reporting units, each representing groups of
products that are separately managed. For this purpose, the
Company has one reporting unit. To determine whether or not
goodwill may be impaired, a test is required at least annually,
and more often when there is a change in circumstances that
could result in an impairment of goodwill. If the trading of our
common stock is below the book value for a sustained period, or
if other negative trends occur in our results of operations, a
goodwill impairment test will be performed by comparing book
value to estimated market value. To the extent goodwill is
determined to be impaired, an impairment charge is recorded in
accordance with SFAS 142.

During the fourth quarter of 2003, management
determined that the goodwill recorded for both IST and Velagio
was impaired due to the fact that operations of both of these
entities were discontinued. A charge has been recorded in
Loss from discontinued operations, in the
consolidated statement of operations in the amount of $1,295,000
for Velagio and $250,000 for IST.

Results of Operations

The following table sets forth, as a percentage
of sales, certain consolidated statement of operations data
relating to the business for the periods indicated.

|                                        |  |        |     |        |  |  |     |  
|--------------------------------------- |  | ------ | --- | ------ |  |  | --- | -
|                                        |  | Fiscal |     | Fiscal
|                                        |  | 2003   |     | 2002* 
|                                        |  |        |     |       
|Net sales                               |  |        | 100 | %      |  |  | N/A | %
|Cost of goods sold                      |  |        | 84  |        |  |  | N/A |  
|                                        |  |        |     |        |  |  |     |  
|Gross profit                            |  |        | 16  |        |  |  | N/A |  
|Sales General & administrative expenses |  |        | 40  |        |  |  | N/A |  
|                                        |  |        |     |        |  |  |     |  
|Loss from continuing operations         |  |        | (24 | )      |  |  | N/A |  
|Other income (expense)                  |  |        | (6  | )      |  |  | N/A |  
|                                        |  |        |     |        |  |  |     |  
|Loss before income taxes                |  |        | (30 | )      |  |  | N/A |  
|Benefit from income taxes               |  |        |    |        |  |  | N/A |  
|                                        |  |        |     |        |  |  |     |  
|Loss before discontinued operations     |  |        | (30 | )      |  |  | N/A |  
|Discontinued operations                 |  |        | (28 | )      |  |  | N/A |  
|                                        |  |        |     |        |  |  |     |  
|Net loss                                |  |        | (58 | )%     |  |  | N/A | %
|                                        |  |        |     |        |  |  |     |  



---



|  |                                                                                                                                                                                                                      
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|* | The data for the year ended December 28,
    2002, as a percentage of sales, can not be computed, as there
    were no sales made by the Company outside of those included in
    the discontinued operations of IST.

The financial information presented for the year
ended January 3, 2004, represents activity in Velagio and
CTS for the three and a half months from the date of their
acquisitions to the end of the fiscal year, combined with
revenue, other income and S G & A expenses of IST and
Microfield Group, Inc. for the year ended January 3, 2004.
The financial information presented for the year ended
December 28, 2002, represents activity in IST for the three
and a half months from the date of the acquisition,
September 16, 2002 to the end

14



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of the fiscal year, combined with the other
income and general and administrative expenses incurred by
Microfield Group, Inc. for the year ended December 28, 2002.


Sales.Revenue for
the fiscal year ended January 3, 2004 was $10,342,000
compared to none for the fiscal year ended December 28,
2002. The revenue amount for the current fiscal year includes
$10,342,000 from sales of technology products and electrical
construction services in CTS during the three and a half months
from the date of the acquisition to the end of the fiscal year.
There were no sales to any one customer that comprised more than
10% of the Companys total sales for the fiscal year 2003.
Due to new sources of revenues from the newly acquired entities,
and the disproportionate size of the revenues in 2003 compared
to those in 2002, no meaningful comparison can be made between
revenue of the two years presented in the accompanying
consolidated statements of operations.

Cost of Sales.Cost
of sales totaled $8,712,000 for the fiscal year ended
January 3, 2004, compared to none for the same period in
the prior year. All of the current fiscal years cost of
sales includes the cost of labor, products, supplies and
overhead used in providing electrical and technology services in
CTS from September 16, 2003, the date of acquisition of
CTS, to the end of the fiscal year.

Gross Profit.Gross
profit for the fiscal year ended January 3, 2004 was
$1,630,000 (or 16%) compared to none for the fiscal year ended
December 28, 2002. All of the gross profit amount for the
current fiscal year is the result of sales of products and
services of CTS during the three and a half months from the date
of the acquisition of CTS to the end of the fiscal year Due to
new sources of gross profits from newly acquired CTS, and the
disproportionate size of the gross profits in 2003 compared to
those in 2002, no meaningful comparison can be made between
gross profits of the two years presented in the accompanying
consolidated statements of operations.

Future gross profit margins will depend on the
volume and mix of sales of products and services to the
Companys customers, as well as the Companys ability
to control costs. It is anticipated that as savings are realized
from the implementation of cost reduction efforts and higher
gross margin work projects are targeted, overall gross profit
margins may increase.

Sales, General and Administrative
Expenses(S, G & A).S, G & A expenses were $4,104,000 for the
fiscal year ended January 3, 2004, compared to $279,000 for
the fiscal year ended December 28, 2002. The increase is
due to the acquisition of CTS on September 16, 2003.
S, G & A expenses are comprised mainly of
payroll costs, facilities and equipment rent, outside services,
insurance, utilities and depreciation. This acquisition brought
279 employees to the Company, compared to 6 people
that were employed by the Company during the fiscal year ended
December 28, 2002. Payroll costs, which include salary,
payroll taxes and fringe benefits, totaled $2,184,000 for the
fiscal year ended January 3, 2004.

Total rents for the year ended January 3,
2004 were $203,000, which was primarily comprised of facilities
rent. This is compared to $5,000 of rent incurred in the year
ended December 28, 2002. Outside services, professional
fees, insurance, utilities and depreciation for the year ended
January 3, 2004 totaled $842,000, compared to $58,000 for
the year ended December 28, 2002

Due to new sources of expenses from newly
acquired CTS, and the disproportionate size of the expenses in
2003 compared to those in 2002, no meaningful comparison can be
made between expenses of the two years presented in the
accompanying consolidated statements of operations.

The level of S, G & A expenses
for the 2004 fiscal year is expected to increase significantly
compared to the level incurred in the year ended January 3,
2004 due to the future operations, and a full year of
operations, of CVI. The Company anticipates these expenses will
approximate between 23% and 28% of sales in 2004.

Interest Expense.Interest expense was $428,000 for the year ended January 3,
2004, compared to none for the year ended December 28,
2002. The significant addition of interest expense was due to
the acquisition of CTS in September 2003, in which $8,666,000 in
interest-bearing debt was assumed as a part of the transaction.
This debt included an accounts receivable based lending facility
under which the Company incurred $156,000 in interest expense
from September 16, 2003, the date of the acquisition, to
the end of the fiscal year.

The assumed debt also included $4,349,000 of
related party, interest-bearing debt. Interest expense of
$211,000 was incurred on this debt from the date of the
acquisition to January 3, 2004. Of the total related

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party debt amount assumed, $1,400,000 was assumed
with the provision that no interest would be accrued by the
Company between September 16, 2003 and November 15,
2003. On that date, interest would start accruing if the debt
was not converted to equity by the debt holder. On
November 15, 2003 the full amount of that debt was
converted to 3,333,333 shares of preferred Series 2
stock. In April 2004, an additional $1,017,000 in related party
debt, plus accrued interest associated with this related party
debt, was converted to 3,242 shares of Series 3
preferred stock. Each share of Series 3 preferred stock is
convertible into 1000 shares of the Companys common
stock.




| |                                            
| | -------------------------------------------
| | Gain/ Loss From Discontinued
    Operations

After the acquisitions of Velagio and CTS,
management discontinued the operations of both Velagio and IST
due to a decline in sales and a decision to focus on the CTS
business. Accordingly, the revenue, expenses and other income or
losses for both Velagio and CTS are condensed and reported as
discontinued operations in the consolidated statement of
operations. Certain information from those businesses is
reported below.

Sales of IST and Velagio products and services in
2003 totaled $496,000. This includes revenue from IST of
$458,000 and revenue from Velagio of $38,000. Revenue for the
year ended December 28, 2002 was $233,000 and was comprised
of sales of IST products, of which $159,000 was sold to one
customer.

The cost of sales of IST and Velagio products and
services for the year ended January 3, 2004 totaled
$440,000. The cost of sales for the year ended December 28,
2002 was $144,000 and included costs of IST product sales from
September 16, 2002, the date of acquisition of IST, to the
end of the fiscal year.

Gross profit included in discontinued operations
for the years ended January 3, 2004 and December 28,
2002 totaled $56,000 and $89,000, respectively.

S, G & A and other expense incurred in
IST and Velagio for the year ended January 3, 2004 totaled
$2,987,000. Included in this amount is a write down from the
impairment of Goodwill, in both IST and Velagio, of $1,546,000.
Also included in this amount are charges against earnings of
$255,000 for the write off of the remaining value of intangibles
acquired in the acquisition of IST in 2002.

Discontinued operations also contains a gain on
the sale of the SoftBoard business. (See Item 1,
Description of Business  General) The SoftBoard
business was sold in 2000. As part of the sale price, the
Company receives royalties from the purchaser of that business,
based on sales of SoftBoard products. These royalties are listed
in the income statement under Gain on sale of discontinued
operations.

Income Taxes.There
was no provision for income taxes in 2003 or 2002 due to losses
incurred by the Company in both years. No tax benefit from loss
carryback was recorded in either year as there was no income tax
paid in the open loss carryback periods. The Company has
provided a full valuation allowance on its net deferred tax
asset.

Liquidity and Capital Resources

Since inception, the Company has financed its
operations and capital expenditures through public and private
sales of equity securities, cash from operations, and borrowings
under bank lines of credit. At January 3, 2004, the Company
had negative working capital of approximately $3,622,000 and its
primary source of liquidity consisted of cash and its operating
line of credit.

On September 16, 2003, the Company acquired
CTS and Velagio in exchange for 8,386,286 restricted shares of
the Companys common stock. Other than for legal and
professional expenses, no cash was paid for the acquisitions of
the CTS or Velagio. On September 16, 2002, the Company
acquired Innovative Safety Technologies, LLC in exchange for
1,818,181 restricted shares of the Companys common stock.
Other than for legal and advisory expenses, no cash was paid for
the acquisition of the IST.

Accounts receivable increased to $5,432,000 at
January 3, 2004 from $194,000 at December 28, 2002.
The increase is due to outstanding trade receivables resulting
from sales of product by CTS, which later became CVI after
merging with the discontinued operations of IST and Velagio.
These receivables were produced by sales of electrical
construction services and technology infrastructure products and
services. These receivables are net of an allowance for doubtful
accounts of $118,000. Management expects these

16



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##### Table of Contents



receivables to remain fairly constant as a
percentage of sales, decreasing slightly as efficiencies in the
billing and collection processes are achieved.


Inventory increased to $430,000 at
January 3, 2004 from $50,000 at December 28, 2002. The
increase is due to inventory acquired in conjunction with the
Companys merger with CTS. This balance mainly includes
inventory used in the electrical services business. The Company
maintains a fleet of trucks and vans which each maintain a
certain level of inventory needed to provide timely products and
services to the Companys customers. The inventory levels
should remain constant, and increase slightly as the
Companys revenue increases. Management discontinued
operations of IST during the fourth quarter of 2003. In doing
this, it took a charge against earnings of approximately $55,000
to reflect the potential for obsolescence of the IST inventory.
Of the total $430,000 of inventory listed in the consolidated
balance sheet at January 3, 2004, there is $28,000 of
inventory ($109,000 less an $81,000 reserve) from the
discontinued operations of IST.

With the acquisition of CTS the Company recorded
costs in excess of billings which reflect those costs incurred
on construction and services, which have not yet been billed to
customers. This amount was $1,517,000 at January 3, 2004,
and should remain constant as a percentage of sales on an
ongoing basis.

Property and equipment, net of depreciation
increased to $1,818,000 at January 3, 2004 compared to
$134,000 at December 28, 2002. This increase was due to the
acquisitions of CTS and Velagio. In the acquisition of CTS, the
Company acquired $1,993,233 in vehicles. This represents the
majority of fixed assets listed on the balance sheet.

The Company entered into an equipment lease
agreement with a related party, under which it leases furniture
and fixtures, equipment, computer equipment, and job site tools
and equipment (See Related Party Transactions). This lease is
classified as an operating lease with a monthly payment due of
$40,000. The Company does not anticipate spending to acquire
fixed assets for the foreseeable future.

Also, in the acquisition of CTS, the Company
recorded goodwill of $2,299,000 due to the excess of the
purchase price paid over the book value of the net assets of
CTS. The Company also recorded approximately $1.3 million
in goodwill from the acquisition of Velagio. This goodwill was
subsequently written off as management determined that the
goodwill was impaired after the operations of Velagio were
discontinued. No cash was paid for the acquisition of either CTS
or Velagio.

Accounts payable increased to $3,896,000 at
January 3, 2004 from $45,000 at December 28, 2002.
This change is due to the acquisition of payables and accrued
expenses assumed in the acquisition of CTS. Payables consist
primarily of the costs of inventory, materials and supplies used
in the electrical construction services and technology
infrastructure services provided by the Company. An increase in
payables and accrued expenses increases cash for operations. The
Company has extended payments on much of its current obligations
because of cash flow issues. This pattern of payments has
allowed the Company additional time to reduce operating expenses
and maintain the flow of inventory, materials and supplies
needed to provide services to the Companys customers.

Accrued payroll, payroll taxes and benefits were
$1,274,000 at January 3, 2004. These amounts consist of one
week of union payroll and two weeks of non-union payroll in the
amount of $395,000. Additionally, this liability included
Decembers health and welfare benefit, owed to the unions
representing the Companys electricians and technicians,
and other payroll related obligations of $879,000. This
liability will vary between reporting periods based on the fact
that payroll taxes decrease as the tax obligation thresholds for
some of the taxes are exceeded. The combined payroll, payroll
tax and benefit amounts should fluctuate with the revenues of
the Company and as such, represents a main cash use of the
Companys funds. As revenues increase, the amounts due for
these types of expenses will increase as well. These liabilities
are primarily short-term in nature with most of them being paid
within one to six weeks of the expense being incurred.

The bank line of credit was approximately
$4,331,000 at January 3, 2004. This is an increase of
$1,504,000 from the end of the third quarter amount of
$2,827,000. This lending facility is a prime source of funds for
the Company. Amounts are drawn against it each day based on the
amount of eligible revenues that are billed by the Company. As
receivables are collected daily, those funds are used to pay
down the facility. Until the Companys liquidity issues
ease, this facility will continue to be used to the fullest
extent possible, daily, for operating capital. The facility has
a limit of $5,000,000 and borrowings are based on 85% of
eligible accounts receivable.

17



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##### Table of Contents



On September 16, 2002, the Company sold
1,363,629 shares of common stock in conjunction with a
private placement at $.22 per share. The Company received
proceeds from the private placement, net of related costs, of
approximately $280,000. In April and May of 2003, the Company
sold 1,113,078 shares of common stock in conjunction with a
private placement at $.26 per share. The Company received
proceeds of approximately $270,000, net of related costs. On
September 26, 2003, the Company raised an additional
$1,515,000 through the issuance of Series 2 preferred
shares at $.42 per share, of which $750,000 was a cash
investment and $765,000 was a conversion of debt assumed by the
Company as part of its acquisition of CTS. In January 2004, the
Company entered into a borrowing arrangement with Destination
Capital LLC, under which it borrowed $600,000 to be used for
operating capital by the Company. In April 2004, the Company
raised an additional $1,750,000 through the issuance of
Series 4 preferred shares, a portion of which was used to
pay off the $600,000 borrowed in January 2004, with the
remainder to be used for operating capital by the Company.

The acquisition of CTS in September 2003 added a
significant amount of revenue to the Company. Since the date of
the acquisition of both CTS and Velagio, management has been
focused on reducing certain expenses, both to improve gross
margins and to reduce the monthly overhead costs. Additionally,
a substantial amount of debt owed to related parties was
converted to equity in September and November of 2003, and in
April of 2004.

The Company and its subsidiary have suffered
recurring losses from ongoing operations and have experienced
negative cash flows from continuing operating activities during
2002 and 2003. As of January 3, 2004 the Company had
negative working capital of $3,622,000, total liabilities of
$14,034,000 and an accumulated deficit of $21,778,000. While it
is anticipated that the losses from continuing operations will
decline as a result of cost reduction efforts, debt conversions
and fundraising events, recurring losses and liquidity issues
raise doubt about the Companys ability to continue as a
going concern. The financial statements do not include any
adjustments that might result from the outcome of this
uncertainty. The Company may not have sufficient resources to
satisfy cash requirements for the next twelve months. The
Company may have to seek additional investment capital or debt
facilities. Investment capital or debt facilities may be
difficult to obtain due to, among other issues, the
Companys inability to meet certain SEC reporting
requirements relative to historical financial statements of CTS
and from the unresolved lawsuit pending against the Company.
There can be no assurance that additional capital will be
available or, if available, will be at terms acceptable to the
Company. The Company is focusing on opportunities to increase
revenues and grow margins while continuing to reduce monthly
expenses in an attempt to turn cash flow positive and profitable.

The Company had no commitments for capital
expenditures in material amounts at January 3, 2004.

Related Party Transactions

The Company has a number of promissory notes,
lines of credit and lease obligations owing to related parties.
The following table lists the notes and obligations outstanding
at January 3, 2004 by related party.

|  |  |                     |  |                    |                      |               |  |            |                 |         |  |   |           |  |  |  |        | 
|- |  | ------------------- |  | ------------------ | -------------------- | ------------- |  | ---------- | --------------- | ------- |  | - | --------- |  |  |  | ------ | 
|  |  |                     |  |                    |                      |               |  | Amount of  |                 | Monthly
|  |  | Related Party       |  | Type of Obligation |                      | Maturity Date |  | Obligation |                 | Payment
|  |  |                     |  |                    |                      |               |  |            |                 |        
|1 |  | Steven M. Wright    |  |                    | Note payable         |               |  |            | 9/01/03         |         |  | $ | 45,000    |  |  |  |       | 
|2 |  | CLLLC(a)            |  |                    | Note payable         |               |  |            | 10/15/05        |         |  |   | 825,000   |  |  |  | 18,355 | 
|3 |  | Various entities(a) |  |                    | Notes payable        |               |  |            | 01/17/08        |         |  |   | 130,302   |  |  |  | 10,374 | 
|4 |  | CEAC(a)             |  |                    | Bond guarantee fees  |               |  |            | open            |         |  |   |          |  |  |  | 5,000  | 
|5 |  | CEI(a)              |  |                    | Equipment lease      |               |  |            | 12/1/07         |         |  |   |          |  |  |  | 40,000 | 
|6 |  | CLLLC(a)            |  |                    | Vehicle lease        |               |  |            | 8/1/06          |         |  |   | 1,925,844 |  |  |  | 84,777 | 
|7 |  | CEI(a)              |  |                    | Real property leases |               |  |            | 10/31/08        |         |  |   |          |  |  |  | 58,748 | 
|8 |  | R. Patrick Hanlin   |  |                    | Advance payable      |               |  |            | not established |         |  |   | 16,000    |  |  |  |       | 
|9 |  | John B. Conroy      |  |                    | Note receivable      |               |  |            | 9/16/05         |         |  |   | 78,750    |  |  |  |       | 



---



|    |  |                                                                                                                                      
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Robert J. Jesenik, a director and significant
    shareholder of the Company, also owns a significant interest in
    these entities.

18



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Terms and conditions of each of the notes and
agreements are listed below.



| |              
| | -------------
| | Notes Payable

On March 19, 2003, Steven M. Wright, the
Companys Chief Executive Officer at that time, advanced
the Company $40,000 under a line of credit promissory note. This
advance was used as operating capital within Microfield. The
note carried no interest rate and was due and payable on or
before April 25, 2003. On April 1, 2003, the note was
converted to common stock in the Company as a part of a private
placement (See Note 10).

On July 2, 2003, Steven M. Wright, the
Companys Chief Executive Officer at that time, advanced
the Company $25,000 under a line of credit promissory note. This
advance was used as operating capital within Microfield. The
note carries an interest rate of 10% and was due and payable on
September 1, 2003. This note was repaid in cash in October
2003.

1. On June 10, 2003, Steven M. Wright,
the Companys Chief Executive Officer at that time,
advanced the Company $50,000 under a line of credit promissory
note. This advance was used as operating capital within
Microfield. The note carries an interest rate of 10% and was due
and payable on September 1, 2003. As of January 3,
2004, $5,000 of this note had been repaid with the remaining
balance still outstanding. This note was subsequently converted
to Series 3 preferred stock on April 2, 2004.

On September 16, 2003, as part of the
purchase price for the acquisition of CTS, the Company assumed
various long-term notes payable to several entities in which
Robert J. Jesenik, a Director of the Company and significant
Shareholder, has significant ownership interests. A portion of
these debts were converted to equity as a part of the
Companys Series 2 preferred stock private placement
as outlined below. The remaining amounts due were subsequently
converted to Series 3 preferred stock on April 2, 2004.

On September 15, 2003, the Company, CTS and
JMW Capital Partners, Inc. (JMW) entered into an Agreement to
Satisfy Obligations. JMW is an investment banking company in
which Robert J. Jesenik, a Director and significant Shareholder,
owns a significant ownership interest. Under this agreement CTS
acknowledged debt in the amount of $149,000 owed to JMW. This
debt arose within CTS prior to the acquisition by the Company
and was used for operating activities. After consummation of the
acquisition of CTS by the Company and upon issuance of preferred
shares in conjunction with the Series 2 preferred stock
private placement, the Company converted the note payable to JMW
into 357,143 shares of the Companys Series 2
preferred stock.

On September 15, 2003, the Company, CTS and
Christenson Electric, Inc. (CEI) entered into an Agreement to
Consolidate, Amend and Satisfy Obligations. CEI is an electrical
services company in which Robert J. Jesenik, a Director and
significant Shareholder, owns a substantial ownership interest.
Under this agreement CTS acknowledged debts of $1.5 million
and $265,000 owed to CEI. These debts arose within CTS prior to
the acquisition by the Company, and relate to the purchase of
Christenson Electrical Services inventory and customer
lists by CTS. This was a transaction between entities under
common control. After consummation of the acquisition of CTS by
the Company and upon issuance of preferred shares in conjunction
with the Series 2 preferred stock private placement, the
Company converted $365,000 of the two notes payable to CEI into
869,048 shares of Series 2 preferred stock.

On September 15, 2003, CTS executed a new
Subordinated Amended and Restated Promissory Note for the
remaining $1,400,000 due to CEI. On November 17, 2003 the
Company converted the note payable to 3,333,333 shares of
Series 2 preferred stock. There was no interest accrued or
paid on this note, according to its terms.

2. On September 15, 2003, CTS executed
an Amended and Restated Promissory Note in the amount of
$825,000 due to Christenson Leasing Company, LLC (CLC). CLC is
an equipment leasing company in which Robert J. Jesenik, a
Director and significant Shareholder, holds a substantial
ownership interest. This debt arose within CTS prior to the
acquisition by the Company and was contributed to CTS on several
dates as working capital infusions to support operating
activities. Under this note, six interest only payments are due
monthly beginning on November 15, 2003. Thereafter,
payments of $18,355 are due monthly beginning on June 15,
2004, with a balloon payment of $666,889 due and payable on
October 15, 2005. Interest on this note

19



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##### Table of Contents



accrues at 12% per annum beginning on
September 15, 2003. This note was subsequently converted to
equity on April 2, 2004.


3. On January 17, 2003, CTS executed
separate promissory notes with JMW, CLC, Robert Jesenik
dba Jesenik Enterprises and JW Assurance and Holding
Limited for the purchase of the undivided interests in certain
assets previously leased by CTS. Robert J. Jesenik, a Director
and significant Shareholder, owns a substantial ownership
interest in all of the above named entities. An interest only
payment is due on January 17, 2004. Thereafter, payments
totaling $6,337 are due quarterly beginning on April 17,
2004. Interest on these notes accrues at 12% per annum
beginning on January 17, 2003. As of January 3, 2004,
$79,602 was outstanding under these notes. These notes were
subsequently converted to Series 3 preferred stock on
April 2, 2004.

On January 17, 2003, CTS executed separate
promissory notes with JMW, CLC, Robert Jesenik dba Jesenik
Enterprises and JW Assurance and Holding Limited in payment of
certain past due rent amounts due from CTS under an asset lease.
Robert J. Jesenik, a Director and significant Shareholder, owns
a substantial ownership interest in all of the above named
entities. An interest only payment is due on January 17,
2004. Thereafter, payments totaling $4,036 are due quarterly
beginning on April 17, 2004. Interest on these notes
accrues at 12% per annum beginning on January 17,
2003. As of January 3, 2004, $50,700 was outstanding under
these notes. These notes were subsequently converted to
Series 3 preferred stock on April 2, 2004.

