** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-KSB**

** **

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

 

**For the Fiscal Year Ended December 31, 2004**

 

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

 

**For the transition period from                         to                        .**

 

**Commission File No.:  0-1561**

 

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**MAGSTAR TECHNOLOGIES, INC.**

 (Exact name of registrant asspecified in its charter)

 
| **Minnesota**                                              | ** ** | **41-0780999**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) | ** ** | (I.R.S. Employer  Identification No.) |
| ** **                                                      | ** ** | ** **                            |
| **410 11th Avenue South  Hopkins, Minnesota**                   | ** ** | **55343**                             |
| (Address of principal executive offices)                        | ** ** | (Zip Code)                            |

 

Registrant’s telephone number, including area code:  **(952) 935-6921**

 

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

 

Securities registered pursuant to Section 12(g) of the Act:

 

**Common Stock, par value $0.1875 per share**

 

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Check whether theissuer (1) filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act during the preceding 12 months (or for such shorterperiod that the Registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.            YES  ý    NO  o

 

Check if there isno disclosure of delinquent filers in response to Item 405 of Regulation S-Bcontained in this form, and no disclosure will be contained, to the best ofRegistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or anyamendment to this Form 10-KSB.  ý

 

The Registrant’srevenues for the fiscal year ended December 31, 2004 were $7,350,319.

 

The aggregatemarket value of the common stock of the Company held by non-affiliates as of March 24,2005 was approximately $2,381,773 (based on the last sale price of the commonstock on that date).

 

The total numberof shares of the Company’s common stock outstanding on March 24, 2005 was9,040,173 shares.

 

Transitional SmallBusiness Disclosure Format (Check one):  YES  o    NO  ý

 

 

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**PART I**

 

**Forward Looking Statements**

 

*The information in thisdiscussion may contain forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. These forward-looking statements involve risks and uncertainties,including statements regarding the Company’s capital needs, business strategyand expectations.  Any statements thatare not of historical fact may be deemed to be forward-looking statements.  These forward-looking statements involvesubstantial risks and uncertainties.  Insome cases you can identify forward-looking statements by terminology such as “may,”“will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,”“predict,” “potential,” or “continue”, or the negative of such terms or othercomparable terminology.  Forward-lookingstatements in this Report also include references to anticipated sales volumeand product margins, efforts aimed at establishing new or improving existingrelationships with customers, other business development activities,anticipated financial performance, business prospects and similar matters.  Actual events or results may differmaterially from the anticipated results or other expectations expressed in theforward-looking statements.  Inevaluating these statements, you should consider various factors, including therisks included from time to time in other reports or registration statementsfiled with the United States Securities and Exchange Commission.  These factors may cause the Company’s actualresults to differ materially from any forward-looking statements.  The Company disclaims any obligation topublicly update these statements, or disclose any difference between actualresults and those reflected in these statements. Such information constitutesforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995 which provides a safe harbor for forward-lookingstatements.*

 

*In addition, the Company hashistorically had a high concentration of business with one major customer andreductions in scheduled shipments to this customer were partially responsiblefor the losses from operations during the fourth quarter of 2004.  There can be no assurance that this customerwill resume shipments to prior or expected levels in the future.  The risks and uncertainties the Company facesinclude, but are not limited to, the ability to expand sales and productofferings, to develop a reputation in manufacturing products for selectindustries such as medical industries and factory and laboratory automation, tomanufacture and ship in a timely manner and to the ability to acquire rawmaterials, as well as the risks and uncertainties described in “Management’sDiscussion and Analysis or Plan of Operations” in this Report.*

 

# **ITEM 1.  DESCRIPTION OF BUSINESS.**

 

***BusinessOverview***

 

MagStar Technologies, Inc.(“MagStar” or the “Company”) is a publicly owned company headquartered inHopkins, Minnesota that trades over the counter on the Bulletin Board (“OTCBB”)under the symbol “MGST.”

 

The Company wasestablished in 1948 as Reuter Manufacturing, Inc., and specialized inprecision machining and assemblies.  Inlate 2000, the Company acquired the assets of MagStar Technologies, Inc.,a private high-energy magnet and magnetic assembly company.  In early 2001, the Company changed its nameto MagStar Technologies, Inc.  In February 2001,the Company acquired the assets of Quickdraw Conveyors, a provider of conveyersand technology for factory, laboratory and equipment automation.

 

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The Company is aMinnesota corporation.  The principal executiveoffices of the Company are located at 410 Eleventh Avenue South, Hopkins,Minnesota 55343.  The Company’s telephonenumber is (952) 935-6921.

 

See “Item 2. Description of Property” below forinformation regarding the sale and leaseback of the Company’s executive officeand manufacturing facilities in February 2003.

 

***Products and Services***

 

MagStar Technologies is aprototype developer and manufacturer of centrifuges, conveyors, medicaldevices, spindles, and sub assemblies. MagStar’s technical abilities in design,process, and manufacturing specialize in the “concept-to-production” processdesigned to result in short manufacturing cycles, high performance, and costeffective products such as electro-mechanical assemblies and devices for overtwo dozen medical, magnetic, motion control, factory and laboratory automationand industrial original equipment manufacturers (“OEMs”). The Company strivesfor a unique identity as it emphasizes its design and manufacturing engineeringcapabilities, partnering with customers, providing engineering solutions andmachining, manufacturing, and assembly services for efficiently manufactured,long life assemblies.

 

MagStar offers a range ofdesign for manufacture, machining and assembly services and specializes in the followingareas:

 

**Centrifugal Separation andFiltering.**

 

Centrifugal separation and filtering is a method forseparating and removing both mineral particulate and biological material from alarge variety of liquids.  Thistechnology is applied to MagStar’s production of blood and industrial oilcentrifuge assemblies. Blood centrifuge assemblies and devices allow forhigh-speed separation of blood into various components and are used inoperating rooms, laboratories and blood banks. Industrial oil centrifuges facilitate increased drain intervals and oilpurification for engine operation.  Oilcentrifuges are used in marine engines, over the road trucking, powergeneration, and oil and gas production. Current centrifuge product projectsinclude blood centrifuges, proprietary oil centrifuges, private label oilcentrifuges, water centrifuges, gaseous/vapor centrifuges, fuel linecentrifuges, and industrial centrifuges (coolants/lubrication).

 

**Conveyors**

 

MagStar’s Quickdraw Conveyor product line is marketedto automation integrators, process upgrades, and OEMs seeking to automate aprocess that had been previously accomplished manually in factories andlaboratories. Typical processes include factory assembly, inspection,laboratory analysis, testing, and packaging. Industries utilizing these products include high-tech manufacturers,semi-conductor, academic and research institutions, microelectronics, biotech,and automotive. These industries are continually striving to increaseproductivity, decrease rejected products, and minimize workers exposure tostrenuous and tedious operations or hazardous environments.  MagStar makes five types of modular, lowprofile conveyor systems, three with slip roller accumulation, one with a beltedge drive, and one with individual drives. Each provides electrostaticdischarge protection, low power consumption, and are clean room certified.  MagStar’s patent pending clean room conveyor,the CR Series, is a low profile, ultra clean design for high tech clean roommanufacturing.

 

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**Spindles/Motion ControlledDevices**:

 

Motion control devices are predominantly high-speedspindles for assemblies whose uses range from silicon wafer saws to printedcircuit board saws, routers, and optical inspection systems. The Company’sspindles are used to position various devices which allow for greaterflexibility in the customer’s designated processes.  One customer’s spindle application includeselectronically controlled feedback devices and is used in optical inspectionsystems.  Another spindle manufacturedfor a customer controls various medical nuclear imaging devices ongantry-mounted systems.  In anothermedical application, the Company’s spindles lift a patient table and positionit through advanced optical imaging scanners.

 

**Precision Magnet Assemblies**

 

The Company buildsprecision magnet assemblies for aerospace, medical, and motion controlledapplications.  These assemblies generallyinclude high-energy permanent magnetic material that may be components ofmachined parts or sub assemblies of rotors, pumps, stators, motors, anddirectional control devices.

 

***Technology***

 

MagStar has technicalabilities in the following areas:

 

**High Tech Centrifugal SeparationDesign and Manufacturing**

 

High tech centrifugalseparation design and manufacturing involve high-speed electrical motors,precision manufacturing, and precision assembly abilities.  This knowledge is applied to design andmanufacture technological applications. These applications generally involve high-speed rotation whilegenerating minimal noise, heat, and vibration.

 

**Conveyor Design and Manufacturing**

 

Conveyor and roboticmovement devices tend to require fast orientation and movement, minimum surfacecontrast and high-density boards and chips. MagStar aims to meet these needs with its high tolerance machining andassembly skills, its edge belt handling technology, and its skills inservomotor control feedback.  Productionof unwanted particulate can be a side effect of using conveyor devices inmanufacturing.  MagStar’s patent pendingclean room conveyor technology is designed to solve customers’ problems indealing with clean room requirements.

 

**Spindle Design and Manufacturing**

 

Spindles are precisionelectrical motor-based devices.  MagStarmanufactures and designs spindles that rotate from 1,000 up to 40,000 RPMs. Spindles are similar to motors used to power its centrifugal devices andtypically include a DC brushless electric motor, bearings, and afeedback/control device all driving a shaft that engages something else.  For example, in a centrifuge, themotor-driven shaft engages the container holding fluid to which centrifugalforce is being applied.  MagStar’sspindles are especially well known for generating minimal noise, vibration, andheat.  The skills and technology thatthis type of manufacturing requires include strong engineering, precision, andspecialized assembly.

 

**New Generation High EnergyMagnetic Materials**

 

New generation highenergy magnetic materials require higher speed performance, improved torquetransmission and improved holding power. MagStar’s magnet assemblies use bonding capabilities and custom matchingof materials to specific applications enhancing performance for its customers.

 

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***Markets***

 

MagStar supplies its products and services to OEMs inthe following markets:

 

**Medical**

 

MagStar is a manufacturerof blood separation devices used in analysis and component isolation of wholeblood.  MagStar’s primary customer is aleading supplier of automated blood processing systems which provides readilyavailable blood components for pharmaceutical use or patient transfusions.  These products are used in operating roomsand in many of the world’s blood banks and laboratories.  Other blood centrifuge applications includethe market for thrombin-based orthobiologics.

 

**High Tech Manufacturing andLaboratory Automation**

 

MagStar’s conveyor lineprovides solutions for a variety of markets, usually integrated into largermanufacturing solutions for markets such as semiconductors, wafer boards, flatscreen monitor components, pharmaceuticals, and medical devices.  The conveyor line also is frequently used inlaboratory automation.

 

**Combustion Engines**

 

MagStar manufactures anengine oil centrifuge used primarily by OEMs on stationary and non-stationaryengines of 150 hp and above.  Thecentrifuges are also an after market addition to oil field engines and powergenerators.  The centrifuge is designedto provide filtration to .5 micron, the ability to recover and analyzeparticulate for preventive maintenance, and the Company is developing thecentrifuge’s efficiency for soot removal. The oil centrifuge also uses MagStar’s centrifuge technology.  Markets that use this technology include powergeneration, gas and oil production, marine engines, over the road trucking, andoff road and construction equipment.

 

**Filtration/High Tech Separation**

 

MagStar is a manufacturerof centrifugal separation and filtering devices used with a variety of liquidsincluding water and gaseous streams. These devices are used to remove a variety of mineral particulate andbiological material.

 

**Motion Control**

 

MagStar is a supplier ofcustom spindle/electric motor assemblies for high technology applications.  These applications require state of the artcapabilities for large OEM market leaders. Precision magnet assemblies and magnetizing capabilities along withprecision movement and placement systems from Quickdraw technology contributeto and broaden the Company’s capabilities.

 

***Strategy***

 

The Company’s goal is to become a leader incentrifuge, spindle, conveyor design and production technology through steadygrowth and by demonstrating niche manufacturing abilities.  The Company intends to reach these goals throughthe clear identification of the Company’s core business, (centrifuges,spindles, and conveyors), relationships that include both the manufacturing ofspecific parts and the preparation of sub-assemblies and completed assembliesfor our customers, focusing on proprietary products and not contractmanufacturing, and building long-term, sustainable comparative advantages overthe Company’s competitors.  The Companyseeks to become involved with its customers early in their development anddesign process, allowing the Company to participate in the earlier, highervalue added stage of product development and to establish a closer workingrelationship with its

 

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customers.  This also is intendedto lead to a stronger relationship with customers based on the Company’sengineering and prototyping expertise.

 

The Company intends to achieve diversity in growth byadding new customers who wish to apply centrifuge and automation technology toa variety of filtering and separating applications, and by growing andnurturing the conveyor business.  TheCompany seeks to pursue a course investing in research and development thatwill lead to innovation and new value propositions in the future, establishinga reputation and expertise for product development.

 

***Sales and Marketing***

 

The Company’s sales andmarketing effort is focused on the strategic markets outlined above.  The Company uses both an outside sales teamand regional representatives.  The salesforce is supported by an applications design and manufacturing engineeringteam.

 

The Company’s products are sold directly to OEMs,integrators, academic and research institutions, end users and master dealerswho market to other distributors.

 

Marketing efforts focus on MagStar’s reputation forhigh quality, precision assemblies that include blood and industrialcentrifuges, conveyor systems, spindles, and magnetic assemblies.  MagStar uses paid advertising and tradeshows, among other methods, to market its products. MagStar’s website(www.magstar.com) provides in-depth descriptions of MagStar’s sales andproducts.

 

***Customers***

 

In 2004, the Company had centrifuge sales to itslargest customer of $2,198,158, approximately a 10% increase from sales of$1,999,980 to the same customer in 2003. This customer accounted for approximately 30% of the Company’s sales in2004.  Sales with this customer areexpected to remain at current levels and possibly increase in 2005.  Sales in 2004 to the Company’s second largestcustomer, its largest conveyor customer, were $1,207,999, compared to $671,000in 2003.  This accounted forapproximately 16% of the Company’s 2004 sales. The increase of $536,999, or 80%, from 2003 sales to the customer is dueto greater demand from this customer originating in the semiconductorindustry.  The Company anticipates salesto this customer to remain at current levels and possibly increase in 2005.

 

***Supplies***

 

The raw materials used by the Company in itsmanufacturing operations are reasonably available in the competitivemarket.  The Company seeks to maintainmultiple sources of the parts and materials; however, certain significantcustomers limit the number of or designate specific suppliers to be used byMagStar.  The availability of such partsand materials could affect the Company’s ability to fill customers’ orders on atimely basis.  The Company believes thatthe interruption of existing relationships with suppliers would not have amaterial adverse effect over the long term, as parts and materials suitable forthe production of our products would be available from other suppliers.

 

The Company generally manufactures products tocustomer specifications on a contract basis, and as a result carries minimalamounts of inventory.

 

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***Competition***

 

The contract manufacturing, machining, and magneticbusiness in which the Company engages is highly competitive.  Many of the Company’s competitors havegreater sales volume and resources than the Company.  The principal elements of competition arequality, service, delivery, price and meeting customer requirements.  The Company believes that it accounts foronly a small portion of aggregate national sales of the manufacturing service itprovides.  The Company believes, however,that its strong engineering and manufacturing capabilities give it acompetitive advantage.

 

There are many OEM manufacturers of medical andindustrial centrifuges.  However, theCompany is not aware of any other contract manufacturers that also have theability to engineer and manufacture high speed, precision, custom designed andhighly cosmetic centrifuges for these markets to the satisfaction of itscustomers.  It believes that its highspeed, high precision products give it the ability to compete effectively inthe centrifuge market.

 

With regard to the Conveyor product group, there aremany manufacturers of parts and components used in these systems.  However, the Company is not aware of anyother manufacturers that also have the ability to engineer and manufacture highperformance, precision, custom designed and highly cosmetic conveyors for thesemarkets to the satisfaction of its customers. It believes that its high speed, high precision and high performanceproducts give it the ability to compete effectively in the conveyor market.

 

The Company faces competition from several nationalmanufacturers of precision magnets, many of which are capable of supplyingmagnet assemblies.  With its completeengineering and manufacturing capabilities, the Company can play a moresignificant role in its customers’ supply programs and benefit more directlyfrom all of the value that is created in the manufacturing process.

 

***Research and Development***

 

The Company conducts customer funded research anddevelopment activities primarily related to design and prototype development ofcustomers’ products and, to a lesser extent, products sold under the Company’strade names.  The Company also providessome engineering services to support its customers in the development of newproducts, including enhancements to current products. In 2004 and 2003, theCompany collected approximately $125,000 and $47,000 respectively, in researchand development fees.  There were nosignificant expenses that were not customer funded in 2004 or 2003, nor doesthe Company anticipate significant expenses of this nature in 2005.

 

***Intellectual Property***

 

The Company has two patents and one patent pending onits conveyor products.  The Company hastrademarks on its oil centrifuge product and conveyor products.

 

The Company has its employees sign confidentiality andnondisclosure agreements at the time of hiring. The Company also requires certain vendors to sign such agreements.

 

***Backlog***

 

The Company makes product forecasts for futuredelivery based upon frequently updated information from customers; suchforecasts are then adjusted or replaced by actual purchase orders or productionreleases.  The Company’s backlog oforders and releases on December 31, 2004 was

 

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approximately $2.7 million, compared to approximately $2.3 million on December 31,2003. The Company’s backlog often fluctuates because of blanket orders placedby customers who schedule delivery of the product over future months.  The usual period between receipt of an orderfor a new assembly and the first delivery of the product by the Company is 2 to6 months.  The delivery period forsubsequent orders generally is shorter. The Company believes its backlog is firm.

 

***Environmental Matters***

 

See “Item 3. Legal Proceedings” below for informationregarding environmental matters affecting the Company.

 

***Employees***

 

As of December 31, 2004, the Company had 68employees, which includes 67 full time employees and 1 part time employee.  As of December 31, 2003, the Company had65 employees, which included 62 full time employees and 3 part timeemployees.  One executive officer and twoother officers who may make significant contributions to the business of theCompany are not employees of the Company, and are salaried employees of theCompany’s largest shareholder.  See “Item4A. Executive Officers of the Registrant.”

