** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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** **

**FORM 10-KSB**

** **

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

 

**For the Fiscal Year Ended December 31, 2005**

 

**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**

 

**MAGSTAR TECHNOLOGIES, INC.**

(Exact name of registrant as specified 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 is not required to filed reports pursuant to Section 13 or 15(d) ofthe Exchange Act  YES ý   NO  o

 

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  o    NO  ý

 

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. o

 

Indicate by checkmark whether the registrant is a shell company as defined in Rule 12b-2 ofthe Securities Exchange Act.

 

YES  o        NO  ý

 

The Registrant’srevenues for the fiscal year ended December 31, 2005 were $8,104,646.

 

The aggregatemarket value of the common stock of the Company held by non-affiliates as of March 24,2006 was approximately $5,365,720 (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, 2006 was9,130,723 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 statementsinvolve risks and uncertainties, including statements regarding the Company’scapital needs, business strategy and expectations. Any statements that are notof historical fact may be deemed to be forward-looking statements. Theseforward-looking statements involve substantial risks and uncertainties. In somecases 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-looking statements in this Report also includereferences to anticipated sales volume and product margins, efforts aimed atestablishing new or improving existing relationships with customers, otherbusiness development activities, anticipated financial performance, businessprospects and similar matters. Actual events or results may differmaterially from the anticipated results or other expectations expressed in theforward-looking statements. In evaluating these statements, you should considervarious factors, including the risks included from time to time in otherreports or registration statements filed with the United States Securities andExchange Commission. These factors may cause the Company’s actual resultsto differ materially from any forward-looking statements. The Company disclaimsany obligation to publicly update these statements, or disclose any differencebetween actual results and those reflected in these statements. Suchinformation constitutes forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995 which provides a safeharbor for forward-looking statements.*

 

*In addition, the Company hashistorically had a high concentration of business with one major customer. Therisks and uncertainties the Company faces include, but are not limited to, theability to expand sales and product offerings, to develop a reputation inmanufacturing products for select industries such as medical industries andfactory and laboratory automation, to manufacture and ship in a timely mannerand to the ability to acquire raw materials, as well as the risks anduncertainties described in “Management’s Discussion and Analysis or Plan ofOperations” in this Report.*

 

# **ITEM 1.**               DESCRIPTION OFBUSINESS.

# ** **

***BusinessOverview***

 

MagStar Technologies, Inc.(“MagStar” or the “Company”) is a leading global provider of products,technologies, solutions, and services to businesses of all sizes. Our offeringsinclude:

•                  QuickdrawConveyors

•                  Spindles andMotion Control

•                  IndustrialCentrifuges

•                  ContractManufacturing

 

MagStar is a publicly ownedcompany headquartered in Hopkins, Minnesota that trades over the counter on theBulletin Board (“OTCBB”) under the symbol “MGST.”

 

The Company wasestablished in 1948 as Reuter Manufacturing, Inc., and specialized inprecision machining and assemblies. In late 2000, the Company acquired theassets of MagStar Technologies, Inc., a private high-energy magnet andmagnetic assembly company. In early 2001, the

 

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Company changed its name to 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.

 

The Company is aMinnesota corporation. The principal executive offices of the Company arelocated at 410 Eleventh Avenue South, Hopkins, Minnesota 55343. The Company’stelephone number 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 is a manufacturerof material handling, motion control, magnetic assemblies, and contractmanufactured parts and devices. MagStar’s primary product is Quickdraw brandconveyor systems, used in factory and laboratory automation. MagStar alsomanufactures customized motion control products, spindles, medical devices, andits other proprietary product, oil centrifuges. MagStar offers engineering,precision machining, and assembly strengths. Products include conveyors forhigh tech manufacturing, assembly, and laboratory processes, custom servomotors and spindles, motion control devices, linear slides, disposable-basedmedical centrifuges, and oil centrifuges.

 

**PROPRIETARY PRODUCTS**

 

**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 using these productsinclude high-tech manufacturers, semi-conductor, academic and researchinstitutions, microelectronics, biotech, and automotive. These industries arecontinually striving to increase productivity, decrease rejected products, andminimize workers exposure to strenuous and tedious operations or hazardousenvironments. MagStar makes five types of modular, low profile conveyorsystems, three with slip roller accumulation, one with a belt edge drive, andone with individual drives. Each provides electrostatic discharge protection,low power consumption, and are clean room certified.

 

**Spindles/Motion ControlledDevices**:

 

Spindles and motion control devices are predominantlymanufactured per customer specification for assemblies whose uses range frommedical centrifuges to silicon wafer saws to printed circuit board saws,routers, and optical inspection systems. The Company’s spindles are used toposition various devices which allow for greater flexibility in the customer’sdesignated processes. One customer’s spindle application includeselectronically controlled feedback devices and is used in optical inspectionsystems. Another spindle manufactured for a customer controls various medicalnuclear imaging devices on gantry-mounted systems. Blood centrifuge spindleassemblies and devices allow for high-speed separation of blood into variouscomponents and are used in operating rooms, laboratories and blood banks.

 

**Industrial centrifuges**

 

Industrial oil centrifuges facilitate increased drainintervals and oil purification for engine operation. Oil centrifuges are usedin marine engines, over the road trucking, power generation,

 

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and oil and gas production. Current centrifuge productprojects include blood centrifuges, proprietary oil centrifuges, private labeloil centrifuges, water centrifuges, gaseous/vapor centrifuges, fuel linecentrifuges, and industrial centrifuges (coolants/lubrication).

 

**CONTRACT MANUFACTURING**

 

**Precision Magnet Assemblies**

 

The Company buildsprecision magnet assemblies for aerospace, medical, and motion controlledapplications. These assemblies generally include high-energy permanent magneticmaterial that may be components of machined parts or sub assemblies ofrotors, pumps, stators, motors, and directional control devices.

 

**Production machining**

 

The Company designs andmachines metal parts for a small number of customers. The Company has unique expertisein CNC machining precision, close tolerance components.

 

***Technology***

 

MagStar has technicalabilities in the following areas:

 

**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 needswith its high tolerance machining and assembly skills, its edge belt handlingtechnology, and its skills in servomotor control feedback. Production ofunwanted particulate can be a side effect of using conveyor devices inmanufacturing. MagStar’s patent pending clean room conveyor technology isdesigned to solve customers’ problems in dealing with clean room requirements.

 

**Spindle Design and Manufacturing**

 

Spindles are precisionelectrical motor-based devices. MagStar manufactures and designs spindles thatrotate from 1,000 up to 40,000 RPMs. Spindles are similar to motors usedto power its centrifugal devices and typically include a DC brushless electricmotor, bearings, and a feedback/control device all driving a shaft that engagessomething else. For example, in a centrifuge, the motor-driven shaft engagesthe container holding fluid to which centrifugal force is being applied. MagStar’sspindles are especially well known for generating minimal noise, vibration, andheat. The skills and technology that this type of manufacturing requiresinclude strong engineering, precision, and specialized 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 usebonding capabilities and custom matching of materials to specific applicationsenhancing performance for its customers.

 

**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 isapplied to design and manufacture technological applications. Theseapplications generally involve high-speed rotation while generating minimalnoise, heat, and vibration.

 

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***Markets***

 

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

 

**High Tech Manufacturing andLaboratory Automation**

 

MagStar’s conveyor lineprovides solutions for a variety of markets, usually integrated into largermanufacturing solutions for markets such as automated assembly of electronicsand medical devices, semiconductors, wafer boards, flat screen monitorcomponents, fluid analysis, pharmaceuticals, and medical devices. The conveyorline also is frequently used in laboratory automation.

 

**Motion Control**

 

MagStar is a supplier ofcustom spindle/electric motor assemblies for high technology applications. Theseapplications require state of the art capabilities for large OEM market leaders.Precision magnet assemblies and magnetizing capabilities along with precisionmovement and placement systems from Quickdraw technology contribute to andbroaden the Company’s capabilities.

 

**Medical**

 

MagStar is a manufacturerof blood separation spindle devices used in analysis and component isolation ofwhole blood. MagStar’s primary customer is a leading supplier of automatedblood processing systems which provides readily available blood components forpharmaceutical use or patient transfusions. These products are used inoperating rooms and in many of the world’s blood banks and laboratories. Otherblood centrifuge applications include the market for thrombin-basedorthobiologics. The Company also manufactures medical components used in bloodcirculatory devices.

 

**Combustion Engines**

 

MagStar manufactures anengine oil centrifuge used primarily by OEMs on stationary and non-stationaryengines of 150 hp and above. The centrifuges are also an after market additionto oil field engines and power generators. The centrifuge is designed toprovide filtration to .5 micron, the ability to recover and analyze particulatefor preventive maintenance, and the Company is developing the centrifuge’sefficiency for soot removal. The oil centrifuge also uses MagStar’s centrifugetechnology. Markets that use this technology include power generation, gas andoil production, marine engines, over the road trucking, and off road andconstruction equipment.

 

**Filtration/High Tech Separation**

 

MagStar is a manufacturerof centrifugal separation and filtering spindle devices used with a variety ofliquids including water and gaseous streams. These devices are used to remove avariety of mineral particulate and biological material.

 

***Strategy***

 

The Company is strategically focused on growing itsQuickdraw Conveyors and establishing itself as a premiere manufacturer of customand standard spindles. While the Company intends to continue its contractmanufacturing businesses, the Company views Quickdraw Conveyors, spindles, andmotion control as its primary growth opportunities. MagStar is also developingthe distribution channels for its proprietary oil and industrial centrifugeproducts.

 

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***Sales and Marketing***

 

The Company’s sales andmarketing effort is focused on the strategic markets outlined above. TheCompany uses both an outside sales team and 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 usespaid advertising and trade shows, among other methods, to market its products.MagStar’s website (www.magstar.com) provides in-depth descriptions of MagStar’ssales and products.

 

***Customers***

 

In 2005, the Company had sales to its largest customerof $3,373,257, approximately a 53% increase from sales of $2,198,158 to thesame customer in 2004. This customer accounted for approximately 42% of theCompany’s sales in 2005. Sales with this customer are expected to remain atcurrent levels and possibly increase in 2006. Sales in 2005 to the Company’ssecond largest customer were $1,039,926, compared to $1,207,999 in 2004. Thisaccounted for approximately 16% of the Company’s 2005 sales. The decrease of$168,073, or (14%), from 2004 sales to the customer is due to cyclical demandfrom this customer originating in the semiconductor industry. The Companyanticipates sales to this customer to remain at current levels and possiblyincrease in 2006.

 

***Supplies***

 

The raw materials used by the Company in itsmanufacturing operations are reasonably available in the competitive market. TheCompany seeks to maintain multiple sources of the parts and materials; however,certain significant customers limit the number of or designate specificsuppliers to be used by MagStar. The availability of such parts and materialscould affect the Company’s ability to fill customers’ orders on a timely basis.The Company believes that the interruption of existing relationships withsuppliers would not have a material adverse effect over the long term, as partsand materials suitable for the production of our products would be availablefrom other suppliers.

 

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

 

***Competition***

 

With regard to the Quickdraw Conveyor product group,there are many manufacturers of parts and components used in these systems. However,the Company is not aware of any other manufacturers that also have the abilityto engineer and manufacture high performance, precision, custom designed andhighly cosmetic conveyors for these markets to the satisfaction of itscustomers. It believes that its high speed, high precision and high performanceproducts give it the ability to compete effectively in the conveyor market.

 

The contract manufacturing, machining, and magneticbusiness in which the Company engages is highly competitive. Many of theCompany’s competitors have greater sales volume and resources than the Company.The principal elements of competition are quality, service, delivery, price andmeeting

 

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customer requirements. The Company believes that it accounts for only asmall portion of aggregate national sales of the manufacturing service itprovides. The Company believes, however, that its strong engineering andmanufacturing capabilities give it a competitive advantage.

 

There are many OEM manufacturers of medical andindustrial centrifuges. However, the Company is not aware of any other contractmanufacturers that also have the ability to engineer and manufacture highspeed, precision, custom designed and highly cosmetic centrifuges for thesemarkets to the satisfaction of its customers. It believes that its high speed,high precision products give it the ability to compete effectively in thecentrifuge market.

 

The Company faces competition from several nationalmanufacturers of precision magnets, many of which are capable of supplyingmagnet assemblies. With its complete engineering and manufacturingcapabilities, the Company can play a more significant role in its customers’supply programs and benefit more directly from all of the value that is createdin the manufacturing process.

 

***Research and Development***

 

The Company conducts customer funded research anddevelopment activities primarily related to design and prototype development ofcustomer’s products or customer’s requests and, to a lesser extent, productssold under the Company’s trade names. The Company also provides some engineeringservices to support its customers in the development of new products, includingenhancements to current products. In 2005 and 2004, the Company collected $0and $125,000 respectively, in research and development fees. There were nosignificant research and development expenses that were not customer funded in2005 or 2004, nor does the Company anticipate significant expenses of thisnature in 2006.

 

***Intellectual Property***

 

The Company has three patents on its QuickdrawConveyor products. The Company has trademarks on its oil centrifuge product andconveyor products.