As of January 3, 2004, approximately
$191,000 of interest was payable to entities in which
Mr. Jesenik has a significant beneficial interest under the
notes and agreements listed above. This interest was
subsequently converted to Series 3 preferred stock on
April 2, 2004.



| |                    
| | -------------------
| | Bond Indemnity Fees

4. A certain number of CTS construction
projects require the Company to maintain a surety bond. The bond
surety company requires an additional guarantee for issuance of
the bond. The Company has an agreement with CEAC, Inc.
(CEAC) under which at year end paid CEAC $5,025 per
month for CEACs guarantee of this bond liability. CEAC
holds a substantial ownership interest in CEI. Robert J.
Jesenik, a Director and significant Shareholder, owns a
substantial ownership interest in CEAC. The guarantee fee is
computed as 15% (annualized) of the open liability under
bonds issued for CTS and indemnified by certain shareholders of
CEAC.



| |                          
| | -------------------------
| | Equipment Lease Agreement

5. On September 1, 2003, CTS entered
into an agreement with CEI for use of certain equipment leased
by CEI from an outside party. Robert J. Jesenik, a Director and
significant Shareholder, owns a substantial ownership interest
in CEI. The equipment consists of various construction vehicles,
trailers, miscellaneous construction equipment, office
furniture, computer hardware and software. Under the terms of
the lease CTS pays CEI $40,000 monthly beginning on
September 1, 2003, with the final payment due on
December 1, 2007. The lease is accounted for as an
operating lease and contains a 10% purchase option at the end of
the lease term, December 31, 2007. At January 3, 2004,
the Company was past due on payments totaling $125,000, and thus
in default on the lease. Subsequent to year end, the Company
reached agreement on a payment plan to the lessor, and has been
reducing the arrearage.



| |                                   
| | ----------------------------------
| | Master Vehicle Lease
    Agreement

6. On September 1, 2003 CTS entered
into a master vehicle lease agreement with CLLLC for use of
certain vehicles used in its construction business. CLLLC is an
equipment leasing company in which Robert J. Jesenik, a Director
and significant Shareholder, holds a substantial ownership
interest. Under the terms of the lease, CTS pays CLLLC
$84,777 monthly beginning on September 1, 2003, with
the final payment due August 1, 2006. The lease contains a
renewal provision under which it has the option, at the end of
the lease term, to purchase or return the vehicles, or to renew
the lease for an additional 12 months. The lease payment
will remain fixed unless the 30-day Commercial Paper Rate as
published in the Wall Street Journal exceeds 2.00%. If that
occurs, the lessor has the option to increase the lease payment.
This lease is accounted for as a capital lease. On
September 1, 2003 prior to the acquisition of CTS,
$1,993,233 was recorded as cost of the

20



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##### Table of Contents



vehicles leased with the same amount recorded as
debt owed under the lease as of that date. At January 3,
2004, the Company was past due on payments totaling $271,720,
and thus in default on the lease. Subsequent to year end, the
Company reached agreement on a payment plan to the lessor, and
has been reducing the arrearage. Accordingly, the remaining
capital lease obligation is properly classified between current
and long-term debt.




| |                         
| | ------------------------
| | Real Property Sub Leases

7. On September 1, 2003, CTS entered
into seven real property subleases with CEI for use of
buildings, offices and storage yards to house the operations and
property of CTS. Robert J. Jesenik, a Director and significant
Shareholder, owns a substantial ownership interest in CEI. CTS
has operating activities in Portland and Eugene, Oregon, and as
of December 31, 2003, vacated its office in Bend, Oregon as
the lease expired. After January 14, 2004, the Swan Island
facility lease obligation converted to a month-to-month lease.
The monthly sublease payments totaled $58,748 through
December 31, 2003. Of that amount, $798 is due on a
month-to-month basis. The remaining $57,950 is due on leases
with maturity dates between December 31, 2003 and
October 31, 2008. Beginning in February 2004, the
Companys monthly lease obligation will be $55,168, with
$7,922 of that on a month-to-month basis. The annual rent
obligations from January 3, 2004, for each property are
listed in the table below.

|                        |       |          |          |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |         | 
|----------------------- | ----- | -------- | -------- | ---- |  | ---- | ------- | ------- |  | ---- | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- | 
|Location                |       | Maturity |          | 2004 |  | 2005 |         | 2006    |  | 2007 |         | 2008   
|                        |       |          |          |      |  |      |         |         |  |      |         |        
|Thurman Building        |       |          | 10/31/08 |      |  | $    | 464,928 |         |  | $    | 464,928 |         |  | $ | 464,928 |         |  | $ | 464,928 |         |  | $ | 387,440 |        
|Swan Island             |       |          | 01/14/04 |      |  |      | 3,562   |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        
|Eugene                  |       |          | 09/30/05 |      |  |      | 84,048  |         |  |      | 63,036  |         |  |   |         |         |  |   |         |         |  |   |         |        
|Crown Plaza Office      |       |          | 7/31/07  |      |  |      | 17,976  |         |  |      | 17,976  |         |  |   | 17,976  |         |  |   | 10,486  |         |  |   |         |        
|Pope Storage            |       |          | *        |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        
|Montgomery Park Storage |       |          | *        |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        
|                        |       |          |          |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        
|                        | Total |          |          |      |  |      | $       | 570,514 |  |      | $       | 545,940 |  |   | $       | 482,904 |  |   | $       | 475,414 |  |   | $       | 387,440 | 
|                        |       |          |          |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        



---



|  |               
|- | --------------
|* | Month-to-Month



| |                                      
| | -------------------------------------
| | Administrative Services
    Agreement

On September 15, 2003, CTS entered into an
administrative services agreement with CEI for the extension of
certain administrative and related services by the Company to
CEI. Robert J. Jesenik, a Director and Significant shareholder,
owns a substantial ownership interest in CEI. Under the terms of
the agreement, certain employees provided administrative and
related services to CEI upon reasonable request. The agreement
is subject to a 60-day notice period before termination by
either party. The monthly payment for these services was
determined at the effective date of the agreement to be
approximately $35,000, with a provision to be adjusted as needed
based on the level of usage of these services by CEI. During the
first quarter of 2004, the payment by CEI for these services was
renegotiated to $15,000 per month as the cost of services
to CEI has been reduced.

8.     On
November 5, 2003, R. Patrick Hanlin, Chairman of the
Companys board of directors, advanced $16,000 to the
Company in the form of a payment directly to one of the
Companys creditors. The advance is unsecured and does not
carry an interest rate or have any stated due date. On
April 2, 2004 this debt was converted to approximately
38 shares of the Companys Series 3 preferred
stock. These shares of Series 3 preferred stock are
convertible into 38,095 shares of the Companys common
stock at the option of the shareholder.

9.     In 1998, John B.
Conroy, then the Companys Chairman, CEO and President,
entered into a transaction whereby he purchased
45,000 shares of the Companys common stock at
$1.75 per share. Mr. Conroy issued a promissory note
to the Company for $78,750 in payment for the shares. On
May 17, 2004 the Note was replaced with a new non-recourse
note for $66,250 under which the original amount of the note was
offset against a $12,500 amount owed by the Company to
Mr. Conroy. The note also acknowledges the outstanding
accrued interest due by Mr. Conroy in the amount of
$21,937. Additionally, the interest rate of

21



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##### Table of Contents



the new promissory note was established at
3.4% per annum, and the due date was extended to
August 29, 2006. Mr. Conroy resigned as Chairman, CEO
and President on September 16, 2002, and resigned as a
director in October 2003.


Recent Accounting Pronouncements

SFAS 145.In
April 2002, the FASB issued SFAS 145, Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. The most
relevant provision of SFAS 145 is the rescission of
SFAS 4, Reporting Gains and Losses from
Extinguishment of Debt  An Amendment of APB Opinion
No. 30, which required all gains and losses from
extinguishment of debt to be aggregated and, if material,
classified as an extraordinary item, net of related income tax
effect. As a result of the rescission, the criteria in APB
Opinion No. 30 will now be used to classify those gains and
losses. The provisions of SFAS 145 related to the
rescission of SFAS 4 shall be applied in fiscal years
beginning after May 15, 2002, with early application
encouraged. The adoption of SFAS 145 did not have a
material impact on the Company.

SFAS 146.In
June 2002, the FASB issued SFAS 146, Accounting for
Costs Associated with Exit or Disposal Activities.
SFAS 146 addresses financial accounting and reporting for
costs associated with exit or disposal activities and nullifies
EITF 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).
SFAS 146 requires the recognition of a liability when it
has been incurred. The initial measurement of that liability
shall approximate fair value. The provisions of SFAS 146
are effective for exit or disposal activities initiated after
December 31, 2002, with earlier application encouraged. The
adoption of SFAS 146 did not have a material impact on the
Company, but may impact future disposal or exit activities, if
any.

FIN 45.In
November 2002, the FASB issued FASB Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements
for Guarantees, including Indirect Guarantees of Others.
FIN 45 requires that upon issuance of a guarantee, a
guarantor must recognize a liability for the fair value of an
obligation assumed under a guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual
financial statements about the obligations associated with
guarantees issued. The recognition provisions of FIN 45 are
effective for any guarantees issued or modified after
December 15, 2002. The adoption of FIN 45 did not have
a material effect on the Companys financial position,
results of operations, or cash flows.

EITF 00-21.In
November 2002, the EITF reached a consensus on Issue
No. 00-21, Revenue Arrangements with Multiple
Deliverables. EITF 00-21 addresses certain aspects of
the accounting by a vendor for arrangements under which the
vendor will perform multiple revenue generating activities. The
EITF is effective for fiscal years beginning after June 15,
2003. The adoption of EITF 00-21 did not have a material
effect on the Companys financial position, results of
operations or cash flows.

SFAS 148.In
December 2002, the FASB issued Statement of Financial Standards
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure.
SFAS 148 amends SFAS 123, Accounting for Stock
Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method
of accounting for stock-based compensation. In addition,
SFAS 148 amends the disclosure requirements of
SFAS 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting
for stock-based compensation and the effect of the method used
on reported results. The annual disclosure provisions of
SFAS 148 are effective for periods ending after
December 15, 2002. The interim disclosure provisions are
effective for financial reports containing financial statements
for interim periods beginning after December 15, 2002.
Management has adopted the disclosure requirements of
SFAS 148.

FIN 46.In
January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities
(FIN 46). This Interpretation requires certain variable
interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have
the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support
from other parties. FIN 46 is effective immediately for all
new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of
FIN 46 were to be applied for the first interim or annual
period beginning after June 15, 2003. In October 2003, the
FASB released a FASB Staff Position

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(FSP) deferring the effective date for
applying the provisions of FIN 46. A public entity need not
apply the provisions of FIN 46 to an interest held in a
variable interest entity or potential variable interest entity
until the end of the first interim or annual period ending after
December 15, 2003 (as of December 31, 2003, for an
entity with a calendar year-end or quarter-end of
December 31). The Company has no relationships with other
entities for which it is the primary beneficiary. Accordingly,
the Company does not expect the adoption of FIN 46 to have
a material effect on the Companys financial position,
results of operations or cash flows.


SFAS 149.In
May 2003, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging
Activities. SFAS 149 is intended to result in more
consistent reporting of contracts as either freestanding
derivative instruments subject to Statement 133 in its
entirely, or as hybrid instruments with debt host contracts and
embedded derivative features. SFAS 149 is effective for
contracts entered into or modified after June 30, 2003. The
adoption of SFAS 149 did not have a material impact on the
Companys financial position, cash flows or results of
operations.

SFAS 150.In
May 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity.
SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that
an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances). Many
of those instruments were previously classified as equity.
SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period
beginning after September 15, 2003. It is to be implemented
by reporting the cumulative effect of a change in an accounting
principle for financial instruments created before the issuance
date of SFAS No. 150 and still existing at the
beginning of the interim period of adoption. Restatement is not
permitted. On November 7, 2003, the FASB issued FASB Staff
Position No. FAS 150-3 (FSP 150-3), Effective
Date, Disclosures, and Transition for Mandatorily Redeemable
Financial Instruments of Certain Nonpublic Entities and Certain
Mandatorily Redeemable Noncontrolling Interests under FASB
Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and
Equity. FSP 150-3 deferred certain aspects of
FAS 150. The adoption of FAS 150 and FAS 150-3
did not have a material impact on the Companys results of
operations, financial position or cash flows.

SAB 104.On
December 17, 2003, the Staff of the Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin
No. 104 (SAB 104), Revenue Recognition, which
supersedes SAB 101, Revenue Recognition in Financial
Statements. SAB 104s primary purpose is to
rescind accounting guidance contained in SAB 101 related to
multiple element revenue arrangements, superseded as a result of
the issuance of EITF 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables. Additionally,
SAB 104 rescinds the SECs Revenue Recognition in
Financial Statements Frequently Asked Questions and Answers(the FAQ) issued with SAB 101 that had been codified in
SAB Topic 13, Revenue Recognition. Selected portions
of the FAQ have been incorporated into SAB 104. While the
wording of SAB 104 has changed to reflect the issuance of
EITF 00-21, the revenue recognition principles of
SAB 101 remain largely unchanged by the issuance of
SAB 104. The adoption of SAB 104 in December 2003 did
not materially affect the Companys revenue recognition
policies, or the Companys results of operations, financial
position or cash flows.

EITF 03-6.In
March 2004, the Emerging Issues Task Force finalized its
consensus on EITF Issue 03-6, Participating
Securities and the Two  Class Method Under FASB
Statement No. 128, Earnings Per Share
(EITF 03-6). EITF 03-6 clarifies what constitutes a
participating security and requires the use of the two-class
method for computing basic earnings per share when participating
convertible securities exist. EITF 03-6 is effective for
fiscal periods beginning after March 31, 2004. We are
currently analyzing the impact of adoption of EITF 03-6 on
our consolidated financial statements.

23



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REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders

of Microfield Group, Inc.


In our opinion, the accompanying consolidated
balance sheet and the related consolidated statements of
operations, of changes in shareholders equity, and of cash
flows present fairly, in all material respects, the financial
position of Microfield Group, Inc. and its subsidiaries at
January 3, 2004 and December 28, 2002, and the results
of their operations and their cash flows for the years then
ended in conformity with accounting principles generally
accepted in the United States of America. These financial
statements are the responsibility of the Companys
management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

The accompanying financial statements have been
prepared assuming that the Company will continue as a going
concern. As discussed in Note 2 to the financial
statements, the Company has suffered recurring losses from
continuing operations, and has experienced negative cash flows
from continuing operating activities. In addition, the Company
may not have sufficient cash resources to meet short-term cash
requirements. These matters raise substantial doubt about the
Companys ability to continue as a going concern.
Managements plans in regard to these matters are also
discussed in Note 2. The financial statements do not
include any adjustments that might result from the outcome of
this uncertainty.

As more fully described in Note 18, the
Company has entered into debt agreements, lease agreements and
an administrative services agreement with entities owned or
controlled by a significant shareholder and director.



| |                           
| | --------------------------
| | PRICEWATERHOUSECOOPERS LLP

Portland, Oregon

May 19, 2004


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|        |                     
|------- | --------------------
|Item 7. | Financial Statements

MICROFIELD GROUP, INC.

CONSOLIDATED BALANCE SHEET

|                              |                                                                                                                                                                   |                             |            |              |            |   |           |             |         | 
|----------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | ---------- | ------------ | ---------- | - | --------- | ----------- | ------- | 
|                              |                                                                                                                                                                   | January 3,                  |            | December 28,
|                              |                                                                                                                                                                   | 2004                        |            | 2002        
|                              |                                                                                                                                                                   |                             |            |             
|Current assets:               |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              | Cash and cash equivalents                                                                                                                                         |                             | $          | 130,533      |            |   | $         | 90,981      |        
|                              | Accounts receivable, net of allowances of
    $117,650 and $5,162                                                                                                 |                             |            | 5,432,046    |            |   |           | 193,933     |        
|                              | Accounts receivable  related parties                                                                                                                             |                             |            | 385,122      |            |   |           |            |        
|                              | Inventory, net of allowances                                                                                                                                      |                             |            | 429,529      |            |   |           | 50,411      |        
|                              | Costs in excess of billings                                                                                                                                       |                             |            | 1,517,226    |            |   |           |            |        
|                              | Other current assets                                                                                                                                              |                             |            | 125,243      |            |   |           | 13,826      |        
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              |                                                                                                                                                                   | Total current assets        |            |              | 8,019,699  |   |           |             | 349,151 | 
|                              | Property and equipment, net                                                                                                                                       |                             |            | 1,818,415    |            |   |           | 133,856     |        
|                              | Intangible assets, net                                                                                                                                            |                             |            | 1,879,832    |            |   |           | 311,333     |        
|                              | Goodwill                                                                                                                                                          |                             |            | 2,299,084    |            |   |           | 250,490     |        
|                              | Other assets                                                                                                                                                      |                             |            | 24,480       |            |   |           |            |        
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              |                                                                                                                                                                   | $                           | 14,041,510 |              |            | $ | 1,044,830 |            
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            
|Current liabilities:          |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              | Accounts payable                                                                                                                                                  |                             | $          | 3,895,873    |            |   | $         | 221,663     |        
|                              | Accounts payable  related parties                                                                                                                                |                             |            | 424,905      |            |   |           |            |        
|                              | Cash overdraft                                                                                                                                                    |                             |            | 217,781      |            |   |           |            |        
|                              | Accrued payroll taxes and benefits                                                                                                                                |                             |            | 1,274,423    |            |   |           |            |        
|                              | Bank line of credit                                                                                                                                               |                             |            | 4,331,098    |            |   |           |            |        
|                              | Current portion of notes payable                                                                                                                                  |                             |            | 69,773       |            |   |           | 9,000       |        
|                              | Current portion of notes payable 
    related parties                                                                                                            |                             |            | 898,224      |            |   |           |            |        
|                              | Billings in excess of costs                                                                                                                                       |                             |            | 354,544      |            |   |           |            |        
|                              | Other current liabilities                                                                                                                                         |                             |            | 175,395      |            |   |           | 39,457      |        
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              |                                                                                                                                                                   | Total current liabilities   |            |              | 11,642,016 |   |           |             | 270,120 | 
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            
|Long-term liabilities:        |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              | Long term notes payable                                                                                                                                           |                             |            | 129,211      |            |   |           |            |        
|                              | Long term notes payable  related
    parties                                                                                                                     |                             |            | 2,043,923    |            |   |           |            |        
|                              | Derivative liability  notes                                                                                                                                      |                             |            | 35,599       |            |   |           |             |        
|                              | Liability for warrant settlement                                                                                                                                  |                             |            | 182,862      |            |   |           |            |        
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              |                                                                                                                                                                   | Total long-term liabilities |            |              | 2,391,595  |   |           |             |        | 
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            
|Commitments and contingencies |                                                                                                                                                                   |                             |           |              |            |   |          |            
|Shareholders equity:         |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              | Convertible Series 2 preferred stock, no par
    value, redeemable, 10,000,000 shares authorized, 6,940,484
    and 0 shares issued and outstanding, respectively |                             |            | 2,815,101    |            |   |           |            |        
|                              | Common stock, no par value,
    25,000,000 shares authorized, 16,772,570 and
    8,224,652 shares issued and outstanding, respectively                            |                             |            | 18,502,354   |            |   |           | 16,149,034  |        
|                              | Common stock warrants                                                                                                                                             |                             |            | 468,000      |            |   |           | 357,000     |        
|                              | Accumulated deficit                                                                                                                                               |                             |            | (21,777,556  | )          |   |           | (15,731,324 | )      
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              |                                                                                                                                                                   | Total shareholders equity  |            |              | 7,899      |   |           |             | 774,710 | 
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            
|                              |                                                                                                                                                                   | $                           | 14,041,510 |              |            | $ | 1,044,830 |            
|                              |                                                                                                                                                                   |                             |            |              |            |   |           |            

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

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MICROFIELD GROUP, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

|                                                                      |                             |                                               |            |              |            |   |          |           |          |  
|--------------------------------------------------------------------- | --------------------------- | --------------------------------------------- | ---------- | ------------ | ---------- | - | -------- | --------- | -------- | -
|                                                                      |                             |                                              
|                                                                      |                             | Years Ended                                  
|                                                                      |                             |                                              
|                                                                      |                             | January 3,                                    |            | December 28,
|                                                                      |                             | 2004                                          |            | 2002        
|                                                                      |                             |                                               |            |             
|Sales                                                                 |                             |                                               | 10,342,045 |              |            |   |         |          
|Cost of goods sold                                                    |                             |                                               | 8,712,117  |              |            |   |         |          
|                                                                      |                             |                                               |            |              |            |   |          |          
|                                                                      | Gross profit                |                                               |            | 1,629,928    |            |   |          |          |         
|Operating expenses                                                    |                             |                                               |            |              |            |   |          |          
|Sales, general and administrative                                     |                             |                                               | 4,104,098  |              |            |   | 279,162  |          
|                                                                      |                             |                                               |            |              |            |   |          |          
|Loss from operations                                                  |                             |                                               | (2,474,170 | )            |            |   | (279,162 | )        
|Other income (expense)                                                |                             |                                               |            |              |            |   |          |          
|Interest income                                                       |                             |                                               | 3,298      |              |            |   | 9,143    |          
|                                                                      | Interest expense            |                                               |            | (427,623     | )          |   |          |          |         
|                                                                      | Loss on debt extinguishment |                                               |            | (111,000     | )          |   |          |          |         
|                                                                      | Derivative expense          |                                               |            | (123,393     | )          |   |          |          |         
|                                                                      | Other income (expense), net |                                               |            | (10,299      | )          |   |          | 29,210    |         
|                                                                      |                             |                                               |            |              |            |   |          |          
|                                                                      |                             | Loss before provision for income taxes        |            |              | (3,143,187 | ) |          |           | (240,809 | )
|Provision for income taxes                                            |                             |                                               |           |              |            |   |         |          
|                                                                      |                             |                                               |            |              |            |   |          |          
|Loss from continuing operations                                       |                             |                                               | (3,143,187 | )            |            |   | (240,809 | )        
|Discontinued operations:                                              |                             |                                               |            |              |            |   |          |          
|                                                                      |                             | Loss on discontinued operations 
    Velagio |            |              | (1,793,520 | ) |          |           |          |  
|                                                                      |                             | Loss on discontinued operations  IST         |            |              | (1,146,283 | ) |          |           | (146,176 | )
|                                                                      |                             | Gain on discontinued SoftBoard operations     |            |              | 36,758     |   |          |           | 22,669   |  
|                                                                      |                             |                                               |            |              |            |   |          |          
|Net loss                                                              |                             | $                                             | (6,046,232 | )            |            | $ | (364,316 | )        
|                                                                      |                             |                                               |            |              |            |   |          |          
|Basic and diluted net loss per share from
    continuing operations   |                             | $                                             | (0.31      | )            |            | $ | (0.04    | )        
|Basic and diluted net loss per share from
    discontinued operations |                             | $                                             | (0.28      | )            |            | $ | (0.02    | )        
|                                                                      |                             |                                               |            |              |            |   |          |          
|Basic and diluted net loss per share                                  |                             | $                                             | (0.59      | )            |            | $ | (0.06    | )        
|                                                                      |                             |                                               |            |              |            |   |          |          
|Weighted average shares used in per share
    calculations:           |                             |                                               |            |              |            |   |          |          
|                                                                      | Basic and diluted           |                                               |            | 10,308,815   |            |   |          | 5,614,975 |         
|                                                                      |                             |                                               |            |              |            |   |          |          

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

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MICROFIELD GROUP, INC

STATEMENT OF CHANGES IN SHAREHOLDERS
EQUITY

Years Ended January 3, 2004 and
December 28, 2002


|                                                                                                                             |  |                      |           |              |  |              |           |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   |            |  
|---------------------------------------------------------------------------------------------------------------------------- |  | -------------------- | --------- | ------------ |  | ------------ | --------- | ----------- |  | ------------- | ---------- | ------ |  | ------- | ---------- | ------ |  |  | --------- |  |  | - | ------- |  |  | - | ----------- | - |  | - | ---------- | -
|                                                                                                                             |  |                      |           |              |  |              |           |             |  |               |            |       
|                                                                                                                             |  | Series 2 Convertible |           |              |  | Common Stock |           |             |  |              
|                                                                                                                             |  | Preferred            |           | Common Stock |  | Warrants     |           |             |  | Total        
|                                                                                                                             |  |                      |           |              |  |              |           | Accumulated |  | Shareholders
|                                                                                                                             |  | Shares               |           | Amount       |  | Shares       |           | Amount      |  | Warrants      |            | Amount |  | Deficit |            | Equity
|                                                                                                                             |  |                      |           |              |  |              |           |             |  |               |            |        |  |         |            |       
|Balance December 29, 2001                                                                                                    |  |                      |           |              |  |              |           |             |  |               | 4,596,066  |        |  | $       | 15,400,643 |        |  |  | 2,066,000 |  |  | $ | 357,000 |  |  | $ | (15,367,008 | ) |  | $ | 390,635    |  
|Common shares issued upon merger with IST                                                                                    |  |                      |           |              |  |              |           |             |  |               | 1,818,181  |        |  |         | 400,000    |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 400,000    |  
|Common shares issued in private placement                                                                                    |  |                      |           |              |  |              |           |             |  |               | 1,363,629  |        |  |         | 280,000    |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 280,000    |  
|Shares issued to settle miscellaneous liabilities                                                                            |  |                      |           |              |  |              |           |             |  |               | 387,776    |        |  |         | 66,000     |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 66,000     |  
|Stock options exercised                                                                                                      |  |                      |           |              |  |              |           |             |  |               | 59,000     |        |  |         | 2,391      |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 2,391      |  
|Net loss                                                                                                                     |  |                      |           |              |  |              |           |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   |         |  |  |   | (364,316    | ) |  |   | (364,316   | )
|                                                                                                                             |  |                      |           |              |  |              |           |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   |            |  
|Balance, December 28, 2002                                                                                                   |  |                      |          |              |  |              |          |             |  |               | 8,224,652  |        |  |         | 16,149,034 |        |  |  | 2,066,000 |  |  |   | 357,000 |  |  |   | (15,731,324 | ) |  |   | 774,710    |  
|Common shares repurchased                                                                                                    |  |                      |           |              |  |              |           |             |  |               | (951,445   | )      |  |         | (209,318   | )      |  |  |           |  |  |   |         |  |  |   |             |   |  |   | (209,318   | )
|Common shares issued in private placement                                                                                    |  |                      |           |              |  |              |           |             |  |               | 1,113,078  |        |  |         | 269,549    |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 269,549    |  
|Common shares issued upon acquisition of CTS                                                                                 |  |                      |           |              |  |              |           |             |  |               | 4,193,142  |        |  |         | 1,090,217  |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 1,090,217  |  
|Common shares and employee stock options issued
    upon acquisition of Velagio                                              |  |                      |           |              |  |              |           |             |  |               | 4,193,143  |        |  |         | 1,202,872  |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 1,202,872  |  
|Re-measurement of warrant value originally issued
    with debt                                                              |  |                      |           |              |  |              |           |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   | 111,000 |  |  |   |             |   |  |   | 111,000    |  
|Convertible preferred shares issued in private
    placement, net of issuance costs and liability for warrant
    settlement |  |                      | 1,785,714 |              |  |              | 667,636   |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 667,636    |  
|Convertible preferred shares issued for
    retirement of related party debt, net of issuance costs                          |  |                      | 1,821,437 |              |  |              | 747,465   |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 747,465    |  
|Convertible preferred shares issued for
    retirement of related party debt, net of issuance costs                          |  |                      | 3,333,333 |              |  |              | 1,400,000 |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   | 1,400,000  |  
|Net loss                                                                                                                     |  |                      |           |              |  |              |           |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   |         |  |  |   | (6,046,232  | ) |  |   | (6,046,232 | )
|                                                                                                                             |  |                      |           |              |  |              |           |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   |            |  
|Balance, January 3, 2004                                                                                                     |  |                      | 6,940,484 |              |  | $            | 2,815,101 |             |  |               | 16,772,570 |        |  | $       | 18,502,354 |        |  |  | 2,066,000 |  |  | $ | 468,000 |  |  | $ | (21,777,556 | ) |  | $ | 7,899      |  
|                                                                                                                             |  |                      |           |              |  |              |           |             |  |               |            |        |  |         |            |        |  |  |           |  |  |   |         |  |  |   |             |   |  |   |            |  

