<PAGE>   1


                                    FORM 10-Q

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

(Mark One)

[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
      EXCHANGE ACT OF 1934

                     For the quarterly period ended September 26, 1998
                                                    ------------------
                                            OR

[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
      EXCHANGE ACT OF 1934

      For the transition period from                   to                 
                                    -------------------  -----------------

          ------------------------------------------------------------

                    Commission file number      0-10734
                                          -----------------

                            FERROFLUIDICS CORPORATION
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)


              Massachusetts                                 02-0275185
     -------------------------------                   -------------------
     (State or other jurisdiction of                     (I.R.S.Employer
      incorporation or organization                    Identification No.)

            40 Simon Street,
          Nashua, New Hampshire                                03061 
----------------------------------------                    ----------
(Address of principal executive offices)                    (Zip Code)

      (Registrant's telephone number, including area code) (603) 883-9800
                                                          ----------------

              ----------------------------------------------------
              (Former name, former address and former fiscal year,
                         if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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.

                               (1) Yes [X] No [ ]
                               (2) Yes [X] No [ ]

Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock, as of October 30, 1998.

Common Stock, $.004 par value per share                     6,226,301
---------------------------------------                  ---------------
               (Class)                                   (No. of Shares)





                                       1
<PAGE>   2



                                TABLE OF CONTENTS

                                                                    PAGE NOS.
                                                                    ---------
Part I.  Financial Information

Item 1.  Financial Statements

            Consolidated Balance Sheets -
            September 26, 1998 and June 27, 1998                        3

            Consolidated Statements of Operations -
            Three Months Ended September 26, 1998 and
            September 27, 1997                                          4

            Consolidated Statements of Cash Flows -
            Three months Ended September 26, 1998 and 
            September 27, 1997                                          5

            Notes to Consolidated Financial Statements                6-8

Item 2.  Management's Discussion and Analysis of Results of 
         Operations and Financial Position                           9-13

Part II. Other Information                                             14

Signatures                                                             15




                                       2


<PAGE>   3



PART I.  FINANCIAL INFORMATION

ITEM 1.

                            FERROFLUIDICS CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                      September 26, 1998 and June 27, 1998

<TABLE>
<CAPTION>
ASSETS                                                                      September 26, 1998          June 27, 1998
------                                                                      ------------------          -------------
Current Assets:                                                                 (unaudited)                 (note)
<S>                                                                            <C>                       <C>         
   Cash and cash equivalents                                                   $  4,563,000              $  1,516,000
   Accounts receivable - trade, less allowance
       for doubtful accounts of $350,000 at
       September 26, 1998 and $329,000 at June 27, 1998                           8,621,000                12,083,000
   Inventories                                                                   12,730,000                13,855,000
   Advances to suppliers                                                            490,000                   578,000
   Prepaid and other current assets                                                 751,000                   783,000
                                                                               ------------              ------------
Total Current Assets                                                             27,155,000                28,815,000
                                                                               ------------              ------------
Property, plant and equipment, at cost, net
   of accumulated depreciation of $11,088,000 at
   September 26, 1998 and $12,462,000 at June 27, 1998                            6,544,000                 8,826,000
Cash value of life insurance                                                      1,959,000                 1,921,000
Deferred income taxes, net                                                        1,754,000                 3,154,000
Other assets, principally goodwill                                                1,241,000                 1,303,000
                                                                               ------------              ------------
TOTAL ASSETS                                                                   $ 38,653,000              $ 44,019,000
                                                                               ============              ============

LIABILITIES
-----------
Current Liabilities:
   Bank notes payable                                                          $    422,000              $  9,710,000
   Accounts payable                                                               2,753,000                 3,860,000
   Customer deposits                                                              2,766,000                 2,777,000
   Accrued expenses                                                               4,175,000                 4,286,000
                                                                               ------------              ------------
Total Current Liabilities                                                        10,116,000                20,633,000
                                                                               ------------              ------------

Long-term debt obligations                                                        5,000,000                 5,000,000
Other liabilities                                                                   197,000                   185,000

STOCKHOLDERS' EQUITY
--------------------
Preferred stock, $.001 par value, authorized
   100,000 shares, issued and outstanding, none                                           -                         -
Common stock, $.004 par value, authorized
   12,500,000 shares, issued and outstanding 6,218,581 shares                        25,000                    25,000
Additional paid-in capital                                                       36,762,000                36,738,000
Retained deficit                                                                (12,621,000)              (17,443,000)
Currency translation adjustments                                                   (826,000)               (1,119,000)
                                                                               ------------              ------------
Total Stockholders' Equity                                                       23,340,000                18,201,000
                                                                               ------------              ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                     $ 38,653,000              $ 44,019,000
                                                                               ============              ============
</TABLE>

Note: The balance sheet at June 27, 1998 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.