 

**ITEM 2.  DESCRIPTION OF PROPERTY.**

 

The Company’s executive offices and manufacturingfacilities are located at 410 Eleventh Avenue South, Hopkins, Minnesota.  Until February 25, 2003, the Companyowned these facilities and the approximately 7.5 acres of land on which thefacilities are located.  These facilitiesconsist of approximately 110,000 square feet of which approximately 13,000 squarefeet are devoted to office space, and 97,000 square feet are devoted tomanufacturing and warehousing.  TheCompany considers these facilities to be well maintained and in good operatingcondition, and believes that such manufacturing facilities can accommodateanticipated future growth.  On February 25,2003, the Company sold the building to a related party, Hopkins Eleventh AvenueLLC, and entered into a sale-leaseback arrangement.  The Company entered into a 6.5-year grosslease with Hopkins Eleventh Avenue LLC for the building and property at amonthly cost of $34,000 increasing to $44,436 per month.

 

Effective April 1, 2004, the Company and HopkinsEleventh Avenue LLC amended the lease whereby the lease payments from April 1,2004 to December 31, 2005 were waived. The amendment was done based on the Company’s discussions with the bankthat provides financing for the Company in anticipation of changes that wouldbe required for the bank to renew the Company’s line of credit.  See “Item 12. Certain Relationships andRelated Transactions.”

 

On March 1, 2003, the Company subleasedapproximately 30,000 square feet of its facility to an unrelated party for 18months.  The sublease provided for annualincome of $4.55 per square foot, or $149,081 per year.  On November 1, 2004, the Company did notrenew the previous sublease and instead subleased the approximate 30,000 squarefeet to Activar, Inc., a corporation principally owned by a majorshareholder and director of the Company, for its operational use.  The sublease provides annual income ofapproximately $6.00 per square foot, or $180,000 per year and is renewablemonthly.

 

In addition, on May 1, 2004 the Company subleasedapproximately 2,000 square feet of its facility to a different unrelated partyfor 12 months.  The sublease provides forannual income of $12.00 per square foot, or $24,000 per year.

 

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# **ITEM3.  LEGAL PROCEEDINGS.**

 

During a Phase I and Phase II environmental assessmentof its manufacturing facility in December 1997, soil boring andgroundwater work indicated the presence of potentially hazardous substances andpetroleum products within the soil and groundwater located beneath thesite.  The Company notified the MinnesotaPollution Control Agency (the “MPCA”), and worked with the MPCA towardresolution of the issue.  All groundwater investigation has been completed and on December 7, 2004, the MPCAissued a determination to take no further action under Minn. Stat. 115B.01-115B.18with respect to the identified release. All reserves related to this issue have been released.

 

# **ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.**

 

No matter was submittedto a vote of security holders during the fourth quarter of the fiscal yearcovered by this Annual Report on Form 10-KSB, through the solicitation ofproxies or otherwise.

 

**PART II**

** **

# **ITEM5.  MARKET FOR COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS.**

 

***MarketInformation***

 

The Company’s CommonStock is not listed on an exchange; however, market quotes for the Company’scommon stock are available on the over-the-counter bulletin board (“OTCBB”)under the symbol “MGST.”  The followingtable sets forth, for each of the calendar periods indicated, the quarterlyhigh and low bid quotations for the Company’s Common Stock quoted on theOTCBB.  The prices in this tablerepresent prices between dealers, and do not include adjustments for retailmark-ups, markdowns or commissions and may not represent actual transactions.

 
| ** ** | ** ** | ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|------------|------------|----------------|------------|----------|------------|---------|------------|
| 2004:      |       | First Quarter  |       | $        | 1.25       |    | $          | .65 |   |
|       |       | Second Quarter |       | $        | 1.15       |    | $          | .75 |   |
|       |       | Third Quarter  |       | $        | 1.13       |    | $          | .80 |   |
|       |       | Fourth Quarter |       | $        | 1.00       |    | $          | .70 |   |
|       |       |           |       |     |       |    |       |
| ** ** | ** ** | ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
| 2003:      |       | First Quarter  |       | $        | .20        |    | $          | .05 |   |
|       |       | Second Quarter |       | $        | .20        |    | $          | .05 |   |
|       |       | Third Quarter  |       | $        | .60        |    | $          | .20 |   |
|       |       | Fourth Quarter |       | $        | .70        |    | $          | .30 |   |

 

***Holders***

 

As of March 24, 2005there were approximately 1,066 registered record holders of the Company’sCommon Stock and 3 record holders of the Company’s Series A PreferredStock.

 

***Dividends***

 

No cash dividends weredeclared or paid by the Company during 2004 or 2003, and the Company does notintend to pay dividends on its Common Stock or Series A Preferred Stock inthe foreseeable

 

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future.  The Company is prohibited from payingdividends on its Common Stock under agreements with its senior lender.

 

See “Item 11. SecurityOwnership of Certain Beneficial Owners and Management” below for EquityCompensation Plan Information.

 

***RecentSales of Unregistered Securities***

 

None.

 

# **ITEM6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS**

# ** **

***General***

 

Through most of 2004, the Company experienced sustainedsales for its blood centrifuge models and conveyors to the Company’s largestcustomers compared to 2003.  Sales of theCompany’s conveyor products began increasing in the third and fourth quartersof 2003 compared to 2002 and continued throughout 2004.  However, sales to the Company’s two largestcustomers were lower in the fourth quarter of 2004 due to these customers’lower demand.  Sales volumes for 2005 areexpected to return to 2004 levels.  Therecan be no assurance that sales to the Company’s largest customers will returnto previous levels or that sales of other products will be sufficient to allowthe Company to achieve positive cash flow or profitability.

 

***Critical AccountingPolicies***

 

Note 2 of the Notes to the Financial Statementsincludes a summary of the significant accounting policies and methods used inthe preparation of our Financial Statements. The following is a brief discussion of the more significant accountingpolicies and methods used by the Company.

 

*General*

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires general management to make estimates and assumptions that affect thereported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the dates of the financial statements and reportedamounts of revenues and expenses during the reporting periods.  The most significant estimates andassumptions relate to the valuation of inventory and the recognition ofrevenue.  Actual amounts could differfrom these estimates.

 

*Inventory Valuation*

 

The Company considers recent historic usage andfurther demand in estimating its net realizable value of its inventory.  Inventory at December 31, 2004 reflectswrite-downs of $110,375.  Should it bedetermined that write downs are insufficient, then the Company would berequired to record additional inventory write-downs, which would have anegative impact on gross profit.

 

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*Revenue Recognition*

 

The Company recognizes sales when products areshipped, collectability is probable and the sales price is fixed ordeterminable.

 

***Results of Operations***

 

Total revenues for 2004 were $7,350,319, compared to$6,230,898 for 2003.  Net sales for 2004from medical, industrial, magnetic, high tech/contract manufacturing andQuickdraw conveyors were, respectively, $2,584,223, $883,410, $511,235,$1,159,995 and $2,245,695.  Net sales for2003 from medical, industrial, magnetic, high tech/contract manufacturing andQuickdraw conveyors were, respectively, $2,392,842, $854,620, $571,719,$1,443,838 and $1,098,628.  The Company’snet sales increased by approximately 18% in 2004 from 2003, compared to adecrease in net sales of 25% in 2003 from 2002. An element of the salesdecrease for 2003 as compared to 2002 was due to lower sales to the Company’ssignificant customer, combined with reduced market demand in magnets and hightech spindles.  Sales are not subject toseasonal volatility.  The increase insales from 2004 over 2003 is due to slightly increased demand from the Company’slargest customer, significant growth from the Company’s second largestcustomer, and the addition of a new large conveyor customer.  The sales growth is also attributable to theCompany completing significant operational and financial restructuring andplacing strategic emphasis on increasing sales.

 

Cost of sales was $6,296,416 for 2004, compared to$5,699,377 in 2003, an increase in the cost of sales of approximately 10%.  While the cost of sales increased in 2004over 2003, gross profit dollars also increased. The increase in the cost of sales reflects increased sales andproportional improvements in cost control and management of variable expensesincluding labor, benefits, and process and productivity improvement.

 

Gross profit was$1,053,903, or 14% for 2004, compared to $531,521 or 9% in 2003.  This increase in gross profit was due to thefactors discussed above.

 

Selling, general andadministrative expenses were $1,082,553 or 15% of net sales in 2004, comparedto $746,621 or 12% of net sales in 2003. The 45% increase in selling, general and administrative expenses is dueprimarily to an increase in sales expenses including trade shows, advertisingand sales commissions.

 

As a consequence of theforegoing factors, the Company had an operating loss in 2004 of $28,650,compared to an operating loss of $215,100 in 2003, a decrease of approximately87%.

 

Interest expenses in 2004were $238,194, compared to $639,447 in 2003. The decrease in interest expense is due to restructuring of relatedparty debt which included $4,300,754 of debt forgiveness (refer to Relatedparty debt forgiveness.)  Total otherincome, net of interest expenses in 2004 was $53,527, compared to $1,399,710 in2003 when the Company recorded Other Income of $1,205,000 due to theforgiveness of debt.

 

Total other expense, netin 2004 was $184,667, compared to total other income, net in 2003 was $760,263,a decrease of $944,930 which was primarily due to the forgiveness of debt in2003.

 

The effect of inflationon the Company’s results has not been significant.

 

In 2004, the Company hada net loss of $213,317, or $.02 per basic share, compared to net income of$545,163 or $0.06 per basic share for 2003. Net loss for 2004 was $.02 perdiluted share,

 

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compared to net incomeof $0.05 per diluted share for 2003.  Netincome or loss is due to the reasons discussed above.  Had the Company not recorded other income of$1,205,000 in 2003 as discussed above, it would have recorded a net loss of$659,837 in 2003.

 

The Company recorded anet loss for 2004.  Generally, theCompany does not pay regular income taxes because of the availability of itsnet operating loss carry forwards.

 

***Liquidityand Capital Resources***

 

At December 31,2004, the Company had a working capital deficit of $3,039,095, compared to aworking capital deficit of $6,993,750 at December 31, 2003.  The current ratio was**.**37at December 31, 2004, compared to .21 at December 31, 2003.  The decrease in the working capital deficitand the increase in the current ratio are primarily due to a decrease in seniordebt.

 

The Company had negativecash flows from operations of $161,982 for the year ended December 31,2004, compared to negative cash flows from operations of $1,724,766 for theyear ended December 31, 2003. The Company’s ability to meet its continuingcash requirements in the future is dependent on achieving adequate sales andmargins from its manufacturing operations.

 

Net cash (used in)investing activities was $30,509 for the year ended December 31, 2004, comparedto net cash provided of $3,688,739 for the year ended December 31,2003.  The net cash provided by investingactivities in 2003 was primarily due to proceeds generated from a sale andleaseback of most of the Company’s facility in 2003.

 

Net cash provided byfinancing activities was $192,491 for the year ended December 31, 2004,compared to cash used in financing activities of $1,963,973 for the year ended December 31,2003.  The higher amount of net cash usedin financing activities in 2003 was due to payments on indebtedness followingthe sale and leaseback of the Company’s facility.

 

*PreferredStock*

 

On October 10, 2000,the Company completed a private financing (the “Financing”) pursuant to theterms of a Securities Purchase Agreement dated October 10, 2000 (the “SecuritiesPurchase Agreement”) by and among the Company, Activar, Inc., James L.Reissner and Michael J. Tate (collectively, the “Investors”).  Pursuant to the Securities PurchaseAgreement, the Company sold to the Investors an aggregate of 3,500,000 sharesof the Company’s common stock, par value $.1875 per share (“Common Stock”), andan aggregate of 1,000,000 shares of the Company’s Series A convertiblePreferred Stock, par value $.1875 per share (“Series A Preferred”;together with the Common Stock, the “Shares”), all at a purchase price of$.1777778 per share, for an aggregate purchase price of $800,000.  Of the $800,000 total, Activar and Mr. Reissnerpurchased $700,000.  The Shares were soldin a transaction exempt from the registration requirements of the SecuritiesAct of 1933, as amended (the “Securities Act”), and are “restricted securities”within the meaning of Securities Act.

 

The Series APreferred is convertible at any time, without the payment of any additionalconsideration, into such number of fully paid and nonassessable shares ofCommon Stock as is determined by dividing $.1777778 by the conversion price ineffect at the time of any conversion and then multiplying such quotient by eachshare of Series A Preferred to be converted.  The conversion price, initially $.1777778, issubject to adjustment for stock splits and other actions affecting the capitalstructure of the Company.  The Series APreferred generally votes with the Common Stock on matters submitted to theshareholders, with each share of Series A Preferred having that number ofvotes that is

 

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equal to thenumber of whole shares of Common Stock into which such share of Series APreferred is then convertible.  The Series APreferred is entitled to 9% dividends in preference to any dividends paid onthe Common Stock, but such 9% dividends are payable only if, as and whendeclared by the Company’s board of directors.

 

*EquipmentLease Financing*

 

On March 21, 2001, the Company entered into twosale-leaseback agreements with Activar Properties, Inc. (“Lessor”), whichis principally owned by a major shareholder and director of the Company.  Proceeds from the sale-leaseback were used topay off Term Note B in the principal amount of $1,027,000 plus accrued interestdue to the bank and pay off $540,034 owed to the Lessor for equipmentpurchases.  The Lessor has assigned itsrights under these leases to its bank.

 

Under these agreements,the Company had leased two sets of equipment for terms of 61 months and 25months, respectively, and for monthly payments of $30,279 and $17,399,respectively.  On January 1, 2003,the Company amended its equipment lease reducing the payments to $45,646 for aterm of 60 months.  Again on April 1,2004, these leases were amended as part of the fifth amendment to the Company’samended and restated credit agreement, as described in more detail below.  The Company amended the leases on April 1,2004 whereby the minimum lease payments for the remainder of 2004 and 2005 werewaived.  Monthly lease payments in 2006and 2007 would be $20,000 per month (the ending date of the leases were notchanged due to the amendment that occurred on April 1, 2004).  The Company believes that the amendments tothe leases were necessary in order to amend the credit agreement and extend itto June 2005.  The result of theseamendments was reflected in the Notes to the Financial Statements hereto.

 

*AffiliateLoans*

 

On January 21, 2002,the Company borrowed $500,000 from Richard F. McNamara, a majority shareholderand director of the Company, pursuant to a term note bearing interest at12%.  In consideration for the loan, Mr. McNamarareceived warrants to purchase 250,000 shares of Common Stock of theCompany.  Proceeds from this note wereused to pay off $400,000 in debentures issued in 1998 and 1999 and accruedinterest thereon.  In October 2002,the interest rate on the term note was reduced to 8%.  Interest on the term note is payable monthly,with the principal balance due and payable on January 10, 2005.  This term note was required to berestructured in the fifth amendment to the Company’s amended and restatedcredit agreement as required by the senior lender.  The results of this restructuring arereflected in the Notes to Financial Statements.

 

Throughout 2004 and 2003,the Company borrowed monies from Activar, Inc. to fund operations.  These loans are due on demand and accruedinterest at 10% through September 2002, at which time the interest ratewas lowered to 6%.  This lendingarrangement was converted into a revolving credit arrangement with Richard F.McNamara and affiliates on January 1, 2003 with interest remaining at 6%.The Company believes that the terms and conditions of the promissory notesgiven to Activar, Inc. are at least as favorable as the terms andconditions on which the Company could have obtained credit from an unaffiliatedthird party.

 

*CreditAgreement*

 

On October 10, 2000,the Company and US Bancorp entered into an amended and restated senior creditagreement consisting of an asset-based line of credit with availability of upto $1,750,000, and three term notes of $2,800,000, (“Term Note A”), $1,100,000(“Term Note B”) and $1,325,000 (“Term

 

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Note C”).  Although the line of credit was due October 2003,US Bancorp had the right to demand payment at any time.  Because the credit facilities agreement alsoincluded a subjective material adverse change clause under which the borrowingscould become due and payable, the Company classified all of the amounts owingunder the credit facilities at December 31, 2003 as current liabilities.

 

On March 21, 2001,the Company paid Term Note B in full, using proceeds from the sale-leaseback offixed assets to a related party.

 

On February 25,2003, the Company paid off Term Note A to US Bancorp in the amount of$2,658,078 with proceeds from a sale-leaseback arrangement with a relatedparty, Hopkins Eleventh Avenue, LLC.

 

Term Note C wasnon-interest bearing and was due and payable in full on September 30,2003. On August 7, 2003, US Bancorp canceled Term Note C in exchange for300,000 shares of the Company’s restricted common stock. As a consequence ofthe transaction, the Company recorded non-recurring income of $1,205,000 and$120,000 from the value of common stock issued.

 

On October 16, 2003, the Company negotiated a third amendment ofits amended and restated senior credit agreement, an extension with US Bancorp on the line of credit.

 

On January 6, 2004, the Company negotiated a fourth amendment ofits amended and restated senior credit agreement, an extension with US Bancorpon the line of credit.  The extendedasset-based line of credit bore interest at the bank’s reference rate plus twopercent, had availability of $1,350,000 subject to a borrowing base limitationof 80% of the Company’s eligible accounts receivable plus 40% of raw materialsand 30% of finished goods, and was to****expire in June 2004.The credit facilities were collateralized by substantially all the assets ofthe Company.

 

On August 13, 2004,the Company negotiated a fifth amendment of its amended and restated seniorcredit agreement with US Bancorp on the line of credit that is retroactive to June 30,2004.  The extended asset-based line ofcredit bears interest at the bank’s reference rate plus two and one halfpercent, has availability of $1,200,000 subject to a borrowing base limitationof 80% of the Company’s eligible accounts receivable plus 40% of raw materialsand 30% of finished goods and will expire on June 30, 2005. The creditfacilities are collateralized by substantially all the assets of the Company.

 

As a condition toobtaining the amended line of credit, MagStar was required to restructureportions of the Company’s liabilities and lease agreements with relatedparties.  As a result, on August 13,2004, the Company amended its building and equipment leases with HopkinsEleventh Ave, LLC and Activar Properties, respectively, and $4,300,754 ofrelated party debt has been extinguished without additional consideration.Because the transaction is between related parties, the gain on theextinguishment of debt was classified as a contribution to equity in June 2004,and will not affect future statements of operations.  The amended and reduced building andequipment leases will positively affect the statement of operations on anongoing basis.  The reduced related partydebt was restructured with a 3% interest rate and will reduce interest expense,also positively affecting the Company’s statements of operations in thefuture.  The Company believes that the 3%interest rate charged on the restructured debt had a positive influence on thebank’s decision to amend the credit agreement and extend it to June 2005.