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

27



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##### Table of Contents



MICROFIELD GROUP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

|                                                                                         |                                                            |                                                      |                                                                     |              |         |            |   |          |        |          |  
|---------------------------------------------------------------------------------------- | ---------------------------------------------------------- | ---------------------------------------------------- | ------------------------------------------------------------------- | ------------ | ------- | ---------- | - | -------- | ------ | -------- | -
|                                                                                         |                                                            |                                                     
|                                                                                         |                                                            | Years ended                                         
|                                                                                         |                                                            |                                                     
|                                                                                         |                                                            | January 3,                                           |                                                                     | December 28,
|                                                                                         |                                                            | 2004                                                 |                                                                     | 2002        
|                                                                                         |                                                            |                                                      |                                                                     |             
|Cash Flows From Operating Activities:                                                    |                                                            |                                                      |                                                                     |              |         |            |   |         
|                                                                                         | Net loss                                                   |                                                      | $                                                                   | (6,046,232   | )       |            | $ | (364,316 | )     
|                                                                                         | Add (deduct):                                              |                                                      |                                                                     |              |         |            |   |          |       
|                                                                                         |                                                            |                                                      | Loss on discontinued operations  IST                               |              |         | 1,146,283  |   |          |        | 146,176  |  
|                                                                                         |                                                            |                                                      | Loss on discontinued operations 
    Velagio                       |              |         | 1,793,520  |   |          |        |         |  
|                                                                                         |                                                            |                                                      | Gain on sale of discontinued
    operations  SoftBoard             |              |         | (36,758    | ) |          |        | (22,669  | )
|                                                                                         |                                                            |                                                      |                                                                     |              |         |            |   |         
|                                                                                         |                                                            |                                                      | Loss from continuing operations                                     |              |         | (3,143,187 | ) |          |        | (240,809 | )
|                                                                                         |                                                            |                                                      | Depreciation on equipment                                           |              |         | 215,413    |   |          |        | 26,586   |  
|                                                                                         |                                                            |                                                      | Amortization on intangible assets                                   |              |         | 32,244     |   |          |        |         |  
|                                                                                         |                                                            |                                                      | Remeasurement of warrants on term extension                         |              |         | 111,000    |   |          |        |         |  
|                                                                                         |                                                            |                                                      | Remeasurement of warrant liability                                  |              |         | 117,960    |   |          |        |         |  
|                                                                                         |                                                            |                                                      | Remeasurement of derivative associated with
    Steelcase note      |              |         | 35,599     |   |          |        |         |  
|Changes in current assets and liabilities (net of
    effects of business combinations): |                                                            |                                                      |                                                                     |              |         |            |   |         
|                                                                                         | Accounts receivable                                        |                                                      |                                                                     | (280,582     | )       |            |   | (184,340 | )     
|                                                                                         | Accounts receivable  related party                        |                                                      |                                                                     | (183,553     | )       |            |   |         |       
|                                                                                         | Inventory                                                  |                                                      |                                                                     | 178,403      |         |            |   | (25,806  | )     
|                                                                                         | Other current assets                                       |                                                      |                                                                     | (46,266      | )       |            |   | (8,801   | )     
|                                                                                         | Costs in excess of billings                                |                                                      |                                                                     | 525,721      |         |            |   |         |       
|                                                                                         | Other long term assets                                     |                                                      |                                                                     | (24,480      | )       |            |   |         |       
|                                                                                         | Accounts payable                                           |                                                      |                                                                     | 182,451      |         |            |   | 127,681  |       
|                                                                                         | Accounts payable  related party                           |                                                      |                                                                     | 410,636      |         |            |   |         |       
|                                                                                         | Billings in excess of cost                                 |                                                      |                                                                     | (133,010     | )       |            |   |         |       
|                                                                                         | Other current liabilities                                  |                                                      |                                                                     | 690,211      |         |            |   | (229,378 | )     
|                                                                                         |                                                            |                                                      |                                                                     |              |         |            |   |         
|                                                                                         |                                                            |                                                      | Net cash used by continuing operations                              |              |         | (1,311,440 | ) |          |        | (534,867 | )
|                                                                                         |                                                            |                                                      | Net cash provided (used) by discontinued
    operations  IST       |              |         | (1,146,283 | ) |          |        |         |  
|                                                                                         |                                                            |                                                      | Net cash provided (used) by discontinued
    operations  Velagio   |              |         | (1,793,520 | ) |          |        |         |  
|                                                                                         |                                                            |                                                      | Net cash provided (used) by discontinued
    operations  SoftBoard |              |         | 36,758     |   |          |        | (123,507 | )
|                                                                                         |                                                            |                                                      | Assets disposed in discontinued operations                          |              |         | 2,016,492  |   |          |        |         |  
|                                                                                         |                                                            |                                                      |                                                                     |              |         |            |   |         
|                                                                                         |                                                            |                                                      | Net cash used by operating activities                               |              |         | (2,197,993 | ) |          |        | (658,374 | )
|                                                                                         |                                                            |                                                      |                                                                     |              |         |            |   |         
|Cash flows from investing activities                                                     |                                                            |                                                      |                                                                     |              |         |            |   |         
|                                                                                         | Purchases of fixed assets                                  |                                                      |                                                                     | (2,000       | )       |            |   | (8,348   | )     
|                                                                                         | Net cash acquired in mergers with 1ST, CTS and
    Velagio |                                                      |                                                                     | 621,391      |         |            |   | 2,194    |       
|                                                                                         |                                                            |                                                      |                                                                     |              |         |            |   |         
|                                                                                         |                                                            | Net cash provided (used) by investing
    activities |                                                                     |              | 619,391 |            |   |          | (6,154 | )       
|                                                                                         |                                                            |                                                      |                                                                     |              |         |            |   |         

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|                                                                          |                                                                                                |                                                 |                                                          |              |             |           |         |          |         |          |  
|------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------- | ----------------------------------------------- | -------------------------------------------------------- | ------------ | ----------- | --------- | ------- | -------- | ------- | -------- | -
|                                                                          |                                                                                                |                                                
|                                                                          |                                                                                                | Years ended                                    
|                                                                          |                                                                                                |                                                
|                                                                          |                                                                                                | January 3,                                      |                                                          | December 28,
|                                                                          |                                                                                                | 2004                                            |                                                          | 2002        
|                                                                          |                                                                                                |                                                 |                                                          |             
|Cash flows from financing activities:                                     |                                                                                                |                                                 |                                                          |              |             |           |         |         
|                                                                          |                                                                                                | Borrowings on line of credit                    |                                                          |              | 10,832,886  |           |         |          |        |         
|                                                                          |                                                                                                | Repayments on line of credit                    |                                                          |              | (10,185,200 | )         |         |          |        |         
|                                                                          |                                                                                                | Repayments on notes payable                     |                                                          |              | (11,527     | )         |         |          |        |         
|                                                                          |                                                                                                | Repayments on notes payable  related
    party |                                                          |              | (97,389     | )         |         |          |        |         
|                                                                          |                                                                                                | Borrowings on note payable  related
    party  |                                                          |              | 90,000      |           |         |          |        |         
|                                                                          |                                                                                                | Proceeds from issuance of preferred stock       |                                                          |              | 750,003     |           |         |          |        |         
|                                                                          |                                                                                                | Proceeds from issuance of common stock          |                                                          |              | 239,381     |           |         |          | 280,000 |         
|                                                                          |                                                                                                | Proceeds from exercise of stock options         |                                                          |              |             |           |         |          | 2,391   |         
|                                                                          |                                                                                                |                                                 |                                                          |              |             |           |         |         
|                                                                          |                                                                                                |                                                 | Net cash provided (used) in financing
    activities     |              |             | 1,618,154 |         |          |         | 282,391  |  
|                                                                          |                                                                                                |                                                 |                                                          |              |             |           |         |         
|                                                                          |                                                                                                |                                                 | Net increase (decrease) in cash and cash
    equivalents |              |             | 39,552    |         |          |         | (382,137 | )
|Cash and cash equivalents, beginning of period                            |                                                                                                |                                                 | 90,981                                                   |              |             |           | 473,118 |         
|                                                                          |                                                                                                |                                                 |                                                          |              |             |           |         |         
|Cash and cash equivalents, end of period                                  |                                                                                                | $                                               | 130,533                                                  |              |             | $         | 90,981  |         
|                                                                          |                                                                                                |                                                 |                                                          |              |             |           |         |         
|Supplemental schedule of non-cash financing and
    investing activities: |                                                                                                |                                                 |                                                          |              |             |           |         |         
|                                                                          | Common stock issued upon acquisitions (See Note
    10)                                        |                                                 | $                                                        | 2,293,089    |             |           | $       | 400,000  |        
|                                                                          | Costs of acquisitions                                                                          |                                                 | $                                                        | 139,800      |             |           | $       | 67,106   |        
|                                                                          | Net tangible liabilities acquired from mergers                                                 |                                                 | $                                                        | 13,910,104   |             |           | $       | 113,400  |        
|                                                                          | Net intangible assets acquired in mergers                                                      |                                                 | $                                                        | 5,704,548    |             |           | $       | (580,400 | )      
|                                                                          | Common stock issued to settle miscellaneous
    liabilities                                    |                                                 | $                                                        |             |             |           | $       | 66,000   |        
|                                                                          | Common stock issued to settle related party
    debt  Steven M. Wright                        |                                                 | $                                                        | 40,000       |             |           | $       |         |        
|                                                                          | Repurchase of common stock with issuance of note
    payable  Steelcase                       |                                                 | $                                                        | 209,318      |             |           | $       |         |        
|                                                                          | Issuance of preferred stock in exchange for
    conversion of related party debt (See Note 18) |                                                 | $                                                        | 2,165,000    |             |           | $       |         |        
|                                                                          | Preferred stock private placement placement costs                                              |                                                 | $                                                        | 35,000       |             |           | $       |         |        
|                                                                          | Valuation of warrants issued with preferred stock                                              |                                                 | $                                                        | 64,902       |             |           | $       |         |        

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

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##### Table of Contents



MICROFIELD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|   |                        
|-- | -----------------------
|1. | Description of Business

Microfield Group, Inc. (the Company)
specializes in the installation of electrical products and
services. The Companys objective is to leverage its assets
and value to successfully build a viable, profitable electrical
services and technology infrastructure business.

In September 2003, the Company acquired privately
held Velagio, Inc. (Velagio) and Christenson Technology
Services, Inc. (CTS). In December, 2003 the service and
technology teams of Velagio and CTS were consolidated into one
subsidiary under the name Christenson Velagio, Inc.
(CVI) in order to take full advantage of inherent synergies
within the subsidiaries, as well as capture competitive
advantage. The newly formed organization conducts business in
the electrical services and technology infrastructure sectors.

The Company was incorporated in October 1986 as
an Oregon Corporation, succeeding operations that began in
October 1984. The Companys headquarters are located in
Portland, Oregon.



|   |                  
|-- | -----------------
|2. | Liquidity Matters

The Company has raised approximately $1,300,000
in cash through issuances of new common and preferred shares in
the periods reported, and raised an additional $1,750,000 from
the sale of Series 4 preferred shares in April and May of
2004. Debt to related parties, in the amount of approximately
$2,165,000 has been converted to equity during the same period.
Management has been focused on cutting certain expenses, both to
improve gross margins and to reduce the monthly overhead costs.
The Company and its subsidiary have suffered recurring losses
from ongoing operations and have experienced negative cash flows
from continuing operating activities, and have negative working
capital of $3,622,000 as of January 3, 2004. While it is
anticipated that the losses from continuing operations will
decline as a result of cost reduction efforts, debt conversions
and fundraising events, recurring losses and liquidity issues
raise doubt about the Companys ability to continue as a
going concern. The financial statements do not include any
adjustments that might result from the outcome of this
uncertainty. The Company may not have sufficient resources to
satisfy cash requirements for the next twelve months. The
Company may have to seek additional investment capital or debt
facilities. Investment capital or debt facilities may be
difficult to obtain due, among other issues, to the
Companys inability to meet certain SEC reporting
requirements relative to historical financial statements of CTS
and from the unresolved lawsuit pending against the Company.
There can be no assurance that additional capital will be
available or, if available, will be at terms acceptable to the
Company. The Company is focusing on opportunities to increase
revenues and grow margins while continuing to reduce monthly
expenses in an attempt to turn cash flow positive and profitable.



|   |                                               
|-- | ----------------------------------------------
|3. | Summary of Significant Accounting
    Policies



| |            
| | -----------
| | Fiscal Year

The Companys fiscal year is the 52- or
53-week period ending on the Saturday closest to the last day of
December. The Companys current fiscal year is the 53-week
period ending January 3, 2004. The Companys last
fiscal year was the 52-week period ended December 28, 2002.



| |                            
| | ---------------------------
| | Principles of Consolidation

The Consolidated Statements of Operations
presented above, contain revenue and expense data of Microfield
Group, Inc. for the years ended January 3, 2004 and
December 28, 2002. On September 16, 2003, the Company
acquired two wholly-owned subsidiaries, Christenson Technology
Services, Inc. (CTS) and Velagio, Inc. (Velagio) (see
Note 9). The revenue and expense data of CTS is included in
the Consolidated Statement of Operations from the acquisition
date, September 16, 2003, to the end of the period
presented. Revenue and expense data of its subsidiaries, Velagio
and Innovative Safety Technologies are included in

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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

discontinued operations in the Consolidated
Statement of Operations. All significant inter-company accounts
and transactions between the Company and its subsidiaries have
been eliminated in consolidation.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

The Company considers all highly liquid
investments with an original maturity or remaining maturity of
three months or less at the date of purchase to be cash
equivalents. Cash and cash equivalents are primarily maintained
at two financial institutions.



| |                                        
| | ---------------------------------------
| | Fair Value of Financial
    Instruments

The carrying value of the Companys
financial instruments, including cash and cash equivalents,
accounts receivable, accounts payable and accrued liabilities
are carried at cost, which approximates fair value due to the
relative short maturities of these instruments. The carrying
value of debt, derivatives and the liability for warrant
settlement are recorded at the estimated fair value of these
instruments.



| |            
| | -----------
| | Inventories

Inventories are stated at the lower of cost or
market, using the first-in, first-out method. Inventory is
comprised almost entirely of the cost of material. The Company
provides inventory allowances based on estimates of excess and
obsolete inventories.



| |                  
| | -----------------
| | Advertising Costs

Advertising costs in the current year of $27,000
were expensed as incurred.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation of
computer equipment and software is computed using straight line
or accelerated declining balance method over the estimated
useful lives of the assets. Estimated lives of three to five
years are used for computer equipment and software. Depreciation
of vehicles is computed using the straight-line method over the
estimated useful lives of the assets. Estimated lives of three
years are used for vehicles. Depreciation of furniture and
fixtures is computed using straight line or accelerated
declining balance method over the estimated useful lives of the
assets. Estimated lives of five to seven years are used for
furniture and fixtures.



| |               
| | --------------
| | Concentrations

Financial instruments that potentially subject
the Company to concentrations of credit risk consist primarily
of accounts receivable. At January 3, 2004 there were no
customers whose accounts receivable accounted for more than 10%
of total outstanding trade receivables. At December 28,
2002, with accounts receivable at a much lower level, 79% of
accounts receivable was concentrated with one customer. The
Company performs limited credit evaluations of its customers,
does not require collateral on accounts receivable balances, but
does often retain lien rights to reduce its risk. The Company
has not experienced material credit losses for the periods
presented. The level of sales to any single customer may vary
and the loss of any one of these customers, or a decrease in the
level of sales to any one of these customers, could have a
material adverse impact on the Companys financial
condition and results of operations.

The Company currently relies on various sources
for key components used in the installation and sales of its
products and services. None of the Companys products or
supplies used in the performance of its services is from a
single source. The inability of any limited source suppliers to
fulfill supply and production requirements, could materially
impact future operating results.

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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The Companys business is concentrated in
the electrical services and technology services industry. Its
future success depends on the buying patterns of its customers
and continued demand by customers for the Companys
products and services. The Companys success will depend on
its ability to maintain its history of first rate quality in
designing customer solutions and performing its services,
enhancing its existing products and services and to develop and
introduce, on a timely basis, successful new products or
services as a result of the acquisition of companies in line
with its mission statement.



| |                             
| | ----------------------------
| | Revenue and Cost Recognition

Significant portions of the Companys
revenues are derived from construction and service projects.
Revenues from fixed-price, cost-plus-fee, time and material and
unit-price contracts are recognized using the
percentage-of-completion method of accounting which recognizes
income as work on a contract progresses. Recognition of revenues
and profits generally are related to costs incurred in providing
the services required under the contract. Earned revenue is the
amount of cost incurred on the contract in the period plus the
amount of gross profit earned during the same period. This
method is used because management considers total cost to be the
best available measure of completion of construction contracts
in progress. Provisions for estimated losses on construction
contracts in progress are made in their entirety in the period
in which such losses are determined without reference to the
percentage complete. Changes in job performance, job conditions
and estimated profitability, including those arising from
contract penalty provisions and final contract settlements, may
result in revisions to revenue and costs, and are recognized in
the period in which the revisions are determined. Claims for
additional revenue are not recognized until the period in which
such claims are allowed. Direct contract costs include all
direct labor, direct materials and some estimating costs and
shop and equipment costs. General and administrative costs are
charged to expense as incurred. As of January 3, 2004,
accounts receivable does not include any retainage that is over
one year old. Revenue from discontinued operations was
recognized when persuasive evidence of an arrangement existed,
the price was fixed, title had transferred, collection of
resulting receivables was probable, no customer acceptance
requirements existed and there were no remaining significant
obligations.

A small portion of the Companys revenue in
2003 was derived from software consulting and services.
Consulting and service revenue consists of strategic advisory,
business process re-engineering, design, engineering, software
development, systems integration, systems testing and
implementation, end user training and post-implementation
support activities. Consulting services are generally billed
under time and material contracts. Revenue earned from these
services is recognized as services are performed. Prior to its
acquisition by the Company, Velagio also earned revenue from
sales of a software license and the related professional
services. During the period since its acquisition by the
Company, no revenue from sales of software products has been
recognized. Certain consulting services only
contracts included post contract consumer support (PCS) to
assist customers with post-implementation issues. PCS services
are generally offered under renewable, fee-based contracts or as
part of multiple element arrangements. PCS revenue is deferred
and recognized ratably over the contract period. This segment of
the Companys business was acquired in the acquisition of
Velagio. It is anticipated that there will be little or no
revenues from software consulting and services after 2003.



| |                                    
| | -----------------------------------
| | Impairment of Long-lived
    Assets

Long-lived assets to be held and used are
reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amounts of such assets
may not be recoverable. Determination of recoverability is based
on an estimate of discounted future cash flows resulting from
the use of the asset and its eventual disposition. Measurement
of an impairment loss for long-lived assets that management
expects to hold and use is based on the fair value of the asset
as estimated using a discounted cash flow model. (See
Note 7.)

32



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The Company measures the carrying value of
goodwill recorded in connection with the acquisitions for
potential impairment in accordance with SFAS No. 142,
Goodwill and Other Intangible Assets. To apply
SFAS 142, a company is divided into separate
reporting units, each representing groups of
products that are separately managed. For this purpose, the
Company has one reporting unit. To determine whether or not
goodwill may be impaired, a test is required at least annually,
and more often when there is a change in circumstances that
could result in an impairment of goodwill. If the trading of our
common stock is below book value for a sustained period, or if
other negative trends occur in our results of operations, a
goodwill impairment test will be performed by comparing book
value to estimated market value. To the extent goodwill is
determined to be impaired, an impairment charge is recorded in
accordance with SFAS 142.



| |             
| | ------------
| | Income Taxes

The Company accounts for income taxes using the
asset and liability approach in accordance with Statement of
Financial Accounting Standards (SFAS) No. 109,
Accounting for Income Taxes. The asset and liability approach
requires the recognition of deferred tax liabilities and assets
for the expected future tax consequences of temporary
differences between the carrying amounts and the tax basis of
assets and liabilities. The effect on deferred taxes of a change
in tax rates is recognized in operations in the period that
includes the enactment date. Due to recurring losses, there has
been no provision for income taxes in the periods presented.



| |                                        
| | ---------------------------------------
| | Computation of Net Income per
    Share

Basic earnings (loss) per common share is
computed using the weighted-average number of common shares
outstanding during the period. Diluted earnings per common share
is computed using the combination of dilutive common share
equivalents, which include convertible preferred shares, options
and warrants and the weighted-average number of common shares
outstanding during the period. Diluted loss per common share for
2003 and 2002 is based only on the weighted-average number of
common shares outstanding during the period, as the inclusion of
10,140,063 and 2,347,188 common share equivalents would
have been anti-dilutive.



| |                           
| | --------------------------
| | Pension Plan Contributions

The Company contributes to several Multi-Employer
Pension Benefit Plans on behalf of its employees covered by a
collective bargaining agreement. During 2003, The Company
contributed $630,000 to these plans, which was expensed as
incurred.



| |              
| | -------------
| | Stock Options

The Company accounts for its employee and
director stock options in accordance with provisions of
Accounting Principles Board Opinion No. 25
(APB 25), Accounting for Stock Issued to
Employees. Pro forma disclosures a required under
SFAS 123, Accounting for Stock-Based
Compensation and as amended by SFAS 148,
Accounting for Stock-Based Compensation 
Transition and Disclosure, are presented below. Under this
method, no stock based compensation expense has been recognized
for stock options issued to employees because the exercise
prices of options issued were equal to or greater than the fair
value of the underlying shares at the date of grant.

Had compensation cost for the Companys plan
been determined based on the fair value at the grant dates
consistent with the method of SFAS No. 123, the total
value of options granted would have been $141,530 for the year
ended January 3, 2004 and $85,835 for the year ended
December 28, 2002. Such amounts would be amortized over the
vesting period of the options. The total compensation expense
that would have been recognized if the Company had determined
such costs based on the fair value method would have been
$19,174 and $4,545 for the years ended January 3, 2004 and
December 28, 2002, respectively.

33



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Accordingly, under SFAS No. 123, the
Companys net loss and loss per share for the years ended
January 3, 2004 and December 28, 2002, would have been
changed to the pro forma amounts indicated below:

|                                                                                                                                                  |  |  |             |      |  |      |            |   |  |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------- |  |  | ----------- | ---- |  | ---- | ---------- | - |  | - | -------- | -
|                                                                                                                                                  |  |  |             | 2003 |  | 2002
|                                                                                                                                                  |  |  |             |      |  |     
|Net loss                                                                                                                                          |  |  | As reported |      |  | $    | (6,046,232 | ) |  | $ | (364,316 | )
|Less: Total stock-based employee compensation
    expense determined under fair value based method for all awards,
    net of related tax effects |  |  |             |      |  |      | (19,174    | ) |  |   | (4,545   | )
|                                                                                                                                                  |  |  |             |      |  |      |            |   |  |   |          |  
|                                                                                                                                                  |  |  | Pro forma   |      |  | $    | (6,065,406 | ) |  | $ | (368,861 | )
|                                                                                                                                                  |  |  |             |      |  |      |            |   |  |   |          |  
|Basic and diluted net loss per share                                                                                                              |  |  | As reported |      |  | $    | (0.59      | ) |  | $ | (0.06    | )
|                                                                                                                                                  |  |  | Pro forma   |      |  | $    | (0.59      | ) |  | $ | (0.07    | )

The effects of applying SFAS 123 for
providing pro forma disclosures for 2003 and 2002 are not likely
to be representative of the effects on reported net loss and net
loss per share for future years, because options vest over
several years and additional awards generally are made each year.



| |                     
| | --------------------
| | Comprehensive Income

The Company has no items of other comprehensive
income or expense. Accordingly, the Companys comprehensive
loss and net loss are the same for all periods presented.



| |                 
| | ----------------
| | Use of Estimates

The preparation of financial statements and
related disclosures in conformity with accounting principles
generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. The Company
evaluates, on an on-going basis, its estimates and judgments,
including those related to revenue recognition, sales returns,
bad debts, excess inventory, income taxes, contingencies and
litigation. Its estimates are based on historical experience and
assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or
conditions.



| |                                     
| | ------------------------------------
| | Recent Accounting
    Pronouncements

SFAS 145.In
April 2002, the FASB issued SFAS 145, Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. The most
relevant provision of SFAS 145 is the rescission of
SFAS 4, Reporting Gains and Losses from
Extinguishment of Debt  An Amendment of APB Opinion
No. 30, which required all gains and losses from
extinguishment of debt to be aggregated and, if material,
classified as an extraordinary item, net of related income tax
effect. As a result of the rescission, the criteria in APB
Opinion No. 30 will now be used to classify those gains and
losses. The provisions of SFAS 145 related to the
rescission of SFAS 4 shall be applied in fiscal years
beginning after May 15, 2002, with early application
encouraged. The adoption of SFAS 145 did not have a
material impact on the Company.