 

The Company has its employees sign confidentiality andnondisclosure agreements at the time of hiring. The Company also requirescertain 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 of orders and releases on December 31,2005 was approximately $4.2 million, compared to approximately $2.7 million on December 31,2004. The Company’s backlog often fluctuates because of blanket orders placedby customers who schedule delivery of the product over future months. Theusual period between receipt of an order for a new assembly and the firstdelivery of the product by the Company is 2 to 6 months. The delivery periodfor subsequent orders generally is shorter. The Company believes its backlog isfirm.

 

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***Employees***

 

As of December 31, 2005, the Company had 57employees, which includes 56 full time employees and 1 part time employee.As of December 31, 2004, the Company had 68 employees, which included 67full time employees and 1 part time employee. One executive officer whomakes significant contributions to the business of the Company is not anemployee of the Company.

 

**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 Company owned these facilities and the approximately 7.5 acres ofland on which the facilities are located. These facilities consist ofapproximately 110,000 square feet of which approximately 13,000 square feet aredevoted to office space, and 97,000 square feet are devoted to manufacturingand warehousing. The Company considers these facilities to be well maintainedand in good operating condition, and believes that such manufacturingfacilities can accommodate anticipated 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 a6.5-year gross lease with Hopkins Eleventh Avenue LLC for the building andproperty at a monthly 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 theCompany’s discussions with the bank that provides financing for the Company inanticipation of changes that would be required for the bank to renew theCompany’s line of credit. See “Item 12. Certain Relationships and RelatedTransactions.”

 

On March 31, 2003, the Company subleasedapproximately 30,000 square feet of its facility to an unrelated party for 18months. The sublease provided for annual income of $4.55 per square foot, or$149,081 per year. On November 1, 2004, the Company did not renew theprevious sublease and instead subleased the approximate 30,000 square feet toActivar, Inc., a corporation principally owned by a major shareholder anddirector of the Company, for its operational use. The sublease provides annualincome of approximately $6.00 per square foot, or $180,000 per year and isrenewable monthly.

 

In addition, on May 1, 2004 the Company subleasedapproximately 2,000 square feet of its facility to a different unrelated partyon a month to month basis. The sublease provides for annual income of $12.00per square foot, or $24,000 per year.

 

# **ITEM3. LEGAL PROCEEDINGS.**

# ** **

None.

 

# **ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY 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.

 

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**PART II**

** **

# **ITEM5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.**

# ** **

***MarketInformation***

 

 The Company’s common stock is not listed on anexchange; however, market quotes for the Company’s common stock are availableon the over-the-counter bulletin board (“OTCBB”) under the symbol “MGST.”  The following table sets forth, for each ofthe calendar periods indicated, the quarterly high and low bid quotations forthe Company’s common stock quoted on the OTCBB. The prices in this tablerepresent prices between dealers, and do not include adjustments for retailmark-ups, markdowns or commissions and may not represent actualtransactions.

 
| ** ** | ** ** | ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|------------|------------|----------------|------------|----------|------------|---------|------------|
| 2005:      |       | First Quarter  |       | $        | .65        |    | $          | .45 |   |
|       |       | Second Quarter |       | $        | .45        |    | $          | .40 |   |
|       |       | Third Quarter  |       | $        | .75        |    | $          | .40 |   |
|       |       | Fourth Quarter |       | $        | .65        |    | $          | .45 |   |
| ** ** | ** ** | ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
| 2004:      |       | First Quarter  |       | $        | 1.25       |    | $          | .65 |   |
|       |       | Second Quarter |       | $        | 1.15       |    | $          | .75 |   |
|       |       | Third Quarter  |       | $        | 1.13       |    | $          | .80 |   |
|       |       | Fourth Quarter |       | $        | 1.00       |    | $          | .70 |   |

 

***Holders***

 

As of March 24, 2006there 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 2005, and the Company does notintend to pay dividends on its common stock or Series A preferred stock inthe foreseeable future.

 

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

 

***RecentSales of Unregistered Securities***

 

On July 25, 2005,the Company issued 54,182 shares of Common Stock to a former employee of theCompany in satisfaction of a retirement benefit obligation owed to such formeremployee by the Company. The Company issued the shares in reliance of anexemption from registration under section 4(2) of the Securities Actof 1933, as amended, for offers and sales of securities that do not involve apublic offering. The shares may not be transferred absent registration oran applicable exemption from registration requirements.

 

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

# ** **

***General***

 

Through most of 2005, the Company experienced sustainedsales for its blood centrifuge spindles and conveyors to the Company’s largestcustomers compared to 2004. Quickdraw Conveyor and spindle orders account forthe majority of the December 31, 2005 backlog. The Company sees conveyorand spindle sales growing and being important to the Company’s strategic growth.There can be no assurance that sales to the Company’s largest customers, orthat sales of other products will be sufficient to allow the Company tomaintain 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 briefdiscussion of the more significant accounting policies and methods used by theCompany.

 

*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 mostsignificant estimates and assumptions relate to the valuation of inventory andthe recognition of revenue. Actual amounts could differ from these estimates.

 

*Inventory Valuation*

 

The Company considers recent historic usage andfurther demand in estimating its net realizable value of its inventory. Inventoryat December 31, 2005 reflects write-downs of $210,000. 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.

 

*Revenue Recognition*

 

The Company recognizes sales when products are shipped,collectability is probable and the sales price is fixed or determinable.

 

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***Results of Operations***

 

Total revenues for 2005 were $8,104,646, compared to$7,350,319 for 2004. As part of the Company’s strategic initiatives,revenue classifications have been reclassified for 2006 and forward. Based onthe former classifications, the Company’s sales were as follows:

 

| ** **             | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|------------------------|------------|-----------|------------|-----------|------------|
| Medical                |       | $         | 3,605,594  |      | $          | 2,584,223 |   |
| Magnets                |       | 484,123   |       | 511,235   |       |
| Industrial             |       | 918,952   |       | 883,410   |       |
| Contract manufacturing |       | 1,101,468 |       | 1,159,995 |       |
| Quickdraw Conveyors    |       | 1,937,525 |       | 2,245,695 |       |
|                        |            |           |            |           |            |  |  |

 

The Company’s new classifications are now QuickdrawConveyors, Spindles and Motion Control, Industrial Centrifuges, and Contractmanufacturing. Net sales for 2005 and 2004 were as follows:

 

| ** **                  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-----------------------------|------------|-----------|------------|-----------|------------|
| Quickdraw Conveyors         |       | $         | 1,937,525  |      | $          | 2,245,695 |   |
| Spindles and Motion Control |       | 3,780,717 |       | 2,648,652 |       |
| Industrial Centrifuges      |       | 918,952   |       | 883,410   |       |
| Contract manufacturing      |       | 1,410,467 |       | 1,606,801 |       |
|                             |            |           |            |           |            |  |  |

 

Based on the previous sales classifications, net salesfor 2005 from medical, industrial, magnetic, high tech/contract manufacturingand Quickdraw conveyors were, respectively, $3,605,594, $484,123, $918,952, $1,101,468,and $1,937,525. Net sales for 2004 from medical, industrial, magnetic, hightech/contract manufacturing and Quickdraw conveyors were, respectively,$2,584,223, $511,235, $883,410, $1,159,995 and $2,245,695. Based on the newsales classifications, net sales for 2005 from Quickdraw Conveyors, Spindlesand Motion Control, Industrial Centrifuges, and Contract manufacturing were,respectively, $1,937,525, $3,780,717, $918,952, and $1,410,467. Net sales for2004 from Quickdraw Conveyors, Spindles and Motion Control, Industrial Centrifuges,and Contract manufacturing were, respectively, $2,245,695, $2,648,652,$883,410, and $1,606,801.

 

The Company’s net sales increased by approximately 10%in 2005 from 2004, compared to an increase in net sales of 18% in 2004 from2003. Sales are not subject to seasonal volatility. The increase in sales from2005 over 2004 is due to slightly increased demand from the Company’s largestcustomer. The sales growth is also attributable to the Company completingsignificant operational and financial restructuring and placing strategicemphasis on increasing sales.

 

Cost of sales was $6,552,155 for 2005, compared to$6,296,416 in 2004, an increase in the cost of sales of approximately 4%. Whilethe cost of sales increased in 2005 over 2004, gross profit dollars alsoincreased. 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$1,552,491, or 19% for 2005, compared to $1,053,903 or 14% in 2004. Thisincrease in gross profit was due to the factors discussed above.

 

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Selling, general andadministrative expenses were $1,217,782 or 15% of net sales in 2005, comparedto $1,082,553 or 15% of net sales in 2004. The 11% increase in selling, generaland administrative expenses is due primarily to an increase in sales expensesincluding trade shows, advertising and sales commissions.

 

As a consequence of theforegoing factors, the Company had operating income in 2005 of $334,709,compared to an operating loss of $28,650 in 2004, an increase of approximately1,268%.

 

Interest expenses in 2005were $149,669, compared to $238,194 in 2004. The decrease in interest expenseis due to restructuring of related party debt which included $4,300,754 of debtforgiveness (refer to related party debt forgiveness in 2004.)  Total other income, net of interest expensesin 2005 was $7,804, compared to $53,527 in 2004.

 

Total other expense, netin 2005 was $141,865, compared to total other expense, net in 2004 of $184,667other income, net, a decrease of $42,802 which was primarily due to a loweraverage loan balance on the bank line of credit in 2005 compared to 2004.

 

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

 

In 2005, the Company hadnet income of $192,844, or $.01 per basic share, compared to a net loss of$213,317 or $0.03 per basic share for 2004. Net income for 2005 was $.01 per dilutedshare, compared to a net loss of $0.03 per diluted share for 2004. Net incomeor loss is due to the reasons discussed above.

 

The Company recorded netincome for 2005. Generally, the Company does not pay regular income taxesbecause of the availability of its net operating loss carry forwards.

 

***Liquidityand Capital Resources***

 

At December 31,2005, the Company had a working capital deficit of $3,004,467, compared to aworking capital deficit of $3,039,095 at December 31, 2004. The currentratio was****.44 at December 31, 2005,compared to .37 at December 31, 2004. The decrease in the working capitaldeficit and the increase in the current ratio are primarily due to a decreasein senior debt.

 

The Company had positivecash flows from operations of $34,972 for the year ended December 31,2005, compared to negative cash flows from operations of $161,982 for the yearended December 31, 2004. The Company’s ability to meet its continuing cashrequirements in the future is dependent on sustaining adequate sales andmargins from its manufacturing operations.

 

Net cash (used in)investing activities was $85,328 for the year ended December 31, 2005,compared to net cash (used in) of $30,509 for the year ended December 31,2004.

 

Net cash provided byfinancing activities was $50,456 for the year ended December 31, 2005,compared to cash provided by financing activities of $192,491 for the yearended December 31, 2004.

 

*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 theSecurities Purchase Agreement, the Company sold to the

 

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Investors an aggregate of 3,500,000 shares of the Company’s commonstock, par value $.1875 per share (“Common Stock”), and an aggregate of1,000,000 shares of the Company’s Series A convertible preferred stock,par value $.1875 per share (“Series A Preferred”; together with the CommonStock, the “Shares”), all at a purchase price of $.1777778 per share, for anaggregate purchase price of $800,000. Of the $800,000 total, Activar and Mr. Reissnerpurchased $700,000. The shares were sold in a transaction exempt from theregistration requirements of the Securities Act of 1933, as amended (the “SecuritiesAct”), 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 fully paid and nonassessable shares of common stock on aone for one basis subject to anti-dilution. The Series A Preferredgenerally votes with the common stock on matters submitted to the shareholders,with each share of Series A Preferred having that number of votes that isequal to the number of whole shares of common stock into which such share of Series APreferred is then convertible. The Series A Preferred is entitled to 9%dividends in preference to any dividends paid on the common stock, but such 9%dividends are payable only if, as and when declared by the Company’s board ofdirectors.

 

*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. Proceedsfrom the sale-leaseback were used to pay off Term Note B (as defined below) inthe principal amount of $1,027,000 plus accrued interest due to the bank andpay off $540,034 owed to the Lessor for equipment purchases. The Lessor hasassigned its rights 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 leasereducing the payments to $45,646 for a term of 60 months. Again on April 1,2004, these leases were amended as part of the fifth amendment to theCompany’s amended and restated credit agreement, as described in more detailbelow. The Company amended the leases on April 1, 2004 whereby the minimumlease payments for the remainder of 2004 and 2005 were waived. Monthly leasepayments in 2006 and 2007 would be $20,000 per month (the ending date of theleases were not changed due to the amendment that occurred on April 1,2004). The Company believes that the amendments to the leases were necessary inorder to amend the credit agreement and extend it to June 2005. The resultof these amendments was reflected in the Notes to the Financial Statementshereto. In June 2005, the Amended and Restated Credit Agreement wasextended to June 2006.

 

*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 at 12%. Inconsideration for the loan, Mr. McNamara received warrants to purchase250,000 shares of common stock of the Company. 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 wasreduced to 8%. Interest on the term note is payable monthly, with the principalbalance due and payable on January 10, 2005. This term note was requiredto be restructured in the fifth amendment to the Company’s amended and restatedcredit agreement as required by the senior lender. The results of thisrestructuring are reflected in the Notes to Financial Statements.