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




                                       3


<PAGE>   4



                            FERROFLUIDICS CORPORATION
                      CONSOLIDATED STATEMENTS OF OPERATIONS
      For the Three Months Ended September 26, 1998 and September 27, 1997
                                   (unaudited)

<TABLE>
<CAPTION>
                                                                               1998              1997
                                                                            ----------        ----------

<S>                                                                         <C>               <C>       
Net sales                                                                   $5,950,000        $6,610,000
Cost of goods sold                                                           3,747,000         3,753,000
                                                                            ----------        ----------
                                                                             2,203,000         2,857,000

Engineering and product development expenses                                   568,000           494,000
Selling, general and administrative expense                                  1,888,000         1,761,000
                                                                            ----------        ----------
Income(loss) from operations                                                  (253,000)          602,000

Interest income                                                                  2,000             1,000
Interest (expense)                                                            (153,000)         (144,000)
Other income (expense), net                                                     40,000           (82,000)
                                                                            ----------        ----------

Income(loss) from continuing operations before income taxes                   (364,000)          377,000
Income taxes                                                                     1,000            60,000
                                                                            ----------        ----------

Income (loss) from continuing operations                                      (365,000)          317,000

Discontinued operations--Note D:
   Income from discontinued operations, less applicable
     income taxes of $31,000                                                         -           339,000
   Estimated gain on disposal of Systems Division, less applicable
      income taxes of $1,400,000                                             5,187,000                 -
                                                                            ----------        ----------

Net income                                                                  $4,822,000        $  656,000
                                                                            ==========        ==========

Per Share:
Income (loss) from continuing operations:
     Basic                                                                  $    (0.06)       $     0.05
     Diluted                                                                $    (0.06)       $     0.05

Income from discontinued operations:
     Basic                                                                  $     0.84        $     0.06
     Diluted                                                                $     0.84        $     0.06

Net income:
     Basic                                                                  $     0.78        $     0.11
     Diluted                                                                $     0.78        $     0.11

Weighted average common shares outstanding:
     Basic                                                                   6,218,581         6,178,262
     Diluted                                                                 6,218,581         6,194,632
</TABLE>

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

                                       4
<PAGE>   5



                            FERROFLUIDICS CORPORATION
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
      For the Three Months Ended September 26, 1998 and September 27, 1997
                                   (unaudited)

<TABLE>
<CAPTION>
                                                                    1998               1997
                                                                 -----------        -----------
<S>                                                              <C>                <C>        
Cash flows from operating activities:
   Net income                                                    $ 4,822,000        $   656,000
   Adjustments to reconcile net income (loss) to net
     cash provided by (used in) operating activities:
       Depreciation and amortization                                 429,000            382,000
       Deferred income taxes (credits)                             1,400,000                  -
       Increase in cash surrender value                              (38,000)                 -
       Gain on disposal of Systems Division                       (6,587,000)                 -
       Gain on sale of assets                                         (2,000)                 -
       Stock-related compensation                                     23,000             73,000
       Foreign currency transaction (gains) losses                  (131,000)           184,000
       Other                                                        (460,000)          (244,000)
   Changes in operating assets and liabilities:
       Accounts receivable, net                                    3,686,000            393,000
       Inventories                                                (1,683,000)           385,000
       Prepaid expenses and other current assets                     132,000           (237,000)
       Accounts payable and accrued expenses                      (1,439,000)        (1,302,000)
       Customer deposits                                             (11,000)        (1,262,000)
                                                                 -----------        -----------
Net cash provided by (used in) operating activities                  141,000           (972,000)
                                                                 -----------        -----------

Cash flow from investing activities:
   Acquisition of property, plant, equipment                        (104,000)          (431,000)
   Proceeds from sale of assets                                    1,390,000                  -
   Proceeds from the disposal of Systems Division                 10,800,000                  -
                                                                 -----------        -----------
Net cash provided by (used in) investing activities               12,086,000           (431,000)
                                                                 -----------        -----------