SFAS 146.In
June 2002, the FASB issued SFAS 146, Accounting for
Costs Associated with Exit or Disposal Activities.
SFAS 146 addresses financial accounting and reporting for
costs associated with exit or disposal activities and nullifies
EITF 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).
SFAS 146 requires the recognition of a liability when it
has been incurred. The initial measurement of that liability
shall approximate fair value. The provisions of SFAS 146
are effective for exit or disposal activities initiated after

34



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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

December 31, 2002, with earlier application
encouraged. The adoption of SFAS 146 did not have a
material impact on the Company, but may impact future disposal
or exit activities, if any.

FIN 45.In
November 2002, the FASB issued FASB Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements
for Guarantees, including Indirect Guarantees of Others.
FIN 45 requires that upon issuance of a guarantee, a
guarantor must recognize a liability for the fair value of an
obligation assumed under a guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual
financial statements about the obligations associated with
guarantees issued. The recognition provisions of FIN 45 are
effective for any guarantees issued or modified after
December 15, 2002. The adoption of FIN 45 did not have
a material effect on the Companys financial position,
results of operations, or cash flows.

EITF 00-21.In
November 2002, the EITF reached a consensus on Issue
No. 00-21, Revenue Arrangements with Multiple
Deliverables. EITF 00-21 addresses certain aspects of
the accounting by a vendor for arrangements under which the
vendor will perform multiple revenue generating activities. The
EITF is effective for fiscal years beginning after June 15,
2003. The adoption of EITF 00-21 did not have a material
effect on the Companys financial position, results of
operations or cash flows.

SFAS 148.In
December 2002, the FASB issued Statement of Financial Standards
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure.
SFAS 148 amends SFAS 123, Accounting for Stock
Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method
of accounting for stock-based compensation. In addition,
SFAS 148 amends the disclosure requirements of
SFAS 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting
for stock-based compensation and the effect of the method used
on reported results. The annual disclosure provisions of
SFAS 148 are effective for periods ending after
December 15, 2002. The interim disclosure provisions are
effective for financial reports containing financial statements
for interim periods beginning after December 15, 2002.
Management has adopted the disclosure requirements of
SFAS 148.

FIN 46.In
January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities
(FIN 46). This Interpretation requires certain variable
interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have
the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support
from other parties. FIN 46 is effective immediately for all
new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of
FIN 46 were to be applied for the first interim or annual
period beginning after June 15, 2003. In October 2003, the
FASB released a FASB Staff Position (FSP) deferring the
effective date for applying the provisions of FIN 46. A
public entity need not apply the provisions of FIN 46 to an
interest held in a variable interest entity or potential
variable interest entity until the end of the first interim or
annual period ending after December 15, 2003 (as of
December 31, 2003, for an entity with a calendar year-end
or quarter-end of December 31). The Company has no
relationships with other entities for which it is the primary
beneficiary. Accordingly, the Company does not expect the
adoption of FIN 46 to have a material effect on the
Companys financial position, results of operations or cash
flows.

SFAS 149.In
May 2003, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging
Activities. SFAS 149 is intended to result in more
consistent reporting of contracts as either freestanding
derivative instruments subject to Statement 133 in its
entirely, or as hybrid instruments with debt host contracts and
embedded derivative features. SFAS 149 is effective for
contracts entered into or modified after June 30, 2003. The
adoption of SFAS 149 did not have a material impact on the
Companys financial position, cash flows or results of
operations.

35



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

SFAS 150.In
May 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity.
SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that
an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances). Many
of those instruments were previously classified as equity.
SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period
beginning after September 15, 2003. It is to be implemented
by reporting the cumulative effect of a change in an accounting
principle for financial instruments created before the issuance
date of SFAS No. 150 and still existing at the
beginning of the interim period of adoption. Restatement is not
permitted. On November 7, 2003, the FASB issued FASB Staff
Position No. FAS 150-3 (FSP 150-3), Effective
Date, Disclosures, and Transition for Mandatorily Redeemable
Financial Instruments of Certain Nonpublic Entities and Certain
Mandatorily Redeemable Noncontrolling Interests under FASB
Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and
Equity. FSP 150-3 deferred certain aspects of
FAS 150. The adoption of FAS 150 and FAS 150-3
did not have a material impact on the Companys results of
operations, financial position or cash flows.

SAB 104.On
December 17, 2003, the Staff of the Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin
No. 104 (SAB 104), Revenue Recognition, which
supersedes SAB 101, Revenue Recognition in Financial
Statements. SAB 104s primary purpose is to
rescind accounting guidance contained in SAB 101 related to
multiple element revenue arrangements, superseded as a result of
the issuance of EITF 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables. Additionally,
SAB 104 rescinds the SECs Revenue Recognition in
Financial Statements Frequently Asked Questions and Answers(the FAQ) issued with SAB 101 that had been codified in
SAB Topic 13, Revenue Recognition. Selected portions
of the FAQ have been incorporated into SAB 104. While the
wording of SAB 104 has changed to reflect the issuance of
EITF 00-21, the revenue recognition principles of
SAB 101 remain largely unchanged by the issuance of
SAB 104. The adoption of SAB 104 in December 2003 did
not materially affect the Companys revenue recognition
policies, or the Companys results of operations, financial
position or cash flows.

EITF 03-6.In
March 2004, the Emerging Issues Task Force finalized its
consensus on EITF Issue 03-6, Participating
Securities and the Two  Class Method Under FASB
Statement No. 128, Earnings Per Share
(EITF 03-6). EITF 03-6 clarifies what constitutes a
participating security and requires the use of the two-class
method for computing basic earnings per share when participating
convertible securities exist. EITF 03-6 is effective for
fiscal periods beginning after March 31, 2004. We are
currently analyzing the impact of adoption of EITF 03-6 on
our consolidated financial statements.



|   |            
|-- | -----------
|4. | Inventories

Inventories are stated at the lower of first-in,
first-out, cost or market value, and consist of the following:

|                                      |  |            |          |              |  |   |        |  
|------------------------------------- |  | ---------- | -------- | ------------ |  | - | ------ | -
|                                      |  | January 3, |          | December 28,
|                                      |  | 2004       |          | 2002        
|                                      |  |            |          |             
|Raw materials                         |  | $          | 73,455   |              |  | $ | 54,971 |  
|Finished Goods                        |  |            | 513,727  |              |  |   | 2,734  |  
|                                      |  |            |          |              |  |   |        |  
|                                      |  |            | 587,182  |              |  |   | 57,705 |  
|Less allowance for obsolete inventory |  |            | (157,653 | )            |  |   | (7,294 | )
|                                      |  |            |          |              |  |   |        |  
|                                      |  | $          | 429,529  |              |  | $ | 50,411 |  
|                                      |  |            |          |              |  |   |        |  

36



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|   |                       
|-- | ----------------------
|5. | Property and Equipment

Property and equipment consist of the following:

|                                               |  |            |           |              |  |   |         |  
|---------------------------------------------- |  | ---------- | --------- | ------------ |  | - | ------- | -
|                                               |  | January 3, |           | December 28,
|                                               |  | 2004       |           | 2002        
|                                               |  |            |           |             
|Equipment                                      |  | $          | 376,027   |              |  | $ | 33,241  |  
|Product Mold                                   |  |            |          |              |  |   | 108,534 |  
|Leasehold Improvements                         |  |            | 76,716    |              |  |   |        |  
|Vehicles under capital lease                   |  |            | 1,993,233 |              |  |   |        |  
|                                               |  |            |           |              |  |   |         |  
|                                               |  |            | 2,445,976 |              |  |   | 141,775 |  
|Less accumulated depreciation and amortization |  |            | (627,561  | )            |  |   | (7,919  | )
|                                               |  |            |           |              |  |   |         |  
|                                               |  | $          | 1,818,415 |              |  | $ | 133,856 |  
|                                               |  |            |           |              |  |   |         |  



|   |                                   
|-- | ----------------------------------
|6. | Construction Contracts in Progress

Revenues and costs recognized on construction
contracts in progress contrast the related billings as follows:

|                                                   |  |            |             |              |  |   |   | 
|-------------------------------------------------- |  | ---------- | ----------- | ------------ |  | - | - | 
|                                                   |  | January 3, |             | December 28,
|                                                   |  | 2004       |             | 2002        
|                                                   |  |            |             |             
|Direct costs to date                               |  | $          | 8,712,117   |              |  | $ |  | 
|Gross profit to date                               |  |            | 1,629,928   |              |  |   |  | 
|                                                   |  |            |             |              |  |   |   | 
|Earned contract revenue                            |  |            | 10,342,045  |              |  |   |  | 
|Net under billings within CTS prior to acquisition |  |            | 1,522,569   |              |  |   |  | 
|Contract billings to date                          |  |            | (10,701,932 | )            |  |   |  | 
|                                                   |  |            |             |              |  |   |   | 
|Net under billings                                 |  | $          | 1,162,682   |              |  | $ |  | 
|                                                   |  |            |             |              |  |   |   | 

Included in the accompanying consolidated balance
sheets under the following captions are:

|                                                   |  |            |           |              |  |   |   | 
|-------------------------------------------------- |  | ---------- | --------- | ------------ |  | - | - | 
|                                                   |  | January 3, |           | December 28,
|                                                   |  | 2003       |           | 2002        
|                                                   |  |            |           |             
|Costs and estimated earnings in excess of billings |  | $          | 1,517,226 |              |  | $ |  | 
|Billings in excess of costs and estimated earnings |  |            | (354,544  | )            |  |   |  | 
|                                                   |  |            |           |              |  |   |   | 
|Net under billings                                 |  | $          | 1,162,682 |              |  | $ |  | 
|                                                   |  |            |           |              |  |   |   | 



|   |                               
|-- | ------------------------------
|7. | Intangible Assets and Goodwill

The Company amortizes its intangible assets on a
straight-line basis. The Companys acquisition of CTS
resulted in the valuation of CTS Christenson name and
customer lists as intangible assets. The Companys trade
name is considered to have an undeterminable life, and as such
will not be amortized. The customer lists were determined to
have a six-year life. Shortly after the acquisition of IST, the
Company elected to eliminate further investment in its IOS
product line. As of the end of the quarter ended
September 27, 2003, the intangible value of the IOS product
line was written off. Due to managements decision to
discontinue the operations of Velagio and IST prior to
January 3, 2004, it was determined by the Company that the
intangibles of Velagio and IST were impaired, and it was
appropriate to write off the remaining net intangible value
assigned to assets in those entities.

37



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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Intangible assets consist of the following:

|                                                   |  |            |           |              |  |   |         |  
|-------------------------------------------------- |  | ---------- | --------- | ------------ |  | - | ------- | -
|                                                   |  | January 3, |           | December 28,
|                                                   |  | 2004       |           | 2002        
|                                                   |  |            |           |             
|Christenson trade name                             |  | $          | 1,248,771 |              |  |   |        |  
|Christenson customer lists                         |  |            | 663,305   |              |  |   |        |  
|Purchased technology  discontinued
    operations |  |            |          |              |  |   | 330,000 |  
|                                                   |  |            |           |              |  |   |         |  
|                                                   |  |            | 1,912,076 |              |  |   | 330,000 |  
|Less accumulated depreciation and amortization     |  |            | (32,244   | )            |  |   | (18,667 | )
|                                                   |  |            |           |              |  |   |         |  
|                                                   |  | $          | 1,879,832 |              |  | $ | 311,333 |  
|                                                   |  |            |           |              |  |   |         |  

Based on the Companys current intangible
assets, amortization expense for the five succeeding years will
be as follows:

|            |  |              |         | 
|----------- |  | ------------ | ------- | 
|            |  | Amortization
|Fiscal year |  | expense     
|            |  |             
|2004        |  | $            | 110,551 | 
|2005        |  |              | 110,551 | 
|2006        |  |              | 110,551 | 
|2007        |  |              | 110,551 | 
|2008        |  |              | 110,551 | 

The Company does not amortize goodwill. As a
result of the acquisitions of CTS, Velagio and IST, the Company
recorded goodwill of $3,792,472 and $250,490 in fiscal years
2003 and 2002, respectively. Due to managements decision
to discontinue the operations of Velagio and IST at
January 3, 2004, it was determined by the Company that the
goodwill of Velagio and IST were impaired, and it was
appropriate to write off the goodwill in those entities. The
changes in the carrying amount of goodwill for the years ended
January 3, 2004 and December 28, 2002 are recorded
below.

|                                              |  |            |            |              |  |   |         | 
|--------------------------------------------- |  | ---------- | ---------- | ------------ |  | - | ------- | 
|                                              |  | January 3, |            | December 28,
|                                              |  | 2004       |            | 2002        
|                                              |  |            |            |             
|Beginning goodwill balance                    |  | $          | 250,490    |              |  | $ | 0       | 
|Goodwill recorded upon acquisition of IST     |  |            |           |              |  |   | 250,490 | 
|Goodwill recorded upon acquisition of Velagio |  |            | 1,295,366  |              |  |   |        | 
|Goodwill recorded upon acquisition of CTS     |  |            | 2,497,106  |              |  |   |        | 
|Adjustment to goodwill                        |  |            | (198,022   | )            |  |   |        | 
|Goodwill write off due to impairment          |  |            | (1,545,856 | )            |  |   |        | 
|                                              |  |            |            |              |  |   |         | 
|Ending goodwill balance                       |  | $          | 2,299,084  |              |  | $ | 250,490 | 
|                                              |  |            |            |              |  |   |         | 



|   |                                      
|-- | -------------------------------------
|8. | Series 2 Preferred Stock
    Issuance

On September 26, 2003 the Company issued
3,607,151 shares of Series 2 preferred stock in
conjunction with a private placement at $.42 per share. On
November 17, 2003, the Company issued 3,333,334 shares
of Series 2 preferred stock in exchange for the conversion
of debt. The terms of the Series 2 preferred stock are as
follows.

Dividends.Series 2 preferred stock issued and outstanding shall be
entitled to receive a cash dividend in the amount of 6.5% of the
Issue Price per annum. The Series 2 preferred stock
dividends shall be payable in cash, quarterly, subject to the
declaration of the dividend by the board of directors, if and
when the board of

38



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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

directors deems advisable. Any declared but
unpaid dividend will not bear interest and will be payable out
of net profits; if net profits are not sufficient to pay this
dividend, either in whole or in part, then any unpaid portion of
the dividend will be paid in full out of net profits of the
Corporation in subsequent quarters before any dividends are paid
upon shares of Junior Stock. Thus far, no dividends have been
declared. As of January 3, 2004 there were dividends of
approximately $26,000 in arrears.

Liquidation
Preference.In the event of any
liquidation, dissolution or winding up of the Corporation,
either voluntary or involuntary, except in certain
circumstances, the holders of each share of Series 2
preferred stock shall be entitled to be paid out of the assets
of the Corporation available for distribution to its
shareholders, before any declaration and payment or setting
apart for payment of any amount shall be made in respect of
Junior Stock, an amount equal to the Issue Price and all accrued
but unpaid dividends.

Conversion.Each
holder of any share(s) of Series 2 preferred stock may, at
the holders option, convert all or any part of such
share(s) from time to time held by the holder into shares of
common stock at any time after the date of issuance. Each such
share of Series 2 preferred stock shall be converted into
one share of fully-paid and non-assessable shares of common
stock. Each share of Series 2 preferred stock shall
automatically be converted into shares of common stock on a
one-for-one basis immediately upon the consummation of the
Companys sale of its common stock in a bona fide, firm
commitment, underwritten public offering under the Securities
Act of 1933, as amended, which results in aggregate cash
proceeds (before underwriters commissions and offering
expenses) to the Company of $5,000,000 or more. In any event, if
not converted to common stock, each share of Series 2
preferred stock shall automatically be converted into shares of
common stock on a one-for-one basis immediately upon the third
anniversary of the date of issuance of the Series 2
preferred stock.

Voting Rights.Each
holder of Series 2 preferred stock shall have the right to
one vote for each share of Common Stock into which such
Series 2 preferred stock could then be converted.



|   |             
|-- | ------------
|9. | Acquisitions



| |                                                         
| | --------------------------------------------------------
| | Acquisition of Christenson Technology
    Services, Inc.

On September 16, 2003, the Company acquired
Christenson Technology Services, Inc. (CTS) in exchange for
4,193,142 shares of the Companys common stock. The
shares of common stock issued in conjunction with the merger
were not registered under the Securities Act of 1933. The
acquisition of CTS was accounted for using the purchase method
in accordance with SFAS 141, Business
Combinations. The results of operations for CTS have been
included in the Consolidated Statements of Operations since the
date of acquisition.

CTS is a combination of Christenson Technology
Services, Inc. and Christenson Electrical Services, (CES). These
two lines of business sell different products and services, but
often support the same customer. CTS provides complete
structured voice, video and data cabling solutions, local and
wide area network design, enterprise computing services,
security solutions and wireless LAN applications.

CES core businesses include electrical
contracting and support for commercial and high-tech
construction of high-rise office towers, hospitals, clean rooms
or production areas, custom design and manufacture of energy
management systems and industrial control panels, and
maintenance of commercial lighting for retail, office, warehouse
and industrial work environments.

39



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The value of the Companys common stock
issued as a part of the acquisition was determined based on the
average price of the Companys common stock for several
days before the acquisition of CTS. The components of the
purchase price were as follows:

|                         |  |   |           | 
|------------------------ |  | - | --------- | 
|Common stock             |  | $ | 1,090,217 | 
|Direct acquisition costs |  |   | 59,984    | 
|                         |  |   |           | 
|Total purchase price     |  | $ | 1,150,201 | 

In accordance with Financial Accounting Standard
(SFAS) No. 141, Business Combinations, the total
purchase price was allocated to the estimated fair value of
assets acquired and liabilities assumed. The estimate of fair
value of the assets acquired was based on managements and
an independent appraisers estimates. The total purchase
price was allocated to the assets and liabilities acquired as
follows:

|                                   |  |   |            |  
|---------------------------------- |  | - | ---------- | -
|Cash and other current assets      |  | $ | 8,221,945  |  
|Equipment and other assets         |  |   | 2,003,977  |  
|Intangible assets  Trade name     |  |   | 1,248,771  |  
|Intangible assets  Customer lists |  |   | 663,305    |  
|Goodwill                           |  |   | 2,299,084  |  
|Current liabilities                |  |   | (8,303,952 | )
|Notes payable                      |  |   | (4,982,929 | )
|                                   |  |   |            |  
|Total                              |  | $ | 1,150,201  |  
|                                   |  |   |            |  

The intangible assets of $1,912,076 consist of a
trade name and customer lists. These intangible assets acquired
have estimated useful lives as follows: Christenson trade
name  indeterminate life; customer lists relative to
the CTS base of customers  six years. Goodwill of
$2,299,084 represents the excess of the purchase price over the
fair value of the net tangible and intangible assets acquired.
In accordance with SFAS 142, goodwill is not amortized and
will be tested for impairment at least annually. The goodwill
value was tested for impairment in the fourth quarter of 2003.



| |                             
| | ----------------------------
| | Acquisition of Velagio, Inc.

On September 16, 2003, the Company acquired
Velagio, Inc. (Velagio) in exchange for 4,193,143 shares of
the Companys common stock and 473,907 employee stock
options to purchase the Companys common shares, of which
412,027 options were fully vested. The shares of common stock
issued in conjunction with the merger were not registered under
the Securities Act of 1933. The acquisition of Velagio was
accounted for using the purchase method in accordance with
SFAS 141, Business Combinations. The results of
operations for Velagio have been included in the Consolidated
Statements of Operations since the date of acquisition.

Velagio, Inc. was a business solutions provider
that offered a blend of business consulting and information
technology integration services. Specifically, Velagio had
professional service capabilities in strategic business
consulting; business process re-engineering; enterprise
application software selections and implementations; commercial
software development; and technology infrastructure integration
and support services. Velagio had licensed proprietary customer
relationship management (CRM) software in the area of sales
force automation.

The value of the Companys common stock
issued as a part of the acquisition was determined based on the
average price of the Companys common stock for several
days before the acquisition of Velagio. The fair value of
employee stock options issued in conjunction with this
acquisition has been included in the determination of the
purchase price. The fair value of such options was determined
using the Black-Scholes model. The Company used the following
assumptions in calculating the value of these options: Risk

40



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

free rate  1.94%; Volatility
index  118%. Dividend yield: 0%. The components of
the purchase price were as follows:

|                         |  |   |           | 
|------------------------ |  | - | --------- | 
|Common stock             |  | $ | 1,090,217 | 
|Option issuance value    |  |   | 112,655   | 
|Direct acquisition costs |  |   | 59,984    | 
|                         |  |   |           | 
|Total purchase price     |  |   | 1,262,856 | 

In accordance with Financial Accounting Standard
(SFAS) No. 141, Business Combinations, the total
purchase price was allocated to the estimated fair value of
assets acquired and liabilities assumed. The estimate of fair
value of the assets acquired was based on managements and
an independent appraisers estimates. The total purchase
price was allocated to the assets and liabilities acquired as
follows:

|                              |  |   |           |  
|----------------------------- |  | - | --------- | -
|Cash and other current assets |  | $ | 224,166   |  
|Equipment and other assets    |  |   | 53,298    |  
|Goodwill                      |  |   | 1,295,366 |  
|Current liabilities           |  |   | (309,974  | )
|                              |  |   |           |  
|Total                         |  | $ | 1,262,856 |  
|                              |  |   |           |  

Goodwill of $1,295,366 represented the excess of
the purchase price over the fair value of the net tangible and
intangible assets acquired. At January 3, 2004, it was the
Companys view that the goodwill generated in this
transaction was impaired. The Company decided to write off this
goodwill due to the fact that separations of nearly all of the
former Velagio employees have left few intangible assets from
the acquisition and no further identifiable Velagio product or
market. New Microfield management, who joined in February,
further concentrated on improving the electrical businesses with
no intention of re-establishing the enterprise software
development business.

The write-off of the goodwill, and the financial
results of Velagio since its acquisition are included
discontinued operations in the consolidated statement of
operations.



| |                                                       
| | ------------------------------------------------------
| | Acquisition of Innovative Safety
    Technologies, LLC

On September 17, 2002, the Company acquired
Innovative Safety Technologies, LLC (IST) in exchange for
1,818,181 shares of the Companys common stock. The
shares of common stock issued in conjunction with the merger
were not registered under the Securities Act of 1933. The
acquisition of IST was accounted for using the purchase method
in accordance with SFAS 141, Business
Combinations. The results of operations for IST have been
included in the Consolidated Statements of Operations since the
date of acquisition.

IST designed and sold safety and security related
products under the brand names No Tug PlugTM and
Internet ObservationTM Systems. The Company owns the
patent for the No Tug PlugTM which has a remaining
life of approximately 10 years. The Internet
ObservationTM Systems product was an application of
digital video security cameras that relay the signal to a
monitoring station that can be accessed locally, or using the
internet, from anywhere around the world.

41



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The value of the Companys common stock
issued as a part of the acquisition was determined based on the
price of the Companys common stock sold simultaneously
with the merger in a private placement offering to private
investors on September 17, 2002. The components of the
purchase price were as follows:

|                         |  |   |         | 
|------------------------ |  | - | ------- | 
|Common stock             |  | $ | 400,000 | 
|Direct acquisition costs |  |   | 67,000  | 
|                         |  |   |         | 
|Total purchase price     |  | $ | 467,000 | 

In accordance with Financial Accounting Standard
(SFAS) No. 141, Business Combinations, the total
purchase price was allocated to the estimated fair value of
assets acquired and liabilities assumed. The estimate of fair
value of the assets acquired was based on managements
estimates. The total purchase price was allocated to the assets
and liabilities acquired as follows:

|                              |  |   |          |  
|----------------------------- |  | - | -------- | -
|Cash and other current assets |  | $ | 36,400   |  
|Equipment                     |  |   | 133,400  |  
|Amortizable intangible assets |  |   | 330,000  |  
|Goodwill                      |  |   | 250,400  |  
|Current liabilities           |  |   | (230,800 | )
|Note payable                  |  |   | (52,400  | )
|                              |  |   |          |  
|Total                         |  | $ | 467,000  |  

Amortizable intangible assets consisted of
patents and developed technology used in the Companys No
Tug PlugTM and Internet ObservationTM
System (IOS). These intangible assets, when acquired had
estimated useful lives as follows: Patent and existing
technology relative to the Companys No Tug
PlugTM  ten years; Developed technology
relative to the IOS product  five years. Goodwill of
$250,490 represented the excess of the purchase price over the
fair value of the net tangible and intangible assets acquired.
At September 27, 2003, it was the Companys view that
the goodwill generated in this transaction was impaired. The
Company decided to write off this goodwill due to the fact that
no further efforts were being channelled toward ISTs
products or markets. New Microfield management, who joined in
February, further concentrated on improving the electrical
businesses with no intention of re-establishing the former IST
business. The write-off of the goodwill and the financial
results of IST since its acquisition in 2002 are included
discontinued operations in the consolidated statement of
operations.