 

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Throughout 2004 and 2003,the Company borrowed monies from Activar, Inc. to fund operations. Theseloans are due on demand and accrued interest at 10% through September 2002,at which time the interest rate was lowered to 6%. This lending arrangement wasconverted into a revolving credit arrangement with Richard F. McNamara andaffiliates on January 1, 2003 with interest remaining at 6%. The Companybelieves that the terms and conditions of the promissory notes given to Activar, Inc.are at least as favorable as the terms and conditions on which the Companycould have obtained credit from an unaffiliated third party. For the year ended2005, all accrued interest related to these notes was forgiven which wasapproximately $90,000.

 

*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 Note C”). Although the line of credit wasdue October 2003, US Bancorp had the right to demand payment at any time. Becausethe credit facilities agreement also included a subjective material adversechange clause under which the borrowings could become due and payable, theCompany classified all of the amounts owing under 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 athird amendment of its amended and restated senior credit agreement, anextension with US Bancorp onthe line of credit.

 

On January 6, 2004, the Company negotiated afourth amendment of its amended and restated senior credit agreement, anextension with US Bancorp on the line of credit. The extended asset-based lineof credit bore interest at the bank’s reference rate plus two percent, hadavailability of $1,350,000 subject to a borrowing base limitation of 80% of theCompany’s eligible accounts receivable plus 40% of raw materials and 30% offinished goods, and 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 of credit bears interest at the bank’sreference rate plus two and one half percent, has availability of $1,200,000subject to a borrowing base limitation of 80% of the Company’s eligibleaccounts receivable plus 40% of raw materials and 30% of finished goods andwill expire on June 30, 2005. The credit facilities are collateralized bysubstantially 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 related parties.As a result, on August 13, 2004, the Company amended its building andequipment leases with Hopkins Eleventh Ave,

 

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LLC and Activar Properties, respectively, and $4,300,754 of relatedparty debt has been extinguished without additional consideration. Because thetransaction is between related parties, the gain on the extinguishment of debtwas classified as a contribution to equity in June 2004, and will notaffect future statements of operations. The amended and reduced building andequipment leases will positively affect the statement of operations on anongoing basis. The reduced related party debt was restructured with a 3%interest rate and will reduce interest expense, also positively affecting theCompany’s statements of operations in the future. The Company believes that the3% interest rate charged on the restructured debt had a positive influence onthe bank’s decision to amend the credit agreement and extend it to June 2005.

 

The Company entered into its second amended andrestated senior credit agreement with US Bancorp on June 30, 2005. Theextended asset-based line of credit bears interest at the bank’s reference rateplus two percent, has availability of $1,200,000 subject to a borrowing baselimitation of 80% of the Company’s eligible accounts receivable plus 40% of rawmaterials and 30% of finished goods and will expire on June 30, 2006. Thecredit facilities are collateralized by substantially all the assets of theCompany.

 

*FacilitiesSale/Leaseback*

 

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

 

The purchase price forthe building and property was $3,700,000. The Company entered into a 6.5-yeargross lease with Eleventh Avenue for the building and property at a monthlycost of $34,000 increasing to $44,436 per 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 theCompany’s amended and restated credit agreement, the Company was required bythe bank to restructure this lease in a manner which is favorable to theCompany, which is reflected in the Notes to Financial Statements. The mortgagehad originally been entered into as security for Term Loan A under theprovisions of 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 theCompany’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 the site. TheCompany notified the Minnesota Pollution Control Agency (the “MPCA”), andworked with the MPCA toward resolution of the issue. All ground waterinvestigation has been completed and on December 7, 2004, the MPCA issueda determination to take no further action under Minn. Stat. 115B.01-115B.18with respect to the identified release. All reserves related to this issue havebeen released.

 

*Expected Capital Needs for 2006*

 

The Company does notexpect capital needs in 2006 to exceed the capacity of its asset based line ofcredit as allowable receivables and inventory borrowings are expected to coveroperating

 

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requirements. While the asset based line of credit expires in June 2006,the Company believes it will be able to replace this facility. The Companybelieves that cash from operations, and renewal of and advances from its creditfacility will provide enough liquidity for at least the next 12 months ofoperations.

 

***BusinessConditions***

 

The Company recognizednet income of $192,844 for the year ended December 31, 2005, and has aworking capital deficit and stockholders’ deficiency of $3,004,467****and $4,510,158, respectively, at December 31, 2005.

 

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

 

Steady growth may beachieved by identifying the Company’s core business (conveyors, motion controland spindles), seeking relationships that move beyond the manufacturing ofspecific parts and into the preparation of sub-assemblies and completedassemblies for its customers, developing a focus towards proprietary productsand away from contract manufacturing and building long-term, sustainablecomparative advantages over competitors. The Company seeks to become involvedwith its customers early in their development and design process allowing theCompany to participate in the earlier, higher value added stage of productdevelopment and to establish a closer working relationship with its customers.

 

The Company intends toadd new conveyor, spindle, and motion control customers by expanding itsdistribution network, creating strategic alliances, and new marketinginitiatives. The Company seeks to pursue a course investing in market drivenresearch and development that will lead to innovation and new valuepropositions in the future, establishing a reputation and expertise for productdevelopment. The Company seeks to be identified as a conveyor, motion control,and spindle manufacturer and intends to focus on higher value added productsthat allow 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 priorities include recapitalizing the balance sheet,generating liquidity, monitoring and changing processes to increaseproductivity, and strategically adding key managers and operational expertiseas a measured response as required in a prudent and responsible manner. TheCompany also has excess capacity. Through mergers, acquisitions and organicgrowth, it believes it can increase its revenues while incurring proportionallyless additional overhead. By increasing productivity, improving cost control,reducing expenses and keeping expenses in proportion to the Company’s currentsales level, the Company intends to sustain positive cash flow.

 

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. Seniormanagement executive needs and expenses 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 not include any adjustments that might resultfrom the outcome of this uncertainty as this probability is indeterminate.

 

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***Summary***

 

The Company feels that2005 showed improvements over 2004 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. Productivity improvements, cost control measures,profitability, and growing sales remain the highest priorities for the Company.The Company feels that it has established a trend in growing sales,productivity improvement and cost control. There can be no assurance that theseachievements, actions, and future actions, if necessary, will be sufficient forthe Company to meet its continuing cash flow requirements in the future orreturn 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. In addition, the Company has a highconcentration of business with one major customer and any reduction in sales tothis customer may affect net income. Because of these and otheruncertainties, actual results could differ materially from those reflected inthe forward-looking statements.

 

***Off-Balance SheetArrangements***

 

During the year ended December 31, 2005, theCompany did not engage in any off-balance sheet arrangements as defined in item303(c) of the SEC’s Regulation S-B.

 

***FactorsThat May Affect Future Results***

 

Dependence on MajorCustomers. Sales were affected by increases in sales to majormedical and conveyor customers in 2005. These increases were driven by higherdemand and reduced customer inventories. The Company continues to take ordersfrom these major customers and expects overall business with such customers toremain steady for 2006 or increase. However, no assurance can be given thatsales to these customers will reach or exceed previous levels. The Company hasno production contracts with its major customers and believes that reductionsin orders from these customers would have material adverse effects on futureoperating results. The Company continues to pursue customer diversification toreduce dependence on sales to its significant customer.

 

Dependence on NewProducts and Continued Growth in Sales Volume. The Company’sfuture success will depend on its ability to retain current customers and addnew customers. While the Company focuses attention on contract manufacturing,it also looks to develop new customers for products manufactured under its owntrade names, Quickdraw conveyors and oil centrifuges. The Company looks toobtain production orders for existing conveyor and prototype products includingmotion control, magnetic, spindle, and centrifuge assemblies, and maintain asatisfactory volume of orders for current customers.

 

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 believes the Company represents only a smallportion of the aggregate national sales of proprietary product and contractmanufacturing services.

 

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***Impactof Recent Accounting Pronouncements.***

 

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 of ARB 43, Chapter4, previously stated that under some circumstances, items such as idle facilityexpense, excessive spoilage, double freight, and rehandling costs may beso abnormal as to require treatment as current period charges.” SFAS No. 151requires that those items be recognized as current-period charges regardless ofwhether they meet the criterion of “so abnormal.” In addition, SFAS No, 151requires that allocation of fixed production overheads to the costs ofconversion be based 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 Company does notexpect the adoption of SFAS No. 151 to have a material effect on itsfinancial 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 be effectivefor nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,2005. Earlier application is permitted for nonmonetary asset exchangesoccurring in fiscal periods beginning after the date SFAS No. 153 wasissued. SFAS No. 153 shall be applied prospectively. The Company does notexpect the adoption of SFAS No. 153 to have a material effect on itsfinancial 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 are allowedto select from two alternative transition methods, each having differentreporting implications. The impact of SFAS No. 123R has not beendetermined 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, 2005 and 2004                                                   |       |
|                                                                                                    |       |
| Statements  of Operations for the years  ended December 31,  2005 and 2004                    |       |
|                                                                                                    |       |
| Statements  of Stockholders’ Deficiency for the years   ended December 31, 2005 and 2004 |       |
|                                                                                                    |       |
| Statements  of Cash Flows for the years ended  December 31,  2005 and 2004                    |       |
|                                                                                                    |       |
| Notes to the Financial Statements                                                                       |       |

 

# **ITEM8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE.**

# ** **

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. Basedon that evaluation, the Chief Executive Officer and Chief Financial Officer ofthe Company have concluded that the Company’s disclosure controls andprocedures as of the end of the fiscal year covered by this Annual Report on Form 10-KSBare effective to provide reasonable assurance that information required to bedisclosed by the Company in the reports that it files or submits under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the rules and forms of the Securities and ExchangeCommission. However, due to the limited number of Company employees engaged inthe authorization, recording, processing and reporting of transactions, thereis inherently a lack of segregation of duties. The Company periodicallyassesses the cost versus benefit of adding the resources that would remedy ormitigate this situation and currently, does not consider the benefits tooutweigh the costs of adding additional staff in light of the oversight of thefinancial statements 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. Therewas no change in the Company’s internal control over financial reportingidentified in that evaluation

 

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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.****                                            OTHERINFORMATION.**

 

Not applicable.

 

**PART III**

 

# **ITEM9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCEWITH SECTION 16(A) OF THE EXCHANGE ACT.**

# ** **

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

 
| **Name**                  | ** ** | **Age**    | ** ** | **Position**                                                                        |
|---------------------------|------------|------------|------------|-------------------------------------------------------------------------------------|
| ** **                | ** ** | ** ** | ** ** | ** **                                                                          |
| Richard F. McNamara       |       | 73         |       | Chairman of the Board and Director                                                  |
|                      |       |       |       |                                                                                |
| James L. Reissner         |       | 66         |       | Director, Former Chief Executive Officer, President,  and Secretary                 |
|                      |       |       |       |                                                                                |
| Michael J. Tate           |       | 66         |       | Director and Former President, Chief Executive  Officer and Chief Financial Officer |
|                      |       |       |       |                                                                                |
| Robert L. Stehlik         |       | 67         |       | Director                                                                            |
|                      |       |       |       |                                                                                |
| Dr. James H. Zavoral |       | 67         |       | Director                                                                            |
|                      |       |       |       |                                                                                |
| Jon L. Reissner           |       | 36         |       | Chief Executive Officer, President, and Secretary                                   |
|                      |       |       |       |                                                                                |
| Joseph A. Petrich         |       | 45         |       | Treasurer and Chief Financial Officer                                               |
|                      |       |       |       |                                                                                |
| Duane R. Bryngelson       |       | 44         |       | Chief Operating Officer                                                             |
|                      |       |       |       |                                                                                |
| Theodore A. Colvin        |       | 60         |       | Vice President of Sales and Marketing                                               |
|                      |       |       |       |                                                                                |
| David E. Helgerson        |       | 43         |       | Chief Technology Officer                                                            |

 

*Mr. McNamara*has served as Chairman of the Board and as a director of the Company since October 2000.Mr. McNamara has been a director of various other public companiesincluding Rimage Corporation and TCF Financial Corporation and was also memberof the University of Minnesota Board of Regents. Mr. McNamara is agraduate of the University of Minnesota.

 

*Mr. James L. Reissner*hasserved as a director of the Company since October 2000. From September 2001to August 2004, Mr. Reissner served as the Chief Executive Officer ofthe Company and as President of the Company from October 2002 until August 2004.He served as Secretary of the Company from October 2000 until August 2004.Mr. Reissner also served as Chief Financial Officer from September 2001to March 2002. Mr. Reissner has been President of Activar, Inc.since January 1996 and served as Chief Financial Officer of Activar from1992 until becoming President. Mr. Reissner is a director of several otherpublic companies, including the Chairman of the Board of Rimage

 

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Corporation and a member of the Board of Winland Electronics. Mr. Reissneris a graduate of Macalester College in Minnesota.

 

*Mr. Tate*has served as a director of the Company since April 1998. From April 1998to September 2001, Mr. Tate served as Chief Executive Officer andPresident of the Company. From April 1998 to December 1998 and from December 1999to September 2001, Mr. Tate also served as the Chief FinancialOfficer of the Company. Previously, he served as Vice President/Chief OperatingOfficer of Minnesota Valley Engineering from August 1996 until joining theCompany. Prior to serving at Minnesota Valley Engineering, Mr. Tate wasemployed in the Consulting divisions of Coopers & Lybrand and KPMGLLP.