Cash flow from financing activities:
   Proceeds from (repayments of) short term borrowings, net       (9,288,000)         1,591,000
                                                                 -----------        -----------
Net cash provided by (used in) financing activities               (9,288,000)         1,591,000
                                                                 -----------        -----------
Effect of currency rate changes on cash                              108,000            (10,000)
                                                                 -----------        -----------
Net increase in cash and cash equivalents                          3,047,000            178,000
                                                                 -----------        -----------
Cash and cash equivalents at beginning of period                   1,516,000            883,000
                                                                 -----------        -----------

Cash and cash equivalents at end of period                       $ 4,563,000        $ 1,061,000
                                                                 ===========        ===========
</TABLE>

Cash paid for interest and income taxes for the three months ended September 26,
1998 and September 27, 1997 is as follows:

<TABLE>
<CAPTION>
                                                                      1998               1997
                                                                    --------           --------
             <S>                                                    <C>                <C>     
             Interest                                               $284,000           $243,000
             Income taxes, net                                      $  1,000           $      -
</TABLE>


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

                                       5
<PAGE>   6



                            FERROFLUIDICS CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A.       BASIS OF PRESENTATION

         The accompanying consolidated financial statements of Ferrofluidics
Corporation and its subsidiaries (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and in accordance with the instructions to Form 10-Q and Rule 10-01
of Regulation S-X. They do not therefore include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. The results of operations of any interim period are subject to
year-end adjustments, and are not necessarily indicative of the results of
operations for the fiscal year. For further information, refer to the
consolidated financial statements and the footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended June 27, 1998 ("fiscal
1998").

B.       INVENTORIES

         Inventories are stated at the lower of cost (first-in, first-out) or
market. Inventories are comprised of the following elements at September 26,
1998 and June 27, 1998:

                                              September 26, 1998   June 27, 1998
                                              ------------------   -------------

         Raw materials and purchased parts           $ 5,398,000     $ 6,348,000
         Work-in-process                               3,832,000       2,650,000
         Finished goods                                3,500,000       4,857,000
                                                     -----------     -----------
                                                     $12,730,000     $13,855,000
                                                     ===========     ===========

C.       SHORT-TERM BORROWINGS AND OTHER DEBT OBLIGATIONS

         On September 23, 1998, in connection with the sale of the Systems
Division, the Company used a portion of the cash proceeds to pay off the then
outstanding balance under the Company's line of credit with its bank and
$1,500,000 that was then outstanding under a 90 day promissory note with its
bank. As a result of this sale, the Company and its bank agreed to reduce the
maximum available borrowings under the line of credit agreement from $8,500,000
to $2,000,000. The present line of credit agreement expires at the end of
November 1998.

         There were no borrowings under the line of credit at September 26,
1998.

D.       DISCONTINUED OPERATIONS

         On September 23, 1998, the Company sold certain assets of the Systems
Division to General Signal Technology Corporation ("General Signal") for
$10,800,000 in cash (the "Sale"). Assets sold included approximately $2,818,000
in inventory, and approximately $625,000 in fixed assets and intangible assets
in the first quarter of fiscal 1999. After providing for transaction fees and
income taxes, the Company recorded an estimated gain on the sale of $5,187,000.

         The Systems Division represented a separate line of business and,
accordingly, its net operating results have been reported, net of applicable
income taxes, as discontinued operations for all periods up through June 29,
1998, the date when Company management decided to dispose of the Systems
Division. The Sale, as structured, did not include any Systems Division
liabilities, which remain with the Company. The sale did not include the
obligation by the Company to complete approximately $18,433,000 in Systems
Division backlog, which obligation remains with the Company, nor did it include
approximately $5,873,000 in inventory on hand on the date of the sale, all of
which is needed to 



                                       6




<PAGE>   7

fulfill existing backlog. The terms of the sale of the Systems Division provide
that, generally, any backlog existing on December 31, 1998, will be transferred
to General Signal. The backlog includes a purchase order from a customer for
nine machines (valued at approximately $7,658,000) for which the customer has
not provided firm delivery dates. The Company believes that the customer is
seeking to modify the terms of the order, including its potential cancellation.
However, the Company believes that the purchase order remains legally valid, and
that under its terms, the customer is obligated to pay the Company the costs
incurred up to cancellation of the order. In connection with these machines, on
September 23, 1998, the Company had inventory of approximately $3,104,000 on
hand and approximately $2,471,000 in parts on order at vendors. The Company and
the customer are actively negotiating a settlement of the Company's claims under
this purchase order. If the Company is unable to recover these cancellation
charges from the customer, the Company may be required to take a material
write-down of the inventory relating to the purchase order, which would require
the Company to adjust the estimated gain on disposal of the Systems Division
recorded in this quarter.