In accordance with the terms of the acquisition,
on September 26, 2002, the Company issued an additional
281,346 shares of common stock to employees of IST as
settlement for $46,000 of past due wages incurred prior to the
acquisition. These shares of stock are not registered under the
Securities Act of 1933 and must be held for the time required by
Rule 144 promulgated under the Securities Act. Subsequent
to that date, the Company paid an additional $64,000 in cash to
employees of IST for the remaining amounts owed for past due
wages. These amounts were included in the liabilities assumed on
September 17, 2002.

Also in accordance with the terms of the
acquisition, the Company issued an additional 45,454 shares
of its common stock in payment of $10,000 of past due amounts
owed by IST to JMW Capital Partners, Inc. which served as
their financial advisor. These shares of stock are not
registered under the Securities Act of 1933 and must be held for
the time required by Rule 144 promulgated under the
Securities Act. Subsequent to the acquisition, the Company paid
an additional $20,500 for the remaining amount owed to this
creditor. These amounts were included in the liabilities assumed
on September 17, 2002.

On November 6, 2002, the Company issued
60,976 shares of its common stock in partial payment of a
note payable owed by IST to the individual from whom Innovative
Safety Technologies, LLC purchased the initial version of the
IOS product concept. These shares of stock are not registered
under the Securities Act of 1933 and must be held for the time
required by Rule 144 promulgated under the Securities Act.
Subsequent to

42



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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

the common stock issuance, the remaining note
payable balance was $10,000. The note payable balance was paid
in full in the fourth quarter of 2003.

The following unaudited proforma information
presents a summary of the consolidated results of operations of
the Company assuming the acquisitions of CTS, Velagio and IST
occurred on the first day of each fiscal period presented. In
the course of trying to complete the audit of GAAP compliant
financial statements related to its Form 8-K/ A filing, the
Companys independent accountants and management noted
certain material internal control weaknesses within the
operations of CTS in the areas of: revenue recognition; cash
disbursements; inventory accounting; and document control. The
Companys management concluded that fully compliant GAAP
financial statements of CTS for FY 2002 and FY 2001 could not be
prepared. In addition, the Companys independent
accountants concluded that they could not complete an audit nor
render an audit opinion on the FY 2002 and FY 2001 historical
financial statements of CTS. Given the significance of CTS, and
for the purpose of informing shareholders and prospective
investors, the Company has prepared the following summary
proforma with the best information available, which management
believes fairly represents the unaudited proforma results of
operations of the combined Company for the periods presented.
The following information is unaudited.

|                                     |  |             |            |              |  |   |            |  
|------------------------------------ |  | ----------- | ---------- | ------------ |  | - | ---------- | -
|                                     |  |            
|                                     |  | Years Ended
|                                     |  |            
|                                     |  | January 3,  |            | December 28,
|                                     |  | 2004        |            | 2002        
|                                     |  |             |            |             
|                                     |  |            
|                                     |  | (Unaudited)
|Sales                                |  | $           | 27,548,335 |              |  | $ | 63,050,754 |  
|                                     |  |             |            |              |  |   |            |  
|Net loss                             |  | $           | (6,553,924 | )            |  | $ | (4,718,570 | )
|                                     |  |             |            |              |  |   |            |  
|Basic and diluted net loss per share |  | $           | (.39       | )            |  | $ | (.34       | )
|                                     |  |             |            |              |  |   |            |  

Prior to the end of the year 2003, the
Companys management decided to discontinue the operations
of IST and Velagio, and concentrate on the operations of the
newly merged subsidiary CVI.



|    |                   
|--- | ------------------
|10. | Private Placements

Concurrent with the acquisition on
September 16, 2002, the Company issued
1,363,629 shares of restricted common stock in conjunction
with a private placement at $.22 per share. In total, the
Company received net proceeds from the private placement of
approximately $280,000. Issuance costs relative to the private
placement were $20,000. These shares of stock are not registered
under the Securities Act of 1933 and must be held for the time
required by Rule 144 promulgated under the Securities Act.

During April and May 2003 the Company issued
1,113,078 shares of restricted common stock in conjunction
with a private placement at $.26 per share. The private
placement included an issuance of 111,308 warrants for the
purchase of common stock which are exercisable at a purchase
price of $.40 per share with a 3-year term. Of the total
capital raised, $50,000 was converted from a $40,000 note
payable and a $10,000 miscellaneous payable, both owed to Steven
M. Wright, a Director of the Company and a member of senior
management. These payables arose from cash that had been
previously advanced by him to the Company. The shares issued in
the private placement were issued at a discount, were not
registered and are restricted from sale for at least one year
pursuant to federal securities laws. R. Patrick Hanlin, Chairman
of the Board and Steven M. Wright, President & CEO at
that time, both purchased additional shares in the private
placement.

Prior to the Companys acquisitions of CTS
and Velagio on September 16, 2003, the Company entered into
subscription agreements to issue 3,607,151 shares of
restricted, Series 2 preferred stock at $0.42 per
share. The subscription agreements were contingent upon the
closing of the Companys acquisitions of CTS and Velagio.
The funding of the subscriptions occurred on or near
October 3, 2003. In total, the Company received net
proceeds from the private placement of approximately $715,000 in
cash and $765,000 in debt conversion.

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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Issuance costs relative to the private placement
were approximately $35,000. These shares of stock are not
registered under the Securities Act of 1933 and must be held for
the time required by Rule 144 promulgated under the
Securities Act. The private placement included an issuance of
333,335 warrants for the purchase of common stock, which are
exercisable at a purchase price of $.42 per share with a
5-year term. Each investor was awarded one warrant for every $3
invested in the private placement. The proceeds from the
offering were allocated between the Series 2 preferred
stock and the warrants issued in the transaction. The Black
Scholes valuation method was used to determine the value of the
warrants. This value is presented as a liability for warrant
settlement in the consolidated balance sheet (See Note 12).
The Company used the following assumptions in calculating the
value of these warrants: Risk free rate  1.94%;
Volatility index  118%; Stock price on 9/26/03:
$0.30 per share.



|    |                        
|--- | -----------------------
|11. | Discontinued Operations



| |                
| | ---------------
| | Velagio and IST

During the fourth quarter of 2003, management
determined that the previous operations of Velagio and IST
should be discontinued. After the acquisition of Velagio and CTS
on September 16, 2003, management decided to focus on the
electrical construction services and technology infrastructure
products and services business acquired with CTS. As a result of
expense cuts made after the acquisitions, all of the previous
employees of Velagio and IST were either refocused in areas
within the Company that supported the electrical and technology
side of the business, or separated from the Company.

Sales of Velagio from September 16, 2003,
the date of the acquisition, to January 3, 2004, were
approximately $154,000. The net loss of Velagio for this period
was $1,677,000, of which $1,295,000 was from the write-off of
goodwill recorded upon its acquisition. Sales of IST for the
years ended January 3, 2004 and December 28, 2002 were
approximately $458,000 and $144,000, respectively. The net
losses of IST for these periods were approximately $1,146,000
and 364,000, respectively. The loss of IST in fiscal year 2003
included a write-off of goodwill and intangible assets of
approximately $515,000.

Discontinued operations accounting treatment has
been applied to the Velagio and IST operations. The revenues,
operating expenses and other income and losses of both Velagio
and IST are reported as loss from discontinued
operations for all periods presented to reflect the
reclassification of these operations as discontinued. Also, cash
flows from the Velagio and IST operations are reported as
net cash provided by (used in) discontinued
operations whether associated with operating, investing or
financing activities.



| |          
| | ---------
| | SoftBoard

On September 7, 2000, the Company entered
into a definitive agreement with Greensteel, Inc. (Greensteel),
a wholly-owned subsidiary of Polyvision Corporation, for the
sale of substantially all of the Companys assets used in
the SoftBoard operations. The terms of the asset sale called for
Greensteel to pay the Company up to $3,500,000, with $2,000,000
payable at the closing of the transaction and up to an
additional $1,500,000 in contingent earn-out payments based on
net sales of the Companys SoftBoard products over a
five-year period. Shareholders approved the agreement and the
transaction was finalized on October 24, 2000 and resulted
in a gain of $1,221,852.

A total of $39,413 in contingent earn-out
payments were received by the Company during the year ended
January 4, 2004. The Company received $22,669 during the
year ended December 28, 2002. These amounts were recorded
as gain on the sale of discontinued operations in the
Consolidated Statements of Operations.

As a result of shareholder approval of the
Greensteel agreement, discontinued operations accounting
treatment has been applied to the SoftBoard operation.
Accordingly, the net gain incurred from the Softboard operations
is reported in gain from discontinued operations for all periods
presented to reflect the reclassification of these operations as
discontinued. Also, cash flows from the SoftBoard operations are
reported as net

44



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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

cash provided by (used in) discontinued
operations whether associated with operating, investing or
financing activities.



|    |                     
|--- | --------------------
|12. | Shareholders Equity



| |                            
| | ---------------------------
| | Incentive Stock Option Plan

The Company has a Stock Option Plan (the
Plan). At January 3, 2004 and December 28,
2002, 688,936 and 261,188 shares of common stock were
reserved, respectively, for issuance to employees, officers,
directors and outside advisors. Under the Plan, the options may
be granted to purchase shares of the Companys common stock
at fair market value, as determined by the Companys Board
of Directors, at the date of grant. The options are exercisable
over a period of up to five years from the date of grant or such
shorter term as provided for in the Plan. The options become
exercisable over four years.

A summary of the status of the Companys
Stock Option Plan as of January 3, 2004 and
December 28, 2002 and for the years then ended is presented
below:

|                                 |                                      |                 |         |                   |   |        |      |          |  |  |         |         |   |   |     |      |  
|-------------------------------- | ------------------------------------ | --------------- | ------- | ----------------- | - | ------ | ---- | -------- |  |  | ------- | ------- | - | - | --- | ---- | -
|                                 |                                      |                 |         |                  
|                                 |                                      | January 3, 2004 |         | December 28, 2002
|                                 |                                      |                 |         |                  
|                                 |                                      |                 |         | Weighted          |   |        |      | Weighted
|                                 |                                      |                 |         | Average           |   |        |      | Average 
|                                 |                                      |                 |         | Exercise          |   |        |      | Exercise
|                                 |                                      | Shares          |         | Price             |   | Shares |      | Price   
|                                 |                                      |                 |         |                   |   |        |      |         
|Outstanding at beginning of year |                                      |                 | 261,188 |                   |   | $      | .39  |          |  |  | 69,000  |         |   | $ | .04 |     
|                                 | Granted at market price              |                 |         | 95,000            |   |        |      | .42      |  |  |         | 176,188 |   |   |     | .39  |  
|                                 | Granted at greater than market price |                 |         | 473,907           |   |        |      | 1.05     |  |  |         | 75,000  |   |   |     | .44  |  
|                                 | Exercised                            |                 |         |                  |   |        |      |          |  |  |         | (59,000 | ) |   |     | (.04 | )
|                                 | Cancelled                            |                 |         | (141,159          | ) |        |      |          |  |  |         |         |   |   |     |      |  
|                                 |                                      |                 |         |                   |   |        |      |          |  |  |         |         |   |   |     |     
|Outstanding at end of year       |                                      |                 | 688,936 |                   |   | $      | .84  |          |  |  | 261,188 |         |   | $ | .39 |     
|Options exercisable at year end  |                                      |                 | 474,719 |                   |   | $      | 1.02 |          |  |  | 26,216  |         |   | $ | .19 |     

|               |              |                   |  |                  |         |                            |  |  |         |  |  |  |           | 
|-------------- | ------------ | ----------------- |  | ---------------- | ------- | -------------------------- |  |  | ------- |  |  |  | --------- | 
|               |              |                   |  |                 
|               |              | Number of Options |  |                 
|               |              |                   |  | Weighted Average
|Exercise price |              | Outstanding       |  | Exercisable      |         | Contractual Life Remaining
|               |              |                   |  |                  |         |                           
|$              | 0.04 -  0.05 |                   |  |                  | 16,000  |                            |  |  | 16,000  |  |  |  | 2.9 years | 
|$              | 0.40 -  0.59 |                   |  |                  | 536,312 |                            |  |  | 323,864 |  |  |  | 6.3 years | 
|$              | 1.76 -  2.70 |                   |  |                  | 136,624 |                            |  |  | 134,855 |  |  |  | 6.8 years | 
|               |              |                   |  |                  |         |                            |  |  |         |  |  |  |           | 
|               |              |                   |  |                  | 688,936 |                            |  |  | 474,719 |  |  |  |           | 

On June 5, 2002, the Company granted 6,000
options to purchase shares of the Companys common stock to
directors of the Company. These options were 100% vested upon
grant. On October 30, 2002, the Company granted 245,188
options to purchase shares of the Companys common stock to
employees of the Company. During 2003 a total of 95,000 options
to purchase shares of the Companys common stock were
granted to directors and employees of the Company. The 245,188
options issued on October 30, 2002 and the 95,000 options
issued during 2003 are forfeited if not exercised within five
years, and vest ratably over forty-eight months starting with
the month of grant.

On September 16, 2003, in conjunction with
the acquisition of Velagio, the Company granted 473,907 options
to prior holders of options in the Velagio, Inc. Incentive Stock
Option Plan. The number of options granted was calculated based
on a conversion rate that gave the holders of 10,000 options to
purchase Velagio common stock, options to
purchase 851 shares of Microfield Group, Inc. common
stock. These options were granted with credit for 25%, 50%, 75%
or 100% vesting based on the grant date of their original
Velagio options. These options have a ten-year expiration
starting on the date of their original Velagio option grant, and
vest at 25% per year.

45



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The weighted average per share value of options
granted during the years ended January 3, 2004 and
December 28, 2002 was $0.95 and $0.34, respectively.

The Company has computed for pro forma disclosure
purposes the value of all options granted during fiscal years
2003 and 2002 using the Black-Scholes pricing model as
prescribed by SFAS No. 123 (see note 2). The
following assumptions were used to calculate the value of
options granted during 2003 and 2002:

|                        |  |      |             |      |  |  |          |  
|----------------------- |  | ---- | ----------- | ---- |  |  | -------- | -
|                        |  | 2003 |             | 2002
|                        |  |      |             |     
|Risk-free interest rate |  |      | 2.12        | %    |  |  | 2.78     | %
|Expected dividend yield |  |      |            |      |  |  |         |  
|Expected lives          |  |      | 5-10  years |      |  |  | 5  years |  
|Expected volatility     |  |      | 123         | %    |  |  | 133      | %



| |                      
| | ---------------------
| | Common stock warrants

On October 15, 1999 the Company issued a
warrant to certain of its debt holders to
purchase 20,000 shares of the Companys common
stock at an exercise price of $0.75 per share. In
accordance with the terms of the warrant, the holder, in lieu of
exercising the warrant, has the option to convert the warrant
into a number of shares to be determined based on a formula
which considers the difference between the fair market value of
the Companys common stock at the time of conversion and
the exercise price of the warrant. The fair value of the
warrants determined utilizing the Black-Scholes pricing model at
the time of issuance is immaterial. The warrant expired in
October 2003.

In connection with debt financing entered into
during fiscal year 2000, the Company issued 2,066,000 detachable
warrants to purchase common stock. The warrants had an initial
term of 3 years and were to expire in June 30, 2005.
Proceeds from the debt were allocated between the debt and
warrants based on the fair value of the warrants issued using
the Black-Scholes model. The combined value assigned to the
warrants when they were issued was approximately $357,000 and
was initially recorded as debt discount and recognized as
interest expense over the life of the debt. On
September 15, 2003, the Company extended the life of these
warrants until June 30, 2007 as partial consideration to
satisfy a $150,000 promissory note between CTS and JMW Capital
Partners, Inc. In accordance with FIN 44, the fair value of
the warrants on the date of the settlement of the $150,000
promissory note between CTS and JMW Capital Partners, Inc was
determined to be $468,000. The difference between the initial
fair value and the fair value at the date of the extension was
recorded as equity and a loss on debt extinguishment.

In connection with the April 2003 common stock
private placement (See Note 10), the Company issued 111,308
warrants to purchase common stock. Each warrant is exercisable
into one share of common stock at $0.40 per share and will
expire in 2008. Subsequent to this private placement, the
Company exercised an option to convert $1,400,000 of outstanding
debt into preferred stock that is convertible into shares of
common stock. This exercise, when aggregated with all other
outstanding equity arrangements, resulted in the total number of
common shares that could be required to be delivered to exceed
the number of authorized common shares. In accordance with
EITF 00-19, the fair value of the warrants issued in the
private placement must be recorded as a liability in the
financial statements using the Black-Scholes model, and any
subsequent changes in the Companys stock price to be
recorded in earnings. Accordingly, the fair value of these
warrants at the date of issuance was determined to be $64,902.
At January 3, 2004, the fair value was determined to be
$135,667 and the increase from the initial amount was recorded
in earnings.



| |                         
| | ------------------------
| | Preferred stock warrants

In connection with the September 2003 preferred
stock private placement (See Note 11), the Company issued
333,334 warrants to purchase common stock. Each warrant is
exercisable into one share of common

46



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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

stock at $0.42 per share and will expire in
2008. Subsequent to this private placement, the Company
exercised an option to convert $1,400,000 of outstanding debt
into preferred stock that is convertible into shares of common
stock. This exercise, when aggregated with all other outstanding
equity arrangements, resulted in the total number of common
shares that could be required to be delivered to exceed the
number of authorized common shares. In accordance with
EITF 00-19, the fair value of the warrants issued in the
private placement must be recorded as a liability in the
financial statements using the Black-Scholes model, and any
subsequent changes in the Companys stock price to be
recorded in earnings. Accordingly, the fair value of these
warrants at the date of issuance was determined to be $19,832.
At January 3, 2004, the fair value was determined to be
$47,195 and the increase from the initial amount was recorded in
earnings.



|    |                    
|--- | -------------------
|13. | Segment Information

During the year ended January 3, 2004, the
Companys operations comprised electrical construction
services and information technology in the areas of voice, data,
video and life safety.

The Company is managed as one specific line of
business including construction and electrical services. The
Companys management makes financial decisions and
allocates resources based on the information it receives from
its internal management system. The Companys management
relies on the internal management system to provide sales, cost
and asset information for the business as a whole.

All of the Companys assets as of
January 3, 2004, and December 28, 2002, were
attributable to U.S. operations. For the year ended
January 3, 2004, no single customer accounted for 10% or
more of the Companys net sales. For the year ended
December 28, 2002, one customer accounted for 79% of the
Companys net sales which are included in discontinued
operations in the consolidated statement of operations.



|    |             
|--- | ------------
|14. | Income Taxes

The provision for income taxes for the years
ended January 3, 2004 and December 28, 2002 differs
from the amount which would be expected as a result of applying
the statutory tax rates to the losses before income taxes due
primarily to changes in the valuation allowance to fully reserve
net deferred tax assets.

As of January 3, 2004 and December 28,
2002, Microfield had deferred tax assets primarily consisting of
its net operating loss carryforwards. However, because of
cumulative losses in several consecutive years, the Company has
recorded a full valuation allowance such that its net deferred
tax asset is zero. The tax benefit recorded at the statutory
rate in Microfields pre-tax loss in fiscal years 2003 and
2002 would have been approximately $2,192,457 and $148,740,
respectively. However, because of recognition of a full
valuation allowance the effective tax rate for the Company was
zero in both 2003 and 2002.

47



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Deferred tax assets are comprised of the
following components:

|                                       |  |                 |            |                   |  |   |            |  
|-------------------------------------- |  | --------------- | ---------- | ----------------- |  | - | ---------- | -
|                                       |  | January 3, 2004 |            | December 28, 2002
|                                       |  |                 |            |                  
|Current                                |  |                 |            |                   |  |   |            |  
|Allowance for doubtful accounts        |  | $               | 45,295     |                   |  | $ | 1,980      |  
|Employee benefits                      |  |                 | 57,826     |                   |  |   |           |  
|Start-up costs                         |  |                 | 31,486     |                   |  |   | 31,372     |  
|Inventory allowance                    |  |                 | 60,696     |                   |  |   | 2,808      |  
|Other allowances                       |  |                 | 9,299      |                   |  |   | 5,840      |  
|                                       |  |                 |            |                   |  |   |            |  
|                                       |  |                 | 204,602    |                   |  |   | 42,000     |  
|                                       |  |                 |            |                   |  |   |            |  
|Non-current                            |  |                 |            |                   |  |   |            |  
|Net operating loss carryforwards       |  |                 | 7,916,244  |                   |  |   | 5,726,210  |  
|Start-up costs                         |  |                 | 62,972     |                   |  |   | 94,115     |  
|Research and development credits       |  |                 | 145,045    |                   |  |   | 176,829    |  
|                                       |  |                 |            |                   |  |   |            |  
|                                       |  |                 | 8,124,261  |                   |  |   | 5,997,154  |  
|                                       |  |                 |            |                   |  |   |            |  
|Total deferred tax asset               |  |                 | 8,328,863  |                   |  |   | 6,039,154  |  
|Deferred tax asset valuation allowance |  |                 | (8,328,863 | )                 |  |   | (6,039,154 | )
|                                       |  |                 |            |                   |  |   |            |  
|Net deferred tax assets                |  | $               |           |                   |  | $ |           |  
|                                       |  |                 |            |                   |  |   |            |  

At January 3, 2004, the Company had
available net operating loss carryforwards of approximately
$20,590,192 for federal income tax purposes. Such carryforwards
may be used to reduce consolidated taxable income, if any, in
future years through their expiration in 2004 to 2023.
Utilization of net operating loss carryforwards may be limited
due to the ownership changes resulting from the Companys
initial public offering in 1995 and the Companys
acquisition of CTS, Velagio and IST. In addition, the Company
has research and development credits aggregating $145,045 for
income tax purposes at January 3, 2004. Such credits may be
used to reduce taxes payable, if any, in future years through
their expiration in 2004 to 2012.

15.     Net Income
Per Share:

Net income per share is computed based on the
weighted average number of shares of common stock and
potentially dilutive securities assumed to be outstanding during
the period using the treasury stock method. Potentially dilutive
securities consist of stock options, convertible preferred stock
and warrants to purchase common stock.

The most significant difference between basic and
diluted net income per share is that basic net income per share
does not treat potentially dilutive securities such as stock
options and warrants as outstanding. For all periods presented,
the computation of net loss per share excludes the effect of
stock options and warrants as they were antidilutive. There were
688,936 options and 2,510,643 warrants outstanding at
January 3, 2004, and 261,188 options and 2,086,000 warrants
outstanding at December 28, 2002.



|    |                           
|--- | --------------------------
|16. | Repurchase of Common Stock

On February 28, 2003, the Company entered
into a Stock Purchase and Pledge Agreement (the
Agreement) with Steelcase, Inc.
(Steelcase) to repurchase 951,445 of the
Companys common shares held by Steelcase. Pursuant to the
terms of the Agreement, the Company repurchased these shares for
a base amount of approximately $209,318, or $0.22 per
share, subject to adjustment. The Company issued a three-year
Promissory Note (the Note) for payment of this
amount. Payments of principal under the Note will be made in
three equal annual installments of approximately $69,773, on the
first, second and third anniversaries

48



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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

of the date of the Note. The Note carries an
interest rate of 12%, payable quarterly, starting on
June 1, 2003 until the principal amount of the Note is paid
in full.

If the Note and accrued interest are paid
according to the terms of the Note, on the third anniversary
date of the Note the parties shall calculate a new purchase
price based on the average market closing price of the
Companys common stock for the 180 days prior to the
third anniversary date. If the average market closing price per
common share over this 180 day period is less than
$0.22 per common share, then the purchase price payable
under the Agreement will remain at $209,318 or $0.22 per
common share. If the average market closing price per share over
this 180 day period is greater than $0.22 per common
share, then the purchase price payable under the Agreement will
be increased by an amount equal to the excess of this
180 day average market closing price per common share over
$0.22 per common share, times 951,445 shares. However,
under this purchase price adjustment, the maximum purchase price
paid will not exceed approximately $333,006, or $0.35 per
common share. This feature is considered to be an embedded
derivative option under the provisions of Financial Accounting
Standards No. 133. Under these provisions a derivative
liability was established at inception in the amount of $14,310
using the Black-Scholes valuation model. Changes based on
fluctuations in the Companys stock price are reflected in
the other expense section of the Statement of Operations. From
the date of inception of this note to the end of the fiscal
year, January 3, 2004 this liability increased by $21,289,
and the Company recorded incremental expense of $25,266. The
value of this liability as of January 3, 2004 was $35,599,
and is reflected as a long term liability on the Consolidated
Balance Sheet.

For purposes of all purchase price adjustments
under the Agreement, the number of common shares and per share
amounts are subject to adjustments to give effect to stock
splits, dividends, reorganizations, recapitalizations and other
similar transactions occurring after the date of the Agreement.

As of January 3, 2004, the Company had not
made its required quarterly interest payment of approximately
$6,000, which was due December 1, 2003. Subsequent to
January 3, 2004, the Company has paid $30,000 of the first
annual principal payment of approximately $70,000 which was due
on February 28, 2004, and is current on all required
interest payments. The remaining $40,000 due on the first
installment has been renegotiated and will be paid on
May 30, 2004.



|    |     
|--- | ----
|17. | Debt



| |                         
| | ------------------------
| | Operating Line of Credit

As of January 3, 2004, the Company has a
$5,000,000 credit facility, which expires in August 2004.
Borrowings under the line of credit are due on demand, bear
interest payable weekly at prime plus 6 1/2% and are
collateralized by accounts receivable. The borrowing base is
limited by certain factors such as length of collection cycle,
subordination of collateral position on bonded work and other
credit related factors. Subject to these limitations, the
Company had $668,902 available borrowing capacity at
January 3, 2004. As of January 3, 2004, borrowings of
$4,331,098 were outstanding under the facility. The Company was
in compliance with the terms of the borrowing facility at year
end.

49



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |               
| | --------------
| | Long Term Debt

The Company had several notes payable outstanding
at January 3, 2004. The total amount of the notes and their
terms are summarized below.