 

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*FacilitiesSale/Leaseback*

 

On February 25,2003, MagStar Technologies, Inc. sold and leased back its headquarters andmanufacturing facility in Hopkins, Minnesota. The purchaser was Hopkins Eleventh Avenue LLC (“Eleventh Avenue”), an affiliateof the Company’s largest shareholder.

 

The purchase price forthe building and property was $3,700,000. The Company entered into a 6.5-year gross lease with Eleventh Avenue forthe building and property at a monthly cost of $34,000 increasing to $44,436per month.  In the transaction, theCompany paid in full its mortgage on the property with US Bancorp in the amountof $2,675,798, including accrued interest. Due to the fifth amendment to the Company’s amended and restated creditagreement, the Company was required by the bank to restructure this lease in amanner which is favorable to the Company, which is reflected in the Notes toFinancial Statements.  The mortgage hadoriginally been entered into as security for Term Loan A under the provisionsof the Company’s Credit Agreement with US Bancorp dated October 20, 2000.

 

As a result of the saleof the property, the Company recognized a gain on its balance sheet of$2,157,855, which will be realized over the life of the lease from EleventhAvenue.  The Company realized proceeds of$1,001,397, which was applied to the Company’s debt to Activar Properties, Inc.and affiliates.

 

*EnvironmentalExpense*

 

During a Phase I and Phase II environmental assessmentof its manufacturing facility in December 1997, soil boring andgroundwater work indicated the presence of potentially hazardous substances andpetroleum products within the soil and groundwater located beneath thesite.  The Company notified the MinnesotaPollution Control Agency (the “MPCA”), and worked with the MPCA towardresolution of the issue.  All groundwater investigation has been completed and on December 7, 2004, the MPCAissued a determination to take no further action under Minn. Stat. 115B.01-115B.18with respect to the identified release. All reserves related to this issue have been released.

 

*Expected Capital Needs for 2005*

 

The Company does notexpect capital needs in 2005 to exceed the capacity of its asset based line ofcredit as allowable receivables and inventory borrowings are expected to coveroperating requirements.  While the assetbased line of credit expires in June 2005, the Company believes it will beable to replace this facility.  Inaddition, borrowing agreements with the Company’s major shareholder areexpected to remain in place. The Company believes that cash from operations,renewal of and advances from its credit facility and borrowings from its majorshareholder will provide enough liquidity for the next 12 months of operations.

 

***BusinessConditions***

 

The Company recognized anet loss of $213,317 for the year ended December 31, 2004, and has aworking capital deficit and stockholders’ deficiency of $3,039,095****and $4,907,477, respectively, at December 31, 2004.

 

Management’s plans andobjectives to improve the financial condition of the Company are based on astrategy to become a technology leader in centrifuge and conveyor design andproduction by being a product focused company, growing sales, reducing debt,and accumulating cash.

 

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Steady growth may beachieved by identifying the Company’s core business (centrifuges, conveyors andspindles), seeking relationships that move beyond the manufacturing of specificparts and into the preparation of sub-assemblies and completed assemblies forits customers, developing a focus towards proprietary products and away fromcontract manufacturing and building long-term, sustainable comparativeadvantages over competitors.  The Companyseeks to become involved with its customers early in their development anddesign process allowing the Company to participate in the earlier, higher valueadded stage of product development and to establish a closer workingrelationship with its customers.

 

The Company intends toadd new centrifuge customers by applying centrifuge technology to a variety offiltering and separating applications, developing new spindle applications. TheCompany intends to add new conveyor customers by expanding its distributionnetwork, creating strategic alliances, and new marketing initiatives.  The Company seeks to pursue a courseinvesting in market driven research and development that will lead toinnovation and new value propositions in the future, establishing a reputationand expertise for product development. The Company seeks to be identified as a centrifuge, spindle, andconveyor manufacturer and intends to focus on higher value added products thatallow it to use its design, manufacturing, and engineering capabilities.

 

Cash control, costmanagement, and margin preservation are fundamental to the Company’sprofitability. Any new corporate strategies considered must be accountable toexisting headcounts and capital resources meaning the Company must resiststrategies that require significant inflows of capital, unless capital can beprudently raised.  Other prioritiesinclude recapitalizing the balance sheet, generating liquidity, monitoring andchanging processes to increase productivity, and strategically adding keymanagers and operational expertise as a measured response as required in aprudent and responsible manner.  TheCompany also has excess capacity. Through mergers, acquisitions and organic growth, it believes it canincrease its revenues while incurring proportionally less additionaloverhead.  By increasing productivity,improving cost control, reducing expenses and keeping expenses in proportion tothe Company’s current sales level, the Company intends to achieve positive cashflow.  The Company achieved positive cashflow for the last six months of 2004.

 

There can be no assurancethat management will be able to accomplish all of the above plans andobjectives or achieve the necessary improvements in its cash flows andfinancial position to meet its obligations as they become due.  Senior management executive needs andexpenses are expected to increase in the future.

 

Accordingly, there can beno assurance that the Company will continue as a going concern in its currentform.  The financial statements do notinclude any adjustments that might result from the outcome of this uncertaintyas this probability is indeterminate.

 

***Summary***

 

2004 sales were up fromsales in 2003.  The Company feels that2004 showed improvements over 2003 due to strategic improvement in sales andmarketing, better management of variable expenses, including labor, employeebenefits, and process and productivity improvements, in addition to broadeningthe customer base.  2002 and 2003 resultsreflect significant efforts in operational and financial restructuring while2004 results reflect a focus on sales and marketing and the impact on improvedoperations.  Productivity improvements,cost control measures, profitability, and growing sales remain the highestpriorities for the Company.  While theresults of 2004 were below management’s expectations, the Company feels that ithas established a trend in growing sales, productivity improvement and costcontrol.  There can be no assurance thatthese achievements, actions, and future

 

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actions, ifnecessary, will be sufficient for the Company to meet its continuing cash flowrequirements in the future or return to profitability.

 

Except for the historicalfinancial information reported above, this report contains forward-lookingstatements that involve risk and uncertainties, including references toanticipated and projected sales volume, the risk associated with establishingnew or improving existing relationships with customers of the Company, otherbusiness development activities, anticipated financial performance, businessprospects, and similar matters.  Inaddition, the Company has a high concentration of business with one majorcustomer and any reduction in sales to this customer may affect net income.  Because of these and other uncertainties,actual results could differ materially from those reflected in theforward-looking statements.

 

***FactorsThat May Affect Future Results***

 

Dependence on MajorCustomers.  Sales wereaffected by increases in sales to major medical and conveyor customers in2004.  These increases were driven byhigher demand and reduced customer inventories. The Company continues to take orders from these major customers andexpects overall business with such customers to remain steady for 2005 orincrease.  However, no assurance can begiven that sales to these customers will reach or exceed previous levels.  The Company has no production contracts withits major customers and believes that reductions in orders from these customerswould have material adverse effects on future operating results.  The Company continues to pursue customerdiversification to reduce dependence on sales to its significant customer.

 

Dependence on NewProducts and Continued Growth in Sales Volume.  The Company’s future success will depend onits ability to retain current customers and add new customers.  While the Company focuses attention oncontract manufacturing, it also looks to develop new customers for productsmanufactured under its own trade names, Quickdraw conveyors and oil centrifuges.The Company looks to obtain production orders for existing conveyor andprototype products including motion control, magnetic, spindle, and centrifugeassemblies, and maintain a satisfactory volume of orders for current customers.During 2003 and 2004, shipments to additional centrifuge customers occurred asdid research and development into new centrifuge products, and may continue in2005.  Shipments to new conveyorcustomers began in 2004 and the Company expects sales to these customers tocontinue in 2005.

 

Competition.While the Company believes its engineering capability is a competitiveadvantage, and that it offers value added assistance and solutions for improveddesign, manufacturability and reliability of higher-level assemblies, customerswith existing products may not change from suppliers of discretecomponents.  Company management believesthe Company represents only a small portion of the aggregate national sales ofproprietary product and contract manufacturing services.

 

***Impactof Recent Accounting Pronouncements.***

 

In December 2003, the Financial AccountingStandards Board (FASB) issued FASB Interpretation No. 46R, “Consolidationof Variable Interest Entities” (FIN 46R).  FIN 46R states that companiesthat have exposure to the economic risks and potential rewards from anotherentity’s assets and activities have a controlling financial interest in avariable interest entity and should consolidate the entity, despite the absenceof clear control through a voting equity interest.  The consolidationrequirements apply to all special-purpose entities by the end of the firstreporting period ending after December 15, 2003.  FIN 46R shall beapplied to all variable interest entities by the end of the first reportingperiod ending after March 15, 2004, for enterprises that are not smallbusiness issuers or

 

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December 15,2004 for enterprises that are small business issuers.  The adoption of FIN46R did not have a material effect on the financial statements.

 

In November 2004, FASB issued Statement ofFinancial Accounting Standards (SFAS) No. 151 “Inventory Costs” whichamends the guidance in ARB No. 43, Chapter 4 “Inventory Pricing,” toclarify the accounting for abnormal amounts of idle facility expense, freight,handling costs, and wasted material (spoilage). Paragraph 5 pf ARB 43, Chapter4, previously stated that under some circumstances, items such as idle facilityexpense, excessive spoilage, double freight, and rehandling costs may be so abnormalas to require treatment as current period charges.” SFAS No. 151 requiresthat those items be recognized as current-period charges regardless of whetherthey meet the criterion of “so abnormal.” In addition, SFAS No, 151 requiresthat allocation of fixed production overheads to the costs of conversion bebased on the normal capacity of the production facilities.  SFAS No. 151shall be effective for inventory costs incurred during fiscal years beginningafter June 15, 2005. Earlier application is permitted for inventory costsincurred during fiscal years beginning after the date SFAS No. 151 wasissued. SFAS No. 151 shall be applied prospectively.  The Companydoes not expect the adoption of SFAS No. 151 to have a material effect onits financial statements.

 

In December 2004, FASB issued SFAS No. 153 “Exchangesof Nonmonetary Assets” amends APB Opinion No. 29, “Accounting forNonmonetary Transactions.” APB No. 29 is based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofthe assets exchanged. The guidance in that Opinion, however, included certainexceptions to that principle. SFAS No. 153 amends APB No. 29 toeliminate the exception for nonmonetary exchanges of similar productive assetsand replaces it with a general exception for exchanges of nonmonetary assetsthat do not have commercial substance. A nonmonetary exchange has commercialsubstance if the future cash flows of the entity are expected to changesignificantly as a result of the exchange.  SFAS No. 153 shall beeffective for nonmonetary asset exchanges occurring in fiscal periods beginningafter June 15, 2005. Earlier application is permitted for nonmonetaryasset exchanges occurring in fiscal periods beginning after the date SFAS No. 153was issued. SFAS No. 153 shall be applied prospectively.  The Companydoes not expect the adoption of SFAS No. 153 to have a material effect onits financial statements.

 

In December 2004, FASB issued SFAS No. 123(revised 2004), “Share-Based Payment”, that focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions.  This statement replaces SFAS No. 123, “Accountingfor Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees.”  Beginning with our quarterly period thatbegins January 1, 2006, we will be required to expense the fair value ofemployee stock options and similar awards.  As a public company, we areallowed to select from two alternative transition methods, each havingdifferent reporting implications.  The impact of SFAS No. 123R hasnot been determined at this time.

 

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# **ITEM7.  FINANCIAL STATEMENTS.**

 

The following FinancialStatements and Report of Independent Registered Public Accountant Firm thereonare included herein (page numbers refer to pages in this Report):

 
| Report  of Independent Registered Public Accounting Firm                                         |   |
|--------------------------------------------------------------------------------------------------|--------|
|                                                                                             |   |
| Balance Sheets as of December 31,  2004 and 2003                                            |   |
|                                                                                             |   |
| Statements of Operations for  the years ended December 31, 2004 and 2003                    |   |
|                                                                                             |   |
| Statements of  Stockholders’ Deficiency for the years ended December 31, 2004 and 2003 |   |
|                                                                                             |   |
| Statements of Cash Flows for  the years ended December 31, 2004 and 2003                    |   |
|                                                                                             |   |
| Notes to the  Financial Statements                                                               |   |

 

# **ITEM8.  CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.**

 

Not applicable.

 

**ITEM 8A. CONTROLS AND PROCEDURES.**

 

Management of the Companyhas evaluated, with the participation of the Chief Executive Officer and ChiefFinancial Officer of the Company, the effectiveness of the Company’s disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the fiscal year covered by this Annual Report on Form 10-KSB.  Based on that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer of the Company have concluded that theCompany’s disclosure controls and procedures as of the end of the fiscal yearcovered by this Annual Report on Form 10-KSB are effective to providereasonable assurance that information required to be disclosed by the Companyin the reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the rules andforms of the Securities and Exchange Commission.  However, due to the limited number of Companyemployees engaged in the authorization, recording, processing and reporting oftransactions, there is inherently a lack of segregation of duties.  The Company periodically assesses the costversus benefit of adding the resources that would remedy or mitigate thissituation and currently, does not consider the benefits to outweigh the costsof adding additional staff in light of the oversight of the financialstatements by senior management.

 

Management of the Companyhas also evaluated, with the participation of the Chief Executive Officer andChief Financial Officer of the Company, any change in the Company’s internalcontrol over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) that occurred during the fourth fiscalquarter of the fiscal year covered by this Annual Report on Form 10-KSB.  There

 

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was no change in theCompany’s internal control over financial reporting identified in thatevaluation that occurred during the fourth fiscal quarter of the fiscal yearcovered by this Annual Report on Form 10-KSB that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

**ITEM 8B.  UNREPORTED8-K EVENTS.**

 

Not applicable.

 

**PART III**

 

# **ITEM9.  DIRECTORS, EXECUTIVE OFFICERS,PROMOTERS AND CONTROL PERSONS, COMPLIANCE WITH SECTION 16(A) OF THEEXCHANGE ACT.**

## ** **

## **Directors and ExecutiveOfficers of the Registrant**

 
| **Name**            | ** ** | **Age** | ** ** | **Position**                                                                        |
|---------------------|------------|---------|------------|-------------------------------------------------------------------------------------|
|                |       |    |       |                                                                                |
| Richard F. McNamara |       | 72      |       | Chairman of the Board and Director                                                  |
|                |       |    |       |                                                                                |
| James L. Reissner   |       | 65      |       | Director, Former Chief Executive Officer, President,  and Secretary                 |
|                |       |    |       |                                                                                |
| Michael J. Tate     |       | 66      |       | Director and Former President, Chief Executive  Officer and Chief Financial Officer |
|                |       |    |       |                                                                                |
| Jon L. Reissner     |       | 35      |       | Chief Executive Officer, President, and Secretary                                   |
|                |       |    |       |                                                                                |
| Joseph A. Petrich   |       | 44      |       | Treasurer and Chief Financial Officer                                               |

 

*Mr. McNamara*has served as Chairman of the Board and as a director of the Company since October 2000.  Since 1978, Mr. McNamara has been theowner of Activar, Inc., a company that operates as sixteen manufacturingdivisions.  Mr. McNamara has been adirector of various other public companies including Rimage Corporation and TCFFinancial Corporation and is a member of the University of Minnesota Board ofRegents.  Mr. McNamara is a graduateof the University of Minnesota.

 

*Mr. James L. Reissner*hasserved as a director of the Company since October 2000.  From September 2001 to August 2004,Mr. Reissner served as the Chief Executive Officer of the Company, and asPresident of the Company from October 2002 until August 2004.  He served as Secretary of the Company from October 2000until August 2004.  Mr. Reissneralso served as Chief Financial Officer from September 2001 to March 2002.  Mr. Reissner has been President ofActivar, Inc. since January 1996 and served as Chief FinancialOfficer of Activar from 1992 until becoming President.  Mr. Reissner is a director of severalother public companies, including the Chairman of the Board of RimageCorporation and a member of the Board of Winland Electronics.  Mr. Reissner is a graduate of MacalesterCollege in Minnesota.

 

*Mr. Tate*has served as a director of the Company since April 1998.  From April 1998 to September 2001, Mr. Tateserved as Chief Executive Officer and President of the Company.  From April 1998 to December 1998and from December 1999 to September 2001, Mr. Tate also servedas the Chief Financial Officer of the Company. Previously, he served as Vice President/Chief Operating Officer ofMinnesota Valley Engineering from August 1996 until joining theCompany.  Prior to serving at

 

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Minnesota ValleyEngineering, Mr. Tate was employed in the Consulting divisions of Coopers &Lybrand and KPMG LLP. 

 

*Mr. Jon L. Reissner* hasserved as President, Chief Executive Officer and Secretary since August,2004.  Formerly and since May 2002,he was the Company’s Director of Finance. Since May 2002, Mr. Reissner has served on a part-timeconsulting basis for Activar, Inc., performing corporate and real estatefinancing services.  From November 2001to May 2002, he was employed by Vermillion State Bank in Hastings,Minnesota, performing commercial lending and general banking functions.  From 1992 to 2000, Mr. Reissner servedas a Director of Capital Markets and traded Fixed Income Securities andderivatives and also structured Asset Backed Securities for GMAC-RFC, adivision of General Motors.  Mr. Reissneris also the Chairman of the St. Johns University Private Investment FundAdvisory Board.  Mr. Reissnerreceived his Bachelor of Science degree in Economics from St. Johns Universityin Collegeville, Minnesota and his Masters of Business Administration from theUniversity of St. Thomas.  

 

*Mr. Petrich*has served asTreasurer and Chief Financial Officer since March 2002.  Mr. Petrich also serves as GeneralManager of the Activar Plastics Group, a subdivision of Activar, Inc.  The Activar Plastics Group includes SeelyePlastics, Eiler Plastics, Circuit Chemistry, and Afton Plastics.  He joined Seelye Plastics as OperationsManager in 1997 and became General Manager in 1998.  Prior to joining Seelye, Mr. Petrich wasa controller for Frank W. Griswold and Companies from 1980 through 1994.  He has served as General Manger/VicePresident of Sentry Technologies and Sentry Metal Forming from 1994 through1995, and served as Chief Financial Officer for Famous Dave’s of America from1995 through 1996.  Mr. Petrich is agraduate from Bethel College with a business management degree. 