         The sale of the Systems Business also did not include approximately
$6,472,000 in accounts receivable which were outstanding as of the closing of
the sale ($5,747,000 remains outstanding at September 26, 1998). The Company
believes that it will be able to collect these receivables within established
reserves but there can be no assurance that the sale of the Systems Business
will not adversely affect their collectibility.

         The operating results of the discontinued business for the quarter
ended September 27, 1997 is summarized as follows (000's omitted):

    Net sales                                                    $8,720
                                                                 ======
    Income  from operations before income taxes                  $  370
    Income taxes                                                     31
                                                                 ------
    Income from operations                                       $  339
                                                                 ======


         The net assets at September 26, 1998 of the discontinued businesses are
summarized as follows (000's omitted)

    Current assets                                              $13,137
    Current liabilities                                           2,893
                                                                -------
    Net assets of the discontinued Systems Division             $10,244
                                                                =======

E.       INCOME TAXES

         FASB Statement No. 109, Accounting for Income Taxes, requires a
valuation allowance against deferred tax assets if it is more likely than not
that some or all of the deferred tax assets will not be realized. Due to the
uncertainty surrounding the Company's ability to realize the benefit of the
entire deferred tax asset, a valuation allowance in the amount of $12,217,000
had been established at June 27, 1998. As a result of the $5,187,000 gain on
sale of the System Division, the valuation allowance was reduced by an
additional $1,100,000 during the first quarter of fiscal 1999 ($1,400,000 of the
valuation allowance had previously been reduced during fiscal 1998 based on a
preliminary estimate of the gain on disposal of the Systems Division). However,
based upon a current assessment of the future earnings prospects for the Company
through the first quarter of fiscal 2000, management has concluded that no
further adjustment to the valuation allowance was necessary as of September 26,
1998.

         As of September 26, 1998, the Company had remaining net operating loss
carryforwards for Federal income tax purposes of approximately $27,572,000, and
for foreign income tax purposes of approximately $3,300,000, which can be used
to offset future taxable income. The net operating loss carryforwards for
Federal income tax purposes will expire at various dates through 2013. Included
in the loss carryforward, for income tax purposes, is approximately 



                                       7




<PAGE>   8

$16,800,000 of tax deductions resulting from the excess of the market price over
the exercise price on the date of exercise of the Company's stock purchase
options and warrants which were exercised during 1993 and prior years. The tax
benefit to be realized upon utilization of the $16,800,000 of loss carryforwards
will result in a decrease in current income taxes payable and an increase to
additional paid-in capital.

F.       EARNINGS PER SHARE

         The following table sets forth the computation of basic and diluted
earnings per share for the three month periods which ended September 26, 1998
and September 27, 1997:

<TABLE>
<CAPTION>
                                                                           1998              1997
                                                                        ----------        ----------

         <S>                                                            <C>               <C>       
         Numerator:                                                
                  Income (loss) from continuing operations              $ (365,000)       $  317,000
                  Income from discontinued operations                    5,187,000           339,000
                                                                        ----------        ----------
                  Net income                                            $4,822,000        $  656,000
                                                                        ==========        ==========
                                                                                                    
         Denominator:                                                                               
                  Denominator for basic earnings per share -                                        
                    weighted average shares                              6,218,581         6,178,262

                  Effect of dilutive securities:                        
                    Employee stock options                                       -                 -
                    Non-vested restricted stock awards                           -            16,370
                                                                        ----------        ----------
                    Dilutive potential common shares                             -            16,370
                                                                        ----------        ----------

                  Denominator for diluted earnings per share -                                      
                    adjusted weighted average shares                     6,218,581         6,194,632
                                                                        ==========        ==========
                                                                                                    
         Per Share:                                                                                 
                                                                                                    
         Income (loss) from continuing operations:                                                  
                  Basic                                                 $   (0.06)        $     0.05
                  Diluted                                               $   (0.06)        $     0.05
                                                                                                    