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |            |           |              |  |   |   | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------- | --------- | ------------ |  | - | - | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  | January 3, |           | December 28,
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  | 2004       |           | 2002        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |            |           |             
|Steven M. Wright unsecured promissory note,
    interest at 10%, due September 1, 2003. This note was
    subsequently converted to Series 3 preferred stock on
    April 2, 2004. (See notes 18 and 20)                                                                                                                                                                                                                                                                               |  | $          | 45,000    |              |  | $ |  | 
|R. Patrick Hanlin, unsecured advance paid to a
    creditor of the Company on November 5, 2003. No terms were
    negotiated. This debt was subsequently converted to
    Series 3 preferred stock on April 2, 2004. (See
    notes 18 and 20)                                                                                                                                                                                                                                         |  |            | 16,000    |              |  |   |   | 
|Christenson Leasing Company, LLC
    (CLLLC)       subordinated
    promissory note, six monthly interest only payments beginning
    November 15, 2003, payments of $18,354.82 including
    interest at 12% beginning June 15, 2004, amortized over
    five years, due and payable in full on October 15, 2005.
    This debt was subsequently converted to Series 3 preferred
    stock on April 2, 2004. (See notes 18 and 20)                                                    |  |            | 825,000   |              |  |   |  | 
|Various subordinated notes payable to Robert
    Jesenik dba Jesenik Enterprises ($23,217), Christenson Leasing
    Company, LLC ($23,217), JW Assurance and Holding Limited
    ($33,168), interest only payments due January 17, 2004,
    sixteen quarterly payments totaling $6,337.19 beginning
    April 15, 2004 including interest at 12% until paid in
    full. This debt was subsequently converted to Series 3
    preferred stock on April 2, 2004. (See notes 18 and 20) |  |            | 79,602    |              |  |   |  | 
|Steelcase, Inc. promissory note, quarterly
    interest only payments of $6,279.54 beginning June 1, 2003.
    Annual principal payments of $69,773, first payment due and
    payable February 28, 2004, collateralized by
    951,445 shares of the Companys common stock (reduced
    by derivative allocation of $10,333). (See note 15)                                                                                                                                          |  |            | 198,984   |              |  |   |  | 
|Various subordinated notes payable to Robert
    Jesenik dba Jesenik Enterprises, Christenson Leasing Company
    LLC, JW Assurance and Holding Limited, JMW Capital Partners,
    Inc., interest only payment due January 17, 2004, sixteen
    quarterly payments of $4,036.31 beginning April 15, 2004
    including interest at 12% until paid in full. This debt was
    subsequently converted to Series 3 preferred stock on
    April 2, 2004. (See notes 18 and 20)           |  |            | 50,700    |              |  |   |  | 
|Christenson Leasing Company, LLC capital
    equipment lease, thirty six monthly payments of $84,777
    including interest at 30.15% beginning September 1, 2003,
    amortized over three years, due and payable in full on
    August 1, 2006. (See note 18)                                                                                                                                                                                                                        |  |            | 1,925,845 |              |  |   |  | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |            |           |              |  |   |   | 
|Total debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |            | 3,141,131 |              |  |   |  | 
|Less current portion                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  |            | (967,997  | )            |  |   |  | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |            |           |              |  |   |   | 
|Long term debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  | $          | 2,173,134 |              |  | $ |  | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |            |           |              |  |   |   | 

50



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|    |                           
|--- | --------------------------
|18. | Related Party Transactions

The Company has a number of promissory notes,
lines of credit and lease obligations owing to related parties.
The following table lists the notes and obligations outstanding
at January 3, 2004 by related party.

|  |  |               |                     |                    |  |          |                      |            |  |         |                 |  |  |   |           |  |  |  |        | 
|- |  | ------------- | ------------------- | ------------------ |  | -------- | -------------------- | ---------- |  | ------- | --------------- |  |  | - | --------- |  |  |  | ------ | 
|  |  |               |                     |                    |  | Maturity |                      | Amount of  |  | Monthly
|  |  | Related Party |                     | Type of Obligation |  | Date     |                      | Obligation |  | Payment
|  |  |               |                     |                    |  |          |                      |            |  |        
|1 |  |               | Steven M. Wright    |                    |  |          | Note payable         |            |  |         | 9/01/03         |  |  | $ | 45,000    |  |  |  |       | 
|2 |  |               | CLLLC(a)            |                    |  |          | Note payable         |            |  |         | 10/15/05        |  |  |   | 825,000   |  |  |  | 18,355 | 
|3 |  |               | Various entities(a) |                    |  |          | Notes payable        |            |  |         | 01/17/08        |  |  |   | 130,302   |  |  |  | 10,374 | 
|4 |  |               | CEAC(a)             |                    |  |          | Bond guarantee fees  |            |  |         | open            |  |  |   |          |  |  |  | 5,000  | 
|5 |  |               | CEI(a)              |                    |  |          | Equipment lease      |            |  |         | 12/1/07         |  |  |   |          |  |  |  | 40,000 | 
|6 |  |               | CLLLC(a)            |                    |  |          | Vehicle lease        |            |  |         | 8/1/06          |  |  |   | 1,925,844 |  |  |  | 84,777 | 
|7 |  |               | CEI(a)              |                    |  |          | Real property leases |            |  |         | 10/31/08        |  |  |   |          |  |  |  | 58,748 | 
|8 |  |               | R. Patrick Hanlin   |                    |  |          | Advance payable      |            |  |         | not established |  |  |   | 16,000    |  |  |  |       | 
|9 |  |               | John B. Conroy      |                    |  |          | Note receivable      |            |  |         | 9/16/05         |  |  |   | 78,750    |  |  |  |       | 



---



|    |  |                                                                                                                                      
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Robert J. Jesenik, a director and significant
    shareholder of the Company, also owns a significant interest in
    these entities.

Terms and conditions of each of the notes and
agreements are listed below.



| |              
| | -------------
| | Notes Payable

On March 19, 2003, Steven M. Wright, the
Companys Chief Executive Officer at that time, advanced
the Company $40,000 under a line of credit promissory note. This
advance was used as operating capital within Microfield. The
note carried no interest rate and was due and payable on or
before April 25, 2003. On April 1, 2003, the note was
converted to common stock in the Company as a part of a private
placement (See Note 10).

On July 2, 2003, Steven M. Wright, the
Companys Chief Executive Officer at that time, advanced
the Company $25,000 under a line of credit promissory note. This
advance was used as operating capital within Microfield. The
note carries an interest rate of 10% and was due and payable on
September 1, 2003. This note was repaid in cash in October
2003.

1. On June 10, 2003, Steven M. Wright,
the Companys Chief Executive Officer at that time,
advanced the Company $50,000 under a line of credit promissory
note. This advance was used as operating capital within
Microfield. The note carries an interest rate of 10% and was due
and payable on September 1, 2003. As of January 3,
2004, $5,000 of this note had been repaid with the remaining
balance still outstanding. This note was subsequently converted
to Series 3 preferred stock on April 2, 2004.

On September 16, 2003, as part of the
purchase price for the acquisition of CTS, the Company assumed
various long-term notes payable to several entities in which
Robert J. Jesenik, a Director of the Company and significant
Shareholder, has significant ownership interests. A portion of
these debts were converted to equity as a part of the
Companys Series 2 preferred stock private placement
as outlined below. The remaining amounts due were subsequently
converted to Series 3 preferred stock on April 2, 2004.

On September 15, 2003, the Company, CTS and
JMW Capital Partners, Inc. (JMW) entered into an Agreement to
Satisfy Obligations. JMW is an investment banking company in
which Robert J. Jesenik, a Director and significant Shareholder,
owns a significant ownership interest. Under this agreement CTS
acknowledged debt in the amount of $149,000 owed to JMW. This
debt arose within CTS prior to the acquisition by the Company
and was used for operating activities. After consummation of the
acquisition of

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MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

CTS by the Company and upon issuance of preferred
shares in conjunction with the Series 2 preferred stock
private placement, the Company converted the note payable to JMW
into 357,143 shares of the Companys Series 2
preferred stock.

On September 15, 2003, the Company, CTS and
Christenson Electric, Inc. (CEI) entered into an Agreement to
Consolidate, Amend and Satisfy Obligations. CEI is an electrical
services company in which Robert J. Jesenik, a Director and
significant Shareholder, owns a substantial ownership interest.
Under this agreement CTS acknowledged debts of $1.5 million
and $265,000 owed to CEI. These debts arose within CTS prior to
the acquisition by the Company, and relate to the purchase of
Christenson Electrical Services inventory and customer
lists by CTS. This was a transaction between entities under
common control. After consummation of the acquisition of CTS by
the Company and upon issuance of preferred shares in conjunction
with the Series 2 preferred stock private placement, the
Company converted $365,000 of the two notes payable to CEI into
869,048 shares of Series 2 preferred stock.

On September 15, 2003, CTS executed a new
Subordinated Amended and Restated Promissory Note for the
remaining $1,400,000 due to CEI. On November 17, 2003 the
Company converted the note payable to 3,333,333 shares of
Series 2 preferred stock. There was no interest accrued or
paid on this note, according to its terms.

2. On September 15, 2003, CTS executed
an Amended and Restated Promissory Note in the amount of
$825,000 due to Christenson Leasing Company, LLC (CLC). CLC is
an equipment leasing company in which Robert J. Jesenik, a
Director and significant Shareholder, holds a substantial
ownership interest. This debt arose within CTS prior to the
acquisition by the Company and was contributed to CTS on several
dates as working capital infusions to support operating
activities. Under this note, six interest only payments are due
monthly beginning on November 15, 2003. Thereafter,
payments of $18,355 are due monthly beginning on June 15,
2004, with a balloon payment of $666,889 due and payable on
October 15, 2005. Interest on this note accrues at
12% per annum beginning on September 15, 2003. This
note was subsequently converted to equity on April 2, 2004.

3. On January 17, 2003, CTS executed
separate promissory notes with JMW, CLC, Robert Jesenik
dba Jesenik Enterprises and JW Assurance and Holding
Limited for the purchase of the undivided interests in certain
assets previously leased by CTS. Robert J. Jesenik, a Director
and significant Shareholder, owns a substantial ownership
interest in all of the above named entities. An interest only
payment is due on January 17, 2004. Thereafter, payments
totaling $6,337 are due quarterly beginning on April 17,
2004. Interest on these notes accrues at 12% per annum
beginning on January 17, 2003. As of January 3, 2004,
$79,602 was outstanding under these notes. These notes were
subsequently converted to Series 3 preferred stock on
April 2, 2004.

On January 17, 2003, CTS executed separate
promissory notes with JMW, CLC, Robert Jesenik dba Jesenik
Enterprises and JW Assurance and Holding Limited in payment of
certain past due rent amounts due from CTS under an asset lease.
Robert J. Jesenik, a Director and significant Shareholder, owns
a substantial ownership interest in all of the above named
entities. An interest only payment is due on January 17,
2004. Thereafter, payments totaling $4,036 are due quarterly
beginning on April 17, 2004. Interest on these notes
accrues at 12% per annum beginning on January 17,
2003. As of January 3, 2004, $50,700 was outstanding under
these notes. These notes were subsequently converted to
Series 3 preferred stock on April 2, 2004.

As of January 3, 2004, approximately
$191,000 of interest was payable to entities in which
Mr. Jesenik has a significant beneficial interest under the
notes and agreements listed above. This interest was
subsequently converted to Series 3 preferred stock on
April 2, 2004.

52



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                    
| | -------------------
| | Bond Indemnity Fees

4. A certain number of CTS construction
projects require the Company to maintain a surety bond. The bond
surety company requires an additional guarantee for issuance of
the bond. The Company has an agreement with CEAC, Inc.
(CEAC) under which at year end paid CEAC $5,025 per
month for CEACs guarantee of this bond liability. CEAC
holds a substantial ownership interest in CEI. Robert J.
Jesenik, a Director and significant Shareholder, owns a
substantial ownership interest in CEAC. The guarantee fee is
computed as 15% (annualized) of the open liability under
bonds issued for CTS and indemnified by certain shareholders of
CEAC.



| |                          
| | -------------------------
| | Equipment Lease Agreement

5. On September 1, 2003, CTS entered
into an agreement with CEI for use of certain equipment leased
by CEI from an outside party. Robert J. Jesenik, a Director and
significant Shareholder, owns a substantial ownership interest
in CEI. The equipment consists of various construction vehicles,
trailers, miscellaneous construction equipment, office
furniture, computer hardware and software. Under the terms of
the lease CTS pays CEI $40,000 monthly beginning on
September 1, 2003, with the final payment due on
December 1, 2007. The lease is accounted for as an
operating lease and contains a 10% purchase option at the end of
the lease term, December 31, 2007. At January 3, 2004,
the Company was past due on payments totaling $125,000, and thus
in default on the lease. Subsequent to year end, the Company
reached agreement on a payment plan to the lessor, and has been
reducing the arrearage.



| |                                   
| | ----------------------------------
| | Master Vehicle Lease
    Agreement

6. On September 1, 2003 CTS entered
into a master vehicle lease agreement with CLLLC for use of
certain vehicles used in its construction business. CLLLC is an
equipment leasing company in which Robert J. Jesenik, a Director
and significant Shareholder, holds a substantial ownership
interest. Under the terms of the lease, CTS pays CLLLC
$84,777 monthly beginning on September 1, 2003, with
the final payment due August 1, 2006. The lease contains a
renewal provision under which it has the option, at the end of
the lease term, to purchase or return the vehicles, or to renew
the lease for an additional 12 months. The lease payment
will remain fixed unless the 30-day Commercial Paper Rate as
published in the Wall Street Journal exceeds 2.00%. If that
occurs, the lessor has the option to increase the lease payment.
This lease is accounted for as a capital lease. On
September 1, 2003 prior to the acquisition of CTS,
$1,993,233 was recorded as cost of the vehicles leased with the
same amount recorded as debt owed under the lease as of that
date. At January 3, 2004, the Company was past due on
payments totaling $271,720, and thus in default on the lease.
Subsequent to year end, the Company reached agreement on a
payment plan to the lessor, and has been reducing the arrearage.
Accordingly, the remaining capital lease obligation is properly
classified between current and long-term debt.



| |                         
| | ------------------------
| | Real Property Sub Leases

7. On September 1, 2003, CTS entered
into seven real property subleases with CEI for use of
buildings, offices and storage yards to house the operations and
property of CTS. Robert J. Jesenik, a Director and significant
Shareholder, owns a substantialownership interest in CEI. CTS
has operating activities in Portland and Eugene, Oregon, and as
of December 31, 2003, vacated its office in Bend, Oregon as
the lease expired. After January 14, 2004, the Swan Island
facility lease obligation converted to a month-to-month lease.
The monthly sublease payments totaled $58,748 through
December 31, 2003. Of that amount, $798 is due on a
month-to-month basis. The remaining $57,950 is due on leases
with maturity dates between December 31, 2003 and
October 31, 2008. Beginning in February 2004, the
Companys monthly lease obligation will be

53



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

$55,168, with $7,922 of that on a month-to-month
basis. The annual rent obligations from January 3, 2004,
for each property are listed in the table below.

|                        |       |          |          |      |  |      |         |         |  |      |         |         |  |  |         |         |  |  |         |         |  |  |         |         | 
|----------------------- | ----- | -------- | -------- | ---- |  | ---- | ------- | ------- |  | ---- | ------- | ------- |  |  | ------- | ------- |  |  | ------- | ------- |  |  | ------- | ------- | 
|Location                |       | Maturity |          | 2004 |  | 2005 |         | 2006    |  | 2007 |         | 2008   
|                        |       |          |          |      |  |      |         |         |  |      |         |        
|Thurman Building        |       |          | 10/31/08 |      |  |      | 464,928 |         |  |      | 464,928 |         |  |  | 464,928 |         |  |  | 464,928 |         |  |  | 387,440 |        
|Swan Island             |       |          | 01/14/04 |      |  |      | 3,562   |         |  |      |         |         |  |  |         |         |  |  |         |         |  |  |         |        
|Eugene                  |       |          | 09/30/05 |      |  |      | 84,048  |         |  |      | 63,036  |         |  |  |         |         |  |  |         |         |  |  |         |        
|Crown Plaza Office      |       |          | 7/31/07  |      |  |      | 17,976  |         |  |      | 17,976  |         |  |  | 17,976  |         |  |  | 10,486  |         |  |  |         |        
|Pope Storage            |       |          | *        |      |  |      |         |         |  |      |         |         |  |  |         |         |  |  |         |         |  |  |         |        
|Montgomery Park Storage |       |          | *        |      |  |      |         |         |  |      |         |         |  |  |         |         |  |  |         |         |  |  |         |        
|                        | Total |          |          |      |  |      |         | 570,514 |  |      |         | 545,940 |  |  |         | 482,904 |  |  |         | 475,414 |  |  |         | 387,440 | 



---



|  |               
|- | --------------
|* | Month-to-Month



| |                                      
| | -------------------------------------
| | Administrative Services
    Agreement

On September 15, 2003, CTS entered into an
administrative services agreement with CEI for the extension of
certain administrative and related services by the Company to
CEI. Robert J. Jesenik, a Director and Significant shareholder,
owns a substantial ownership interest in CEI. Under the terms of
the agreement, certain employees provided administrative and
related services to CEI upon reasonable request. The agreement
is subject to a 60-day notice period before termination by
either party. The monthly payment for these services was
determined at the effective date of the agreement to be
approximately $35,000, with a provision to be adjusted as needed
based on the level of usage of these services by CEI. During the
first quarter of 2004, the payment by CEI for these services was
renegotiated to $15,000 per month as the cost of services
to CEI has been reduced.

8. On November 5, 2003, R. Patrick
Hanlin, Chairman of the Companys board of directors,
advanced $16,000 to the Company in the form of a payment
directly to one of the Companys creditors. The advance is
unsecured and does not carry an interest rate or have any stated
due date. On April 2, 2004 this debt was converted to
approximately 38 shares of the Companys Series 3
preferred stock. These shares of Series 3 preferred stock
are convertible into 38,095 shares of the Companys
common stock at the option of the shareholder.

9. In 1998, John B. Conroy, then the
Companys Chairman, CEO and President, entered into a
transaction whereby he purchased 45,000 shares of the
Companys common stock at $1.75 per share.
Mr. Conroy issued a promissory note to the Company for
$78,750 in payment for the shares. On May 17, 2004 the Note
was replaced with a new non-recourse note for $66,250 under
which the original amount of the note was offset against a
$12,500 amount owed by the Company to Mr. Conroy. The note
also acknowledges the outstanding accrued interest due by
Mr. Conroy in the amount of $21,937. Additionally, the
interest rate of the new promissory note was established at
3.4% per annum, and the due date was extended to
August 29, 2006. Mr. Conroy resigned as Chairman, CEO
and President on September 16, 2002, and resigned as a
director in October 2003.



|    |                              
|--- | -----------------------------
|19. | Commitments and Contingencies



| |                                           
| | ------------------------------------------
| | Manufacturing and Purchase
    Commitments

In the acquired CTS business, the Company
purchases inventory on an as needed basis. There are no purchase
commitments for products that CTS uses in the performance of its
services.

54



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The Company is party to a number of lease
agreements, many of which are included in Note 18 above.
Following is a schedule of the Companys annual lease
commitments for the coming five years.

|                |  |        |           | 
|--------------- |  | ------ | --------- | 
|Year            |  | Amount
|                |  |       
|2004            |  | $      | 2,245,342 | 
|2005            |  |        | 2,175,138 | 
|2006            |  |        | 1,623,144 | 
|2007            |  |        | 944,928   | 
|2008 and beyond |  |        | 320,000   | 



|    |                  
|--- | -----------------
|20. | Subsequent Events



| |                    
| | -------------------
| | Shareholder Lawsuit

In March, 2004, Kurt Underwood (former
President/CEO of Microfield Group, Inc.) filed a lawsuit in
Multnomah County Circuit Court, Portland, Oregon under case
number 0403-02370 against Robert J. Jesenik, JMW Capital
Partners, Inc., Destination Capital, LLC, Microfield Group,
Inc., Christenson Electric, Inc., Steven M. Wright, Andrew S.
Craig, Thomas A. Sidley, R. Patrick Hanlin, Michael Stansell,
Brian A. Oliver, Brian N. Christopher, Kevin D. Robertson,
Christenson Group, LLC, and Christenson Velagio, Inc. The
lawsuit alleges that the Defendants violated Oregon securities
law and Oregon common law in connection with the following
transactions (which closed simultaneously in September 2003):
(1) the merger of CTS Acquisition Co. (a wholly-owned
subsidiary of the Company) with and into Christenson Technology
Services, Inc.; and (2) the merger of VSI Acquisition Co.
(A wholly-owned subsidiary of the Company) with and into
Velagio, Inc. In addition, the lawsuit alleges that
Mr. Underwood was terminated as an employee entitling him
to severance pay. The lawsuit seeks damages of approximately
$1.4 million. The Company intends to vigorously defend the
lawsuit, however at the date of this filing, the outcome of this
matter is uncertain. The financial statements do not reflect any
adjustments relative to this uncertainty.



| |                                                          
| | ---------------------------------------------------------
| | Debt Financing, Debt Conversion and Private
    Placement

On January 22, 2004, the Company entered
into a Contract of Sale and Security Agreement with Destination
Capital LLC (Destination) under which the Company agreed to sell
up to 15% of its acceptable, eligible accounts receivable to
Destination, in exchange for borrowing up to $600,000 from that
entity under the terms of a Promissory Note. Destination is an
entity in which Robert J. Jesenik, a shareholder and director of
the Company, holds a significant beneficial interest. Under the
terms of the agreement between the Company and Destination, the
Company pays interest at the rate of 18% per annum on the
amount of the note outstanding, and also issued warrants in the
amount of 1% of the fully diluted common shares, per month, for
each month the Note is outstanding. The warrants have a
five-year life and will be issued at the lower of $.42 or the
price of any other common or preferred equity issued in the six
months following this agreement. This warrant issuance requires
shareholder approval at the Companys next shareholder
meeting. The Note was repaid in full during April 2004.

On April 2, 2004, the Company entered into
an agreement with several of its related party creditors to
convert approximately $1,529,000 of debt into approximately
3,242 shares of Series 3 preferred stock of the
Corporation. The Series 3 Preferred Stock had an issue
price of $420 per share, and each Series 3 Preferred
Share is convertible into 1,000 shares of common stock of
the Company after March 31, 2005 at the election of the
shareholder. The Series 3 preferred stock will
automatically convert to common stock on the third anniversary
of the stock issuance date.

Also in April and May 2004, the Company raised an
additional $1,750,000 from investors who purchased Series 4
preferred stock. The Company issued 4,605 shares of
Series 4 preferred stock to these investors. The
Series 4 preferred stock had an issue price of
$380 per share, and each share of Series 4 preferred
stock is

55



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##### Table of Contents



MICROFIELD GROUP, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

convertible into 1,000 shares of common
stock of the Company after March 31, 2005 at the election
of the shareholder. The Series 4 preferred stock will
automatically convert to common stock on the third anniversary
of the stock issuance date. Proceeds from this capital were used
to pay off the $600,000 borrowing from Destination as well as to
provide for working capital needs.

Both the Series 3 and Series 4
preferred shares have the right to receive a 6% dividend,
payable out of legally available funds, and receive a
liquidation preference upon dissolution of the Company.

56



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##### Table of Contents








|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 8. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

None.






|         |                        
|-------- | -----------------------
|Item 8A. | Controls and Procedures

Prior to the September 16, 2003 acquisitions
of CTS and Velagio, the Company officers, including the then
current Chief Executive Officer, had evaluated the effectiveness
of the Companys disclosure controls and procedures
pursuant to Rule 13a-14 of the Securities and Exchange Act
of 1934 (Exchange Act) and found them to be
effective in alerting the Chief Executive Officer on a timely
basis to material information relating to the Company required
to be included in the Companys securities filings. At that
time, the Company did not have a Chief Financial Officer.

After closing the acquisitions of CTS and Velagio
on September 16, 2003, the Company and its then, newly
organized management team, including the new Chief Executive
Officer, the newly appointed and acting Chief Financial Officer
and the Chief Operating Officer (the Companys former CEO
prior to the acquisitions), reviewed the effectiveness of the
Companys disclosure controls and procedures. In response
to this review, the officers of the Company developed a
formalized Periodic Evaluation of Disclosure Controls and
Procedures process to implement periodic internal reports,
disclosure controls, procedures and internal controls.

In the course of trying to complete the audit of
GAAP compliant financial statements related to Form 8-K/A
filing, the Companys independent accountants and
management team noted certain material internal control
weaknesses within the operations of CTS in the areas of: revenue
recognition, cash disbursements, inventory accounting and
document control. The Companys management concluded that
fully compliant GAAP financial statements of CTS for
FY 2002 and FY 2001 could not be prepared.
Accordingly, the Companys independent accountants
concluded that they could not render an opinion on the
historical FY 2002 and FY 2001 financial statements of
CTS. In addition, the Company received notice from its
independent auditors that, in conjunction with the
2003 year-end audit of the Companys financial
statements, the auditors had identified material weaknesses
relating to the Companys internal controls and procedures
within the area of accounts payable, cash disbursements,
inventory accounting and document retention. Certain of these
internal control deficiencies may also constitute deficiencies
in the Companys disclosure controls. In response to these
material internal control weaknesses, the Company conducted a
Company-wide core business process and systems assessment
initiative. Upon completing the assessment work of this
initiative, the Company and management team commenced business
process re-engineering activities related to core business
processes (contract-to-cash business cycle), and are actively
implementing improved information systems (accounting and
financial reporting tools) to address deficiencies related to
internal financial controls and accounting procedures.