 

Executive officers are elected annually and serve atthe discretion of the Board of Directors.

 

The Company also believes that the following persons,who are not executive officers or employees of the Company but who areassisting the Company at the request of Activar, Inc., the largestshareholder of the Company, may make a significant contribution to the businessof the Company.

 

Kirby Bayerle, 51, was appointed as Vice President –Sales and Marketing of the Company in September 2002.  Since 2003, Mr. Bayerle has been theGeneral Manager of the Activar Construction Products Group, a subdivision ofActivar, Inc.  The ActivarConstruction Products Group includes JL Industries, Hiawatha Inc., SamsonProducts, Air Louvers, Inc., Thomas Industries, and Aztec Inc.  Mr. Bayerle had served as GeneralManager of JL Industries, Hiawatha, and Aztec and Vice President of Sales and Marketingfor Air Louvers Inc. and Samson Products since 1996.  Mr. Bayerle has been with Activar, Inc.since 1978 and is a graduate of the University of Minnesota with a degree inBusiness Administration and Economics.

 

Duane Bryngelson, 42, wasappointed Vice President - Operations of the Company in September 2002.  Mr. Bryngelson is the General Manager ofBending Technologies and Comfort Ride, members of the Activar group.  Mr. Bryngelson joined BendingTechnologies in 1995 as the Director of Operations and took over as Director ofSales as well in 1997, before receiving his current and continuing role asGeneral Manager in 1998.  Mr. Bryngelsonserved as President of D & D Technical Design from 1991 to 1993 beforejoining Bending Technologies.  

 

***FamilyRelationships***

 

Jon L. Reissner, thecurrent President and Chief Executive Officer of the Company, is the son ofJames L. Reissner, a director and former President and Chief Executive Officerof the Company.  

 

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**Audit Committee; Audit Committee Financial Expert**

 

The Board of Directors of the Company has an AuditCommittee composed of James L. Reissner and Michael J. Tate.  The Audit Committee provides assistance tothe Board in satisfying its fiduciary responsibilities relating to theaccounting, auditing, operating and reporting practices of the Company. TheAudit Committee reviews the Company’s annual financial statements, theselection and work of the Company’s independent accountants and the adequacy ofinternal controls for compliance with corporate policies and directives. TheAudit Committee does not have a written charter.

 

Because Mr. Reissner is a former executiveofficer and is a principal shareholder of the Company, Mr. Reissner wouldnot be considered “independent” under the Securities and Exchange Commissiondefinition of that term.

 

The Board of Directors has reviewed the education,experience and other relevant qualifications of Mr. Tate and hasdetermined that Mr. Tate meets the Securities and Exchange Commissiondefinition of an “audit committee financial expert” and would also beconsidered “independent” under the Securities and Exchange Commissiondefinition of that term.

 

The Board and Audit Committee have not yet establishedprocedures for the handling of complaints regarding accounting, internalaccounting controls or auditing matters.

 

## **Compliance with Section 16(a) ofthe Exchange Act**

 

Section 16(a) of the Securities Exchange Actof 1934 requires the directors and executive officers of the Company and allpersons who beneficially own more than 10% of the outstanding shares of commonstock of the Company to file with the Securities and Exchange Commissioninitial reports of ownership and reports of changes in ownership of the commonstock.  Executive officers, directors andgreater than 10% beneficial owners are also required to furnish the Companywith copies of all Section 16(a) forms they file.  Based upon a review of the copies of suchreports furnished to the Company and upon other information known to theCompany, the Company believes that all filing requirements applicable to itsdirectors, executive officers and beneficial owners of more than 10% of theCompany’s outstanding shares of common stock were complied with during thefiscal year ended December 31, 2004.

 

**Code of Ethics**

 

The Company has adopted a Code of Ethics and BusinessConduct that applies to all directors, officers and employees, including theCompany’s Chief Executive Officer, Chief Financial Officer and Controller.  In addition, the Company has a supplementalCode of Ethics for Senior Financial****Executives.  The Company’s Code of Ethics and BusinessConduct and Code of Ethics for Senior Financial Executives are set forth asexhibits to this Annual Report on Form 10-KSB.  In addition, copies of the Company’s Code ofEthics and Business Conduct and Code of Ethics for Senior Financial Executivesmay be obtained from the Company upon request to Jon L. Reissner, in hiscapacity as Secretary of the Company.  

 

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# **ITEM10.  EXECUTIVE COMPENSATION.**

 

## **Summary of Cash and Other Compensation**

 

The following tableprovides summary information concerning cash and non-cash compensation paid toor earned by the Company’s Chief Executive Officer and executive officers ofthe Company who received or earned cash and non-cash salary and bonus of morethan $100,000 for the fiscal year ended December 31, 2004.

 

**SummaryCompensation Table**

 
| ** **                                                                                    | ** ** | **Annual  Compensation** | ** ** | **Long-Term  Compensation** | ** ** | ** **                              | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|
| **Name and Principal Position**                                                               | ** ** | **Year**                 | ** ** | **Salary ($)**              | ** ** | **Securities  Underlying  Options (#)** | ** ** | **All Other  Compensation ($)** | ** ** |
| Jon L. Reissner  (1)  Chief Executive Officer and President                              |       | 2004                     |       | 100,000                     |       | 100,000                                 |       | -0- |   |
|                                                                                          |       | 2003                     |       | 80,000                      |       | 25,000                                  |       | -0- |   |
|                                                                                          |       | 2002                     |       | 60,000                      |       | 25,000                                  |       | -0- |   |
|                                                                                          |       |                     |       |                        |       |                                    |       |   |   |
| Joseph A. Petrich(2)  Chief Financial Officer and Treasurer                                   |       | 2004                     |       | -0-                         |       | 100,000                                 |       | -0- |   |
|                                                                                          |       | 2003                     |       | -0-                         |       | 25,000                                  |       | -0- |   |
|                                                                                          |       | 2002                     |       | -0-                         |       | 25,000                                  |       | -0- |   |
|                                                                                          |       |                     |       |                        |       |                                    |       |   |   |
| James L. Reissner (3)*Former Chief Executive Officer,  President and Chief Financial Officer* |       | 2004                     |       | -0-                         |       | 10,000                                  |       | -0- |   |
|                                                                                          |       | 2003                     |       | -0-                         |       | -0-                                     |       | -0- |   |
|                                                                                          |       | 2002                     |       | -0-                         |       | 50,000                                  |       | -0- |   |

 

----

| (1)    |   | Jon Reissner became  President and Chief Executive Officer in August, 2004                                                                                                                                                                                                               |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                     |
| (2)    |   | Joseph Petrich became Chief Financial Officer in  March 2002.                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                     |
| (3)    |   | James Reissner became Chief Executive Officer and  Chief Financial Officer in September 2001, and President in  October 2002. Mr. Reissner served as Chief Financial Officer until  March 2002, and as Chief Executive Officer and President until August 2004. |

 

## **Option Grants**

 

The following table sets forth information withrespect to the grants of options to our Chief Executive Officer and other namedexecutive officers of the Company during the fiscal year ended December 31,2004.

 

23

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| **Name**          | ** ** | **Number of  Options  Granted** | ** ** | **Percent total  options granted  to employees in  fiscal 2004** | ** ** | **Exercise/base  price ($)** | ** ** | **Expiration Date** | ** ** |
|-------------------|------------|---------------------------------|------------|------------------------------------------------------------------|------------|------------------------------|------------|---------------------|------------|
| Jon L. Reissner   |       | 100,000                         |       | 23.0                                                             |       | $                            | 1.03       |                | 4/7/2014   |   |
| Joseph A. Petrich |       | 100,000                         |       | 23.0                                                             |       | $                            | 1.03       |                | 4/7/2014   |   |
| James L. Reissner |       | 10,000                          |       | 2.3                                                              |       | $                            | 1.03       |                | 4/7/2014   |   |

 

## **Option Exercises and Values of Unexercised Options**

 

The following table setsforth information regarding options to purchase Common Stock of the Companyexercised by the named executive officers of the Company during the fiscal yearended December 31, 2004 and the number and value of unexercised optionsheld by them at that date.

 

**OptionExercises During Fiscal Year Ended December 31, 2004 and Fiscal Year End Option Values**

 
| **Name**          | ** ** | **Shares  Acquired on  Exercise (#)** | ** ** | **Value  Realized ($)** | ** ** | **Number of  Unexercised  Options  At FY-end (#)  Exercisable/  Unexercisable** | ** ** | **Value of Unexercised  in-the-Money Options  at FY-end ($)  Exercisable/  Unexercisable (1)** | ** ** |
|-------------------|------------|---------------------------------------|------------|-------------------------|------------|---------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|
| ** **        | ** ** | ** **                            | ** ** | ** **              | ** ** | ** **                                                                      | ** ** | ** **                                                                                     | ** ** |
| Jon L. Reissner   |       | —                                |       | —                  |       | 75,001/ 74,999                                                                  |       | $17,244 / $31,557                                                                              |       |
|              |       |                                  |       |                    |       |                                                                            |       |                                                                                           |       |
| Joseph A. Petrich |       | —                                |       | —                  |       | 105,001 / 74,999                                                                |       | $17,817 / 31,557                                                                               |       |

 

----

(1)          These amounts representthe difference between the exercise price of the in-the-money options and themarket price of the Company’s Common Stock on December 30, 2004 (the lasttrading date before December 31, 2004). The last reported sale on the OTC Bulletin Board on that date was at$0.70.  Options are in-the-money if themarket value of the shares covered thereby is greater than the option exerciseprice.

 

***Director Compensation***

 

On April 7, 2004,each of the directors, Richard McNamara, James Reissner and Michael Tate,received options to purchase 10,000 shares of common stock at an exercise priceof $1.03 per share.  Each option vests inthree annual installments, beginning on the date of grant.

 

***Employment Contracts/Termination of Employment/Change in Control***

 

The Company does not have any employment contracts inplace with any of its employees.

 

# **ITEM11.  SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT.**

 

***Principal Shareholders and Beneficial Ownership of Management***

 

The following table sets forth information known tothe Company with respect to the beneficial ownership of each class of theCompany’s capital stock as of March 24, 2005 for (1) each personknown by the Company to beneficially own more than 5% of any class of theCompany’s voting securities, (2) each of the executive officers named inthe Summary Compensation Table under the heading “Executive

 

24

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Compensation,” (3) each of the Company’s directors and (4) allof the Company’s executive officers and directors as a group.  Except as otherwise indicated, the Companybelieves that each of the beneficial owners of the Company’s capital stock listedbelow, based on information provided by these owners, has sole investment andvoting power with respect to its shares, subject to community property lawswhere applicable.

 
| ** **                                                                          | ** ** | **Common Stock** | ** ** | **Series A  Preferred Stock** | ** ** | **Common Stock  and Common** | ** ** | **Percent of  Total  Voting** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------|------------|------------------------------------|------------|------------------------------|------------|-------------------------------|------------|
| **Name**                                                                            | ** ** | **Number**       | ** ** | **Percent**                        | ** ** | **Number**                   | ** ** | **Percent**                   | ** ** | **Stock Equivalents** | ** ** | **Power** | ** ** |
| Jon L. Reissner  410 11th Avenue South  Hopkins, MN 55343                           |       | 108,334          | (1)        | 1.2                                | %          | —                       |       | 0.0                           | %          | 108,334 |   | 1.1 | % |
|                                                                                |       |             |       |                               |       |                         |       |                          |       |   |   |   |   |
| Joseph A. Petrich  410 11th Avenue South  Hopkins, MN 55343                         |       | 138,334          | (2)        | 1.5                                | %          | —                       |       | 0.0                           | %          | 138,334 |   | 1.3 | % |
|                                                                                |       |             |       |                               |       |                         |       |                          |       |   |   |   |   |
| Richard F. McNamara  7808 Creekridge Circle  Suite 200  Minneapolis, MN 55439  |       | 2,501,667        | (3)        | 26.8                               | %          | 625,000                      |       | 62.5                          | %          | 3,126,667 |   | 30.2 | % |
|                                                                                |       |             |       |                               |       |                         |       |                          |       |   |   |   |   |
| James L. Reissner  7808 Creekridge Circle  Suite 200  Minneapolis, MN 55439    |       | 3,119,167        | (4)        | 34.3                               | %          | 875,000                      | (5)        | 87.5                          | %          | 3,994,167 |   | 39.6 | % |
|                                                                                |       |             |       |                               |       |                         |       |                          |       |   |   |   |   |
| Michael J. Tate  410 11th Avenue South  Hopkins, MN 55343                           |       | 790,070          | (6)        | 8.6                                | %          | 125,000                      |       | 12.5                          | %          | 915,070 |   | 9.0 | % |
|                                                                                |       |             |       |                               |       |                         |       |                          |       |   |   |   |   |
| All executive officers  and directors as a group  (5 persons)                       |       | 4,470,072        | (7)        | 45.8                               | %          | 1,000,000                    |       | 100.0                         | %          | 5,470,072 |   | 56.0 | % |
|                                                                                |       |             |       |                               |       |                         |       |                          |       |   |   |   |   |
| Perkins Capital  Management, Inc.  730 East Lake Street  Wayzata, MN55391-1769 |       | 680,150          | (8)        | 7.5                                | %          | —                       |       | 0.0                           | %          | 680,150 |   | 6.8 | % |
|                                                                                |       |             |       |                               |       |                         |       |                          |       |   |   |   |   |
| Activar, Inc.  Suite 200  7808 Creekridge Circle  Minneapolis, MN55439    |       | 2,187,500        | (9)        | 24.2                               | %          | 625,000                      |       | 62.5                          | %          | 2,812,500 |   | 28.0 | % |

 

----

| (1)    |   | Includes 108,333 shares  of common stock that Mr. Jon Reissner has the right to acquire within 60  days upon the exercise of options. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                       |
| (2)    |   | Includes options to  purchase 138,334 shares of common stock which Mr. Petrich has the right  to acquire within 60 days.              |

 

25

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(3)                                  Doesnot include 625,000 shares of Series A Preferred Stock held by Activar, Inc.,which is convertible into 625,000 shares of common stock, but does include (i) 56,667shares of common stock that Mr. McNamara has the right to acquire within60 days and (ii) 250,000 shares of common stock that Mr. McNamara hasthe right to acquire within 60 days upon the exercise of warrants, (iii) 2,187,500shares of common stock held by Activar, Inc. and (iv) 7,500 sharesheld by Activar Properties, Inc.  Mr. McNamarais a principal and Chief Executive Officer of both Activar, Inc. and ActivarProperties, Inc.

 

(4)                                  Doesnot include 250,000 shares of Series A Preferred Stock which isconvertible into 250,000 shares of Common Stock, but includes (i) optionsto purchase 56,667 shares of common stock that Mr. Reissner has the rightto acquire within 60 days and (ii) 2,187,500 shares held by Activar, Inc.,of which Mr. Reissner is President.

 

(5)                                  Includes625,000 shares owned by Activar, Inc., of which Mr. Reissner isPresident.

 

(6)                                  Doesnot include 125,000 shares of Series A Preferred Stock, which isconvertible into an aggregate of 125,000 shares of common stock, but includesoptions to purchase 112,725 shares of common stock that Mr. Tate has theright to acquire within 60 days.  

 

(7)                                  Includesan aggregate of 281,061 shares of common stock and 250,000 shares of commonstock that executive officers and directors have the right to acquire within 60days upon the exercise of options and warrants, respectively.  

 

(8)                                  Accordingto a Schedule 13G/A, dated February 10, 2005, as filed with the Securitiesand Exchange Commission, Perkins Capital Management, Inc. has sole votingpower with respect to 105,000 of such shares, and sole dispositive power overall such shares.  

 

(9)                                  Doesnot include 625,000 shares of Series A Preferred Stock convertible into anaggregate of 625,000 shares of common stock.

 

***Equity Compensation Plan Information ***

 

The following table below presents the Company’sEquity Compensation Plan information as of December 31, 2004.

 
| **Plan Category**                                           | ** ** | **Number of securities to be  issued upon exercise of  outstanding options, warrants  and rights (a)** | ** ** | **Weighted average  exercise price of  outstanding options,  warrants and rights (b)** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a)) (c)** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation  plans approved by security holders     |       | 1,268,579                                                                                              |       | $                                                                                      | 0.68       |                                                                                                                                                      | 1,183,250  |   |
| Equity compensation  plans not approved by security holders |       | —                                                                                                 |       | $                                                                                      | —     |                                                                                                                                                      | —     |   |
| Total                                                       |       | 1,268,579                                                                                              |       | $                                                                                      | 0.68       |                                                                                                                                                      | 1,183,250  |   |

 

The Company has two equity compensation planscurrently in effect: its 2001 Stock Option Plan and its 2001 Employee StockPurchase Plan. The Company also has its 1997 Non-Employee Directors Stock Plan.

 

26

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# **ITEM12.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS.**

 

Since 2001, the Companyhas borrowed monies from Activar, Inc. to fund operations.  These loans are due on demand and accruedinterest at 10% through September 2002, at which time the interest ratewas lowered to 6%.  This lendingarrangement was converted into a revolving credit arrangement with Richard F.McNamara and affiliates on January 1, 2003 with interest remaining at 6%.The Company believes that the terms and conditions of the promissory notesgiven to Activar are at least as favorable as the terms and conditions on whichthe Company could have obtained credit from an unaffiliated third party.  As of December 31, 2004, the Company haddrawn $4,755,776 since 2001 under this arrangement.

 

On January 21, 2002, the Company borrowed$500,000 from Richard F. McNamara, a director, Chairman and major shareholderof the Company, on a term note bearing interest at 12%. The interest rate waslowered to 8% in October 2002. Interest is payable monthly, with the principal balance due and payableon January 10, 2005.  This note wasrequired to be restructured in the fifth amendment to the Company’s amendmentand restated credit agreement as required by the senior lender.  The results of this restructuring arereflected in the Notes to Financial Statements. Mr. McNamara received warrants for the purchase of 250,000 sharesof Common Stock of the Company.  Proceedsfrom this note were used to pay off $400,000 in debentures, which had beenissued in 1998 and 1999 and accrued interest thereon.  The Company believes that the terms andconditions of this financing are substantially the same as the terms andconditions on which the Company could have obtained similar credit from anunaffiliated third party.