         Income from discontinued operations:                                                       
                  Basic                                                 $    0.84         $     0.06
                  Diluted                                               $    0.84         $     0.06
                                                                                                    
         Net income:                                                                                
                  Basic                                                 $    0.78         $     0.11
                  Diluted                                               $    0.78         $     0.11
</TABLE>

         At September 26, 1998 and September 27, 1997, options and warrants to
purchase 543,259 shares at prices ranging from $3.50 to $13.50 per share and
671,697 shares at prices ranging from $7.63 to $15.25 per share, respectively,
of common stock were anti-dilutive and therefore were excluded from the
computation of diluted earnings per share.



                                       8
<PAGE>   9



ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
         FINANCIAL POSITION

         The following discussion provides information to assist in the
understanding of the Company's results of operations unless otherwise noted, and
financial condition. As more fully described in Note D to the Consolidated
Financial Statements, on September 23, 1998, certain of the assets of the
Company's systems Division were sold to General Signal for $10,800,000 in cash.
This discussion reflects the fact that in accordance with generally accepted
accounting principles, the Company is reporting the results of operations from
the Systems Division as discontinued operations and that the Company's
Consolidated Financial Statements for fiscal 1999 and prior periods have been
revised to reflect this accounting treatment of the Systems Division in those
periods. It should be read in conjunction with the consolidated financial
statements and notes thereto that appear elsewhere herein.

RESULTS OF OPERATIONS

         In the quarter ended September 26, 1998, the Company's continuing
operations had a loss of $365,000, or $0.06 per share, as compared to income in
the same period of fiscal 1997 of $317,000, or $0.05 per share. The sale of the
Systems Division resulted in an estimated gain of $5,187,000, or $0.84 per share
for the quarter. Discontinued operations relating to the Systems Division for
the same period of the prior fiscal year had income of $339,000, or $0.06 per
share. Net income for the current quarter was $4,822,000, or $0.78 per share as
compared to $656,000, or $0.11 per share in the quarter ended September 27,
1998. The increase in net income in the first quarter of 1999 was due to the
sale of the Systems Division.

         Net sales and revenues from continuing operations for the quarter ended
September 26, 1998 totaled $5,950,000 as compared to $6,610,000 in the same
period of the prior year. A comparison of the net sales and revenues by major
product line is as follows:

<TABLE>
<CAPTION>
                                                                  Three months ended
                                                     --------------------------------------------
                                                     September 26, 1998        September 27, 1997
                                                     ------------------        ------------------

              <S>                                            <C>                       <C>       
              Components                                     $2,545,000                $4,238,000
              Fluids                                            548,000                   570,000
              Distributed products                            2,857,000                 1,802,000
                                                             ----------                ----------
                Total net sales and revenues                 $5,950,000                $6,610,000
                                                             ==========                ==========
</TABLE>


         Consolidated gross margins for the first quarter of fiscal 1998
amounted to 37% of product sales as compared to 43.2% of product sales in the
prior year's first quarter. The decline in gross margin in the first quarter of
the current year compared to the same period in the prior year is due
principally to the reduced sales of component parts, which resulted in reduced
manufacturing efficiencies in the quarter. Margins for fluids and distributed
products were approximately equal to the same period of the prior year.

         Consolidated order bookings for the three months ended September 26,
1998 totaled $5,588,000 as compared to $7,103,000 in the same period of the
prior year. The decrease is due primarily to a decrease in components' bookings
which is consistent with the decrease in sales for the current quarter. Bookings
for the first quarter for distributed products by AP&T decreased by 17.7% to
$1,893,000 as compared to $2,299,000 in the first quarter of fiscal 1998.

         Consolidated backlog at September 26, 1998 was $7,862,000 as compared
to $8,226,000 at June 27, 1998. The backlog of orders for components products,
including fluids, increased slightly from $4,335,000 at June 27, 1998 to
$4,739,000 at September 26, 1998 while the backlog for distributed products
decreased from $3,891,000 at June 27, 1998 to $3,123,000 at September 26, 1998.
The majority of the order backlog at September 26, 1998 is expected to ship in
fiscal 1999.