 

*Mr. Stehlik*has been a director since 2005 and has been an independent Director of KoppEmerging Growth Fund since September 1997. Mr. Stehlik is retired andserved as Vice President of Peoples Bank of Commerce, Minneapolis, MN, from September 1998to September 2003. For four years prior to that, Mr. Stehlik servedas the Senior Vice President of Richfield Bank and Trust Co., based inRichfield, MN. Prior to his service at Richfield Bank, Mr. Stehlik servedin various capacities at First Bank (now US Bank) from 1961 to 1994, includingas a Senior Vice President and as President of the Southdale Branch from 1982to 1991.

 

*Dr. Zavoral* has been adirector since 2005 and is a practicing clinical and research cardiologist. Dr. Zavoralis a graduate of the University of Minnesota Medical School and University ofSt. Thomas. Since 1992, Dr. Zavoral has been the Director of thePreventive Cardiology Institute. Dr. Zavoral is also an AssistantProfessor at the University of Minnesota. He is the author of 55 peer-reviewedjournal articles and is the past President of the Minnesota Chapter of theAmerican Heart Association. Dr. Zavoral specializes in preventivecardiology, treatment of hypertension, hyperlipidemia, diabetes and obesity. Dr. Zavoralis a principal investigator for Radiant Research Company conducting Phase I-IVHuman Clinical Trials for the biopharmaceutical industry. He has earnedinternational recognition for his achievements in lipids and obesity research. Dr. Zavoralis a Fellow of the American Heart Association.

 

*Mr. Jon L. Reissner* hasserved as President, Chief Executive Officer and Secretary since August, 2004. Formerlyand since May 2002, he was the Company’s Director of Finance. Since May 2002,Mr. Reissner has served on a part-time consulting basis for Activar, Inc.,performing corporate and real estate financing services. From November 2001to May 2002, he was employed by Vermillion State Bank in Hastings,Minnesota, performing commercial lending and general banking functions. From1992 to 2000, Mr. Reissner served as a Director of Capital Markets andtraded Fixed Income Securities and derivatives and also structured Asset BackedSecurities for GMAC-RFC, a division of General Motors. Mr. Reissner isalso the Chairman of the St. Johns University Private Investment Fund AdvisoryBoard and is a member of the Finance Committee for The Association forLaboratory Automation. Mr. Reissner received his Bachelor of Sciencedegree in Economics from St. Johns University in Collegeville, Minnesota andhis Masters of Business Administration from the University of St. Thomas.

 

*Mr. Petrich*has served asTreasurer and Chief Financial Officer since March 2002. As of November 1,2005, Mr. Petrich also serves as Chief Financial Officer of Activar, Inc.He joined Activar in 1997 as the Operations Manager for its Plastics ProductsGroup and became General Manager of that group in 1998. The Activar PlasticsProducts Group includes Seelye Plastics, Eiler Plastics, Circuit Chemistry, andAfton Plastics. Prior to joining Seelye, Mr. Petrich was a controller forFrank W. Griswold and Companies from 1980 through 1994. He has served asGeneral Manger/Vice President of Sentry Technologies and Sentry Metal Formingfrom 1994 through 1995, and served as Chief Financial Officer for Famous Dave’sof America from 1995 through 1996. Mr. Petrich is a graduate from BethelCollege with a business management degree.

 

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*Mr. Bryngelson*was appointed Chief Operating Officer on January 3, 2006. Prior to that, Mr. Bryngelsonserved as Vice President - Operations of the Company since September 2002.Mr. Bryngelson was the General Manager of Bending Technologies and ComfortRide, members of the Activar group from 1995 to 2005. Mr. Bryngelsonjoined Bending Technologies in 1995 as the Director of Operations and took overas Director of Sales as well in 1997, before receiving his current andcontinuing role as General Manager in 1998. Mr. Bryngelson served asPresident of D & D Technical Design from 1991 to 1993 before joiningBending Technologies.

 

*Mr. Helgerson* has served as Chief Technology Officer since2004. Prior to that, Mr. Helgerson had served as the Vice President ofProduct Development since March, 2001. Prior to joining MagStar, Mr. Helgersonwas the President and CEO of Quickdraw Conveyor Systems, Inc., aBurnsville, Minnesota based manufacturer of proprietary conveyor systems andother factory automation devices. Mr. Helgerson has been awarded threepatents in conveyor technology. He worked as a Test Engineer at Honeywell’sDefense Division (now Alliant Techsystems, Inc.) before joining Quickdraw.Mr. Helgerson is a graduate of the University of Minnesota with aBacherlor’s Degree in Mechanical Engineering

 

*Mr. Colvin* has served as the Vice President of Sales andMarketing since January 3, 2006. Mr. Colvin was hired on December 1,2005 as the Quickdraw Conveyor Product Manager. Since 1998 and prior to joiningMagStar, Mr. Colvin was the Regional Sales Manager for NetManage. From1996 to 1998, he was General Manager for INACOM Corp-Midwest. From 1992 to1996, he was Consulting Services Manager at Digital Equipment Corp. From 1986to 1992, he was District Sales Manager at Storagetek. From 1975 to 1986 he wasa Health Industry Manager with IBM. Mr. Colvin served in the United StatesMarine Corps, attaining the rank of Captain and is a graduate of the Universityof St. Thomas with a degree in Political Science Degree.

 

***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.

 

**Audit Committee; Audit Committee Financial Expert**

 

The Board of Directors of the Company has an AuditCommittee composed of James L. Reissner, Robert L. Stehlik, James H. Zavoral,and Michael J. Tate. The Audit Committee provides assistance to the Board insatisfying its fiduciary responsibilities relating to the accounting, auditing,operating and reporting practices of the Company. The Audit Committee reviewsthe Company’s annual financial statements, the selection and work of theCompany’s independent auditors and the adequacy of internal controls forcompliance with corporate policies and directives. The Audit Committee does nothave 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. Messrs. Stehlik and Tate and Dr. Zavoral areall independent directors.

 

The Board of Directors has reviewed the education,experience and other relevant qualifications of Mr. Tate and Mr. Stehlikand has determined that these members meet the Securities and ExchangeCommission definition of an “audit committee financial expert” and would alsobe considered

 

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“independent” under the Securities and Exchange Commission definitionof that term and under current Nasdaq listing standards..

 

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 and greater than 10% beneficial owners arealso required to furnish the Company with copies of all Section 16(a) formsthey file. Based upon a review of the copies of such reports furnished to theCompany and upon other information known to the Company, the Company believesthat all filing requirements applicable to its directors, executive officersand beneficial owners of more than 10% of the Company’s outstanding shares ofcommon stock were complied with during the fiscal year ended December 31,2005, except for the transaction in the following table:

 
| **Name of Filer**   | ** ** | **Description of Transaction**                 | ** ** | **Transaction Date**             | ** ** | **Filing Date**           | ** ** |
|---------------------|------------|------------------------------------------------|------------|----------------------------------|------------|---------------------------|------------|
| ** **          | ** ** | ** **                                     | ** ** | ** **                       | ** ** | ** **                | ** ** |
| Duane R. Bryngelson |       | Option Grant                                   |       | 5/12/05                          |       | 1/11/06                   |       |
|                |       |                                           |       |                             |       |                      |       |
| David Helgerson     |       | Initial Form 3                            |       | Due on 7/11/05                   |       | 7/21/05                   |       |
|                |       |                                           |       |                             |       |                      |       |
| Richard McNamara    |       | Option Grant                                   |       | 6/10/05                          |       | 3/28/06                   |       |
|                |       |                                           |       |                             |       |                      |       |
| Joseph A. Petrich   |       | Option Grant                                   |       | 5/12/05                          |       | 3/14/06                   |       |
|                |       |                                           |       |                             |       |                      |       |
| James L. Reissner   |       | Option Grant

Stock Grant

Stock Grant         |       | 6/10/05

6/10/05

8/03/05        |       | 11/3/05

11/3/05

11/3/05 |       |
|                |       |                                           |       |                             |       |                      |       |
| Jon L. Reissner     |       | Option Grant                                   |       | 5/12/05                          |       | 3/09/06                   |       |
|                |       |                                           |       |                             |       |                      |       |
| Robert L. Stehlik   |       | Option Grant

Stock Grant

Stock Grant         |       | 6/10/05

6/10/05

8/03/05        |       | 9/1/05

9/1/05

9/1/05    |       |
|                |       |                                           |       |                             |       |                      |       |
| Michael Tate        |       | Option Grant

Stock Grant

Stock Grant         |       | 6/10/05

6/10/05

8/03/05        |       | 11/3/05

11/3/05

11/3/05 |       |
|                |       |                                           |       |                             |       |                      |       |
| James Zavoral       |       | Initial Form 3

Option Grant

Stock Grant |       | Due on 6/20/05

6/10/05

8/03/05 |       | 6/30/05

9/8/05

9/8/05   |       |

 

**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. Inaddition, the Company has a supplemental Code of Ethics for Senior Financial****Executives.

 

23

----

 

The Company’s Code of Ethics and Business Conduct and Code of Ethicsfor Senior Financial Executives are set forth as exhibits to this Annual Reporton Form 10-KSB. In addition, copies of the Company’s Code of Ethics andBusiness Conduct and Code of Ethics for Senior Financial Executives may beobtained from the Company upon request to Jon L. Reissner, in his capacity asSecretary of the Company.

 

# **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, 2005.

 

**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 |       | 2005

 

2004

 

2003 |       | 125,000

 

100,000

 

80,000 |       | 50,000

 

100,000

 

25,000 |       | -0-

 

-0-

 

-0- |   |
|                                                              |       |                             |       |                                     |       |                                    |       |   |   |
| Joseph A. Petrich(2)  Chief Financial Officer and Treasurer       |       | 2005

 

2004

 

2003 |       | -0-

 

-0-

 

-0-            |       | 20,000

 

100,000

 

25,000 |       | -0-

 

-0-

 

-0- |   |
|                                                              |       |                             |       |                                     |       |                                    |       |   |   |
| Theodore A. Colvin(3)  Vice President of Sales and Marketing      |       | 2005

 

2004               |       | 128,000

 

8,000                   |       | 5,000

 

-0-                      |       | -0-

 

-0- |   |

 

----

#### (1)                                  JonReissner became President and Chief Executive Officer in August, 2004

####  

#### (2)                                  JosephPetrich became Chief Financial Officer in March 2002.

 

#### (3)                                  TheodoreColvin was hired in December 2004 and became the Vice President of Salesin January 2006.

 

24

----

 

## **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 31,2005.

 
| **Name**           | ** ** | **Number of  Options  Granted** | ** ** | **Percent total  options granted  to employees in  fiscal 2005** | ** ** | **Exercise/base  price ($)** | ** ** | **Expiration Date** | ** ** |
|--------------------|------------|---------------------------------|------------|------------------------------------------------------------------|------------|------------------------------|------------|---------------------|------------|
| Jon L. Reissner    |       | 50,000                          |       | 19.8%                                                            |       | $ 0.36                  |       | 5/12/2015           |       |
| Joseph A. Petrich  |       | 20,000                          |       | 8.0%                                                             |       | $ 0.36                  |       | 5/12/2015           |       |
| Theodore A. Colvin |       | 5,000                           |       | 2.0%                                                             |       | $ 0.45                  |       | 5/21/2015           |       |

 

## **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, 2005 and the number and value of unexercised optionsheld by them at that date.

 

**OptionExercises During Fiscal Year Ended December 31, 2005 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    |       | —                                |       | —                   |       | 91,668 / 108,332                                                                |       | $26,917 / $12,583                                                                              |       |
|               |       |                                  |       |                     |       |                                                                            |       |                                                                                           |       |
| Joseph A. Petrich  |       | —                                |       | —                   |       | 153,333 / 46,667                                                                |       | $44,600 / $3,200                                                                               |       |
|               |       |                                  |       |                     |       |                                                                            |       |                                                                                           |       |
| Theodore A. Colvin |       | —                                |       | —                   |       | 1,667 / 3,333                                                                   |       | $250 / $500                                                                                    |       |

 

----

**(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, 2005 (the lasttrading date before December 31, 2005). The last reported sale on the OTCBulletin Board on that date was at $0.60. Options are in-the-money if themarket value of the shares covered thereby is greater than the option exerciseprice.

 

***Director Compensation***

 

On June 10, 2005,each of the directors, Richard McNamara, James Reissner, James Zavoral, RobertStehlik, and Michael Tate, received options to purchase 15,000 shares of commonstock at an exercise price of $0.40 per share (the closing price on the date ofgrant). Each option vests in three annual installments, beginning on the dateof grant.