During January 2004, the Companys CEO, CFO
and Executive Vice President left the employ of the Company. A
new interim CEO and acting CFO joined the Company in late
January and early February 2004 having had no prior affiliation
with the combined companies or operations. Not having been in a
position of active management or knowledge over transactions
during FY 2003, this new management team began their
assessment of disclosure controls and internal controls while
continuing the efforts of prior management.

In order to review the financial condition and
prepare the financial disclosures in this document, the
Companys officers have been responding to recommendations
from the Companys auditors to ensure that the purchase
accounting is accurate and to properly and accurately account
for the financial information contained in this
Form 10-KSB. Detailed validation work was done by internal
personnel with respect to all consolidated balance sheet account
balances to substantiate the financial information that is
contained in this Form 10-KSB. Additional analysis was
performed on consolidated income statement amounts and compared
to prior period (both year over year and consecutive period)
amounts for reasonableness. Management is in the process of
implementing a more effective system of controls, procedures and
other changes in the areas of revenue recognition, cash
disbursements, account reconciliation and document control to
insure that

57



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##### Table of Contents



information required to be disclosed in this
annual report on Form 10-KSB has been recorded, processed,
summarized and reported accurately. Among the changes
implemented subsequent to 2003 year end are:


Revenue Recognition



| |   |                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------
| |  | Criteria and procedures established defining
    approved customer contracts                       
|
| |  | Control function established to review and
    monitor compliance to new procedures                
|
| |  | Improved document control and file check out
    procedures                                        
|
| |  | Procedure established defining consistent
    percentage completion Gross Margin estimation process

Cash Disbursements and liability
recognition



| |   |                                                                     
| | - | --------------------------------------------------------------------
| |  | Document control system established and monitored
    for compliance
|
| |  | Cut off procedures formalized and consistently
    applied          
|
| |  | Centralized departmental accountability
    established             

Account Reconciliations



| |   |                                                                                              
| | - | ---------------------------------------------------------------------------------------------
| |  | Procedures established and personnel assigned to
    reconcile key accounts on a timely basis
|
| |  | Control function added to review reconciliations                                             

The Companys officers have been working
closely with the Board of Directors to address recommendations
from the Companys auditors regarding deficiencies in the
disclosure controls and procedures. The Company is currently
engaged in the implementation of a new ERP system and associated
new internal control procedures. Management expects that this
system along with new associated procedures, once implemented,
will correct the deficiencies and will implement disclosure
controls and procedures pursuant to Rule 13a-14 of the
Exchange Act, that will timely alert the Chief Executive Officer
and Chief Financial Officer to material information relating to
the Company required to be included in the Companys
Exchange Act filings.




PART III





|        |                                                                                                                        
|------- | -----------------------------------------------------------------------------------------------------------------------
|Item 9. | Directors, Executive Officers, Promoters
    and Control Persons; Compliance with Section 16(a) of the
    Exchange Act

The names, ages and positions of the
Companys executive officers and directors are as follows:

|                     |  |     |    |                          |  |                                                
|-------------------- |  | --- | -- | ------------------------ |  | -----------------------------------------------
|Name                 |  | Age |    | Position(s) with Company
|                     |  |     |    |                         
|William C. McCormick |  |     | 70 |                          |  | Interim Chief Executive Officer                
|Gary M. Kapral       |  |     | 48 |                          |  | Chief Financial Officer                        
|Steven M. Wright     |  |     | 41 |                          |  | Vice President, Director                       
|R. Patrick Hanlin    |  |     | 43 |                          |  | Chairman of the Board of Directors             
|Robert J. Jesenik    |  |     | 44 |                          |  | Director                                       
|Michael W. Stansell  |  |     | 61 |                          |  | Director                                       
|Kurt A. Underwood    |  |     | 38 |                          |  | President and Chief Executive Officer, Director
|James L. Kotchik     |  |     | 60 |                          |  | Chief Financial Officer                        
|Peter A. Arrezini    |  |     | 52 |                          |  | Executive Vice President                       

William C. McCormickjoined the Company in January 2004 as
Interim Chief Executive Officer. Prior to coming to the Company,
Mr. McCormick was Chief Executive Officer of Precision
Castparts, Corp., a publicly traded aerospace company, from
August 1994 to August 2002. He also served as the Chairman of
the board of directors there from October 1994 to August 2003.
Mr. McCormick joined Precision Castparts in

58



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April 1985. He serves as a consultant to the
company. Prior to Precision Castparts, Mr. McCormick spent
32 years at General Electric in various businesses,
including GE Aircraft Engines, Carboloy Systems, Distribution
Equipment, and Industrial Electronics. Mr. McCormick serves
on the board of directors and is Chair of the Audit Committee of
Merix Corporation, a publicly traded manufacturer of high
performance interconnect products. He serves on the boards of
several other for profit and non profit companies.
McCormick holds a BS in Mathematics from the University of
Cincinnati.


Gary M. Kapraljoined the Company in May, 2004 as
Chief Financial Officer after having served as a full time
financial consultant with the Company since February 2004.
Mr. Kapral has been a partner with Tatum CFO Partners LLP
since September, 2003. During the three year period prior to
joining Tatum, Mr. Kapral was a Vice President and
corporate officer of Electro Scientific Industries, a
manufacturer of semiconductor capital equipment. Prior to ESI,
Mr. Kapral spent 13 years with SGL Carbon, a division
of Hoechst, a multinational German-based conglomerate.
Mr. Kaprals career includes CFO, VP Finance,
Divisional President and Group VP responsibilities in a wide
variety of industrial businesses. He holds a BS degree in
Accounting form the University of Illinois and is a Certified
Public Accountant.

Steven M. Wrightjoined Microfield in September 2002
and was appointed President and Chief Executive Officer that
same month. He served in that position until August 31,
2003 when he was appointed Chief Operating Officer.
Mr. Wright left the employ of the Company from December
2003 to April 2004. Upon his return Mr. Wright was
appointed Vice President and Corporate Secretary.
Mr. Wright remains a director. Prior to joining Microfield,
Mr. Wright was the founder and Managing Partner of
Innovative Safety Technologies, LLC from its inception in July
2001 to September 2002. Mr. Wright was Chief Operating
Officer, Director and Co-founder of Card Capture Services, Inc.
an international ATM provider, from March 1992 through May 2000.
Mr. Wright holds a BBS in Marketing and Management from the
University of Oregon.

R. Patrick Hanlinjoined the Company as its Chairman in
September 2002. Mr. Hanlin founded and has been the
President and a director of Livebridge, Inc. a multi-channel
communications service provider from February 1988 to the
present time. Mr. Hanlin holds a BA in Business and
Communications from the University of Oregon.

Robert J. Jesenikjoined the Company in September 2003
as a director. Mr. Jesenik was a founder and has been a
partner with JMW Capital Partners, an investment banking company
since 1992. He was appointed the Chief Executive Officer of
Christenson Electric, Inc. an electrical services company,
in 2002. Prior to that, Mr. Jesenik spent 16 years in
various operating management positions in technology and
distribution firms. Mr. Jesenik sits on the Boards of
Directors of several companies and foundations. Mr. Jesenik
holds a BS in Accounting from the University of Oregon and an
MBA from the University of Portland.

Michael W. Stanselljoined the Company in November 1985 as
Director of Manufacturing and was appointed Vice President,
Operations, in January 1987. Mr. Stansell was appointed to
the Companys board of directors in November 1999 and
served as the Companys President from November 1999 until
October 2002. Mr. Stansell was a division manufacturing
manager, among other positions, at Tektronix Corporation from
August 1965 through October 1985.

Kurt A. Underwoodjoined the Company in September 2003
as President and Chief Executive Officer. Mr. Underwood
founded and was President and a director of Velagio, Inc. a
software applications and systems integration consulting company
from June 2000 until that companys acquisition by
Microfield Group, Inc. in September 2003. Prior to that,
Mr. Underwood was Senior Vice President and Partner in the
firm KPMG, an international financial services firm, from 1997
to 2000. He is a director on several boards in the high
technology industry. Mr. Underwood left the employ of the
Company in January 2004. Mr. Underwood holds a BA in
Economics from UCLA.

James L. Kotchikjoined the Company in December 2003 as
Chief Financial Officer. Mr. Kotchik was Senior Vice
President and Chief Financial Officer of the Portland Trail
Blazers and Oregon Arena Corporation from March 1996 to March
2003. Prior to that, he held significant management positions
with United Grain Corporation and Tektronix. Mr. Kotchik
was an auditor with PricewaterhouseCoopers from

59



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##### Table of Contents



1968 to 1976, and is a CPA. Mr. Kotchik left
the employ of the Company in January 2004. He holds a BS in
Business and an MBA in Decision Sciences from the University of
Oregon.


Peter A. Arrezinijoined the Company in December 2003 as
Executive Vice President. Arrezini was Chief Operating Officer
of the Security and Life-Safety Division of General Electric
with operations in the U.S. and Mexico. Prior to that
experience, he was President of Sentrol, an electronic security
products manufacturer. He spent his early career in several
divisions of Ingersoll-Rand Corporation in a number of executive
roles in operations, engineering, and sales and marketing. He is
a director on several boards in the high technology industry.
Mr. Arrezini left the employ of the Company in January
2004. Mr. Arrezzini holds a B.S. in Economics from the
University of Hartford and an MBA in Marketing from Golden Gate
University.

Compliance with Section 16(a) of the
Exchange Act

Section 16(a) of the Securities Exchange Act
of 1934 requires the Companys executive officers an
directors, and persons who own more than ten percent of a
registered class of the Companys equity securities to file
reports of ownership and change in ownership with the Securities
and Exchange Commission (SEC). Executive officers, directors and
greater than ten percent shareholders are require by SEC
regulation to furnish the Company with copies of all
Section 16(a) forms they file. Based solely on its review
of the copies of such forms received by it, or written
representations from certain reporting persons, the Company
believes that, during 2003, all executive officers, directors
and greater than ten percent shareholders complied with all
applicable filing requirements. Mr. Wright had one late
Form 4 filing and Mr. Hanlin had 3 late
Form 4 filings.

Audit Committee

The Audit Committee charter was discussed,
reviewed and adopted February 6, 2003. The Audit Committee
consists of Mr. Hanlin and Mr. Jesenik. The Board of
Directors has determined that Mr. Hanlin and
Mr. Jesenik are each an audit committee financial
expert as defined in SEC rules. The audit committee held
one formal meeting and several other meetings during fiscal year
2003. Mr. Hanlin serves as Chairman of the Audit Committee.

The Audit Committee oversees the accounting,
financial reporting and audit processes; makes recommendations
to the board of directors regarding the selection of independent
auditors; reviews the results and scope of audit and other
services provided by the independent auditors; reviews the
accounting principles and auditing practices and procedures to
be used in preparing the Companys financial statements;
and reviews the Companys internal controls.

Ethics Committee

The Code of Ethics was discussed, reviewed and
adopted in the February 6, 2003 Microfield board of
directors Meeting. In its October 16, 2003 Board Meeting,
the Companys board of directors appointed directors John
B. Conroy, Mr. Wright and Mr. Underwood to the Ethics
Committee. The ethics committee had informal meetings and
discussions throughout 2003. Mr. Conroy resigned from the
Microfield board of directors and all related obligations on
October 17, 2003. Mr. Underwood resigned from the
board of directors and all related obligations on
January 21, 2004. The current policy requires that the
ethics committee consist of two Board Members. A copy of the
Code of Ethics is available from the Company by contacting
Mr. Steven M. Wright, c/o Microfield Group, Inc., 1631
NW Thurman St., Suite 200, Portland, Oregon 97209.

Compensation Committee

In its October 16, 2003 board meeting, the
Companys board of directors unanimously appointed
Mr. Hanlin, and Mr. Jesenik, to the compensation
committee. The committee had numerous informal meetings and
discussions throughout 2003. The committee determines the
compensation level, option grants and other compensation for the
executive officers of the Company.

60



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##### Table of Contents








|         |                       
|-------- | ----------------------
|Item 10. | Executive Compensation

Summary of Cash and Certain Other
Compensation

The following table provides certain summary
information concerning compensation awarded to, earned by or
paid to the Companys Chief Executive Officer and other
executive officers of the Company whose total annual salary and
bonus exceeded $100,000 (collectively, the named
officers) for fiscal years 2003, 2002 and 2001.

Summary Compensation Table

|                     |                              |                     |      |            |  |           |         |              |  |     |        |        |  |  |        |         |  |  |        |   | 
|-------------------- | ---------------------------- | ------------------- | ---- | ---------- |  | --------- | ------- | ------------ |  | --- | ------ | ------ |  |  | ------ | ------- |  |  | ------ | - | 
|                     |                              |                     |      |            |  |           |         | Long Term    |  |    
|                     |                              |                     |      |            |  |           |         | Compensation |  |    
|                     |                              |                     |      |            |  |           |         | Awards       |  |    
|                     |                              |                     |      |            |  |          
|                     |                              | Annual Compensation |      | Securities |  |          
|                     |                              |                     |      | Underlying |  | All Other
|                     |                              | Fiscal              |      |            |  | Options   |         | Compensation
|                     |                              | Year                |      | Salary ($) |  | Bonus ($) |         | (#)          |  | ($)
|                     |                              |                     |      |            |  |           |         |              |  |    
|Kurt A. Underwood(1) |                              |                     | 2003 |            |  |           | 94,178  |              |  |     | 37,242 |        |  |  |       |         |  |  |       |  
|                     | President, Chief Executive   |                     |      | 2002       |  |           |         |             |  |     |        |       |  |  |        |        |  |  |        |  | 
|                     | Officer and Director         |                     |      | 2001       |  |           |         |             |  |     |        |       |  |  |        |        |  |  |        |  | 
|Steven M. Wright(2)  |                              |                     | 2003 |            |  |           | 123,535 |              |  |     |       |        |  |  |        |         |  |  |       |  
|                     | Chief Operating Officer and  |                     |      | 2002       |  |           |         | 48,462       |  |     |        |       |  |  |        | 145,188 |  |  |        |  | 
|                     | Director                     |                     |      | 2001       |  |           |         |             |  |     |        |       |  |  |        |        |  |  |        |  | 
|John B. Conroy(3)    |                              |                     | 2003 |            |  |           |        |              |  |     |       |        |  |  | 25,000 |         |  |  | 54,047 |  
|                     | Chairman of the Board, Chief |                     |      | 2002       |  |           |         | 106,062      |  |     |        | 10,922 |  |  |        |        |  |  |        |  | 
|                     | Executive Officer and        |                     |      | 2001       |  |           |         | 173,078      |  |     |        | 82,714 |  |  |        |        |  |  |        |  | 
|                     | President, 2002 and 2001     |                     |      |            |  |           |         |              |  |     |        |        |  |  |        |         |  |  |        |   | 



---



|    |                                                                                                                                                                                                                                                      
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Mr. Underwood was appointed the
    Companys Chief Executive Officer on September 16,
    2003.                                                                                                                                                     
|   
|(2) | Mr. Wright was appointed the Companys
    Chief Executive Officer on September 16, 2002, and served
    in that capacity until August 31, 2003, when he was
    appointed Chief Operating Officer. Mr. Wright left the
    Company in December 2003.
|   
|(3) | Mr. Conroy was the Companys Chief
    Executive Officer from May 1986 until his retirement in
    September 2002. Mr. Conroy remained a director until his
    resignation from the board in October 2003.                                          

Options Granted in Last Fiscal Year

There were no grants of stock options under the
Companys Stock Incentive Plan during fiscal 2003 to the
named officers. No other current executive officers received
options exercisable for shares of the Companys Common
Stock during fiscal 2003. All other employees who are not
currently executive officers of the Company received options
exercisable for a total of 277,270 shares of the
Companys Common Stock during fiscal 2003. There were an
additional 196,639 nonqualified stock options awarded to
individuals or entities not employed by the Company. These
options were issued at the acquisition of Velagio in September
2003, and were issued in exchange for 2,310,000 existing stock
options for the purchase of Velagio, Inc. common stock.

61



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Option Exercise and Holdings

The following table provides information
concerning the exercise of options during fiscal 2003 and
unexercised options held as of the end of the fiscal year with
respect to the named officers.

Aggregated Option Exercises in Last Fiscal
Year

and FY-End Option Values


|                  |  |                 |   |          |  |                |   |                  |  |       |        |            |  |  |        |  |  |  |       |  |  |  |       |  |  |  |       |  |  |  |       | 
|----------------- |  | --------------- | - | -------- |  | -------------- | - | ---------------- |  | ----- | ------ | ---------- |  |  | ------ |  |  |  | ----- |  |  |  | ----- |  |  |  | ----- |  |  |  | ----- | 
|                  |  |                 |   |          |  |                |   |                  |  |       |        |            |  | 
|                  |  |                 |   |          |  | Number of      |   |                  |  |       |        |           
|                  |  |                 |   |          |  | Securities     |   | Value of         |  |       |        |           
|                  |  |                 |   |          |  | Underlying     |   | Unexercised      |  |       |        |           
|                  |  |                 |   |          |  | Unexercised    |   | In-The-Money     |  |       |        |           
|                  |  |                 |   |          |  | Options        |   | Options          |  |       |        |           
|                  |  | Shares Acquired |   | Value    |  | At FY-End (#)  |   | At FY-End ($)(2) |  |       |        |           
|                  |  | on Exercise     |   | Realized |  | Exerciseable/  |   | Exerciseable/    |  | Grant |        | Expiration
|Name              |  | (#)             |   | ($)(1)   |  | Unexerciseable |   | Unexerciseable   |  | Date  |        | Date      
|                  |  |                 |   |          |  |                |   |                  |  |       |        |           
|                  |  |                 |   |          |  |                |   |                  |  |       |        |            |  |  |        | 
|Kurt A. Underwood |  |                 |  |          |  |                |  |                  |  |       |       |            |  |  |       |  |  |  |      |  |  |  |      |  |  |  | N/A   |  |  |  | N/A   | 
|                  |  |                 |  |          |  |                |  |                  |  |       |       |            |  |  |       |  |  |  |      |  |  |  |      |  |  |  | N/A   |  |  |  | N/A   | 
|Steven M. Wright  |  |                 |  |          |  |                |  |                  |  |       | 20,472 |            |  |  | 49,716 |  |  |  | 2,866 |  |  |  | 6,960 |  |  |  | 10/02 |  |  |  | 10/07 | 
|                  |  |                 |  |          |  |                |  |                  |  |       | 21,875 |            |  |  | 53,125 |  |  |  | 2,188 |  |  |  | 5,312 |  |  |  | 10/02 |  |  |  | 10/07 | 



---



|    |                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------
|(1) | Market value of the underlying securities at
    exercise date, minus exercise price of the options.                                  
|   
|(2) | Market value of the underlying securities at
    January 3, 2004, $.54 per share, minus exercise price
    of the unexercised options.






|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 11. | Security Ownership of Certain Beneficial
    Owners and Management

The following table sets forth certain
information regarding the beneficial ownership of Common Stock
of the Company as of March 1, 2004 as to (i) each
person who is known by the Company to own beneficially more than
5% of the outstanding shares of Common Stock, (ii) each
director of the Company, (iii) each of the executive
officers named in the Summary Compensation Table below and
(iv) all directors and executive officers as a group.
Except as otherwise noted, the Company believes the persons
listed below have sole investment and voting power with respect
to the Common Stock owned by them.

|                                                 |                        |                          |            |             |  |  |      |   | 
|------------------------------------------------ | ---------------------- | ------------------------ | ---------- | ----------- |  |  | ---- | - | 
|                                                 |                        |                         
|                                                 |                        | Common Stock and        
|                                                 |                        | Common Stock Equivalents
|                                                 |                        |                         
|                                                 |                        | Equivalent               |            |            
|                                                 |                        | Common                   |            |            
|                                                 |                        | Shares                   |            | Approximate
|Five Percent Shareholders, Directors,            |                        | Beneficially             |            | Voting     
|Director Nominees and Certain Executive Officers |                        | Owned(1)                 |            | Percentage 
|                                                 |                        |                          |            |            
|Robert J. Jesenik(2)                             |                        |                          | 16,435,911 |             |  |  | 40.9 | %
|                                                 | Suite 400              |                          |            |             |  |  |      |   | 
|                                                 | 1631 NW Thurman Street |                          |            |             |  |  |      |   | 
|                                                 | Portland, OR 97209     |                          |            |             |  |  |      |   | 
|JMW Group, LLC(3)                                |                        |                          | 15,551,206 |             |  |  | 39.6 | %
|                                                 | Suite 400              |                          |            |             |  |  |      |   | 
|                                                 | 1631 NW Thurman Street |                          |            |             |  |  |      |   | 
|                                                 | Portland, OR 97209     |                          |            |             |  |  |      |   | 
|Christenson Group, LLC(4)                        |                        |                          | 8,521,159  |             |  |  | 26.4 | %
|                                                 | Suite 400              |                          |            |             |  |  |      |   | 
|                                                 | 1631 NW Thurman Street |                          |            |             |  |  |      |   | 
|                                                 | Portland, OR 97209     |                          |            |             |  |  |      |   | 
|Christenson Electric, Inc.(5)                    |                        |                          | 4,328,017  |             |  |  | 15.4 | %
|                                                 | Suite 400              |                          |            |             |  |  |      |   | 
|                                                 | 1631 NW Thurman Street |                          |            |             |  |  |      |   | 
|                                                 | Portland, OR 97209     |                          |            |             |  |  |      |   | 

62



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##### Table of Contents



|                                                                                  |                        |                          |            |             |  |  |      |   | 
|--------------------------------------------------------------------------------- | ---------------------- | ------------------------ | ---------- | ----------- |  |  | ---- | - | 
|                                                                                  |                        |                         
|                                                                                  |                        | Common Stock and        
|                                                                                  |                        | Common Stock Equivalents
|                                                                                  |                        |                         
|                                                                                  |                        | Equivalent               |            |            
|                                                                                  |                        | Common                   |            |            
|                                                                                  |                        | Shares                   |            | Approximate
|Five Percent Shareholders, Directors,                                             |                        | Beneficially             |            | Voting     
|Director Nominees and Certain Executive Officers                                  |                        | Owned(1)                 |            | Percentage 
|                                                                                  |                        |                          |            |            
|Kurt A. Underwood(6)                                                              |                        |                          | 3,540,675  |             |  |  | 13.0 | %
|                                                                                  | 5125 SW Macadam Ave.,  |                          |            |             |  |  |      |   | 
|                                                                                  | Suite 200              |                          |            |             |  |  |      |   | 
|                                                                                  | Portland, OR 97239     |                          |            |             |  |  |      |   | 
|Christenson Leasing Company, LLC(7)                                               |                        |                          | 3,241,922  |             |  |  | 12.0 | %
|                                                                                  | Suite 400              |                          |            |             |  |  |      |   | 
|                                                                                  | 1631 NW Thurman Street |                          |            |             |  |  |      |   | 
|                                                                                  | Portland, OR 97209     |                          |            |             |  |  |      |   | 
|William C. McCormick(8)                                                           |                        |                          | 263,158    |             |  |  | 1.1  | %
|                                                                                  | Suite 200              |                          |            |             |  |  |      |   | 
|                                                                                  | 1631 NW Thurman Street |                          |            |             |  |  |      |   | 
|                                                                                  | Portland, OR 97209     |                          |            |             |  |  |      |   | 
|Steven M. Wright(1)(9)                                                            |                        |                          | 1,238,025  |             |  |  | 5.0  | %
|                                                                                  | Suite 200              |                          |            |             |  |  |      |   | 
|                                                                                  | 1631 NW Thurman Street |                          |            |             |  |  |      |   | 
|                                                                                  | Portland, OR 97209     |                          |            |             |  |  |      |   | 
|R. Patrick Hanlin(10)                                                             |                        |                          | 1,070,334  |             |  |  | 4.3  | %
|                                                                                  | Suite 200              |                          |            |             |  |  |      |   | 
|                                                                                  | 1631 NW Thurman Street |                          |            |             |  |  |      |   | 
|                                                                                  | Portland, OR 97209     |                          |            |             |  |  |      |   | 
|Michael Stansell(11)                                                              |                        |                          | 160,810    |             |  |  | *    | %
|                                                                                  | Suite 200              |                          |            |             |  |  |      |   | 
|                                                                                  | 1631 NW Thurman Street |                          |            |             |  |  |      |   | 
|                                                                                  | Portland, OR 97209     |                          |            |             |  |  |      |   | 
|All directors and executive officers as a group
    as of 4/30/04 (6 persons)(12) |                        |                          | 19,168,238 |             |  |  | 44.7 | %



---



| |   |             
| | - | ------------
| | * | Less than 1%



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Shares to which the person or group has the right
    to acquire within 60 days after March 1, 2004 are
    deemed to be outstanding in calculating the percentage ownership
    of the person or group but are not deemed to be outstanding as
    to any other person or group.                                                                                                                                                                                                                                                                                                                                          
|
| | (2) | Includes 5,160,953 Series 2 preferred shares
    (4,202,381 owned by CEI, 357,143 owned by JMW Capital Partners
    LLC and 601,429 owned by JMW Group, Inc.), 6,088 Series 3
    and 4 preferred shares (126 owned by CEI, 3,242 owned by CLC, 68
    owned by JMW Capital Partners LLC and 2,632 owned by JMW Group,
    Inc.) purchased within 60 days of March 1, 2004, and
    910,600 warrants (84,200 owned by JMW Group, Inc.) convertible
    into common stock within 60 days after March 1, 2004.
    Each share of Series 3 and Series 4 preferred is
    convertible into 1,000 shares of voting common stock.
|
| | (3) | Includes 5,160,953 Series 2 preferred shares
    (4,202,381 shares owned by CEI and 357,143 owned by JMW Capital
    Partners, LLC), 6,067 Series 3 and 4 preferred shares(126
    owned by CEI, 3,242 owned by CLC and 68 owned by JMW Capital
    Partners LLC) purchased within 60 days of March 1,
    2004, and 84,200 warrants convertible into common stock within
    60 days after March 1, 2004. Each share of
    Series 3 and Series 4 preferred is convertible into
    1,000 shares of voting common stock.                                                                                                  
|
| | (4) | Includes 4,202,381 Series 2 preferred shares
    (4,202,381 owned by CEI) and 126 Series 3 and 4 preferred
    shares (owned by CEI) purchased within 60 days of
    March 1, 2004. Each share of Series 3 and
    Series 4 preferred is convertible into 1,000 shares of
    voting common stock.                                                                                                                                                                                                                                                                                                                         