                                       9



<PAGE>   10

         Engineering and product development expenditures in the three months
ended September 26, 1998 totaled $568,000, an increase of $74,000, or 15%,
compared to $494,000 in the same period last year. As a percentage of revenues,
engineering and product development expenses increased from 7.5% in the
September 1997 quarter to 9.5% in the September 1998 quarter. The increase in
the current quarter is due to new product development of seals and fluids.

         Selling, general and administrative expenses (SG&A) for the three
months ended September 26, 1998 totaled $1,888,000, an increase of 7.2% from the
SG&A of $1,761,000 in the same period of the prior year. The increase is due
primarily to an increase in legal costs.

         Interest expense of $153,000 for the three months ended September 26,
1998 increased 6.3% from the $144,000 incurred during the same period in fiscal
1998.The increase is due principally to higher borrowings under the Company's
revolving credit facility.

         As of September 26, 1998, the Company had remaining net operating loss
carryforwards for Federal income tax purposes of approximately $27,572,000, and
for foreign income tax purposes of approximately $3,300,000, which can be used
to offset future taxable income. The net operating loss carryforwards for
Federal income tax purposes will expire at various dates through 2013. Included
in the loss carryforward, for income tax purposes, is approximately $16,800,000
of tax deductions resulting from the excess of the market price over the
exercise price on the date of exercise of the Company's stock purchase options
and warrants which were exercised during 1993 and prior years. The tax benefit
to be realized upon utilization of the $16,800,000 of loss carryforwards will
result in a decrease in current income taxes payable and an increase to
additional paid-in capital.

LIQUIDITY AND CAPITAL RESOURCES

         Net working capital at September 26, 1998 was $17,039,000 as compared
to $8,182,000 at June 27, 1998. Current assets of the Company declined, due
primarily to the collection of accounts receivable and a reduction in inventory
levels, but total current liabilities declined further, resulting in the
increase in working capital. The decrease in current liabilities was $10,517,000
and was due principally to a $9,288,000 decrease in short term borrowings. See
discussion below regarding the repayment of debt. Accounts payable also
decreased by $1,107,000 due principally to the decrease in sales.

         During the first quarter of fiscal 1998, the operations of the business
generated $141,000 of cash, due principally to the reduction in accounts
receivable. At September 26, 1998, the Company had outstanding purchase
commitments for material of approximately $3,600,000, the majority of which was
related to the discontinued Systems business.

         Cash flow from investing activities during the three months ended
September 26, 1998 consisted almost entirely of proceeds from the sale of the
Systems Division. In addition, the Company sold a 300mm crystal growing system,
that was included in property, plant and equipment, at approximately book value.
Upon signing of the sales agreement for this machine, the Company received
$1,385,000 in cash with the balance of $225,000 due upon shipment of the
machine, which is expected to occur within six months. Financing activities of
the Company during the three months ended September 26, 1998 included the
complete paydown of all short term debt from the cash proceeds of the sale of
the Systems Division (see also Note D to the financial statements). The
consolidated results of operations for the three months ended September 26, 1998
includes a non-cash charge of $23,000 for compensation to employees as a result
of restricted stock grants made in prior years. In the same period last year, a
charge of $73,000 was made for the same purpose.

         The Company has long-term financing in the form of a $5,000,000
Variable Rate Industrial Revenue Bond ("VRIRB"). The VRIRB is subject to a
variable rate of interest keyed to short-term nontaxable rates (at September 26,
1998, 4.75%). Under an arrangement with its bank, and throughout most of the
quarter ended September 26, 1998, the Company had available to it a total credit
facility of approximately $15,400,000, which includes approximately $5,400,000
in the form of a stand-by letter of credit for the Company's VRIRB, which
expires in August 1999 and carries 




                                       10




<PAGE>   11

a fee of 1% per year, an $8,500,000 revolving line-of-credit for working capital
purposes, and $1,500,000 of which was in the form of a 90 day promissory note,
which bears interest at the same rate as the revolving line of credit. In
addition, the Company has an installment demand note with its bank ($422,000
outstanding at September 26, 1998) that was used to finance the expansion of its
in-house machine shop. The entire credit facility is collateralized by
substantially all of the assets of the Company.