 

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

 

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

 

25

----

 

# **ITEM11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.**

# ** **

 ***PrincipalShareholders 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 Compensation,” (3) eachof the Company’s directors and (4) all of the Company’s executive officersand directors as a group. Except as otherwise indicated, the Company believesthat each of the beneficial owners of the Company’s capital stock listed below,based on information provided by these owners, has sole investment and votingpower with respect to its shares, subject to community property laws whereapplicable. 

 
| ** **                                                                         | ** ** | **Common Stock** | ** ** | **Series A   Preferred Stock** | ** ** | **Common Stock  and Common** | ** ** | **Percent of  Total  Voting** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------------------------------|------------|----------------------------------------|------------|------------------------------------|------------|
| **Name and Address (1)**                                            | ** ** | **Number**            | ** ** | **Percent**                                   | ** ** | **Number**                             | ** ** | **Percent**                        | ** ** | **Stock Equivalents** | ** ** | **Power** | ** ** |
| Jon L. Reissner                                                                    |       | 200,001               | (2)        | 2.1                                           | %          | —                                 |       | 0.0                                | %          | 133,334 |   | 1.9 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| Joseph A. Petrich                                                                  |       | 196,668               | (3)        | 2.1                                           | %          | —                                 |       | 0.0                                | %          | 153,333 |   | 1.9 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| Richard F. McNamara  7808 Creekridge Circle  Suite 200  Minneapolis, MN 55439 |       | 2,531,667             | (4)        | 27.0                                          | %          | 625,000                                |       | 62.5                               | %          | 3,156,667 |   | 30.2 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| James L. Reissner  7808 Creekridge Circle  Suite 200  Minneapolis, MN 55439   |       | 933,994               | (5)        | 10.3                                          | %          | 250,000                                |       | 25.0                               | %          | 1,183,994 |   | 11.6 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| Robert Stehlik  10313 Normandy Court  Eden Prairie, MN 55347                       |       | 7,027                 | (6)        | 0.2                                           | %          | —                                 |       | 0.0                                | %          | 7,027 |   | 0.1 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| Michael J. Tate                                                                    |       | 800,430               | (7)        | 8.7                                           | %          | 125,000                                |       | 12.5                               | %          | 925,430 |   | 9.0 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| Dr. James R.  Zavoral  6545 France Avenue South  Edina, MN 55345              |       | 6,277                 | (8)        | 0.2                                           | %          | —                                 |       | 0.0                                | %          | 6,277 |   | 0.1 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| Theodore A. Colvin                                                                 |       | 8,334                 | (9)        | 0.1                                           | %          | —                                 |       | 0.0                                | %          | 8,334 |   | 0.1 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| Duane R. Bryngelson                                                                |       | 178,334               | (10)       | 1.9                                           | %          | —                                 |       | 0.0                                | %          | 178,334 |   | 1.7 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| David Helgerson                                                                    |       | 95,001                | (11)       | 1.0                                           | %          | —                                 |       | 0.0                                | %          | 95,001 |   | 0.9 | % |
|                                                                               |       |                  |       |                                          |       |                                   |       |                               |       |   |   |   |   |
| All executive officers  and  Directors as a group  (10 persons)                    |       | 4,902,731             | (12)       | 48.0                                          | %          | 1,000,000                              |       | 100.0                              | %          | 5,902,731 |   | 52.6 | % |

 

26

----

| ** **                                                                         | ** ** | **Common Stock** | ** ** | **Series A   Preferred Stock** | ** ** | **Common Stock  and Common** | ** ** | **Percent of  Total  Voting** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------------------------------|------------|----------------------------------------|------------|------------------------------------|------------|
| **Name and Address (1)**                                            | ** ** | **Number**            | ** ** | **Percent**                                   | ** ** | **Number**                             | ** ** | **Percent**                        | ** ** | **Stock Equivalents** | ** ** | **Power** | ** ** |
| Perkins Capital  Management, Inc. 730 East Lake Street Wayzata, MN 55391-1769 |       | 952,650               | (13)       | 10.5                                          | %          | —                                 |       | 0.0                                | %          | 952,650 |   | 9.4 | % |

 

----

(1)       Unlessotherwise stated, the principal business address is 410 11th AvenueSouth,  Hopkins, MN  55343.

 

(2)       Includes200,001 shares of common stock that Mr. Jon Reissner has the right toacquire within 60 days upon the exercise of options.

 

(3)       Includesoptions to purchase 196,668 shares of common stock which Mr. Petrich hasthe right to acquire within 60 days.

 

(4)       Doesnot include 625,000 shares of Series A Preferred Stock held by Mr. McNamara.,which is convertible into 625,000 shares of common stock, but does include (i) 86,667shares 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 and (iv) 7,500 shares held by Activar Properties, Inc.Mr. McNamara is a principal and Chief Executive Officer of ActivarProperties, Inc.

 

(5)       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.

 

(6)       Includes5,000 shares of common stock that Mr. Stehlik has the right to acquirewithin 60 days upon the exercise of options.

 

(7)       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 121,058 shares of common stock that Mr. Tate has theright to acquire within 60 days.

 

(8)       Includes5,000 shares of common stock that Dr. Zavoral has the right to acquirewithin 60 days upon the exercise of options.

 

(9)       Includes8,334 shares of common stock that Mr. Colvin has the right to acquirewithin 60 days upon the exercise of options.

 

(10)     Includes168,334 shares of common stock that Mr. Bryngelson has the right toacquire within 60 days upon the exercise of options.

 

(11)     Includes95,001 shares of common stock that Mr. Helgerson has the right to acquirewithin 60 days upon the exercise of options.

 

(12)     Includesan aggregate of 832,728 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.

 

(13)     Accordingto a Schedule 13G/A, dated January 27, 2006, as filed with theSecurities and Exchange Commission, Perkins Capital Management, Inc. hassole voting power with respect to 105,000 of such shares, and sole dispositivepower over all such shares.

 

27

----

 

***Equity Compensation Plan Information***

 

The following table below presents the Company’sEquity Compensation Plan information as of December 31, 2005.

 
| **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     |       | 1,433,691                                                                                             | (1) (2) | $                                                                                      | 0.64       |                                                                                                                                                      | 862,309    | (3) |
|                                                        |       |                                                                                                  |         |                                                                                   |       |                                                                                                                                                      |       |
| Equity compensation  plans not approved by security holders |       | —                                                                                                |         | $                                                                                      | —     |                                                                                                                                                      | —     |   |
|                                                        |       |                                                                                                  |         |                                                                                   |       |                                                                                                                                                      |       |
| Total                                                       |       | 1,433,691                                                                                             |         | $                                                                                      | 0.64       |                                                                                                                                                      | 862,309    |   |

 

----

(1) Includes 2,000,000 shares authorized forissuance pursuant to the 2001 Stock Option Plan and 250,000 shares authorizedfor issuance pursuant to the 2001 Employee Stock Purchase Plan, both Plans areregistered by the Company on Form S-8 dated September 24, 2004. Underthe 2001 Stock Option Plan, eligible recipients include all employees of theCompany or any Subsidiary and any non-employee directors, consultants andindependent contractors of the Company or any Subsidiary. Under the 2001Employee Stock Purchase Plan only employees of the Company are eligible toparticipate.

 

(2) Includes 125,000 shares authorized forissuance pursuant to the 1997 Non-Employee Director Stock Option Plan,registered on Form S-8 dated August 10, 1998. These shares  may only be issued to directors that arenot employees of the Company.

 

(3) Represents 487,309 shares remaining under the2001 Stock Option Plan; 250,000 shares remaining under the  2001 Employee Stock Purchase Plan; and125,000 shares remaining under the 1997 Non-Employee Director Stock OptionPlan.

 

# **ITEM12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.**

# ** **

From 2001 to 2005, theCompany had borrowed monies from Activar, Inc. to fund operations. Theseloans are due on demand and accrued interest at 10% through September 2002,at which time the interest rate was lowered to 6%. This lending arrangement wasconverted into a revolving credit arrangement with Richard F. McNamara andaffiliates on January 1, 2003 with interest remaining at 3%. The Companybelieves that the terms and conditions of the promissory notes given to Activarwere at least as favorable as the terms and conditions on which the Companycould have obtained credit from an unaffiliated third party. As of December 31,2005, the Company had drawn $4,990,776 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 theprincipal balance due and payable on 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 ofthis restructuring are reflected in the Notes to Financial Statements. Mr. McNamarareceived warrants for the purchase of 250,000 shares of Common Stock of theCompany. Proceeds from this note were used to pay

 

28

----

 

off $400,000 in debentures, which had been issued in 1998 and 1999 andaccrued interest thereon. The Company believes that the terms and conditions ofthis financing are substantially the same as the terms and conditions on whichthe Company could have obtained similar credit from an unaffiliated thirdparty.

 

On February 25,2003, MagStar Technologies, Inc. sold and leased back its headquarters andmanufacturing facility in Hopkins, Minnesota. The purchaser was HopkinsEleventh Avenue LLC (“Eleventh Avenue”), a wholly owned subsidiary of ActivarProperties, Inc., which in turn is wholly owned by Mr. McNamara. Thepurchase price for the building and property was $3,700,000. The Companyentered into a 6.5-year gross lease with Eleventh Avenue for the building andproperty at a monthly cost of $34,000 increasing to $44,436 per month. Proceedsof $1,001,397 realized by the Company in the transaction were applied to reducethe Company’s debt to Activar Properties, Inc. and affiliates. The Company’soutstanding balance to Activar Properties, Inc. and other affiliates of Mr. McNamarawas approximately $5,512,918 as of February 28, 2003. James L. Reissner,the President of Activar Properties, Inc., is also a director andshareholder of the Company. The Board of Directors of the Company authorizedthe transaction in order to reduce the indebtedness of the Company, provideworking 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. The purchase price was based upon anindependent appraisal of the value of the property and building obtained by thebank which provided financing to Eleventh Avenue in connection with thetransaction.

 

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 amended the lease whereby the lease paymentsfrom 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 $343,392 and $374,018 for the years ended December 31, 2005 and 2004,respectively. Included in rent expense is deferred rent of $343,392 and$272,018 for the years ended December 31, 2005 and December 21, 2004respectively, as a result of the April 1, 2004 amendment.

 

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. Theextended asset-based line of credit bears interest at the bank’s reference rateplus two and one half percent, has availability of $1,200,000 subject to aborrowing base limitation of 80% of the Company’s eligible accounts receivableplus 40% of raw materials and 30% of finished goods and will expire on June 30,2005. The credit facilities are collateralized by substantially all the assetsof the Company.

 

The Company entered into its second amended andrestated senior credit agreement with US Bancorp on June 30, 2005. Theextended asset-based line of credit bears interest at the bank’s reference rateplus two percent, has availability of $1,200,000 subject to a borrowing baselimitation of 80% of the Company’s eligible accounts receivable plus 40% of rawmaterials and 30% of finished goods and will expire on June 30, 2006. Thecredit facilities are collateralized by substantially all the assets of theCompany.

 

As a condition toobtaining the amended line of credit, MagStar was required to restructureportions of the Company’s liabilities and lease agreements with related parties.As a result, on August 13, 2004, the Company amended its building andequipment leases with Hopkins Eleventh Ave, LLC and Activar Properties,respectively, and $4,300,754 of related party debt has been extinguishedwithout additional consideration. Because the transaction is between relatedparties, the gain on the extinguishment of debt will be classified as acontribution to equity in June 2004, and will not affect

 

29

----

 

future statements of operations. The amended and reduced building andequipment leases will positively affect the statement of operations on anongoing basis. The reduced related party debt was restructured with a 3%interest rate and will reduce interest expense, also positively affecting theCompany’s statements of operations in the future. The Company believes that the3% interest rate charged on the restructured debt had a positive influence onthe bank’s decision to amend the credit agreement and extend it to June 2006.

 

**PART IV**

** **

# **ITEM13. EXHIBITS.**

# ** **

## **(a)**                                  Exhibits

## ** **

The exhibits to thisReport are listed in the Exhibit Index on pages [52 to 56] of thisReport.

 

**ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.**

 

***Audit Fees***

 

Audit fees billed to the Company by Virchow Krause &Company, LLP during the fiscal year ended December 31, 2005 and for reviewof our quarterly report on Form 10-QSB and annual report on Form 10-KSBfor the same fiscal year totaled $64,678. In the fiscal year ended December 31,2004, these fees 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****$13,050. In fiscal year ended December 31, 2004 thesefees totaled $7,170.

 

**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 audit plansand anticipated fees for audit and tax work prior to the commencement of thatwork. Approximately 100% of all fees paid to our independent auditors arepre-approved by the audit committee.