 

On February 25,2003, MagStar Technologies, Inc. sold and leased back its headquarters andmanufacturing facility in Hopkins, Minnesota. The purchaser was Hopkins Eleventh Avenue LLC (“Eleventh Avenue”), awholly owned subsidiary of Activar Properties, Inc., which in turn is whollyowned by Mr. McNamara.  The purchaseprice for the building and property was $3,700,000.  The Company entered into a 6.5-year grosslease with Eleventh Avenue for the building and property at a monthly cost of$34,000 increasing to $44,436 per month. proceeds of $1,001,397 realized by theCompany in the transaction were applied to reduce the Company’s debt to ActivarProperties, Inc. and affiliates. The Company’s outstanding balance to Activar Properties, Inc. andother affiliates of Mr. McNamara was approximately $5,512,918 as of February 28,2003.  James L. Reissner, the Presidentof Activar Properties, Inc., is also a director and shareholder of theCompany.  The Board of Directors of theCompany authorized the transaction in order to reduce the indebtedness of theCompany, provide working capital and improve cash flow.  The transaction with Eleventh Avenue wasdetermined to be on better terms than could be obtained by the Company directlyfrom unaffiliated financing sources.  Thepurchase price was based upon an independent appraisal of the value of theproperty and building obtained by the bank which provided financing to EleventhAvenue in connection with the transaction.

 

Due to the fifth amendment to the Company’s amendedand restated credit agreement, the Company was required by the bank torestructure this lease in a manner which is favorable to the Company, which isreflected in the Notes to Financial Statements. Effective April 1, 2004, the Company and Eleventh Avenue amendedthe lease whereby the lease payments from April 1, 2004 to December 31,2005 were waived.  The Company willresume monthly payments in 2006 according to the original lease.  

 

Rent expense on the leasewas $374,018 and $392,390 for the years ended December 31, 2004 and 2003,respectively.  Included in rent expenseis deferred rent of $272,018 for the year ended December 31, 2004 as aresult of the April 1, 2004 amendment.

 

27

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On August 13, 2004, the Company negotiated afifth amendment of its amended and restated senior credit agreement with USBancorp on the line of credit that is retroactive to June 30, 2004.  The extended asset-based line of credit bearsinterest at the bank’s reference rate plus two and one half percent, hasavailability of $1,200,000 subject to a borrowing base limitation of 80% of theCompany’s eligible accounts receivable plus 40% of raw materials and 30% offinished goods and will expire on June 30, 2005. The credit facilities arecollateralized by substantially all the assets of the Company.

 

As a condition toobtaining the amended line of credit, MagStar was required to restructureportions of the Company’s liabilities and lease agreements with relatedparties.  As a result, on August 13,2004, the Company amended its building and equipment leases with HopkinsEleventh Ave, LLC and Activar Properties, respectively, and $4,300,754 ofrelated party debt has been extinguished without additional consideration.Because the transaction is between related parties, the gain on theextinguishment of debt will be classified as a contribution to equity in June 2004,and will not affect future statements of operations.  The amended and reduced building andequipment leases will positively affect the statement of operations on anongoing basis.  The reduced related partydebt was restructured with a 3% interest rate and will reduce interest expense,also positively affecting the Company’s statements of operations in thefuture.  The Company believes that the 3%interest rate charged on the restructured debt had a positive influence on thebank’s decision to amend the credit agreement and extend it to June 2005.

 

**PART IV**

 

# **ITEM13. EXHIBITS AND REPORTS ON FORM 8-K.**

 

## **(a)**                                  Exhibits

 

The exhibits to thisReport are listed in the Exhibit Index on pages [48 to 52] of thisReport.

 

**ITEM 14.  PRINCIPALACCOUNTING FEES AND SERVICES.**

 

***Audit Fees***

 

Audit fees billed to the Company by Virchow Krause &Company, LLP during the fiscal year ended December 31, 2004 and for reviewof our quarterly report on Form 10-QSB and annual report on Form 10-KSBfor the same fiscal year totaled $38,640.

 

***Financial Information Systems Design and Implementation Fees***

 

The Company did not engage Virchow Krause &Company, LLP to provide advice regarding financial information systems designand implementation during the last fiscal year.

 

***All Other Fees***

 

Fees billed or expected to be billed to us by VirchowKrause & Company, LLP for all other non-audit services, includingtax-related services, provided during the last fiscal year totaled****$7,170.

 

28

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**AuditCommittee**

 

The audit committee meets prior to filing of anyQuarterly Report on Form 10-QSB or Annual Report on Form 10-KSB toapprove those filings.  In addition, the committee meets to discuss auditplans and anticipated fees for audit and tax work prior to the commencement ofthat work.  Approximately 100% of all fees paid to our independentauditors are pre-approved by the audit committee.

**SIGNATURES**

 

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

 
| Dated: April 14, 2005 | MAGSTAR TECHNOLOGIES, INC. |
|----------------------------|----------------------------|
|                       |                       |
|                       |                       | /s/ Jon L. Reissner |   |
|                       |                       | Jon L. Reissner |
|                       |                       | President and Chief Executive Officer. |

 

In accordance with the Exchange Act, this report has been signed belowby the following persons on behalf of the registrant and in the capacities andon the dates indicated.

 
| **Signature**              | ** ** | **Title**                     | ** ** | **Date**            |
|----------------------------|------------|-------------------------------|------------|---------------------|
|                       |       |                          |       |                |
| /s/ Richard F. McNamara    |       | Chairman of the Board and     |       | April 14, 2005 |
| Richard F. McNamara        |       | Director                      |       |                |
|                       |       |                          |       |                |
| /s/ James L. Reissner      |       | Director                      |       | April 14, 2005 |
|                       |       |                          |       |                |
| /s/ Michael J. Tate        |       | Director                      |       | April 14, 2005 |
| Michael J. Tate            |       |                          |       |                |
|                       |       |                          |       |                |
| /s/ Jon L. Reissner        |       | President and Chief Executive |       | April 14, 2005 |
|                       |       | Officer                       |       |                |
|                       |       |                          |       |                |
| /s/ Joseph A. Petrich      |       | Treasurer and Chief Financial |       | April 14, 2005 |
| Joseph A. Petrich          |       | Officer (Principal Financial  |       |                |
|                       |       | Officer)                      |       |                |
|                       |       |                          |       |                |
| /s/ Jacqueline R. Mitchell |       | Controller                    |       | April 14, 2005 |
| Jacqueline R. Mitchell     |       |                          |       |                |

 

29

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**REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

 

Audit Committee,Stockholders and Board of Directors

MagStarTechnologies, Inc.

Hopkins,Minnesota

 

We have auditedthe accompanying balance sheets of MagStar Technologies, Inc., as of December 31,2004 and 2003 and the related statements of operations, stockholders’deficiency and cash flows for the years then ended.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted ouraudits in accordance with auditing standards of the Public Company AccountingOversight Board (United States).  Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In our opinion,the financial statements referred to above present fairly, in all materialrespects, the financial position of MagStar Technologies, Inc. as of December 31,2004 and 2003 and the results of its operations and cash flows for the yearsthen ended in conformity with U.S. generally accepted accounting principles.

 

The accompanyingfinancial statements have been prepared assuming that the Company will continueas a going concern.  As discussed in Note1 to the financial statements, the Company has suffered recurring losses fromoperations and its total liabilities exceed its total assets.  This raises substantial doubt about theCompany’s ability to continue as a going concern.  Management’s plans in regard to these mattersare also described in Note 1.  Thefinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

 

 
|                   | /s/ Virchow, Krause & Company, LLP |   |
|------------------------|---------------------------------------------|--------|
|                   |                                        |   |
|                   |                                        |   |
| Minneapolis, Minnesota |                                        |   |
| March 4, 2005     |                                        |   |

 

30

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MagStar Technologies, Inc. 

Balance Sheets

At December 31, 2004 and 2003

 
| ** **                                                                                                                                                                                  | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| **ASSETS**                                                                                                                                                                                  |       |        |       |        |       |
| Current Assets:                                                                                                                                                                             |       |        |       |        |       |
| Cash                                                                                                                                                                                        |       | $           | 500        |        | $          | 500 |   |
| Accounts receivable,  net                                                                                                                                                                   |       | 583,401     |       | 723,413     |       |
| Inventories, net                                                                                                                                                                            |       | 1,174,871   |       | 1,074,242   |       |
| Other current assets                                                                                                                                                                        |       | 64,637      |       | 73,731      |       |
| Total current assets                                                                                                                                                                        |       | 1,823,409   |       | 1,871,886   |       |
|                                                                                                                                                                                        |       |        |       |        |       |
| Property, plant and  equipment, net                                                                                                                                                         |       | 37,991      |       | 52,855      |       |
| Patents                                                                                                                                                                                     |       | 13,530      |       | 11,261      |       |
| Total assets                                                                                                                                                                                |       | $           | 1,874,930  |        | $          | 1,936,002 |   |
|                                                                                                                                                                                        |       |        |       |        |       |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIENCY**                                                                                                                                           |       |        |       |        |       |
| Current Liabilities:                                                                                                                                                                        |       |        |       |        |       |
| Senior debt                                                                                                                                                                                 |       | $           | 708,463    |        | $          | 802,240 |   |
| Capital lease  obligations                                                                                                                                                                  |       | 80,129      |       | 126,754     |       |
| Checks issued in excess  of cash in bank                                                                                                                                                    |       | 77,960      |       | 20,180      |       |
| Accounts payable to  related parties                                                                                                                                                        |       | 60,205      |       | 820,411     |       |
| Notes payable to  related parties                                                                                                                                                           |       | 2,746,154   |       | 5,703,689   |       |
| Accounts payable                                                                                                                                                                            |       | 365,422     |       | 503,995     |       |
| Accrued expenses                                                                                                                                                                            |       | 336,617     |       | 400,813     |       |
| Short term deferred  gain on sale - leaseback equipment                                                                                                                                     |       | 155,576     |       | 155,576     |       |
| Short term deferred gain  on sale - leaseback building                                                                                                                                      |       | 331,978     |       | 331,978     |       |
| Total current  liabilities                                                                                                                                                                  |       | 4,862,504   |       | 8,865,636   |       |
|                                                                                                                                                                                        |       |        |       |        |       |
| Long-Term Liabilities:                                                                                                                                                                      |       |        |       |        |       |
| Deferred gain on sale –  leaseback equipment, net of current portion                                                                                                                   |       | 311,152     |       | 466,728     |       |
| Deferred gain on sale –  leaseback building, net of current portion                                                                                                                    |       | 1,217,252   |       | 1,549,229   |       |
| Deferred Rent                                                                                                                                                                               |       | 353,547     |       | 54,478      |       |
| Deposits                                                                                                                                                                                    |       | 2,000       |       | 10,000      |       |
| Other liabilities                                                                                                                                                                           |       | 35,952      |       | 23,845      |       |
|                                                                                                                                                                                        |       |        |       |        |       |
| Total Liabilities                                                                                                                                                                           |       | 6,782,407   |       | 10,969,916  |       |
|                                                                                                                                                                                        |       |        |       |        |       |
| Stockholders’ deficiency:                                                                                                                                                              |       |        |       |        |       |
| Preferred stock, par  value $.1875 per share, authorized 2,500,000 shares; 1,000,000 issued and  outstanding                                                                                |       | 187,500     |       | 187,500     |       |
| Common stock, par value  $.1875 per share, authorized 30,000,000 shares; issued and outstanding  9,040,173 shares at December 31, 2004 and 9,040,173 shares at December 31,  2003 |       | 1,695,032   |       | 1,695,032   |       |
| Additional paid-in  capital                                                                                                                                                                 |       | 22,420,483  |       | 18,002,729  |       |
| Deferred compensation                                                                                                                                                                       |       | (78,000     | )          | —      |       |
| Accumulated deficit                                                                                                                                                                         |       | (29,132,492 | )          | (28,919,175 | )          |
|                                                                                                                                                                                        |       |        |       |        |       |
| Total stockholders’  deficiency                                                                                                                                                        |       | (4,907,477  | )          | (9,033,914  | )          |
| Total liabilities and  stockholders’ deficiency                                                                                                                                        |       | $           | 1,874,930  |        | $          | 1,936,002 |   |

 

The accompanying notes are an integral part of the financialstatements.

 

31

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MagStar Technologies, Inc. 

Statements ofOperations

For the years ended December 31, 2004 and 2003

 
| ** **                                               | ** ** | **2004**  | ** ** | **2003**   | ** ** |
|----------------------------------------------------------|------------|-----------|------------|------------|------------|
|                                                     |       |      |       |       |       |
| Net Sales                                                |       | $         | 7,350,319  |       | $          | 6,230,898 |   |
| Cost of sales                                            |       | 6,296,416 |       | 5,699,377  |       |
|                                                     |       |      |       |       |       |
| Gross profit                                             |       | 1,053,903 |       | 531,521    |       |
|                                                     |       |      |       |       |       |
| Selling, general and  administrative expenses            |       |      |       |       |       |
| Gains on sale –  leasebacks                         |       | (487,554  | )          | (432,224   | )          |
| Other selling, general  and administrative expenses      |       | 1,570,107 |       | 1,178,845  |       |
|                                                     |       |      |       |       |       |
| Total selling, general  and administrative expenses, net |       | 1,082,553 |       | 746,621    |       |
|                                                     |       |      |       |       |       |
| Operating loss                                           |       | (28,650   | )          | (215,100   | )          |
|                                                     |       |      |       |       |       |
| Other income (expense):                                  |       |      |       |       |       |
| Interest expense                                         |       | (238,194  | )          | (639,447   | )          |
| Gain on conversion of  senior debt for common stock      |       | —    |       | 1,205,000  |       |
| Other, net                                               |       | 53,527    |       | 194,710    |       |
|                                                     |       |      |       |       |       |
| Total other income  (expense), net                       |       | (184,667  | )          | 760,263    |       |
|                                                     |       |      |       |       |       |
| Net Income (loss)                                        |       | $         | (213,317   | )          | $          | 545,163 |   |
|                                                     |       |      |       |       |       |
| Net income (loss) per  share – basic                |       | $         | (0.02      | )          | $          | 0.06 |   |
| Net income (loss) per  share – diluted              |       | $         | (0.02      | )          | $          | 0.05 |   |
|                                                     |       |      |       |       |       |
| Weighted average common  shares outstanding - basic      |       | 9,040,173 |       | 8,860,995  |       |
| Weighted average common  shares outstanding - diluted    |       | 9,040,173 |       | 10,323,637 |       |

 

The accompanying notes are an integral part of the financialstatements.

 

32

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MagStar Technologies, Inc. 

Statements ofStockholders’ Deficiency

For the years ended December 31, 2004 and 2003

 
| ** **                                                        | ** ** | **Series A  Preferred  Stock  Shares** | ** ** | **Common  Stock  Par  Value** | ** ** | **Additional  Shares** | ** ** | **Par  Value** | ** ** | **Paid-in  Capital** | ** ** | **Deferred  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Total**  | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------|------------|------------------------|------------|----------------|------------|----------------------|------------|----------------------------|------------|--------------------------|------------|------------|------------|
|                                                              |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       |                     |       |       |       |
| Balances,  December 31, 2002                                 |       | 1,000,000                                   |       | $                             | 187,500    |                   | 8,740,173  |           | $          | 1,638,782            |       | $                          | 17,938,979 |                     |       |       | $          | (29,464,338 | ) | (9,699,077 | ) |
|                                                              |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       |                     |       |       |       |
| Conversion of senior  debt for Common stock                       |       |                                        |       |                          |       | 300,000                |       | 56,250         |       | 63,750               |       |                       |       |                     |       | 120,000    |       |
|                                                              |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       |                     |       |       |       |
| Net income                                                        |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       | 545,163                  |       | 545,163    |       |
|                                                              |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       |                     |       |       |       |
| Balances,  December 31, 2003                                 |       | 1,000,000                                   |       | 187,500                       |       | 9,040,173              |       | 1,695,032      |       | 18,002,729           |       |                       |       | (28,919,175              | )          | (9,033,914 | )          |
|                                                              |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       |                     |       |       |       |
| Deferred compensation  related to options issued to non-employees |       |                                        |       |                          |       |                   |       |           |       | 117,000              |       | (117,000                   | )          |                     |       |       |       |
|                                                              |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       |                     |       |       |       |
| Compensation expense on  options related to non-employees         |       |                                        |       |                          |       |                   |       |           |       |                 |       | 39,000                     |       |                     |       | 39,000     |       |
|                                                              |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       |                     |       |       |       |
| Forgiveness of related  party debt                                |       |                                        |       |                          |       |                   |       |           |       | 4,300,754            |       |                       |       |                     |       | 4,300,754  |       |
|                                                              |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       |                     |       |       |       |
| Net loss                                                          |       |                                        |       |                          |       |                   |       |           |       |                 |       |                       |       | (213,317                 | )          | (213,317   | )          |
| Balances,  December 31, 2004                                 |       | 1,000,000                                   |       | $                             | 187,500    |                   | 9,040,173  |           | $          | 1,695,032            | ** ** | $                          | 22,420,483 |                     | $          | (78,000    | )          | $ | (29,132,492 | ) | $ | (4,907,477 | ) |
|                                                                   |            |                                             |            |                               |            |                        |            |                |            |                      |            |                            |            |                          |            |            |            |  |  |  |  |  |  |

 

The accompanying notes are an integral part of the financialstatements.

 

33

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MagStar Technologies, Inc. 