         On September 23, 1998, the date of the sale of the Systems Division,
there was approximately $7,907,000 outstanding against the revolving
line-of-credit. This amount, together with the $1,500,000 outstanding on the
short-term promissory note, was repaid from the proceeds of the sale of the
Systems Division (see Note D to the Consolidated Financial Statements and the
discussion below regarding the sale of the Systems Division). At the same time,
the Company and the bank agreed to reduce the availability under the revolving
line of credit to $2,000,000 to reflect the Company's reduced working capital
needs after the sale of the Systems Division. The interest rate on the revolving
line-of-credit is equal to the prime rate plus 1% (9.5% at September 26, 1998)
with a fee of 1/8% on the unused portion.

         As more fully described in Note D to the Consolidated Financial
Statements, certain of the assets of the Company's Systems Division were sold on
September 23, 1998 to General Signal for $10,800,000 in cash. A portion of the
cash proceeds from this sale has been used to pay off certain outstanding debt
as of the closing of the sale of the Systems Division. The sale, as structured,
did not include any of the Systems Division accounts receivable or liabilities,
which remain with the Company. The sale also did not include the obligation to
complete approximately $18,433,000 in backlog for crystal growing systems, which
obligation remains with the Company, or approximately $5,873,000 in inventory on
hand, all of which is needed to fulfill such backlog. The terms of the sale
provide that, generally, any unfulfilled backlog existing as of December 31,
1998, will be transferred to General Signal. The backlog includes a purchase
order from one customer for nine machines, representing approximately
$7,658,000. The Company believes that the customer is seeking to modify the
terms of the order, including its potential cancellation. However, the Company
believes that the purchase order remains legally valid, and that under its
terms, the customer is obligated to pay the Company the costs incurred up to
cancellation of the order. In connection with these machines, the Company has
inventory of approximately $3,104,000 on hand and approximately $2,471,000 in
parts on order at vendors. If the Company is unable to recover these
cancellation charges from the customer, the Company may be required to take a
material write-down of the inventory relating to the purchase order, which would
require the Company to adjust the estimated gain on disposal of the Systems
Division recorded in this quarter.

         The present line of credit from the Company's Bank expires at the end
of November 1998. Management has begun discussions with the bank to renew the
line of credit at a level which management believes will be in line with the
working capital needs in the continuing operations. It is expected that the
proceeds received from the sale of the Systems Division and other cash flow
(including collection of systems receivables and completion of systems backlog)
will significantly reduce the Company's need for short-term borrowing
arrangements to finance working capital needs in the near future. Management
therefore believes that anticipated funds from operations and the borrowing
arrangements that are expected to be put into place will be adequate to meet
cash requirements for the year ahead.

YEAR 2000 READINESS DISCLOSURES

         The Company is currently working to resolve the potential impact of the
Year 2000 on the processing of date-sensitive information by the Company's
computerized information systems. The Year 2000 problem is a result of computer
programs being written using two digits (rather than four) to define the
applicable year.

         The Company's products in the Components Business are mechanical
devices or fluids and do not contain any electronic components. The Company's
products in its Distributed Products Business include an electron beam gun for
use in vacuum deposition processes which is electronically controlled, but
includes no date-sensitive devices. Consequentially, the Company has no need to
make any changes to its products in anticipation of the Year 2000.




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<PAGE>   12

         Prior to the sale of the Company's Systems Division, the Division sold
products that were controlled by computerized hardware and software, but the
processes involved were inherently not date-sensitive. The software involved was
purchased off-the-shelf, and was not customized by the Company. All recent
products delivered to customers with Company-supplied control systems have been
Year 2000 compliant, but some older systems contain older versions of the
software and, as a result, may not be Year 2000 compliant. Since these products
are not in warranty, and since the Company has not warranted their Year 2000
compliance, the Company believes that it has no further obligations with respect
to these products. All products delivered with Company-supplied control systems
out of backlog prior to December 31, 1998, in accordance with the terms of the
sale of the Division, will be Year 2000 compliant.

         The Company has sent requests to all of its principal providers of
services and component parts to advise the Company of their progress in making
their internal systems Year 2000 compliant. The Company believes it has a
sufficient base of critical component suppliers so that if any supplier is
unable to deliver parts due to Year 2000 problems, alternate sources will be
available and that any supply interruption will not be material to its
operations. There can be no assurances, however, that the Company would be able
to obtain all of its supply requirements from such alternate sources on terms
comparable with that of its current suppliers. The Company has identified one
critical service supplier (its bank), the failure of whose systems for an
extended period for any reason, including Year 2000 problems, could cause
financially material adverse consequences to the Company. The bank has provided
assurance in writing to the Company that its systems will be Year 2000
compliant.