 

30

----

 

**SIGNATURES**

** **

In accordance with Section 13 or 15(d) of the ExchangeAct, the registrant caused this Report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| Dated:  April 7, 2006 | MAGSTAR  TECHNOLOGIES, INC.             |
|-----------------------|-----------------------------------------|
|                  |                                    |
|                  | /s/ Jon L.  Reissner                    |   |
|                  | Jon L. Reissner                         |
|                  | President and  Chief Executive Officer. |
|                       |                                         |  |  |

 

In accordance with the Exchange Act, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 
| **Signature**               | ** ** | **Title**                                         | ** ** | **Date**      |
|-----------------------------|------------|---------------------------------------------------|------------|---------------|
|                        |       |                                              |       |
| /s/ Jon L.  Reissner        |       | President and  Chief Executive Officer            |       | April 7, 2006 |
|                        |       |                                              |       |          |
|                        |       |                                              |       |          |
| /s/ Joseph A.  Petrich      |       | Treasurer and  Chief Financial Officer (Principal |       | April 7, 2006 |
| Joseph A.  Petrich          |       | Financial Officer)                                |       |          |
|                        |       |                                              |       |          |
| /s/ Jacqueline  R. Mitchell |       | Controller                                        |       | April 7, 2006 |
| Jacqueline R.  Mitchell     |       |                                              |       |          |
|                        |       |                                              |       |          |
| /s/ Richard F.  McNamara    |       | Director                                          |       | April 7, 2006 |
| Richard F.  McNamara        |       |                                              |       |          |
|                        |       |                                              |       |          |
| /s/ James L.  Reissner      |       | Director                                          |       | April 7, 2006 |
|                        |       |                                              |       |          |
| /s/ Michael J.  Tate        |       | Director                                          |       | April 7, 2006 |
| Michael J. Tate             |       |                                              |       |          |
|                        |       |                                              |       |          |
| /s/ Robert L.  Stehlik      |       | Director                                          |       | April 7, 2006 |
| Robert L.  Stehlik          |       |                                              |       |          |
|                        |       |                                              |       |          |
| /s/ James H.  Zavoral       |       | Director                                          |       | April 7, 2006 |
| James H. Zavoral            |       |                                              |       |          |
|                             |            |                                                   |            |               |  |

 

31

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**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

** **

Audit Committee,Stockholders and Board of Directors

MagStarTechnologies, Inc.

Hopkins,Minnesota

 

We have auditedthe accompanying balance sheets of MagStar Technologies, Inc., as of December31, 2005 and 2004 and the related statements of operations, stockholders’deficiency and cash flows for the years then ended. These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conducted ouraudits in accordance with auditing standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable 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 December31, 2005 and 2004 and the results of its operations and cash flows for theyears then ended in conformity with U.S. generally accepted accountingprinciples.

 

The accompanyingfinancial statements have been prepared assuming that the Company will continueas a going concern. As discussed in Note 1 to the financial statements, theCompany has suffered recurring losses from operations and its total liabilitiesexceed its total assets. This raises substantial doubt about the Company’sability to continue as a going concern. Management’s plans in regard to thesematters are also described in Note 1. The financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

 

 
|   | /s/ Virchow, Krause & Company, LLP |   |
|--------|----------------------------------------|--------|

 

 

Minneapolis,Minnesota

February 24, 2006

 

32

----

 

MagStar Technologies,Inc. 

BalanceSheets

AtDecember 31, 2005 and 2004

 
| ** **                                                                                                                                                             | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| **ASSETS**                                                                                                                                                             |       |        |       |        |       |
| Current Assets:                                                                                                                                                        |       |        |       |        |       |
| Cash                                                                                                                                                                   |       | $           | 600        |        | $          | 500 |   |
| Accounts receivable, net                                                                                                                                               |       | 1,024,035   |       | 583,401     |       |
| Inventories                                                                                                                                                            |       | 1,296,321   |       | 1,174,871   |       |
| Other current assets                                                                                                                                                   |       | 71,495      |       | 64,637      |       |
| Total current assets                                                                                                                                                   |       | 2,392,451   |       | 1,823,409   |       |
|                                                                                                                                                                   |       |        |       |        |       |
| Property, plant and equipment, net                                                                                                                                     |       | 96,511      |       | 37,991      |       |
| Patents                                                                                                                                                                |       | 22,301      |       | 13,530      |       |
| Total assets                                                                                                                                                           |       | $           | 2,511,263  |        | $          | 1,874,930 |   |
|                                                                                                                                                                   |       |        |       |        |       |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIENCY**                                                                                                                      |       |        |       |        |       |
| Current Liabilities:                                                                                                                                                   |       |        |       |        |       |
| Senior debt                                                                                                                                                            |       | $           | 519,649    |        | $          | 708,463 |   |
| Capital lease obligations                                                                                                                                              |       | 48,137      |       | 80,129      |       |
| Checks issued in excess of cash in bank                                                                                                                                |       | 21,972      |       | 77,960      |       |
| Accounts payable to related parties                                                                                                                                    |       | —      |       | 60,205      |       |
| Notes payable to related parties                                                                                                                                       |       | 3,071,154   |       | 2,746,154   |       |
| Accounts payable                                                                                                                                                       |       | 596,267     |       | 365,422     |       |
| Accrued expenses                                                                                                                                                       |       | 408,655     |       | 336,617     |       |
| Short term deferred gain on sale – leaseback  equipment                                                                                                           |       | 155,576     |       | 155,576     |       |
| Short term deferred gain on sale – leaseback  building                                                                                                            |       | 331,978     |       | 331,978     |       |
| Current portion of deferred rent                                                                                                                                       |       | 243,530     |       | —      |       |
| Total current liabilities                                                                                                                                              |       | 5,396,918   |       | 4,862,504   |       |
|                                                                                                                                                                   |       |        |       |        |       |
| Long-Term Liabilities:                                                                                                                                                 |       |        |       |        |       |
| Deferred gain on sale – leaseback equipment, net of  current portion                                                                                              |       | 155,576     |       | 311,152     |       |
| Deferred gain on sale – leaseback building, net of  current portion                                                                                               |       | 885,274     |       | 1,217,252   |       |
| Deferred rent, net of current portion                                                                                                                                  |       | 581,413     |       | 353,547     |       |
| Deposits                                                                                                                                                               |       | 2,000       |       | 2,000       |       |
| Other liabilities                                                                                                                                                      |       | 240         |       | 35,952      |       |
|                                                                                                                                                                   |       |        |       |        |       |
| Total liabilities                                                                                                                                                      |       | 7,021,421   |       | 6,782,407   |       |
|                                                                                                                                                                   |       |        |       |        |       |
| 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 9,130,723 December 31, 2005 and  9,040,173 shares at December 31, 2004 |       | 1,712,011   |       | 1,695,032   |       |
| Additional paid-in  capital                                                                                                                                            |       | 22,557,683  |       | 22,420,483  |       |
| Deferred compensation                                                                                                                                                  |       | (27,704     | )          | (78,000     | )          |
| Accumulated deficit                                                                                                                                                    |       | (28,939,648 | )          | (29,132,492 | )          |
|                                                                                                                                                                   |       |        |       |        |       |
| Total stockholders’ deficiency                                                                                                                                    |       | (4,510,158  | )          | (4,907,477  | )          |
| Total liabilities and stockholders’ deficiency                                                                                                                    |       | $           | 2,511,263  |        | $          | 1,874,930 |   |

 

The accompanying notes are an integralpart of the financial statements.

 

33

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MagStar Technologies,Inc. 

Statementsof Operations

For theyears ended December 31, 2005 and 2004

 
| ** **                                                                      | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|---------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                                            |       |      |       |      |       |
| Net sales                                                                       |       | $         | 8,104,646  |      | $          | 7,350,319 |   |
| Cost of sales                                                                   |       | 6,552,155 |       | 6,296,416 |       |
|                                                                            |       |      |       |      |       |
| Gross profit                                                                    |       | 1,552,491 |       | 1,053,903 |       |
|                                                                            |       |      |       |      |       |
| Selling, general and administrative expenses                                    |       |      |       |      |       |
| Gains on sale – leasebacks                                                 |       | (487,554  | )          | (487,554  | )          |
| Other selling, general and administrative expenses                              |       | 1,705,336 |       | 1,570,107 |       |
|                                                                            |       |      |       |      |       |
| Total selling, general and administrative expenses,  net                        |       | 1,217,782 |       | 1,082,553 |       |
|                                                                            |       |      |       |      |       |
| Operating income (loss)                                                         |       | 334,709   |       | (28,650   | )          |
|                                                                            |       |      |       |      |       |
| Other income (expense):                                                         |       |      |       |      |       |
| Interest expense                                                                |       | (149,669  | )          | (238,194  | )          |
| Other, net                                                                      |       | 7,804     |       | 53,527    |       |
|                                                                            |       |      |       |      |       |
| Total other income (expense), net                                               |       | (141,865  | )          | (184,667  | )          |
|                                                                            |       |      |       |      |       |
| Net income (loss)                                                               |       | 192,844   |       | (213,317  | )          |
|                                                                            |       |      |       |      |       |
| Deemed dividend on preferred stock                                              |       | 72,000    |       | 72,000    |       |
|                                                                            |       |      |       |      |       |
| Net income (loss) attributable to common  shareholders                          |       | $         | 120,844    |      | $          | (285,317 | ) |
|                                                                            |       |      |       |      |       |
| Net income (loss) per share attributable to common  shareholders – basic   |       | $         | 0.01       |      | $          | (0.03 | ) |
|                                                                            |       |      |       |      |       |
| Net income (loss) per share attributable to common  shareholders – diluted |       | $         | 0.01       |      | $          | (0.03 | ) |
|                                                                            |       |      |       |      |       |
| Weighted average common shares outstanding – basic                         |       | 9,127,723 |       | 9,040,173 |       |
|                                                                            |       |      |       |      |       |
| Weighted average common shares outstanding – diluted                       |       | 9,888,323 |       | 9,040,173 |       |

 

The accompanyingnotes are an integral part of the financial statements.

 

34

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MagStar Technologies,Inc. 

Statementsof Stockholders’ Deficiency

For theyears ended December 31, 2005 and 2004

 
| ** **                                                        | ** ** | **Series A  Preferred   Stock** | ** ** | **Series A  Preferred  Stock  Par ** | ** ** | **Common Stock** | ** ** | **Common  Stock  Par ** | ** ** | **Paid-in ** | ** ** | **Deferred**     | ** ** | **Accumulated** | ** **  | ** ** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|-------------------|------------|------------------|------------|-----------------|-------------|------------|------------|
| ** **                                                        | ** ** | **Shares**                                | ** ** | **Value**                                      | ** ** | **Shares**            | ** ** | **Value**                    | ** ** | **Capital**       | ** ** | **Compensation** | ** ** | **Deficit**     | ** **  | **Total**  | ** ** |
| ** **                                                        | ** ** | ** **                                | ** ** | ** **                                     | ** ** | ** **            | ** ** | ** **                   | ** ** | ** **        | ** ** | ** **       | ** ** | ** **      | ** **  | ** ** | ** ** |
| 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 | ) |
|                                                              |       |                                      |       |                                           |       |                  |       |                         |       |              |       |             |       |            |        |       |       |
| Deferred compensation related to options issued to  non-employees |       |                                      |       |                                           |       |                  |       |                         |       | 35,187            |       | (35,187          | )          |            |        | —-    |       |
|                                                              |       |                                      |       |                                           |       |                  |       |                         |       |              |       |             |       |            |        |       |       |
| Compensation expense on options related to non-  employees        |       |                                      |       |                                           |       | 7,358                 |       | 1,380                        |       | 1,920             |       | 85,483           |       |            |        | 88,783     |       |
|                                                              |       |                                      |       |                                           |       |                  |       |                         |       |              |       |             |       |            |        |       |       |
| Forgiveness of related party accrued interest                     |       |                                      |       |                                           |       |                  |       |                         |       | 89,597            |       |             |       |            |        | 89,597     |       |
|                                                              |       |                                      |       |                                           |       |                  |       |                         |       |              |       |             |       |            |        |       |       |
| Conversion of long-term debt                                      |       |                                      |       |                                           |       | 54,192                |       | 10,161                       |       | 13,684            |       |             |       |            |        | 23,845     |       |
|                                                              |       |                                      |       |                                           |       |                  |       |                         |       |              |       |             |       |            |        |       |       |
| Exercise of options                                               |       |                                      |       |                                           |       | 29,000                |       | 5,438                        |       | (3,188            | )          |             |       |            |        | 2,250      |       |
|                                                              |       |                                      |       |                                           |       |                  |       |                         |       |              |       |             |       |            |        |       |       |
| Net income                                                        |       |                                      |       |                                           |       |                  |       |                         |       |              |       |             |       | 192,844         |        | 192,844    |       |
|                                                              |       |                                      |       |                                           |       |                  |       |                         |       |              |       |             |       |            |        |       |       |
| Balances, December 31, 2005                                       |       | 1,000,000                                 |       | $                                              | 187,500    |                  | 9,130,723  |                         | $          | 1,712,011         | ** ** | $                | 22,557,683 |            | $           | (27,704    | )          | $ | (28,939,648 | ) | $ | (4,510,158 | ) |

 

The accompanyingnotes are an integral part of the financial statements.

 

35

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MagStar Technologies,Inc. 