Statements of CashFlows

For the years ended December 31, 2004 and 2003

 
| ** **                                                                              | ** ** | **2004** | ** ** | **2003**   | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------|------------|------------|------------|
| Cash flows from  operating activities:                                                  |       |     |       |       |       |
| Net income (loss)                                                                       |       | $        | (213,317   | )          | $          | 545,163 |   |
| Adjustments to  reconcile net income (loss) to net cash (used in) operating activities: |       |     |       |       |       |
|                                                                                    |       |     |       |       |       |
| Depreciation and  amortization                                                          |       | 43,104   |       | 128,183    |       |
| Gain on conversion of  senior debt for common stock                                     |       | —   |       | (1,205,000 | )          |
| Gain on sale-leaseback  Equipment                                                       |       | (155,576 | )          | (155,577   | )          |
| Gain on sale-leaseback  Building                                                        |       | (331,977 | )          | (276,649   | )          |
|                                                                                    |       |     |       |       |       |
| Deferred compensation  of non-employees                                                 |       | 39,000   |       | —     |       |
| Deferred equipment  leases                                                              |       | 96,003   |       | —     |       |
| Deferred Rent                                                                           |       | 272,018  |       | 54,478     |       |
| Changes in operating  assets and liabilities:                                           |       |     |       |       |       |
| Receivables                                                                             |       | 140,012  |       | 108,407    |       |
| Inventories                                                                             |       | (100,629 | )          | 222,010    |       |
| Other current assets                                                                    |       | (70,552  | )          | (32,234    | )          |
| Accounts payable                                                                        |       | 123,134  |       | (131,332   | )          |
| Accrued expenses                                                                        |       | 48,665   |       | (294,684   | )          |
| Accounts payable,  related parties                                                      |       | (55,974  | )          | (711,758   | )          |
| Other liabilities and  deposits                                                         |       | 4,107    |       | 24,227     |       |
|                                                                                    |       |     |       |       |       |
| Net cash (used in)  operating activities                                                |       | (161,982 | )          | (1,724,766 | )          |
|                                                                                    |       |     |       |       |       |
| Cash flows from  investing activities:                                                  |       |     |       |       |       |
| Proceeds from sale of  building and land and related improvements                       |       | —   |       | 3,700,000  |       |
| Purchase of equipment                                                                   |       | (28,240  | )          | —     |       |
| Payments for patents                                                                    |       | (2,269   | )          | (11,261    | )          |
|                                                                                    |       |     |       |       |       |
| Net cash provided by  investing activities                                              |       | (30,509  | )          | 3,688,739  |       |
|                                                                                    |       |     |       |       |       |
| Cash flows from  financing activities:                                                  |       |     |       |       |       |
| Payments on debt                                                                        |       | —   |       | (2,658,078 | )          |
| Net (payments on) line  of credit                                                       |       | (93,777  | )          | (301,157   | )          |
| Net borrowings  note-payable – related party                                       |       | 275,113  |       | 1,196,180  |       |
| Checks in excess                                                                        |       | 57,780   |       | (70,769    | )          |
| Payments of capital  lease obligations                                                  |       | (46,625  | )          | (130,149   | )          |
|                                                                                    |       |     |       |       |       |
| Net cash provided by  (used in) financing activities                                    |       | 192,491  |       | (1,963,973 | )          |
| Net (decrease) increase  in cash                                                        |       | —   |       | —     |       |
| Cash, beginning of year                                                                 |       | 500      |       | 500        |       |
|                                                                                    |       |     |       |       |       |
| Cash, end of period                                                                     |       | $        | 500        |       | $          | 500 |   |
|                                                                                    |       |     |       |       |       |
| Supplemental  disclosures of cash flow information:                                     |       |     |       |       |       |
| Cash paid for interest                                                                  |       | $        | 56,570     |       | $          | 191,145 |   |
|                                                                                    |       |     |       |       |       |
| Noncash investing and  financing activities:                                            |       |     |       |       |       |
| Conversion of senior  debt to common stock                                              |       | $        | —     |       | $          | 120,000 |   |
| Forgiveness of related  party debt recorded to paid-in-capital                          |       | $        | 4,300,754  |       | $          | — |   |

 

The accompanying notes are an integral part of thefinancial statements*.*

 

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**1.**                                                  BusinessDescription and Conditions

 

**Business Description**

 

MagStar Technologies, Inc.(“MagStar” or the “Company”) is a publicly owned company headquartered inHopkins, Minnesota that trades locally, over the counter, under the symbol “MGST”.MagStar is a prototype developer and manufacturer of centrifuges, conveyors,medical devices, spindles, and sub assemblies. MagStar’s technical abilities indesign, process, and manufacturing specialize in the “concept-to-production”process designed to result in short manufacturing cycles, high performance, andcost effective products such as electro-mechanical assemblies and devices forover two dozen medical, magnetic, motion control, factory and laboratoryautomation and industrial original equipment manufacturers (“OEMs”).  The Company’s products are sold throughoutthe United States and North America, Europe, and Asia.

 

The Company wasestablished in 1948 as Reuter Manufacturing, Inc., and specialized inprecision machining and assemblies.  In early2001, the Company changed its name to MagStar Technologies, Inc.

 

The Company is aMinnesota corporation.  The principalexecutive offices of the Company are located at 410 Eleventh Avenue South,Hopkins, Minnesota 55343.  The Company’stelephone number is (952) 935-6921.

 

**Financial Condition andManagement’s Plans**

 

TheCompany has a net loss of $213,217 for the year ended December 31, 2004and has a working capital deficit of $3,039,095 and stockholders’ deficiency of$4,907,477 at December 31, 2004.

 

Management’s plans and objectives to improve thefinancial condition of the Company are based on a strategy to become atechnology leader in centrifuge and conveyor design and production by being aproduct focused company, growing sales, reducing debt, and accumulating cash.

 

Steady growth may be achieved by identifying theCompany’s core business, (centrifuges, spindles, and conveyors), seekingrelationships that move beyond the manufacturing of specific parts and into thepreparation of sub-assemblies and completed assemblies for its customers,developing a focus towards proprietary products and away from contractmanufacturing, and building long term, sustainable competitive advantages overcompetitors.  The Company seeks to becomeinvolved with its customers early in their development and design processallowing the Company to participate in the earlier, higher value added stage ofproduct development and to establish a closer working relationship with itscustomers.

 

The Company intends to add new customers by applyingcentrifuge technology to a variety of filtering and separating applications,developing new spindle applications, and by growing and nurturing the conveyorbusiness. The Company intends to add new conveyor customers by expanding itsdistribution network, creating strategic alliances and new marketinginitiatives.  The Company seeks to pursuea course investing in market driven research and development that will lead toinnovation and new value propositions in the future, establishing a reputationand expertise for product development. The Company seeks to be identified as a centrifuge, spindle and conveyormanufacturer and intends to focus on higher value added products that allow itto use its design, manufacturing and engineering capabilities.

 

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Cash control, cost management, and margin preservationare fundamental to the Company’s profitability. Any new corporate strategiesconsidered must be accountable to existing headcounts and capital resourcesmeaning the Company must resist strategies that require significant inflows ofcapital, unless capital can be prudently raised.  Other priorities include recapitalizing thebalance sheet, generating liquidity, monitoring and changing processes toincrease productivity and strategically adding key managers and operationalexpertise as a measured response as required in a prudent and responsiblemanner.  The Company also has excesscapacity.  Through mergers, acquisitionsand organic growth, it believes it can increase its revenues while incurringproportionally less additional overhead. By increasing productivity, improving cost control, reducing expensesand keeping expenses in proportion to the Company’s current sales level, theCompany intends to achieve and sustain positive cash flow.  The Company achieved positive cash flow forthe last six months of 2004.

 

The Company does not expect capital needs in 2005 toexceed the capacity of its asset based line of credit as allowable receivablesand inventory borrowings are expected to cover operating requirements.  While the asset based line of credit expiresin June 2005, the Company believes it will be able to replace thisfacility.  In addition, borrowingagreements with the Company’s major shareholder are expected to remain inplace. The Company believes that cash from operations, renewal of and advancesfrom its credit facility and borrowings from its major shareholder will provideenough liquidity for the next 12 months of operations.

 

There can be no assurancethat management will be able to accomplish all of the above plans andobjectives or achieve the necessary improvements in its cash flows andfinancial position to meet its obligations as they become due.  The Company’s ability to continue operationsis dependent on its ability to increase sales and maintain adequate margins onsales, as well as its ability to maintain its credit facilities with U.S.Bancorp.  In addition, if the Company isunable to increase sales from current levels and generate positive cash flowsfrom operations, it would be unable to meet its debt service requirements andmay be forced to cease operations or seek protection under U.S. bankruptcylaws.

 

Accordingly, there can beno assurance that the Company will continue as a going concern in its currentform.  The financial statements do notinclude any adjustments that might result from the outcome of this uncertainty.

 

**2.**                                                  SignificantAccounting Policies

 

**Accounts Receivable**

 

TheCompany extends unsecured credit to customers in the normal course of businessand believes all accounts receivable in excess of the allowance for doubtfulaccounts to be fully collectible.  Ifaccounts receivable in excess of the provided allowance are determineduncollectible, they are charged to expense in the year that determination ismade.  The Company does not accrueinterest on trade accounts receivable. Accounts receivable are due 30 days after the invoice date.  Accounts receivable are written off onlyafter all collection attempts have failed.

 

**Inventories**

 

Inventoriesare valued at the lower of cost or market with cost determined on a first-in,first-out basis.

 

36

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**Property, Plant and Equipment**

 

Property,plant and equipment are recorded at cost. Depreciation and amortization is provided for by the straight-linemethod based on the estimated useful lives of the related assets. Useful livesranged from 15 to 40 years for buildings and building improvements and 5 to 7years for machinery and equipment. Expenditures for major renewals and betterments are capitalized, andexpenditures for maintenance and repairs are charged to operations asincurred.  Upon retirement or otherdisposition of property, plant or equipment, the applicable cost andaccumulated depreciation and amortization are eliminated from the accounts, andthe resulting gain or loss is included in operations unless the sale is subjectto the Company leasing the property back for a period of time.

 

**Revenue Recognition**

 

TheCompany’s revenue is recognized in accordance with generally acceptedaccounting principles as outlined in the SEC’s Staff Accounting Bulletin No. 104“Revenue Recognition,” which requires that four basic criteria be met beforerevenue can be recognized: (i) persuasive evidence of an arrangementexists; (ii) the price is fixed or determinable; (iii) collectibilityis reasonably assured; and (iv) product delivery has occurred or serviceshave been rendered. The Company recognizes revenue as products are shippedbased on FOB shipping point terms when title passes to customers.

 

**Advertising**

 

Advertisingcosts are charged to operations when incurred. Advertising expense was $60,296 and $40,853 for the years ended December 31,2004 and 2003, respectively.

 

**Shipping and Handling Costs**

 

Shippingand handling costs charged to customers have been included in net sales.  Shipping and handling costs incurred by theCompany have been included in the cost of sales.

 

**Income Taxes**

 

TheCompany utilizes the asset and liability method of accounting for income taxeswhereby deferred taxes are determined based on the temporary difference betweenthe financial statement and tax basis of assets and liabilities using enactedtax rates in effect in the years in which the differences are expected toreverse.  Valuation allowances areestablished when necessary to reduce deferred tax assets to the amount expectedto be realized.

 

**Financial Instruments**

 

The carrying amounts for all financial instrumentsapproximates fair value. The carrying amounts for cash, accounts payable andaccrued liabilities approximate fair value because of the short maturity ofthese instruments. The fair value of lines of credit, and related party debtapproximates the carrying amounts based upon the Company’s expected borrowingrate for debt with similar remaining maturities and comparable risk.

 

**Net Income (Loss) per Common Share**

 

Basic net income (loss) per common share is computedby dividing net income (loss) by the weighted average number of common sharesoutstanding for the reporting period. Diluted net income (loss) per commonshare is computed by dividing net income (loss) by the sum of the weightedaverage number of common shares outstanding plus all additional common stockthat would have been outstanding if potentially dilutive common shares relatedto common share equivalents (stock options, stock warrants, and convertiblepreferred shares) had been issued. Dilutive common equivalent shares of1,518,778 and 389,679 at December 31, 2004 and 2003,

 

37

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respectively, have not been included in thecomputation of diluted net income (loss) per common share for all periodspresented because their inclusion would be anti-dilutive.

 

**Cash**

 

The Company deposits its cash in high credit qualityfinancial institutions. The balances, at times, may exceed federally insuredlimits.

 

**Research and Development Disclosures**

 

The Company does not pursue or engage in regularresearch and development of its products. All research and development fees collected in 2003 and 2004 were theresult of customer purchases, initiated and sponsored by a purchase order.  The Company does not intend to pursueunsponsored research and development and classifies existing research anddevelopment work as non-recurring sales and production.

 

**Stock-Based Compensation**

 

In accordance with Accounting Principles Board (APB)Opinion No. 25 “Accounting for Stock Issued to Employees” and relatedinterpretations, the Company uses the intrinsic value-based method formeasuring stock-based compensation cost which measures compensation cost as theexcess, if any, of the estimated fair value of the Company’s common stock atthe grant date over the amount the employee must pay for the stock. The Company’spolicy is to grant stock options at fair value at the date of grant. Requiredpro forma disclosures of compensation expense determined under the fair valuemethod of Statement of Financial Accounting Standards (SFAS) No. 123, “Accountingfor Stock-Based Compensation,” is presented below. Options and warrants issuedto non-employees are recorded at fair value, as required by SFAS No. 123,using the Black Scholes pricing model and the Company accounts for optionsissued to non-employees in accordance with EITF 96-18 “Accounting For EquityInstruments That Are Issued To Other Than Employees For Acquiring, Or InConjunction With Selling Goods Or Services.” The Company recorded $117,000 of deferred compensation related tooptions issued to non-employees and is amortizing the expense over the vestingperiod.  As such, the Company expensed$39,000 during the year ended December 31, 2004.  The Company has adopted the disclosure onlyprovision of SFAS No. 148.

 

Hadcompensation cost for the Plans been determined based on the fair value ofoptions at the grant date for awards in 2004 and 2003, the Company’s pro formanet income/(loss) and net income/(loss) per common share would have been asfollows:

 
| ** **                              | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Net income/(loss)                       |       | Reported   |       | $        | (213,317   | )        | $          | 545,163 |   |
|                                    |       | Pro Forma  |       | $        | (293,655   | )        | $          | 444,004 |   |
|                                    |       |       |       |     |       |     |       |
| Basic income/(loss) per  common share   |       | Reported   |       | $        | (0.02      | )        | $          | 0.06 |   |
|                                    |       | Pro Forma  |       | $        | (0.03      | )        | $          | 0.05 |   |
| Diluted income/(loss)  per common share |       | Reported   |       | $        | (0.02      | )        | $          | 0.05 |   |
|                                    |       | Pro Forma  |       | $        | (0.03      | )        | $          | 0.04 |   |
|                                    |       |       |       |     |       |     |       |
| Stock based  compensation - as reported |       |       |       | $        | 39,000     |     | $          | — |   |
|                                    |       |       |       |     |       |     |       |
| Stock based  compensation - pro forma   |       |       |       | $        | 80,338     |     | $          | 101,159 |   |

 

38

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Theweighted average grant-date fair value of options granted during 2004 and 2003was $0.05 and $.30, respectively, which was determined using the Black-Scholesoption pricing model with the following key assumptions:

 
| **Assumptions**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
|                    |       |     |       |     |       |
| Risk free interest rate |       | 4.25     | %          | 4.00     | %          |
| Volatility              |       | 42       | %          | 60       | %          |
| Expected lives (months) |       | 72       |       | 72       |       |
| Expected dividend yield |       | 0        | %          | 0        | %          |

 

**Use of Estimates**

 

Thepreparation of the Company’s financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting periods. Actual results could differ from those estimates.

 

**Self-Funded Employee Medical Benefits**

 

The Company participates in a self-insured employee healthinsurance plan administered by an outside party.  The Company is required to pay up to $30,000of annual medical claims per participant and the Company’s maximum exposure perthe plan is approximately $1,000,000. The annual plan medical claims will vary depending upon the number ofemployees and their level of participation.

 

**Impact of Recent Accounting Pronouncements**

 

In December 2003,the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46R,“Consolidation of Variable Interest Entities” (FIN 46R).  FIN 46R statesthat companies that have exposure to the economic risks and potential rewardsfrom another entity’s assets and activities have a controlling financialinterest in a variable interest entity and should consolidate the entity,despite the absence of clear control through a voting equity interest. The consolidation requirements apply to all special-purpose entities bythe end of the first reporting period ending after December 15,2003.  FIN 46R shall be applied to all variable interest entities by theend of the first reporting period ending after March 15, 2004, forenterprises that are not small business issuers or December 15, 2004 forenterprises that are small business issuers.  The adoption of FIN 46R didnot have a material effect on the financial statements.

 

In November 2004,FASB issued Statement of Financial Accounting Standards (SFAS) No. 151 “InventoryCosts” which amends the guidance in ARB No. 43, Chapter 4 “InventoryPricing,”  to clarify the accounting for abnormal amounts of idle facilityexpense, freight, handling costs, and wasted material (spoilage). Paragraph 5pf ARB 43, Chapter 4, previously stated that under some circumstances, itemssuch as idle facility expense, excessive spoilage, double freight, andrehandling costs may be so abnormal as to require treatment as current periodcharges.” SFAS No. 151 requires that those items be recognized ascurrent-period charges regardless of whether they meet the criterion of “soabnormal.” In addition, SFAS No, 151 requires that allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities.  SFAS No. 151 shall be effective forinventory costs incurred during fiscal years beginning after June 15,2005. Earlier application is permitted for inventory costs incurred duringfiscal years beginning after the date SFAS No. 151 was issued. SFAS No. 151shall be applied

 

39

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prospectively.  TheCompany does not expect the adoption of SFAS No. 151 to have a materialeffect on its financial statements.

 

In December 2004,FASB issued SFAS No. 153 “Exchanges of Nonmonetary Assets” amends APBOpinion No. 29, “Accounting for Nonmonetary Transactions.” APB No. 29is based on the principle that exchanges of nonmonetary assets should bemeasured based on the fair value of the assets exchanged. The guidance in thatOpinion, however, included certain exceptions to that principle. SFAS No. 153amends APB No. 29 to eliminate the exception for nonmonetary exchanges ofsimilar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance. Anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. SFAS No. 153 shall be effective for nonmonetary asset exchanges occurringin fiscal periods beginning after June 15, 2005. Earlier application ispermitted for nonmonetary asset exchanges occurring in fiscal periods beginningafter the date SFAS No. 153 was issued. SFAS No. 153 shall be appliedprospectively.  The Company does not expect the adoption of SFAS No. 153to have a material effect on its financial statements.