63



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##### Table of Contents





| |     |                                                                                                                                                                                                                                                                                                                     
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (5) | Includes 4,202,381 Series 2 preferred shares
    and 126 Series 3 and 4 preferred shares purchased within
    60 days of March 1, 2004. Each share of Series 3
    and Series 4 preferred is convertible into
    1,000 shares of voting common stock.                                                              
|
| | (6) | Includes 119,050 Series 2 preferred shares
    and 16,667 warrants to purchase common stock within 60 days
    of March 1, 2004,                                                                                                                                                                                    
|
| | (7) | Includes 3,242 Series 3 and 4 preferred
    shares purchased within 60 days of March 1, 2004. Each
    share of Series 3 and Series 4 preferred is
    convertible into 1,000 shares of voting common stock.                                                                                                        
|
| | (8) | Includes 263 Series 3 and 4 preferred shares
    purchased within 60 days of March 1, 2004, Each share
    of Series 3 and Series 4 preferred is convertible into
    1,000 shares of voting common stock.                                                                                                          
|
| | (9) | Includes 118 Series 3 and 4 preferred shares
    purchased within 60 days of March 1, 2004, and 47,356
    warrants and options convertible into common stock within
    60 days after March 1, 2004. Each share of
    Series 3 and Series 4 preferred is convertible into
    1,000 shares of voting common stock.



|     |                                                                                                                                                                                                                                                                                                                                                                   
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Includes 196 Series 3 and 4 preferred
    shares purchased within 60 days of March 1, 2004, and
    48,919 warrants and options convertible into common stock within
    60 days after March 1, 2004. Each share of
    Series 3 and Series 4 preferred is convertible into
    1,000 shares of voting common stock.                                              
|    
|(11) | Includes 21,208 options convertible into common
    stock within 60 days after March 1, 2004.                                                                                                                                                                                                                                                                     
|    
|(12) | Includes 5,339,524 Series 2 preferred
    shares, 6,665 Series 3 and 4 preferred shares purchased
    within 60 days of March 1, 2004, and 1,028,083 options
    and warrants convertible into common stock within 60 days
    after March 1, 2004. Each share of Series 3 and
    Series 4 preferred is convertible into 1,000 shares of
    voting common stock.






|         |                                                   
|-------- | --------------------------------------------------
|Item 12. | Certain Relationships and Related
    Transactions

The Company has a number of promissory notes,
lines of credit and lease obligations owing to related parties.
The following table lists the notes and obligations outstanding
at January 3, 2004 by related party.

|                       |  |                    |                      |               |  |            |                 |         |  |   |           |  |  |  |        | 
|---------------------- |  | ------------------ | -------------------- | ------------- |  | ---------- | --------------- | ------- |  | - | --------- |  |  |  | ------ | 
|                       |  |                    |                      |               |  | Amount of  |                 | Monthly
|Related Party          |  | Type of Obligation |                      | Maturity Date |  | Obligation |                 | Payment
|                       |  |                    |                      |               |  |            |                 |        
|1  Steven M. Wright    |  |                    | Note payable         |               |  |            | 9/01/03         |         |  | $ | 45,000    |  |  |  |       | 
|2  CLLLC(a)            |  |                    | Note payable         |               |  |            | 10/15/05        |         |  |   | 825,000   |  |  |  | 18,355 | 
|3  Various entities(a) |  |                    | Notes payable        |               |  |            | 01/17/08        |         |  |   | 130,302   |  |  |  | 10,374 | 
|4  CEAC(a)             |  |                    | Bond guarantee fees  |               |  |            | open            |         |  |   |          |  |  |  | 5,000  | 
|5  CEI(a)              |  |                    | Equipment lease      |               |  |            | 12/1/07         |         |  |   |          |  |  |  | 40,000 | 
|6  CLLLC(a)            |  |                    | Vehicle lease        |               |  |            | 8/1/06          |         |  |   | 1,925,844 |  |  |  | 84,777 | 
|7  CEI(a)              |  |                    | Real property leases |               |  |            | 10/31/08        |         |  |   |          |  |  |  | 58,748 | 
|8  R. Patrick Hanlin   |  |                    | Advance payable      |               |  |            | not established |         |  |   | 16,000    |  |  |  |       | 
|9  John B. Conroy      |  |                    | Note receivable      |               |  |            | 9/16/05         |         |  |   | 78,750    |  |  |  |       | 



---



|    |  |                                                                                                                                      
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Robert J. Jesenik, a director and significant
    shareholder of the Company, also owns a significant interest in
    these entities.

Terms and conditions of each of the notes and
agreements are listed below.

Notes Payable

On March 19, 2003, Steven M. Wright, the
Companys Chief Executive Officer at that time, advanced
the Company $40,000 under a line of credit promissory note. This
advance was used as operating capital within Microfield. The
note carried no interest rate and was due and payable on or
before April 25, 2003. On April 1, 2003, the note was
converted to common stock in the Company as a part of a private
placement (See Note 10).

64



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##### Table of Contents



On July 2, 2003, Steven M. Wright, the
Companys Chief Executive Officer at that time, advanced
the Company $25,000 under a line of credit promissory note. This
advance was used as operating capital within Microfield. The
note carries an interest rate of 10% and was due and payable on
September 1, 2003. This note was repaid in cash in October
2003.

1. On June 10, 2003, Steven M. Wright,
the Companys Chief Executive Officer at that time,
advanced the Company $50,000 under a line of credit promissory
note. This advance was used as operating capital within
Microfield. The note carries an interest rate of 10% and was due
and payable on September 1, 2003. As of January 3,
2004, $5,000 of this note had been repaid with the remaining
balance still outstanding. This note was subsequently converted
to Series 3 preferred stock on April 2, 2004.

On September 16, 2003, as part of the
purchase price for the acquisition of CTS, the Company assumed
various long-term notes payable to several entities in which
Robert J. Jesenik, a Director of the Company and significant
Shareholder, has significant ownership interests. A portion of
these debts were converted to equity as a part of the
Companys Series 2 preferred stock private placement
as outlined below. The remaining amounts due were subsequently
converted to Series 3 preferred stock on April 2, 2004.

On September 15, 2003, the Company, CTS and
JMW Capital Partners, Inc. (JMW) entered into an Agreement to
Satisfy Obligations. JMW is an investment banking company in
which Robert J. Jesenik, a Director and significant Shareholder,
owns a significant ownership interest. Under this agreement CTS
acknowledged debt in the amount of $149,000 owed to JMW. This
debt arose within CTS prior to the acquisition by the Company
and was used for operating activities. After consummation of the
acquisition of CTS by the Company and upon issuance of preferred
shares in conjunction with the Series 2 preferred stock
private placement, the Company converted the note payable to JMW
into 357,143 shares of the Companys Series 2
preferred stock.

On September 15, 2003, the Company, CTS and
Christenson Electric, Inc. (CEI) entered into an Agreement to
Consolidate, Amend and Satisfy Obligations. CEI is an electrical
services company in which Robert J. Jesenik, a Director and
significant Shareholder, owns a substantial ownership interest.
Under this agreement CTS acknowledged debts of $1.5 million
and $265,000 owed to CEI. These debts arose within CTS prior to
the acquisition by the Company, and relate to the purchase of
Christenson Electrical Services inventory and customer
lists by CTS. This was a transaction between entities under
common control. After consummation of the acquisition of CTS by
the Company and upon issuance of preferred shares in conjunction
with the Series 2 preferred stock private placement, the
Company converted $365,000 of the two notes payable to CEI into
869,048 shares of Series 2 preferred stock.

On September 15, 2003, CTS executed a new
Subordinated Amended and Restated Promissory Note for the
remaining $1,400,000 due to CEI. On November 17, 2003 the
Company converted the note payable to 3,333,333 shares of
Series 2 preferred stock. There was no interest accrued or
paid on this note, according to its terms.

2. On September 15, 2003, CTS executed
an Amended and Restated Promissory Note in the amount of
$825,000 due to Christenson Leasing Company, LLC (CLC). CLC is
an equipment leasing company in which Robert J. Jesenik, a
Director and significant Shareholder, holds a substantial
ownership interest. This debt arose within CTS prior to the
acquisition by the Company and was contributed to CTS on several
dates as working capital infusions to support operating
activities. Under this note, six interest only payments are due
monthly beginning on November 15, 2003. Thereafter,
payments of $18,355 are due monthly beginning on June 15,
2004, with a balloon payment of $666,889 due and payable on
October 15, 2005. Interest on this note accrues at
12% per annum beginning on September 15, 2003. This
note was subsequently converted to equity on April 2, 2004.

3. On January 17, 2003, CTS executed
separate promissory notes with JMW, CLC, Robert Jesenik
dba Jesenik Enterprises and JW Assurance and Holding
Limited for the purchase of the undivided interests in certain
assets previously leased by CTS. Robert J. Jesenik, a Director
and significant Shareholder, owns a substantial ownership
interest in all of the above named entities. An interest only
payment is due on January 17, 2004. Thereafter, payments
totaling $6,337 are due quarterly beginning on April 17,
2004. Interest

65



---



##### Table of Contents



on these notes accrues at 12% per annum
beginning on January 17, 2003. As of January 3, 2004,
$79,602 was outstanding under these notes. These notes were
subsequently converted to Series 3 preferred stock on
April 2, 2004.


On January 17, 2003, CTS executed separate
promissory notes with JMW, CLC, Robert Jesenik dba Jesenik
Enterprises and JW Assurance and Holding Limited in payment of
certain past due rent amounts due from CTS under an asset lease.
Robert J. Jesenik, a Director and significant Shareholder, owns
a substantial ownership interest in all of the above named
entities. An interest only payment is due on January 17,
2004. Thereafter, payments totaling $4,036 are due quarterly
beginning on April 17, 2004. Interest on these notes
accrues at 12% per annum beginning on January 17,
2003. As of January 3, 2004, $50,700 was outstanding under
these notes. These notes were subsequently converted to
Series 3 preferred stock on April 2, 2004.

As of January 3, 2004, approximately
$191,000 of interest was payable to entities in which
Mr. Jesenik has a significant beneficial interest under the
notes and agreements listed above. This interest was
subsequently converted to Series 3 preferred stock on
April 2, 2004.

Bond Indemnity Fees

4. A certain number of CTS construction
projects require the Company to maintain a surety bond. The bond
surety company requires an additional guarantee for issuance of
the bond. The Company has an agreement with CEAC, Inc.
(CEAC) under which at year end paid CEAC $5,025 per
month for CEACs guarantee of this bond liability. CEAC
holds a substantial ownership interest in CEI. Robert J.
Jesenik, a Director and significant Shareholder, owns a
substantial ownership interest in CEAC. The guarantee fee is
computed as 15% (annualized) of the open liability under
bonds issued for CTS and indemnified by certain shareholders of
CEAC.

Equipment Lease Agreement

5. On September 1, 2003, CTS entered
into an agreement with CEI for use of certain equipment leased
by CEI from an outside party. Robert J. Jesenik, a Director and
significant Shareholder, owns a substantial ownership interest
in CEI. The equipment consists of various construction vehicles,
trailers, miscellaneous construction equipment, office
furniture, computer hardware and software. Under the terms of
the lease CTS pays CEI $40,000 monthly beginning on
September 1, 2003, with the final payment due on
December 1, 2007. The lease is accounted for as an
operating lease and contains a 10% purchase option at the end of
the lease term, December 31, 2007. At January 3, 2004,
the Company was past due on payments totaling $125,000, and thus
in default on the lease. Subsequent to year end, the Company
reached agreement on a payment plan to the lessor, and has been
reducing the arrearage.

Master Vehicle Lease Agreement

6. On September 1, 2003 CTS entered
into a master vehicle lease agreement with CLLLC for use of
certain vehicles used in its construction business. CLLLC is an
equipment leasing company in which Robert J. Jesenik, a Director
and significant Shareholder, holds a substantial ownership
interest. Under the terms of the lease, CTS pays CLLLC
$84,777 monthly beginning on September 1, 2003, with
the final payment due August 1, 2006. The lease contains a
renewal provision under which it has the option, at the end of
the lease term, to purchase or return the vehicles, or to renew
the lease for an additional 12 months. The lease payment
will remain fixed unless the 30-day Commercial Paper Rate as
published in the Wall Street Journal exceeds 2.00%. If that
occurs, the lessor has the option to increase the lease payment.
This lease is accounted for as a capital lease. On
September 1, 2003 prior to the acquisition of CTS,
$1,993,233 was recorded as cost of the vehicles leased with the
same amount recorded as debt owed under the lease as of that
date. At January 3, 2004, the Company was past due on
payments totaling $271,720, and thus in default on the lease.
Subsequent to year end, the Company reached agreement on a
payment plan to the lessor, and has been reducing the arrearage.
Accordingly, the remaining capital lease obligation is properly
classified between current and long-term debt.

66



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##### Table of Contents



Real Property Sub Leases

7. On September 1, 2003, CTS entered
into seven real property subleases with CEI for use of
buildings, offices and storage yards to house the operations and
property of CTS. Robert J. Jesenik, a Director and significant
Shareholder, owns a substantial ownership interest in CEI. CTS
has operating activities in Portland and Eugene, Oregon, and as
of December 31, 2003, vacated its office in Bend, Oregon as
the lease expired. After January 14, 2004, the Swan Island
facility lease obligation converted to a month-to-month lease.
The monthly sublease payments totaled $58,748 through
December 31, 2003. Of that amount, $798 is due on a
month-to-month basis. The remaining $57,950 is due on leases
with maturity dates between December 31, 2003 and
October 31, 2008. Beginning in February 2004, the
Companys monthly lease obligation will be $55,168, with
$7,922 of that on a month-to-month basis. The annual rent
obligations from January 3, 2004, for each property are
listed in the table below.

|                        |       |          |          |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |         | 
|----------------------- | ----- | -------- | -------- | ---- |  | ---- | ------- | ------- |  | ---- | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- | 
|Location                |       | Maturity |          | 2004 |  | 2005 |         | 2006    |  | 2007 |         | 2008   
|                        |       |          |          |      |  |      |         |         |  |      |         |        
|Thurman Building        |       |          | 10/31/08 |      |  | $    | 464,928 |         |  | $    | 464,928 |         |  | $ | 464,928 |         |  | $ | 464,928 |         |  | $ | 387,440 |        
|Swan Island             |       |          | 01/14/04 |      |  |      | 3,562   |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        
|Eugene                  |       |          | 09/30/05 |      |  |      | 84,048  |         |  |      | 63,036  |         |  |   |         |         |  |   |         |         |  |   |         |        
|Crown Plaza Office      |       |          | 7/31/07  |      |  |      | 17,976  |         |  |      | 17,976  |         |  |   | 17,976  |         |  |   | 10,486  |         |  |   |         |        
|Pope Storage            |       |          | *        |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        
|Montgomery Park Storage |       |          | *        |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        
|                        |       |          |          |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        
|                        | Total |          |          |      |  |      | $       | 570,514 |  |      | $       | 545,940 |  |   | $       | 482,904 |  |   | $       | 475,414 |  |   | $       | 387,440 | 
|                        |       |          |          |      |  |      |         |         |  |      |         |         |  |   |         |         |  |   |         |         |  |   |         |        



---



|  |               
|- | --------------
|* | Month-to-Month

Administrative Services Agreement

On September 15, 2003, CTS entered into an
administrative services agreement with CEI for the extension of
certain administrative and related services by the Company to
CEI. Robert J. Jesenik, a Director and Significant shareholder,
owns a substantial ownership interest in CEI. Under the terms of
the agreement, certain employees provided administrative and
related services to CEI upon reasonable request. The agreement
is subject to a 60-day notice period before termination by
either party. The monthly payment for these services was
determined at the effective date of the agreement to be
approximately $35,000, with a provision to be adjusted as needed
based on the level of usage of these services by CEI. During the
first quarter of 2004, the payment by CEI for these services was
renegotiated to $15,000 per month as the cost of services
to CEI has been reduced.

8. On November 5, 2003, R. Patrick
Hanlin, Chairman of the Companys board of directors,
advanced $16,000 to the Company in the form of a payment
directly to one of the Companys creditors. The advance is
unsecured and does not carry an interest rate or have any stated
due date. On April 2, 2004 this debt was converted to
approximately 38 shares of the Companys Series 3
preferred stock. These shares of Series 3 preferred stock
are convertible into 38,095 shares of the Companys
common stock at the option of the shareholder.

9. In 1998, John B. Conroy, then the
Companys Chairman, CEO and President, entered into a
transaction whereby he purchased 45,000 shares of the
Companys common stock at $1.75 per share.
Mr. Conroy issued a promissory note to the Company for
$78,750 in payment for the shares. On May 17, 2003 the Note
was replaced with a new non-recourse note for $66,250 under
which the original amount of the note was offset against a
$12,500 amount owed by the Company to Mr. Conroy. The note
also acknowledges the outstanding accrued interest due by
Mr. Conroy in the amount of $21,937. Additionally, the
interest rate of the new promissory note was established at
3.4% per annum, and the due date was extended to
August 29, 2006. Mr. Conroy resigned as Chairman, CEO
and President on September 16, 2002, and resigned as a
director in October 2003.

67



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##### Table of Contents








|         |                                     
|-------- | ------------------------------------
|Item 13. | Exhibits and Reports on
    Form 8-K

(a) Exhibits included herein:

|            |          |     |  |   |  |                                                                                                                                                                                                                                                     
|----------- | -------- | --- |  | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |          |     |  |  
|            |          |     |  |  
|            | *3       | .1  |  |  |  | Articles of Incorporation, as amended                                                                                                                                                                                                               
|            | *3       | .2  |  |  |  | Bylaws, as amended                                                                                                                                                                                                                                  
|            | *4       | .1  |  |  |  | See Article III of Exhibit 3.1 and
    Articles I and VI of Exhibit 3.2#                                                                                                                                                                            
|            | *10      | .1  |  |  |  | 1986 Stock Option Plan, as amended                                                                                                                                                                                                                  
|            | *10      | .3  |  |  |  | Form of Incentive Stock Option Agreement                                                                                                                                                                                                            
|            | *10      | .7  |  |  |  | Form of Representatives Warrants                                                                                                                                                                                                                   
|            | **10     | .11 |  |  |  | Restated 1995 Stock Incentive Plan dated
    May 11, 1998.                                                                                                                                                                                          
|            | ***10    | .14 |  |  |  | Form of $400,000 Subordinated Promissory Note
    issued to JMW Capital Partners, Inc., dated June 30, 2000.                                                                                                                                        
|            | ***10    | .15 |  |  |  | Form of Stock Purchase Warrants to Purchase
    Shares of Common Stock of Microfield Group, Inc. issued to JMW
    Capital Partners, Inc., dated June 30, 2000.                                                                                     
|            | ***10    | .16 |  |  |  | Form of Registration Rights Agreement between the
    Company and JMW Capital Partners, Inc., dated June 30, 2000.                                                                                                                                  
|            | ***10    | .17 |  |  |  | Form of Note and Warrant Purchase Agreement
    between the Company and JMW Capital Partners, Inc. dated
    June 30, 2000.                                                                                                                         
|            | ****10   | .18 |  |  |  | Form of Asset Purchase Agreement between
    Greensteel, Inc., and Microfield Group, Inc., dated
    September 7, 2000, incorporated by reference to the
    Companys Proxy Statement dated October 3, 2000.                                       
|            | *****10  | .19 |  |  |  | Form of Agreement and Plan of Merger between
    Microfield Group, Inc., and Innovative Safety Technologies, LLC.
    dated September 16, 2002 incorporated by reference to the
    Registrants Form 8-K dated September 17, 2002.                  
|            | ******10 | .20 |  |  |  | Form of Agreement and Plan of Merger between
    Microfield Group, Inc., Velagio, Inc., and Christenson
    Technology Services, Inc., dated September 16, 2003
    incorporated by reference to the Registrants Form 8-K dated
    October 1, 2003.
|            | 23       | .1  |  |  |  | Consent of PricewaterhouseCoopers LLP,
    Independent Accountants, filed herewith.                                                                                                                                                                 
|            | 31       | .1  |  |  |  | Certification of President and Chief Executive
    Officer pursuant to Section 302, of the Sarbanes-Oxley Act
    of 2002.                                                                                                                          
|            | 31       | .2  |  |  |  | Certification of Acting Chief Financial Officer
    pursuant to Section 302, of the Sarbanes-Oxley Act of 2002.                                                                                                                                     
|            | 32       | .1  |  |  |  | Certification of President and 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 Acting Chief Financial Officer
    pursuant to 18 U.S.C. Section 1350, as adopted
    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                   



---



|  |                                                                                                                                                                                    
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|* | Incorporated by reference to Exhibits 3.1,
    3.2, 4.1, 10.1, 10.3, 10.7, as applicable, to Registrants
    Registration Statement on Form SB-2 (Registration
    No. 33-918900).



|   |                                                                                                                                                 
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------
|** | Incorporated by reference to Exhibit 10.11
    to Registrants Quarterly Report on Form 10-QSB for the
    three month period ended July 3, 1999.



|    |                                                                                                                                                                                           
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*** | Incorporated by reference to Exhibits 10.14,
    10.15, 10.16, 10.17, as applicable, to Registrants Quarterly
    Report on Form 10-QSB for the three month period ended
    July 1, 2000.



|     |                                                                                                                                                       
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------
|**** | Incorporated by reference to Exhibit 10.18
    to Registrants Quarterly Report on Form 10-QSB for the
    three month period ended September 30, 2000.

68



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##### Table of Contents





|      |                                                                                                                                                       
|----- | ------------------------------------------------------------------------------------------------------------------------------------------------------
|***** | Incorporated by reference to Exhibit 10.19
    to Registrants Quarterly Report on Form 10-QSB for the
    three month period ended September 28, 2002.



|       |                                                                                                                                                       
|------ | ------------------------------------------------------------------------------------------------------------------------------------------------------
|****** | Incorporated by reference to Exhibit 10.20
    to Registrants Quarterly Report on Form 10-QSB for the
    three month period ended September 27, 2003.



| |   |                                                                                         
| | - | ----------------------------------------------------------------------------------------
| | # | This exhibit constitutes a management contract,
    or compensatory plan or arrangement.

(b) Reports filed during the quarter on
Form 8-K

The Companys Form 8-K/ A required to
be filed as an amendment to provide financial statement
information in conjunction with the Form 8-K/ A filed on
October 1, 2003, was filed by the Company on March 16,
2004.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The following is a summary of the fees billed to
Microfield Group, Inc. by PricewaterhouseCoopers LLP for
professional services rendered in connection with the fiscal
years ended, January 3, 2004 and December 28, 2002.

|           |  |            |         |              |  |   |        | 
|---------- |  | ---------- | ------- | ------------ |  | - | ------ | 
|           |  | January 3, |         | December 28,
|           |  | 2004       |         | 2002        
|           |  |            |         |             
|Fee Type   |  |            |         |              |  |   |        | 
|Audit fees |  | $          | 399,000 |              |  | $ | 40,700 | 
|Tax fees   |  |            | 5,400   |              |  |   |       | 
|           |  |            |         |              |  |   |        | 
|Total fees |  | $          | 404,400 |              |  | $ | 40,700 | 
|           |  |            |         |              |  |   |        | 

Audit fees consist of billings for professional
services rendered for the audit of the Companys
consolidated financial statements and review of the interim
consolidated financial statements included in quarterly reports
that are normally provided by PricewaterhouseCoopers LLP in
connection with statutory and regulatory filings, including
audit services performed related to mergers and acquisitions.

Tax fees consist of billings for professional
services for tax compliance and tax planning regarding federal
and state tax filings.

69



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##### Table of Contents



SIGNATURES

In accordance with Section 13 or 15(d) of
the Exchange Act, the registrant caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.



| |                       
| | ----------------------
| | MICROFIELD GROUP, INC.



| |     |                                                                                                 
| | --- | ------------------------------------------------------------------------------------------------
| | By: | /s/ WILLIAM C. MCCORMICK 
     ______________________________________ 
     William C. McCormick

| |                                
| | -------------------------------
| | Interim Chief Executive Officer

Dated: May 20, 2004

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the Registrant and in the
capacities and on the dates indicated:

|                                             |  |                                              |  |      |              |  |  | 
|-------------------------------------------- |  | -------------------------------------------- |  | ---- | ------------ |  |  | 
|                                             |  |                                              |  |     
|Signature                                    |  | Title                                        |  | Date
|                                             |  |                                              |  |     
|                                            
|/s/ WILLIAM C. MCCORMICKWilliam C. McCormick |  | Interim Chief Executive Officer and Director |  |      | May 20, 2004 | 
|                                            
|/s/ GARY M. KAPRALGary M. Kapral             |  | Chief Financial Officer                      |  |      | May 20, 2004 | 
|                                            
|/s/ PATRICK M. HANLINPatrick M. Hanlin       |  | Chairman of the Board and Director           |  |      | May 20, 2004 | 
|                                            
|/s/ STEVEN M. WRIGHTSteven M. Wright         |  | Director                                     |  |      | May 20, 2004 | 
|                                            
|/s/ MICHAEL W. STANSELLMichael W. Stansell   |  | Director                                     |  |      | May 20, 2004 | 
|                                            
|/s/ ROBERT J. JESENIKRobert J. Jesenik       |  | Director                                     |  |      | May 20, 2004 | 

72