Statementsof Cash Flows

For the years endedDecember 31, 2005 and 2004

 
| ** **                                                                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                                               |       |     |       |     |       |
| Net income (loss)                                                                                   |       | $        | 192,844    |     | $          | (213,317 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |     |       |     |       |
|                                                                                                |       |     |       |     |       |
| Depreciation and amortization                                                                       |       | 18,037   |       | 43,104   |       |
| Foregiveness of interest accrual expense                                                            |       | 89,597   |       | —   |       |
| Gain on sale-leaseback Equipment                                                                    |       | (155,576 | )          | (155,576 | )          |
| Gain on sale-leaseback Building                                                                     |       | (331,978 | )          | (331,977 | )          |
|                                                                                                |       |     |       |     |       |
| Stock based compensation of non-employees                                                           |       | 88,783   |       | 39,000   |       |
| Deferred equipment leases                                                                           |       | 128,004  |       | 96,003   |       |
| Deferred Rent                                                                                       |       | 343,392  |       | 272,018  |       |
| Changes in operating assets and liabilities:                                                        |       |     |       |     |       |
| Receivables                                                                                         |       | (440,634 | )          | 140,012  |       |
| Inventories                                                                                         |       | (121,450 | )          | (100,629 | )          |
| Other current assets, prepaid expenses                                                              |       | (6,858   | )          | (70,552  | )          |
| Accounts payable                                                                                    |       | 230,845  |       | 123,134  |       |
| Accrued expenses                                                                                    |       | 72,038   |       | 48,665   |       |
| Accounts payable, related parties                                                                   |       | (60,205  | )          | (55,974  | )          |
| Other liabilities and deposits                                                                      |       | (11,867  | )          | 4,107    |       |
|                                                                                                |       |     |       |     |       |
| Net cash provided by (used in) operating activities                                                 |       | 34,972   |       | (161,982 | )          |
|                                                                                                |       |     |       |     |       |
| Cash flows from investing activities:                                                               |       |     |       |     |       |
| Purchase of equipment                                                                               |       | (76,306  | )          | (28,240  | )          |
| Payments for patents                                                                                |       | (9,022   | )          | (2,269   | )          |
|                                                                                                |       |     |       |     |       |
| Net cash (used in) investing activities                                                             |       | (85,328  | )          | (30,509  | )          |
|                                                                                                |       |     |       |     |       |
| Cash flows from financing activities:                                                               |       |     |       |     |       |
| Net (payments on) line of credit                                                                    |       | (188,814 | )          | (93,777  | )          |
| Net borrowings note-payable – related party                                                    |       | 325,000  |       | 275,113  |       |
| Checks in excess                                                                                    |       | (55,988  | )          | 57,780   |       |
| Proceeds from stock option exercises                                                                |       | 2,250    |       | —   |       |
| Payments of capital lease obligations                                                               |       | (31,992  | )          | (46,625  | )          |
|                                                                                                |       |     |       |     |       |
| Net cash provided by financing activities                                                           |       | 50,456   |       | 192,491  |       |
| Net increase in cash                                                                                |       | 100      |       | —   |       |
| Cash, beginning of year                                                                             |       | 500      |       | 500      |       |
|                                                                                                |       |     |       |     |       |
| Cash, end of period                                                                                 |       | $        | 600        |     | $          | 500 |   |
|                                                                                                |       |     |       |     |       |
| Supplemental disclosures of cash flow information:                                                  |       |     |       |     |       |
| Cash paid for interest                                                                              |       | $        | 67,154     |     | $          | 56,570 |   |
|                                                                                                |       |     |       |     |       |
| Noncash investing and financing activities:                                                         |       |     |       |     |       |
| Forgiveness of related party debt and accrued  interest recorded to paid-in-capital                 |       | $        | 89,597     |     | $          | 4,300,754 |   |
| Conversion of long-term debt                                                                        |       | $        | 23,845     |     | $          | — |   |

 

The accompanyingnotes are an integral part of the financial statements*.*

 

36

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**1.             Business Description and Conditions**

** **

**Business Description**

 

MagStar Technologies, Inc. (“MagStar” or the “Company”)is a leading global provider of products, technologies, solutions, and servicesto businesses of all sizes. Our offering include:

 

•         Quickdraw Conveyors

•         Spindles and Motion Control

•         Industrial Centrifuges

•         Contract Manufacturing

 

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

 

The Company was established in 1948 as ReuterManufacturing, Inc., and specialized in precision machining and assemblies. Inlate 2000, the Company acquired the assets of MagStar Technologies, Inc., aprivate high-energy magnet and magnetic assembly company. In early 2001, theCompany changed its name to MagStar Technologies, Inc. In February 2001, theCompany acquired the assets of Quickdraw Conveyors, a provider of conveyers andtechnology for factory, laboratory and equipment automation.

 

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

 

**FinancialCondition and Management’s Plans**

TheCompany has net income of $192,844 for the year ended December 31, 2005 and hasa working capital deficit of $3,004,467 and stockholders’ deficiency of$4,510,158 at December 31, 2005.

 

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, developinga focus towards proprietary products and away from contract manufacturing, andbuilding long term, sustainable competitive advantages over competitors. TheCompany seeks to become involved with its customers early in their developmentand design process allowing the Company to participate in the earlier, highervalue added stage of product development and to establish a closer workingrelationship with its customers.

 

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 pursue a course investing in market drivenresearch and development that will lead to innovation and new valuepropositions in the future, establishing a reputation and

 

37

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expertise for product development. The Company seeksto be identified as a centrifuge, spindle and conveyor manufacturer and intendsto focus on higher value added products that allow it to use its design,manufacturing and engineering capabilities.

 

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 includerecapitalizing the balance sheet, generating liquidity, monitoring and changingprocesses to increase productivity and strategically adding key managers andoperational expertise as a measured response as required in a prudent andresponsible manner. The Company also has excess capacity. Through mergers,acquisitions and organic growth, it believes it can increase its revenues whileincurring proportionally less additional overhead. By increasing productivity,improving cost control, reducing expenses and keeping expenses in proportion tothe Company’s current sales level, the Company intends to sustain positive cashflow.

 

The Company does not expect capital needs in 2006 toexceed the capacity of its asset based line of credit as allowable receivablesand inventory borrowings are expected to cover operating requirements. Whilethe asset based line of credit expires in June 2006, the Company believes itwill be able to replace this facility. The Company believes that cash fromoperations and renewal of and advances from its credit facility will provideenough liquidity for at least the next 12 months of operations.

 

There can be no assurance that management will be ableto accomplish all of the above plans and objectives or achieve the necessaryimprovements in its cash flows and financial position to meet its obligationsas they become due. The Company’s ability to continue operations is dependenton its ability to sustain sales and maintain adequate margins on sales, as wellas its ability to maintain its credit facilities. In addition, if the Companyis unable to maintain sales from current levels and generate positive cashflows from operations, it would be unable to meet its debt service requirementsand may be forced to cease operations or seek protection under U.S. bankruptcylaws.

 

Accordingly, there can be no assurance that theCompany will continue as a going concern in its current form. The financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

 

**2.             Significant Accounting Policies**

** **

**Accounts Receivable**

The Company extends unsecured creditto customers in the normal course of business and believes all accountsreceivable in excess of the allowance for doubtful accounts to be fullycollectible. If accounts receivable in excess of the provided allowance aredetermined uncollectible, they are charged to expense in the year thatdetermination is made. The Company does not accrue interest on trade accountsreceivable. Accounts receivable are due 30 days after the invoice date. Accountsreceivable are written off only after all collection attempts have failed.

 

**Inventories**

Inventories are valued at the lowerof cost or market with cost determined on a first-in, first-out basis.

 

38

----

 

**Property, Plant and Equipment**

Property,plant and equipment are recorded at cost. Depreciation and amortization isprovided for by the straight-line method based on the estimated useful lives ofthe related assets. Leasehold improvements are amortized over the lesser oftheir useful life or the lease term; and machinery and equipment are amortizedover 5 to 7 years. Expenditures for major renewals and betterments arecapitalized, and expenditures for maintenance and repairs are charged tooperations as incurred. Upon retirement or other disposition of property, plantor equipment, the applicable cost and accumulated depreciation and amortizationare eliminated from the accounts, and the resulting gain or loss is included inoperations unless the sale is subject to the Company leasing the property backfor a period of time.

 

**Revenue Recognition**

The Company’s revenue is recognizedin accordance with generally accepted accounting principles as outlined in theSEC’s Staff Accounting Bulletin No. 104 “Revenue Recognition,” which requiresthat four basic criteria be met before revenue can be recognized: (i)persuasive evidence of an arrangement exists; (ii) the price is fixed ordeterminable; (iii) collectibility is reasonably assured; and (iv) productdelivery has occurred or services have been rendered. The Company recognizesrevenue as products are shipped.

 

**Advertising**

Advertising costs are charged tooperations when incurred. Advertising expense was $91,526 and $60,296 for theyears ended December 31, 2005 and 2004, respectively.

 

**Shipping and Handling Costs**

Shipping and handling costs chargedto customers have been included in net sales. Shipping and handling costsincurred by the Company have been included in the cost of sales.

 

**Income Taxes**

The Company utilizes the asset andliability method of accounting for income taxes whereby deferred taxes aredetermined based on the temporary difference between the financial statementand tax basis of assets and liabilities using enacted tax rates in effect inthe years in which the differences are expected to reverse. Valuationallowances are established when necessary to reduce deferred tax assets to theamount expected to 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) attributable to common shareholders by theweighted average number of common shares outstanding for the reporting period.Diluted net income (loss) per common share is computed by dividing net income(loss) attributable to common shareholders by the sum of the weighted averagenumber of common shares outstanding plus all additional common stock that wouldhave been outstanding if potentially dilutive common shares related to commonshare equivalents (stock options, stock warrants, and convertible preferredshares) had been issued.

 

39

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**Cash**

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

 

**Research and Development**

The Company does not pursue or engage in regularresearch and development of its products. All research and development feescollected in 2005 and 2004 were the result of customer purchases, initiated andsponsored 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. The Company has adopted thedisclosure only provision of SFAS No. 148.

 

Hadcompensation cost for the Plans been determined based on the fair value ofoptions at the grant date for awards in 2005 and 2004, the Company’s pro formanet income/(loss) and net income/(loss) per common share would have been asfollows:

 
| ** **                                                                                                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income (loss) attributable to common  stockholders, as reported                                                            |       | $        | 120,844    |     | $          | (285,317 | ) |
|                                                                                                                           |       |     |       |     |       |
| Employee compensation expense included in net  income, net of forfeitures and related tax effects                              |       | —   |       | —   |       |
|                                                                                                                           |       |     |       |     |       |
| Stock-based employee compensation expense determined  under the fair value based method for awards, net of related tax effects |       | (67,474  | )          | (80,338  | )          |
|                                                                                                                           |       |     |       |     |       |
| Pro forma net income (loss)                                                                                                    |       | $        | 53,370     |     | $          | (365,655 | ) |
|                                                                                                                           |       |     |       |     |       |
| Earnings (loss) per share:                                                                                                     |       |     |       |     |       |
| Basic—as reported                                                                                                         |       | $        | 0.01       |     | $          | (0.03 | ) |
| Basic—pro forma                                                                                                           |       | $        | 0.01       |     | $          | (0.04 | ) |
|                                                                                                                           |       |     |       |     |       |
| Diluted—as reported                                                                                                       |       | $        | 0.01       |     | $          | (0.03 | ) |
| Diluted—pro forma                                                                                                         |       | $        | 0.01       |     | $          | (0.04 | ) |

 

40

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Optionsand warrants issued to non-employees are recorded at fair value, as required bySFAS No. 123, using the Black Scholes pricing model and 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 $35,187 and $117,000 of deferred compensationduring 2005 and 2004 related to options issued to non-employees and isamortizing the expense over the vesting period. As such, the Company expensed$88,783 and $39,000 during the years ended December 31, 2005 and 2004,respectively.

 

Theweighted average grant-date fair value of options granted during 2005 and 2004was $0.28 and $0.68, respectively, which was determined using the Black-Scholesoption pricing model with the following key assumptions:

 
| **Assumptions**               | ** ** | **2005**         | ** ** | **2004**      | ** ** |
|-------------------------------|------------|------------------|------------|---------------|------------|
|                          |       |             |       |          |       |
| Risk free interest rate range |       | 4.05 – 4.36 | %          | 4.25          | %          |
| Volatility range              |       | 53 – 54     | %          | 52            | %          |
| Expected lives (months)       |       | 96 – 120    |       | 96 – 120 |       |
| Expected dividend yield       |       | 0                | %          | 0             | %          |

 

**Use of Estimates**

The preparation of the Company’sfinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting periods. Actual results could differ from those estimates.

 

**Self-FundedEmployee Medical Benefits**

The Companyparticipates in a self-insured employee health insurance plan administered byan outside party. The Company is required to pay up to $30,000 of annualmedical claims per participant and the Company’s maximum exposure per the planis approximately $1,000,000. The annual plan medical claims will vary dependingupon the number of employees and their level of participation.

 

**Impact ofRecent Accounting Pronouncements**

 

In November 2004, FASB issued Statement ofFinancial Accounting Standards (SFAS) No. 151 “Inventory Costs” which amendsthe guidance in ARB No. 43, Chapter 4 “Inventory Pricing,”  to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4,previously stated that under some circumstances, items such as idle facilityexpense, excessive spoilage, double freight, and rehandling costs may be soabnormal as to require treatment as current period charges.” SFAS No. 151requires that those items be recognized as current-period charges regardless ofwhether they meet the criterion of “so abnormal.” In addition, SFAS No, 151requires that allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facilities. SFAS No. 151 shall be effective for inventory costs incurred during fiscalyears beginning after June 15, 2005. Earlier application is permitted forinventory costs incurred during fiscal years beginning after the date SFAS No.151 was issued. SFAS No. 151 shall be applied

 

41

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prospectively.  The Company does not expect theadoption of SFAS No. 151 to have a material effect on its financial statements.