 

In December 2004, FASBissued SFAS No. 123 (revised 2004), “Share-Based Payment”, that focusesprimarily on accounting for transactions in which an entity obtains employeeservices in share-based payment transactions.  This statement replacesSFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedesAPB Opinion No. 25, “Accounting for Stock Issued to Employees.” Beginning with our quarterly period that begins January 1, 2006, we willbe required to expense the fair value of employee stock options and similar awards. As a public company, we are allowed to select from two alternative transitionmethods, each having different reporting implications.  The impact of SFASNo. 123R has not been determined at this time.

 

**SegmentReporting**

 

A business segment is adistinguishable component of an enterprise that is engaged in providing anindividual product or service or a group of related products or services andthat is subject to risks and returns that are different from those of otherbusiness segments. The Company’s segments have similar economic characteristicsand are similar in the nature of the products sold, type of customers, methodsused to distribute the Company’s products and regulatory environment. Management believes that the Company meets the criteria for aggregating itsoperating segments into a single reporting segment.

 

40

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**3.**                                                              SelectedBalance Sheet Information

 
| ** **                                                     | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                     | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                                           |       |                  |       |   |   |
| **Accounts  Receivable, Net**                                  |       |                  |       |   |   |
|                                                           |       |                  |       |   |   |
| Accounts Receivable                                            |       | $                     | 613,144    |   | $ | 787,352 |   |
| Less Allowance for  doubtful accounts and sales returns        |       | (29,743               | )          | (63,939 | ) |
|                                                           |       |                  |       |   |   |
|                                                           |       | $                     | 583,401    |   | $ | 723,413 |   |
|                                                           |       |                  |       |   |   |
| **Inventories,  Net**                                          |       |                  |       |   |   |
|                                                           |       |                  |       |   |   |
| Raw materials and  supplies                                    |       | $                     | 352,956    |   | $ | 372,450 |   |
| Work-in-process                                                |       | 226,859               |       | 262,610 |   |
| Finished goods                                                 |       | 705,431               |       | 497,159 |   |
| Less allowance for  obsolete inventories                       |       | (110,375              | )          | (57,977 | ) |
|                                                           |       |                  |       |   |   |
|                                                           |       | $                     | 1,174,871  |   | $ | 1,074,242 |   |
|                                                           |       |                  |       |   |   |
| **Property,  Plant, and Equipment, Net**                       |       |                  |       |   |   |
|                                                           |       |                  |       |   |   |
| Office equipment                                               |       | $                     | 74,642     |   | $ | 72,167 |   |
| Machinery and equipment                                        |       | 497,610               |       | 471,844 |   |
| Equipment under capital  lease obligations                     |       | 298,599               |       | 298,599 |   |
|                                                           |       |                  |       |   |   |
|                                                           |       | 870,851               |       | 842,610 |   |
| Less accumulated  depreciation                                 |       | (534,261              | )          | (499,250 | ) |
| Less accumulated  depreciation under capital lease obligations |       | (298,599              | )          | (290,505 | ) |
|                                                           |       |                  |       |   |   |
|                                                           |       | $                     | 37,991     |   | $ | 52,855 |   |
|                                                           |       |                  |       |   |   |
| **Accrued  Expenses**                                          |       |                  |       |   |   |
|                                                           |       |                  |       |   |   |
| Accrued vacation                                               |       | $                     | 118,810    |   | $ | 99,072 |   |
| Accrued warranty  reserve                                      |       | 73,693                |       | 74,000 |   |
| Accrued wages and  related payroll taxes                       |       | 54,578                |       | 56,826 |   |
| Accrued medical claims                                         |       | 40,000                |       | 51,318 |   |
| Accrued interest                                               |       | 22,163                |       | 82,621 |   |
| Accrued profit sharing  contribution                           |       | 16,697                |       | 19,107 |   |
| Other accrued expenses                                         |       | 10,676                |       | 17,869 |   |
|                                                           |       |                  |       |   |   |
|                                                           |       | $                     | 336,617    |   | $ | 400,813 |   |

 

**Accounts Payable to RelatedParties**

 

AccountsPayable to Related Parties are due to Activar, Inc. and affiliates andconsist of lease payments and accrued interest. Activar, Inc. and affiliates are related parties as a consequenceof Activar’s significant ownership of stock of the Company and common ownershipby a shareholder of Activar.  Theaccounts payable are unsecured and non-interest bearing.

 

41

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**Warranty Reserve**

 

TheCompany warrants its products for one, two, or five years.  The reserve for warranty is included inaccrued expenses and is computed by averaging the last four years warrantycosts incurred and multiplying by two, which provides a full two-year warrantyon all products.  The Company hasreserved an additional $50,000 to cover any unanticipated or unusual product warrantyproblems.  The following summarizes thewarranty transactions for the years ended December 31:

 
| ** **                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
|                          |       |     |       |     |       |
| Balance at Beginning of  Year |       | $        | 74,000     |     | $          | 104,000 |   |
| Claims Paid                   |       | (20,000  | )(1)       | (30,000  | )          |
| Expense Provision             |       | 19,693   |       | 0        |       |
|                          |       |     |       |     |       |
| Balance at End of Year        |       | $        | 73,693     |     | $          | 74,000 |   |

 

----

(1)          Amounts notseparately tracked by the Company in 2004.

 

**4.**                                                              Senior Debt

 

Seniordebt at December 31, 2004 and 2003, consisted of the following:

 
| ** **                                                                                                                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Asset-based line of  credit, payable to bank, due upon demand.                                                                                                       |       |     |       |     |       |
| The weighted average interest rate of asset-based  line of credit borrowings was 6.48% and 4.00% for the years ended December 31,  2004 and 2003, respectively. |       | $        | 708,463    |     | $          | 802,240 |   |
|                                                                                                                                                                      |            |          |            |          |            |  |  |

 

TheCompany has entered into an amended and restated senior credit agreement.  The credit facilities under the new agreementconsist of an asset-based line of credit with availability of up to $1,350,000,subject to a borrowing base limitation of 80% of the Company’s eligibleaccounts receivable plus eligible inventories.

 

Theasset-based line of credit bears interest at the bank’s reference rate (5.25%at December 31, 2004) plus 2.50%, is due on demand, and is payable in fullin June 2005. Term Note C was non-interest bearing, was due and payable infull on September 2003, and was cancelled in consideration for 300,000shares of common stock in 2003.  TheCompany recorded a non-recurring gain of $1,205,000 related to the conversionof the debt into common stock in September 2003.

 

Thecredit facilities restrict the payment of dividends and the Company’s abilityto incur other indebtedness. The bank may at any time apply the funds availablein any Company bank account against the outstanding loan balances.  In addition, the credit facilities arecollateralized by all of the Company’s assets, except for certain equipmentpurchased with notes payable.

 

42

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**5.**                                      NotesPayable, Related Parties

 

Notes payable, related parties at December 31, 2004and 2003, consisted of the following:

 
| ** **                                                                                                 | ** ** | **2004**  | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------|------------|
| Note payable;  stockholder, due upon demand with interest at 6%  subordinated to senior debt, unsecured    |       | $         | —     |     | $          | 4,255,776 |   |
| Note payable;  stockholder, due upon demand with interest at 8%  subordinated to senior debt, unsecured    |       | —    |       | 430,913  |       |
| Note payable;  stockholder, due upon demand with interest at 8%  subordinated to senior debt, unsecured    |       | —    |       | 467,000  |       |
| Note payable;  stockholder, due upon demand with interest at 6%  subordinated to senior debt, unsecured    |       | —    |       | 500,000  |       |
| Note payable; related  entity, due upon demand with interest at 10  subordinated to senior debt, unsecured |       | —    |       | 50,000   |       |
| Note payable; related  entity, due upon demand with interest at 3%  subordinated to senior debt, unsecured |       | 500,000   |       | —   |       |
| Note payable; related  entity, due upon demand with interest at 3%  subordinated to senior debt, unsecured |       | 300,000   |       | —   |       |
| Note payable; related  entity, due upon demand with interest at 3%  subordinated to senior debt, unsecured |       | 1,946,154 |       | —   |       |
|                                                                                                       |       | $         | 2,746,154  |     | $          | 5,703,689 |   |

 

Accrued interest on thesenotes at December 31, 2004 and 2003 was $0 and $649,000, respectively, andinterest expense for the years ended December 31, 2004 and 2003 was$192,130 and $338,000, respectively. During the year ended December 31, 2004, $4,300,754 of debt andaccrued interest outstanding was forgiven as the Company was informed this wasnecessary for the extension of the senior credit agreement of June 2005.  In addition, the interest rate on the debteffective April 1, 2004 was revised to 3% for the same reason as notedabove.  The amount of debt and accruedinterest forgiven was recorded as additional paid-in capital.  The Company believes that the 3% interestrate charged on the restructured debt had a positive influence on the bank’sdecision to amend the credit agreement and extend it to June 2005.

 

**6.**                                      CapitalLease Obligations

 

The Company leases equipment under noncancelable leasesclassified as capital leases.  Thebalance to pay in full, including accrued interest of $15,852, at December 31,2004 is $96,981.

 

**7.**                                      Sale/Leasebackand Related Party Lease Obligations

 

TheCompany sold equipment during 2001 to an entity owned by a stockholder for$1,987,141 and concurrently entered into operating leases.  The leases were amended on January 1,2003 under a lease that expires in 2007. The Company further amended the leases on April 1, 2004 whereby theminimum lease payments for the remainder of 2004 and 2005 were waived.  In addition, monthly lease payments for 2006and 2007 were amended to $20,000 per month. The amount of related party lease obligations outstanding on March 31,2004 on the building and equipment leases was $261,707 and was forgiven andrecorded as additional paid-in capital. The Company believes that the amendments in 2004 were necessary in orderto amend the Company’s line of credit to mature in June 2005 (see Note 4).

 

43

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Futureminimum payments required under these leases are as follows:

 
| Year ending December 31: | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
|                          |       |       |       |
| 2005                          |       | $          | —     |   |
| 2006                          |       | 240,000    |       |
| 2007                          |       | 240,000    |       |
| Total minimum lease payments  |       | $          | 480,000    |   |

 

Rent expense under these leases for the years ended December 31,2004 and 2003 was $233,003 and $554,000, respectively.  Included in rent expense is deferred rent of$96,003 for the year ended December 31, 2004 as a result of the April 1,2004 amendment.

 

Future deferred gains resulting from this lease are asfollows:

 
| Year ending December 31: | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
|                          |       |       |       |
| 2005                          |       | $          | 155,576    |   |
| 2006                          |       | 155,576    |       |
| 2007                          |       | 155,576    |       |
|                          |       |       |       |
| Total deferred gain           |       | $          | 466,728    |   |

 

On February 25,2003, MagStar Technologies, Inc. sold and leased back its headquarters andmanufacturing facility in Hopkins, Minnesota. The purchaser was Hopkins Eleventh Avenue LLC (“Eleventh Avenue”), awholly owned subsidiary of Activar Properties, Inc., which in turn iswholly owned by Mr. McNamara.  Thepurchase price for the building and property was $3,700,000.  The Company entered into a 6.5-year grosslease with Eleventh Avenue for the building and property at a monthly cost of$34,000 increasing to $44,436 per month. proceeds of $1,001,397 realized by theCompany in the transaction were applied to reduce the Company’s debt to ActivarProperties, Inc. and affiliates. The Company’s outstanding balance to Activar Properties, Inc. andother affiliates of Mr. McNamara was approximately $5,512,918 as of February 28,2003.  James L. Reissner, the Presidentof Activar Properties, Inc., is also a director and shareholder of the Company.  The Board of Directors of the Companyauthorized the transaction in order to reduce the indebtedness of the Company,provide working capital and improve cash flow. The transaction with Eleventh Avenue was determined to be on betterterms than could be obtained by the Company directly from unaffiliatedfinancing sources.  The purchase pricewas based upon an independent appraisal of the value of the property andbuilding obtained by the bank which provided financing to Eleventh Avenue inconnection with the transaction.

 

Due to the fifth amendment to the Company’s amendedand restated credit agreement, the Company was required by the bank torestructure this lease in a manner which is favorable to the Company, which isreflected in the Notes to Financial Statements. Effective April 1, 2004, the Company and Eleventh Avenue amendedthe lease whereby the lease payments from April 1, 2004 to December 31,2005 were waived.  The Company willresume monthly payments in 2006 according to the original lease.

 

44

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Rent expense on the leasewas $374,018 and $392,390 for the years ended December 31, 2004 and 2003,respectively.  Included in rent expenseis deferred rent of $272,028 for the year ended December 31, 2004 as aresult of the April 1, 2004 amendment.

 
| Future minimum lease payments on building |   |
|-------------------------------------------|--------|
|                                      |   |   |   |
| 2005                                      |   | $ | — |   |
| 2006                                      |   | 474,926 |   |
| 2007                                      |   | 501,048 |   |
| 2008                                      |   | 528,600 |   |
| 2009                                      |   | 355,488 |   |
| Total minimum lease payments              |   | $ | 1,860,062 |   |

 
| Future deferred gains resulting from this  lease are as follows: |   |
|------------------------------------------------------------------|--------|
|                                                             |   |   |   |
| 2005                                                             |   | $ | 331,978 |   |
| 2006                                                             |   | 331,978 |   |
| 2007                                                             |   | 331,978 |   |
| 2008                                                             |   | 331,978 |   |
| 2009                                                             |   | 221,317 |   |
| Total deferred gain                                              |   | $ | 1,549,229 |   |

 

**8.**                                      Stockholders’Deficiency

 

**Private Placement**

 

In2000, the Company completed a private placement with certain investors underwhich the Company sold 3,500,000 shares of the Company’s common stock and1,000,000 shares of the Company’s Series A Convertible Preferred Stockvalued at $.1777778 per share, for proceeds of $800,000.

 

The Series A Preferred is convertible at any timeinto shares of common stock as is determined by dividing $.1777778 by theconversion price in effect at the time of any conversion and multiplying suchquotient by each share of Series A Preferred to be converted.  At all meetings of the shareholders of theCompany or in the case of any actions of shareholders in lieu of a meeting,each holder of Series A Preferred stock shall have that number of votesequal to the number of whole shares of Common Stock into which such holder’sshares are then convertible. Holders of the Series A Preferred Stock areentitled to receive cumulative cash dividends, in preference to dividendspayable on common stock, at the annual rate of 9% and share equally with thecommon stock, on an as-converted basis, in any dividends declared on the commonstock.  Dividends in arrears totaled$360,000 and $288,000 at December 31, 2004 and 2003, respectively.  In the event of any liquidation, whethervoluntary or involuntary, the assets of the Company available for distributionto its shareholders shall be distributed equally among the holders of theCommon Stock and the Series A Preferred stock.

 

Inconnection with the private placement, the Company, the investors and certainindividuals from the Company’s existing stockholders (collectively, the controlgroup) entered into a voting agreement. Among other provisions, the voting agreement requires that the controlgroup vote their shares to designate the investors as members of the Company’sBoard of Directors.  The

 

45

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votingagreement further requires the control group to vote as directed by theinvestors on all matters, which are presented for a vote to the Company’sstockholders.

 

**Stock Option Plans**

 

TheCompany’s Stock Option Plans (the Plans) provide for grants of stock options toemployees and directors.  The number ofcommon shares available for grant pursuant to the Plans was 2,125,000 at December 31,2004 and 2003, respectively.  Optionsbecome exercisable over periods of up to four years from the date of grant andexpire 10 years from the date of grant.

 

Thefollowing summarizes all option activity under the Plans:

 
| ** **                                     | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|------------------------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| Balances, December 31,  2002              |       | 795,665                  |       | $                                      | 0.50       |   |
| Cancelled                                      |       | (52,586                  | )          | $                                      | 0.12       |   |
| Granted                                        |       | 110,500                  |       | $                                      | 0.05       |   |
| Balances, December 31,  2003              |       | 855,579                  |       | $                                      | 0.48       |   |
| Cancelled                                      |       | (70,000                  | )          | $                                      | 1.04       |   |
| Granted                                        |       | 435,000                  |       | $                                      | 1.03       |   |
| Balances, December 31,  2004              |       | 1,268,579                |       | $                                      | 0.68       |   |
| Options exercisable at December 31,  2003 |       | 735,627                  |       | $                                      | 0.55       |   |
| Options exercisable at December 31,  2004 |       | 941,750                  |       | $                                      | 0.59       |   |

 

Thefollowing table summarizes information about fixed price stock optionsoutstanding at December 31, 2004:

 
| ** **                    | ** ** | ** **                                        | ** ** | **Options Outstanding**                                       | ** ** | **Options Exercisable**                | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding  December 31,  2004** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (Months)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable at  December 31,  2004** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                          |       |                                              |       |                                                          |       |                                   |       |   |   |   |   |
| $0.05 - $0.24                 |       | 285,500                                           |       | 97                                                            |       | $                                      | 0.05       |   | 248,666 |   | $ | 0.05 |   |
| $0.25 - $0.624                |       | 431,400                                           |       | 72                                                            |       | $                                      | 0.37       |   | 431,400 |   | $ | 0.37 |   |
| $0.625 - $0.99                |       | 73,179                                            |       | 45                                                            |       | $                                      | 0.84       |   | 73,179 |   | $ | 0.84 |   |
| $1.00 - $2.24                 |       | 435,000                                           |       | 111                                                           |       | $                                      | 1.03       |   | 145,005 |   | $ | 1.03 |   |
| $2.25 - $3.375                |       | 13,500                                            |       | 38                                                            |       | $                                      | 2.45       |   | 13,500 |   | $ | 2.45 |   |
| $3.376 - $4.4375              |       | 23,000                                            |       | 29                                                            |       | $                                      | 4.44       |   | 23,000 |   | $ | 4.44 |   |
| $4.4376 - $5.1875             |       | 7,000                                             |       | 30                                                            |       | $                                      | 4.92       |   | 7,000 |   | $ | 4.92 |   |
|                          |       |                                              |       |                                                          |       |                                   |       |   |   |   |   |
| Total                         |       | 1,268,579                                         |       | 88                                                            |       | $                                      | 0.68       |   | 941,750 |   | $ | 0.59 |   |

 

46

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**Warrants**

 

InFebruary 1999, the Company granted five-year warrants to purchase anadditional 50,000 shares of the Company’s common stock at an exercise price of$.6625 per share, exercisable immediately. These warrants expired in February 2005.