         With respect to its internal systems, the Company has undertaken an
assessment of its vulnerability to the Year 2000 issue. The Company does not
rely on electronic interaction with customers or vendors, and has in recent
years relied almost entirely on purchased off-the-shelf software packages for
both business and engineering purposes. These packages have not been materially
customized by the Company for its purposes. These software packages run on a
personal computer based local area network which was installed by the Company in
1993, and which has been upgraded as needed since then. The assessment was based
upon formal and informal communications with the software vendors, literature
supplied with the software, literature received in connection with maintenance
contracts, and test evaluations of the software. Systems critical to the
business which have been identified as vulnerable to the Year 2000 problem
either have been, or are being, replaced with new purchased software or
corrected by upgrades available from vendors. Outside companies such as vendors,
major customers, service suppliers, communications providers and banks are being
asked to verify their Year 2000 readiness and the Company is testing interaction
with such systems where appropriate. The assessment thus far has been
accomplished, and is expected to be completed, utilizing the Company's existing
resources, and is not expected to have an adverse material effect on the
Company's financial results.

         It is the Company's belief that the results of the assessment to date
indicate that all of the Company's major business systems software is Year 2000
compliant, or will be Year 2000 compliant by the end of calendar year 1998, and
that the Year 2000 issue is not likely to have a material impact on the
Company's operations. However, there can be no assurances that the systems or
software of third parties on which the Company relies will be timely converted
and the Company may be adversely affected by the failure of such a third party
to become Year 2000 compliant. The Company has not yet developed a plan to deal
with this contingency but expects to have such a plan in place by the end of
fiscal 1999.

FORWARD-LOOKING STATEMENTS

         This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. There are certain factors that could cause actual results
to differ materially from those anticipated by the statements made above. These
include, but are not limited to, changes in revenues in the Company's
components, fluids and thin film deposition businesses, expected working capital
needs of the continuing operations, a material change in the market conditions
within the semiconductor industry and, changes in management's assessments
regarding the Company's obligations under outstanding purchase orders, ability
to fulfill existing sales order backlog, the recoverability of inventory and the
ability to collect accounts receivable relating to the 



                                       12



<PAGE>   13

discontinued Systems Division, the resolution of a dispute with a customer over
the validity of a purchase order relating to the discontinued Systems Division
and failure of the Company's systems or software, or the systems or software of
a third party on which the Company relies to be Year 2000 compliant. For
additional information concerning these and other important factors, which may
cause the Company's actual results to differ materially from expectations and
underlying assumptions, please refer to the reports filed by the Company with
the Securities and Exchange Commission.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         The Company maintains foreign operations in England, Germany and Japan
and conducts business in many other countries. As a result of these
international activities, the Company is exposed to changes in foreign currency
exchange rates, which could have some impact on the results of operations. The
Company manages exposure to changes in foreign currency exchange rates through
its normal operating and financing activities, as well as through the use of
some financial instruments. Generally, the only financial instruments the
Company utilizes are forward exchange contracts.

         The purpose of the Company's hedging activities is to mitigate the
impact of changes in foreign currency exchange rates. The Company utilizes
foreign currency forward exchange contracts for such hedging purposes. These
contracts generally do not exceed 12 months in duration, and are designed to
coincide with settlement dates of the related transactions, or to hedge balance
sheet translation exposure.

         The Company engages neither in speculative nor derivative trading
activities.






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<PAGE>   14




PART II. OTHER INFORMATION

ITEM b. EXHIBITS AND REPORTS ON FORM 8-K

     (a) Exhibits:

         27 - Financial Data Schedule

     (b) Reports on Form 8-K:

         Current report on Form 8-K dated September 23, 1998 (filed with the SEC
         on September 24, 1998) reporting the sale of the Systems Division.











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<PAGE>   15



                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.


                                    FERROFLUIDICS CORPORATION
                                    -------------------------
                                    (Registrant)




Date: November 9, 1998              By: /s/ Paul F. Avery, Jr.
      ----------------                  ----------------------------------------
                                    Paul F. Avery, Jr.
                                    President, Chief Executive Officer and
                                    Chairman of the Board


                                    By: /s/  William B. Ford
                                        ----------------------------------------
                                    William B. Ford
                                    Vice President and Chief Financial Officer











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