 

Inconnection with the issuance of debt to a stockholder in January 2002, theCompany granted five-year warrants to purchase 250,000 shares of the Company’scommon stock at an exercise price of $0.25 per share, exercisableimmediately.  The warrants were valuedusing the Black Scholes model pricing model. The value was determined to be immaterial.

 

**9.**                                      Income Taxes

 

Thefollowing table sets forth the components of the tax-affected deferred taxassets at December 31, 2004 and 2003:

 
| ** **                                                               | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|--------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| Net operating losses  available for carry forward  (expire 2009 to 2023) |       | $           | 10,849,000 |        | $          | 11,600,000 |   |
| Other future deductible  temporary differences, net                      |       | 1,139,000   |       | 432,000     |       |
|                                                                     |       |        |       |        |       |
| Net deferred tax asset  before valuation allowance                       |       | 11,988,000  |       | 12,032,000  |       |
|                                                                     |       |        |       |        |       |
| Valuation allowance                                                      |       | (11,988,000 | )          | (12,032,000 | )          |
|                                                                     |       |        |       |        |       |
|                                                                     |       | $           | —     |        | $          | — |   |

 

TheCompany has established a valuation allowance for any tax benefits for whichmanagement believes, based on the relative weight of currently available evidence,that it is “more likely than not” that the related net deferred tax asset willnot be realized.  As a result, no taxbenefit has been provided for the net loss incurred for the years ended December 31,2002 and prior years.  The Company’s netincome for the year ended December 31, 2003 was offset by the reduction ofcurrent year temporary differences.  TheCompany has net operating loss carryforwards for federal income tax purposes ofapproximately $29,000,000.  Under theInternal Revenue Code, certain stock transactions, including sales of stock andthe granting of warrants to purchase stock, may limit the amount of netoperating loss carry forwards that may be utilized on an annual basis to offsettaxable income in future periods.

 

Reconciliationof the income tax computed at the federal statutory rate to the actual incometax provision is as follows:

 
| ** **                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
|                                        |       |     |       |     |       |
| Income tax (benefit)                        |       | $        | (44,000    | )        | $          | 218,000 |   |
|                                        |       |     |       |     |       |
| Increase (decrease) in  valuation allowance |       | 44,000   |       | (218,000 | )          |
|                                        |       |     |       |     |       |
| Income tax provision                        |       | $        | —     |     | $          | — |   |

 

47

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**10.**                               EmployeeBenefit Plans

 

Allemployees who are at least 21 years of age and have completed six months ofservice and have worked at least 1,000 hours are eligible to participate in theCompany’s 401(k) Retirement Savings Plan and Profit Sharing Plan.  The Company may make 401(k) matchingcontributions and profit sharing contributions at the discretion of the Boardof Directors.  The Company’s 401(k)matching contributions and profit sharing contributions for the years ended December 31,2004 and 2003 were $17,000 and $18,000, respectively.

 

**11.**                               SignificantCustomer Information

 

TheCompany’s major customers accounted for the following percentages of net sales:

 
| ** ** | ** ** | ** **          | ** ** | **2004**   | ** ** | **2003** | ** ** |
|------------|------------|---------------------|------------|------------|------------|----------|------------|
| ** ** | ** ** | ** **          | ** ** | **Amount** | ** ** | **%**    | ** ** | **Amount** | ** ** | **%** | ** ** |
|       |       |                |       |       |       |     |       |   |   |   |   |
| Customer A |       | Net Sales           |       | $          | 2,198,158  |     | 30         |   | $ | 1,999,980 |   | 32 |   |
|       |       | Accounts Receivable |       | $          | 155,013    |     | 27         |   | $ | 62,586 |   | 8 |   |
|       |       |                |       |       |       |     |       |   |   |   |   |
| Customer B |       | Net Sales           |       | $          | 1,207,999  |     | 16         |   | $ | 671,000 |   | 11 |   |
|       |       | Accounts Receivable |       | $          | 11,819     |     | 2          |   | $ | 101,059 |   | 14 |   |

 

**12.**                               EnvironmentalContingency

 

The Company has undertaken a Phase I and Phase IIenvironmental assessment of its manufacturing facility.  Soil boring and groundwater work indicatedthe presence of potentially hazardous substances and petroleum products withinthe soil and groundwater located beneath the site.  The Company notified the applicableregulatory agency (the Minnesota Pollution Control Agency), and is working withthat agency to resolve these issues.  Asof December 31, 2003, $15,000 has been accrued for the cost of additionalenvironmental work.  No amounts wereaccrued at December 31, 2004. Ground water investigation occurred quarterly during 2004 and concluded December 7,2004.  The Minnesota Pollution ControlAgency issued a determination to take no further action.  All reserves related to this issue have beenreleased.

 

**13.**                               **Sublease on Building**

 

On March 31, 2003,the Company subleased approximately 30,000 square feet of its facility to an unrelatedparty for 18 months.  The subleaseprovided an annual income of $4.55 per square foot, or $149,081 per year.  On November 1, 2004, the Company did notrenew the previous sublease and instead subleased the approximate 30,000 squarefeet to Activar, Inc., a corporation principally owned by a majorshareholder and director of the Company, for its operational use.  The sublease provides annual income ofapproximately $6.00 per square foot, or $180,000 per year and is renewablemonthly.

 

In addition, on May 1,2004, the Company subleased approximately 2,000 square feet of its facility toa different unrelated party for 12 months. The sublease provides for annual income of $12.00 per square foot, or$24,000 per year.

 

48

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The Company has nettedsublease income as part of cost of goods sold and general and administrativeexpenses on the statement of operations. Total sublease income was approximately $140,000 and $128,000 for theyears ended December 31, 2004 and 2003, respectively.

 

 

*The remainder of this page is intentionallyleft blank.*

 

49

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**MAGSTAR TECHNOLOGIES, INC.**

 

**EXHIBIT INDEX TO ANNUAL REPORTON FORM 10-KSB**

 

**For the Fiscal Year Ended December 31, 2004**

 
| **Item No.** | ** ** | **Item**                                                                                                       | ** ** | **Method of Filing**                                                                                                                                                          |
|--------------|------------|----------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                           |       |                                                                                                                                                                          |
| 3.1          |       | Restated Articles of Incorporation, As amended                                                                 |       | Incorporated by reference to Exhibit 3.1 to the  Company’s Annual Report on Form 10-KSB for the year ended December 31,  2001 (File No. 0-1561)      |
|         |       |                                                                                                           |       |                                                                                                                                                                          |
| 3.2          |       | Amended Bylaws                                                                                                 |       | Incorporated by reference to Exhibit 3.2 to the  Company’s Annual Report on Form 10-K for the year ended December 31,  1990 (File No. 0-1561)        |
|         |       |                                                                                                           |       |                                                                                                                                                                          |
| 4.1          |       | Form of the Company’s Common Stock Certificate                                                       |       | Incorporated by reference to Exhibit 4.1 to the  Company’s Annual Report on Form 10-K for the year ended December 31,  1990 (File No. 0-1561)        |
|         |       |                                                                                                           |       |                                                                                                                                                                          |
| 4.2          |       | Voting Agreement, dated September 12, 2000, by  and among the Company, certain shareholders and investors |       | Incorporated by reference to Exhibit 10.2 to the  Company’s Current Report on Form 8-K, dated October 24, 2000 (File No. 0-1561)                     |
|         |       |                                                                                                           |       |                                                                                                                                                                          |
| 10.1         |       | Incentive Stock Option Plan of the Company, as  amended effective December 17, 1987                       |       | Incorporated by reference to Exhibit 10(a) to  the Company’s Annual Report on Form 10-K for the year ended December 31,  1987 (File No. 0-1561) |
|         |       |                                                                                                           |       |                                                                                                                                                                          |
| 10.2         |       | Directors Stock Option Plan of the Company                                                                     |       | Incorporated by reference to Exhibit 10(c) to  the Company’s Annual Report on Form 10-K for the year ended December 31,  1987 (File No. 0-1561) |
| ** **   | ** ** | ** **                                                                                                     | ** ** | ** **                                                                                                                                                                    |
| 10.3         |       | 1991 Non-Employee Director Stock Option Plan                                                                   |       | Incorporated by reference to Exhibit 10.4 to  the Company’s Annual Report on Form 10-K for the year ended December 31,  1993 (File No. 0-1561)       |
|         |       |                                                                                                           |       |                                                                                                                                                                          |
| 10.4         |       | 1991 Stock Option Plan, as amended                                                                             |       | Incorporated by reference to Exhibit 10.6 to  the Company’s Annual Report on Form 10-KSB for the year ended December 31,  1995 (File No. 0-1561)     |

 

50

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| **Item No.** | ** ** | **Item**                                                                                                                                | ** ** | **Method of Filing**                                                                                                                                                      |
|--------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.5         |       | 1997 Non-Employee Director Stock Option Plan                                                                                            |       | Incorporated by reference to Exhibit 10.8 to  the Company’s Annual Report on Form 10-KSB for the year ended December 31,  1997 (File No. 0-1561) |
|         |       |                                                                                                                                    |       |                                                                                                                                                                      |
| 10.6         |       | 2001 Stock Option Plan                                                                                                                  |       | Incorporated by reference to Exhibit 10.6 to  the Company’s Annual Report on Form 10-KSB for the year ended December 31,  2001 (File No. 0-1561) |
|         |       |                                                                                                                                    |       |                                                                                                                                                                      |
| 10.7         |       | 2001 Stock Purchase Plan                                                                                                                |       | Incorporated by reference to Exhibit 10.7 to  the Company’s Annual Report on Form 10-KSB for the year ended December 31,  2001 (File No. 0-1561) |
|         |       |                                                                                                                                    |       |                                                                                                                                                                      |
| 10.8         |       | Environmental and ADA Indemnification Agreement,  dated December 3, 1997, between the Company and US Bancorp National  Association |       | Incorporated by reference to Exhibit 10.7 to  the Company’s Current Report on Form 8-K, dated December 18, 1997  (File No. 0-1561)               |
|         |       |                                                                                                                                    |       |                                                                                                                                                                      |
| 10.9         |       | Environmental Letter of Undertaking, dated December 3,  1997, between the Company and US Bancorp National Association              |       | Incorporated by reference to Exhibit 10.8 to  the Company’s Current Report on Form 8-K, dated December 18, 1997  (File No. 0-1561)               |
|         |       |                                                                                                                                    |       |                                                                                                                                                                      |
| 10.10        |       | Securities Purchase Agreement, dated October 10,  2000, by and among the Company and certain Investors                             |       | Incorporated by reference to Exhibit 10.1 to  the Company’s Current Report on Form 8-K, dated October 24, 2000  (File No. 0-1561)                |
|         |       |                                                                                                                                    |       |                                                                                                                                                                      |
| 10.11        |       | Amended and Restated Credit Agreement dated October 10,  2000, by and between the Company and US Bancorp National Association      |       | Incorporated by reference to Exhibit 10.4 to  the Company’s Current Report on Form 8-K, dated October 24, 2000  (File No. 0-1561)                |

 

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| 10.12  |   | Amended, Restated and Consolidated Mortgage,  Security Agreement, Assignment of Leases and Rents and Fixture Financing  Statement, dated October 10, 2000 by and between the Company and US  Bancorp National Association |   | Incorporated by reference to Exhibit 10.5 to  the Company’s Current Report on Form 8-K, dated October 24, 2000  (File No. 0-1561)                   |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                           |   |                                                                                                                                                                         |
| 10.13  |   | Security Agreement, dated October 10, 2000, by  and between the Company and US Bancorp National Association                                                                                                               |   | Incorporated by reference to Exhibit 10.6 to  the Company’s Current Report on Form 8-K, dated October 24, 2000  (File No. 0-1561)                   |
|   |   |                                                                                                                                                                                                                           |   |                                                                                                                                                                         |
| 10.14  |   | $6,800,000 Amended and Restated Note, dated October 10,  2000, given by the Company to US Bancorp National Association                                                                                                    |   | Incorporated by reference to Exhibit 10.7 to  the Company’s Current Report on Form 8-K, dated October 24, 2000  (File No. 0-1561)                   |
|   |   |                                                                                                                                                                                                                           |   |                                                                                                                                                                         |
| 10.15  |   | First Amendment to Amended and Restated Credit Agreement,  dated November 30, 2001, by and between the Company and US Bancorp  National Association                                                                       |   | Incorporated by reference to Exhibit 10.15 to  the Company’s Annual Report on Form 10-KSB for the year ended December 31,  2001 (File No. 0-1561)   |
|   |   |                                                                                                                                                                                                                           |   |                                                                                                                                                                         |
| 10.16  |   | Asset Purchase Agreement, Promissory Note and  Equipment Lease by and between Reuter Manufacturing, Inc. and MagStar  Technologies, Inc. for the acquisition of certain assets at December 1,  2000             |   | Incorporated by reference to Exhibit 10.20 to  the Company’s Annual Report on Form 10-KSB, for the year ended December 31,  2000 (File No. 0-1561)  |
|   |   |                                                                                                                                                                                                                           |   |                                                                                                                                                                         |
| 10.17  |   | Bill of Sale and two Master Equipment Leases, with  attached exhibits and assignments, dated March 21, 2001 related to the  sale-leaseback of equipment between the Company and Activar Properties, Inc.             |   | Incorporated by reference to Exhibit 10.21 to  the Company’s Quarterly Report on Form 10-Q, for the quarter ended March 31,  2001 (File No. 0-1561) |

 

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| 10.18      |       | Promissory Note between the Company and Activar  Properties, Inc. related to the purchase of Quickdraw Conveyor Systems, Inc.  dated February 23, 2001 |       | Incorporated by reference to Exhibit 10.22 to  the Company’s Quarterly Report on Form 10-Q, for the quarter ended March 31,  2001 (File No. 0-1561) |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                            | ** ** | ** **                                                                                                                                                                   |
| 10.19      |       | Option Amendment Agreement, dated October 1,  2001 by and between Michael J. Tate and the Company                                                                |       | Incorporated by reference to Exhibit 10.19 to  the Company’s Annual Report on Form 10-KSB for the year ended December 31,  2001 (File No. 0-1561)   |
|       |       |                                                                                                                                                                  |       |                                                                                                                                                                         |
| 10.20      |       | 12% Promissory Note dated January 21, 2002  issued to Richard F. McNamara                                                                                        |       | Incorporated by reference to Exhibit 10.20 to  the Company’s Annual Report on Form 10-KSB for the year ended December 31,  2001 (File No. 0-1561)   |
|       |       |                                                                                                                                                                  |       |                                                                                                                                                                         |
| 10.21      |       | Warrant for Purchase of Shares of Common Stock of  the Company dated January 21, 2002 issued to Richard F. McNamara                                              |       | Incorporated by reference to Exhibit 10.21 to  the Company’s Annual Report on Form 10-KSB for the year ended December 31,  2001 (File No. 0-1561)   |
|       |       |                                                                                                                                                                  |       |                                                                                                                                                                         |
| 10.22      |       | Lease from Hopkins Eleventh Avenue, LLC to the  Company dated February 21, 2003                                                                                  |       | Incorporated by reference to Exhibit 10.1 to  the Company’s Current Report on Form 8-K, dated March 11, 2003  (File No. 0-1561)                     |
|       |       |                                                                                                                                                                  |       |                                                                                                                                                                         |
| 10.23      |       | Promissory Note from Hopkins Eleventh Ave LLC dated February 21,  2003                                                                                           |       | Incorporated by reference to Exhibit 10.2 to  the Company’s Current Report on Form 8-K, dated March 11, 2003  (File No. 0-1561)                     |
|       |       |                                                                                                                                                                  |       |                                                                                                                                                                         |
| 10.24      |       | Third Amendment to Amended and Restated Credit  Agreement dated as of September 30, 2003                                                                         |       | Incorporated by reference to Exhibit 10.1 to  the Company’s Current Report on Form 8-K, dated October 31, 2003  (File No. 0-1561)                   |
|       |       |                                                                                                                                                                  |       |                                                                                                                                                                         |
| 10.25      |       | Fourth Amendment to Amended and Restated Credit  Agreement dated as of January 6, 2004                                                                           |       | Incorporated by reference to Exhibit 10.25 to  the Company’s Annual Report on Form 10-KSB, dated December 31, 2003  (File No. 0-1561)               |

 

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| 10.26  |   | Amended Equipment Lease Agreement between Activar  Properties, Inc. and the Company dated as of December 30, 2002 |   | Incorporated by reference to Exhibit 10.26 to  the Company’s Annual Report on Form 10-KSB, dated December 31, 2003  (File No. 0-1561) |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                        |   |                                                                                                                                                           |
| 10.27  |   | Fifth Amendment to Amended and Restated Credit  Agreement dated as of August 13, 2004                                  |   | Incorporated by reference to Exhibit 10.1 to  the Company’s Quarterly Report on Form 10-QSB, dated June 30, 2004  (File No. 0-1561)   |
|   |   |                                                                                                                        |   |                                                                                                                                                           |
| 14.1   |   | Code of Ethics and Business Conduct                                                                                         |   | Incorporated by reference to Exhibit 14.1 to  the Company’s Annual Report on Form 10-KSB, dated December 31, 2003  (File No. 0-1561)  |
|   |   |                                                                                                                        |   |                                                                                                                                                           |
| 14.2   |   | Code of Ethics for Senior [Financial] Executives                                                                            |   | Incorporated by reference to Exhibit 14.2 to  the Company’s Annual Report on Form 10-KSB, dated December 31, 2003  (File No. 0-1561)  |
|   |   |                                                                                                                        |   |                                                                                                                                                           |
| 23.1   |   | Consent of Independent Registered Accounting Firm                                                                           |   | Filed herewith electronically                                                                                                                                  |
|   |   |                                                                                                                        |   |                                                                                                                                                           |
| 31.1   |   | Certification of President and Chief Executive  Officer                                                                     |   | Filed herewith electronically                                                                                                                                  |
|   |   |                                                                                                                        |   |                                                                                                                                                           |
| 31.2   |   | Certification of Treasurer and Chief Financial  Officer                                                                     |   | Filed herewith electronically                                                                                                                                  |
|   |   |                                                                                                                        |   |                                                                                                                                                           |
| 32.1   |   | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                    |   | Filed herewith electronically                                                                                                                                  |
|   |   |                                                                                                                        |   |                                                                                                                                                           |
| 32.2   |   | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                    |   | Filed herewith electronically                                                                                                                                  |

 

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