 

In December 2004, FASB issued SFAS No. 153 “Exchangesof Nonmonetary Assets” amends APB Opinion No. 29, “Accounting for NonmonetaryTransactions.” APB No. 29 is based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of the assetsexchanged. The guidance in that Opinion, however, included certain exceptionsto that principle. SFAS No. 153 amends APB No. 29 to eliminate the exceptionfor nonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance. A nonmonetary exchange has commercial substance if thefuture cash flows of the entity are expected to change significantly as aresult of the exchange.  SFAS No. 153 shall be effective for nonmonetaryasset exchanges occurring in fiscal periods beginning after June 15, 2005.Earlier application is permitted for nonmonetary asset exchanges occurring infiscal periods beginning after the date SFAS No. 153 was issued. SFAS No. 153shall be applied prospectively.  The Company does not expect the adoptionof SFAS No. 153 to have a material effect on its 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 has notbeen determined at this time.

 

**Segment Reporting**

 

A business segment is a distinguishable component ofan enterprise that is engaged in providing an individual product or service ora group of related products or services and that is subject to risks andreturns that are different from those of other business segments. The Company’ssegments have similar economic characteristics and are similar in the nature ofthe products sold, type of customers, methods used to distribute the Company’sproducts and regulatory environment.  Management believes that the Companymeets the criteria for aggregating its operating segments into a single reportingsegment.

 

42

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**3.             Selected Balance Sheet Information**

 
| ** **                                               | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Accounts Receivable, net                                 |       |                  |       |                  |       |
|                                                     |       |                  |       |                  |       |
| Accounts receivable                                      |       | $                     | 1,034,333  |                  | $          | 613,144 |   |
| Less allowances for doubtful accounts and sales  returns |       | (10,298               | )          | (29,743               | )          |
|                                                     |       | $                     | 1,024,035  |                  | $          | 583,401 |   |
| Inventories                                              |       |                  |       |                  |       |
|                                                     |       |                  |       |                  |       |
| Raw materials and supplies                               |       | $                     | 386,178    |                  | $          | 297,769 |   |
| Work-in-process                                          |       | 501,431               |       | 226,859               |       |
| Finished goods                                           |       | 408,712               |       | 650,243               |       |
|                                                     |       | $                     | 1,296,321  |                  | $          | 1,174,871 |   |
|                                                     |       |                  |       |                  |       |
| Property, Plant, and Equipment, Net                      |       |                  |       |                  |       |
|                                                     |       |                  |       |                  |       |
| Office equipment                                         |       | $                     | 82,537     |                  | $          | 74,642 |   |
| Machinery and equipment                                  |       | 528,005               |       | 497,610               |       |
| Equipment under capital lease obligations                |       | 298,599               |       | 298,599               |       |
| Capital tooling                                          |       | 38,015                |       | —                |       |
|                                                     |       | 947,156               |       | 870,851               |       |
| Less accumulated depreciation                            |       | (850,645              | )          | (832,860              | )          |
|                                                     |       | $                     | 96,511     |                  | $          | 37,991 |   |
|                                                     |       |                  |       |                  |       |
| Accrued Expenses                                         |       |                  |       |                  |       |
|                                                     |       |                  |       |                  |       |
| Accrued vacation                                         |       | $                     | 118,957    |                  | $          | 118,810 |   |
| Accrued warranty reserve                                 |       | 20,000                |       | 73,693                |       |
| Accrued wages and related payroll taxes                  |       | 126,981               |       | 54,578                |       |
| Accrued medical claims                                   |       | 40,000                |       | 40,000                |       |
| Accrued interest                                         |       | 15,081                |       | 22,163                |       |
| Accrued profit sharing contribution                      |       | 16,603                |       | 16,697                |       |
| Other accrued expenses                                   |       | 71,033                |       | 10,676                |       |
|                                                     |       |                  |       |                  |       |
|                                                     |       | $                     | 408,655    |                  | $          | 336,617 |   |

 

**Accounts Payable to RelatedParties**

Accounts Payable to related partieswere due to Activar, Inc. and affiliates and consist of lease payments andaccrued interest. Activar, Inc. and affiliates are related parties as aconsequence of Activar’s significant ownership of stock of the Company andcommon ownership by a shareholder of Activar. The accounts payable wereunsecured and non-interest bearing.

 

43

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**WarrantyReserve**

TheCompany warrants its products for one, or five years. The reserve for warrantyis included in accrued expenses and is computed by averaging the last fouryears warranty costs incurred. The following summarizes the warrantytransactions for the years ended December 31:

 

| ** **                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |
| Balance at Beginning of Year |       | $        | 73,693     |     | $          | 74,000 |   |
| Claims Paid                  |       | (3,693   | )          | (20,000  | )          |
| Expense Provision            |       | —   |       | 19,693   |       |
| Reserve reduction            |       | (50,000  | )(1)       | —   |       |
|                         |       |     |       |     |       |
| Balance at End of Year       |       | $        | 20,000     |     | $          | 73,693 |   |

 

----

(1)   The reduction relates to improvementsin actual warranty expense tracking.

 

**4.**                          Senior Debt

** **

Seniordebt at December 31, 2005 and 2004 was $519,649 and $708,463, respectively.The effective interest rate on the asset-based line of credit borrowings was7.25% and 6.48% for the years ended December 31, 2005 and 2004, respectively.The line of credit is due on demand, and is payable in full on June 30, 2006.

 

The Companyentered into its second amended and restated senior credit agreement with USBancorp on June 30, 2005.  The extended asset-based line of credit bearsinterest at the bank’s reference rate plus two percent, has availability of$1,200,000 subject to a borrowing base limitation of 80% of the Company’seligible accounts receivable plus 40% of raw materials and 30% of finished goods.The credit facilities are collateralized by substantially all the assets of theCompany. The bank may at any time apply the funds available in any Company bankaccount against the outstanding loan balances. The line of credit matures onJune 30, 2006 and is due on demand.

 

**5.**                          NotesPayable, Related Parties

** **

Notes payable,related parties at December 31, 2005 and 2004, consisted of the following:

 
| ** **                                                                                                 | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Notes payable; related entity, due upon demand with  interest at 3% subordinated to senior debt, unsecured |       | $         | 500,000    |      | $          | 500,000 |   |
| Note payable; related entity, due upon demand with  interest at 3% subordinated to senior debt, unsecured  |       | 625,000   |       | 300,000   |       |
| Note payable; related entity, due upon demand with  interest at 3% subordinated to senior debt, unsecured  |       | 1,946,154 |       | 1,946,154 |       |
|                                                                                                       |       | $         | 3,071,154  |      | $          | 2,746,154 |   |

 

Accrued interest on these notes at December 31, 2005and 2004 was $0 and $0, respectively, and interest expense for the years endedDecember 31, 2005 and 2004 was $89,597 and $192,130, respectively. During theyear ended December 31, 2005, $89,597 of interest expense was forgiven. Duringthe year ended December 31, 2004, $4,300,754 of debt and accrued interestoutstanding was forgiven as the Company was informed this was necessary for theextension of the senior

 

44

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credit agreement of June 2005. In addition, theinterest rate on the debt effective April 1, 2004 was revised to 3% for thesame reason as noted above. The amount of debt and accrued interest forgivenwas recorded as additional paid-in capital. 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.

 

**6.**                          CapitalLease Obligations

** **

The Companyleases equipment under noncancelable leases classified as capital leases. Thebalance to pay in full, including accrued interest of $10,935, at December 31,2005 is $59,072.

 

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

** **

The Company sold equipment during2001 to an entity owned by a stockholder for $1,987,141 and concurrentlyentered into operating leases. The leases were amended on January 1, 2003 undera lease that expires in 2007. The Company further amended the leases on April1, 2004 whereby the minimum lease payments for the remainder of 2004 and 2005were waived. In addition, monthly lease payments for 2006 and 2007 were amendedto $20,000 per month. The amount of related party lease obligations outstandingon March 31, 2004 on the building and equipment leases was $261,707 and wasforgiven and recorded as additional paid-in capital. The Company believes thatthe amendments in 2004 were necessary in order to amend the Company’s line ofcredit expiring in June 2005 (see Note 4).

 

Future minimum payments requiredunder these equipment leases are as follows:

 

Year ending December 31:

 

| 2006                         |   | $       | 240,000 |   |
|------------------------------|--------|---------|---------|--------|
| 2007                         |   | 240,000 |    |
| Total minimum lease payments |   | $       | 480,000 |   |

 

Rent expenseunder these leases for the years ended December 31, 2005 and 2004 was $128,689and $233,003, respectively. Included in rent expense is deferred rent of$128,004 and $96,003 for the years ended December 31, 2005 and 2004,respectively, as a result of the April 1, 2004 amendment.

 

Future deferredgains resulting from this lease are as follows:

 

Year ending December 31:

 

| 2006                |   | $       | 155,576 |   |
|---------------------|--------|---------|---------|--------|
| 2007                |   | 155,576 |    |
|                |   |    |    |
| Total deferred gain |   | $       | 311,152 |   |

 

45

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On February 25, 2003, MagStar Technologies, Inc. soldand leased back its headquarters and manufacturing 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 purchase price for the building and property was$3,700,000. The Company entered into a 6.5-year gross lease with EleventhAvenue 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 the Company in thetransaction were applied to reduce the Company’s debt to Activar Properties,Inc. and affiliates. The Company’s outstanding balance to Activar Properties,Inc. and other affiliates of Mr. McNamara was approximately $5,512,918 as ofFebruary 28, 2003. James L. Reissner, the President of Activar Properties,Inc., is also a director and shareholder of the Company. The Board of Directorsof the Company authorized the transaction in order to reduce the indebtednessof the Company, provide working capital and improve cash flow. The transactionwith Eleventh Avenue was determined to be on better terms than could beobtained by the Company directly from 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, theCompany and Eleventh Avenue amended the lease whereby the lease payments fromApril 1, 2004 to December 31, 2005 were waived. The Company will resume monthlypayments in 2006 according to the original lease.

 

Rent expense on the lease was $343,392 and $374,018for the years ended December 31, 2005 and 2004, respectively. Included in rentexpense is deferred rent of $343,392 and $272,018 for the years ended December31, 2005 and 2004, respectively, as a result of the April 1, 2004 amendment.

 

Future minimum lease payments on building

 

| 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:                      |

 

| 2006                |   | $       | 331,978   |   |
|---------------------|--------|---------|-----------|--------|
| 2007                |   | 331,978 |      |
| 2008                |   | 331,978 |      |
| 2009                |   | 221,318 |      |
| Total deferred gain |   | $       | 1,217,252 |   |

 

46

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**8.**                          Stockholders’Deficiency

** **

**PrivatePlacement**

In 2000,the Company completed a private placement with certain investors under whichthe Company sold 3,500,000 shares of the Company’s common stock and 1,000,000shares of the Company’s Series A Convertible preferred stock valued at$.1777778 per share, for proceeds of $800,000. The Series A Preferred isconvertible at any time, without the payment of any additional consideration,into fully paid and nonassessable shares of common stock on a one for one basissubject to anti-dilution. The Series A Preferred generally votes with thecommon stock on matters submitted to the shareholders, with each share ofSeries A Preferred having that number of votes that is equal to the number ofwhole shares of common stock into which such share of Series A Preferred isthen convertible. The Series A Preferred is entitled to 9% cumulative dividendsin preference to any dividends paid on the common stock, but such 9% dividendsare payable only if, as and when declared by the Company’s board of directors.

 

At all meetings of the shareholders of the Company orin the case of any actions of shareholders in lieu of a meeting, each holder ofSeries A preferred stock shall have that number of votes equal to the number ofwhole shares of common stock into which such holder’s shares are thenconvertible. Holders of the Series A preferred stock are entitled to receivecumulative cash dividends, in preference to dividends payable on common stock,at the annual rate of 9% and share equally with the common stock, on anas-converted basis, in any dividends declared on the common stock. Dividends inarrears totaled $432,000 and $360,000 at December 31, 2005 and 2004,respectively. In the event of any liquidation, whether voluntary orinvoluntary, the assets of the Company available for distribution to itsshareholders shall be distributed equally among the holders of the common stockand the Series A preferred stock.

 

In connection with the privateplacement, the Company, the investors and certain individuals from the Company’sexisting stockholders (collectively, the control group) entered into a votingagreement. Among other provisions, the voting agreement requires that thecontrol group vote their shares to designate the investors as members of theCompany’s Board of Directors. The voting agreement further requires the controlgroup to vote as directed by the investors on all matters, which are presentedfor a vote to the Company’s stockholders.

 

**Stock Option Plans**

The Company’s Stock Option Plans (thePlans) provide for grants of stock options to employees, directors andnon-employees. The number of common shares available for grant pursuant to thePlans was 862,309 and 1,076,027 at December 31, 2005 and 2004, respectively. Optionsbecome exercisable over periods from the date of grant up to four years fromthe date of grant and expire 10 years from the date of grant.

 

47

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The following summarizes all option activityunder the Plans:

 
| ** **                  | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-----------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| Balances, December 31, 2003 |       | 853,579                  |       | $                                      | 0.48       |   |
| Cancelled                   |       | (68,606                  | )          | $                                      | 1.04       |   |
| Granted                     |       | 435,000                  |       | $                                      | 1.03       |   |
| Balances, December 31, 2004 |       | 1,219,973                |       | $                                      | 0.68       |   |
| Cancelled                   |       | (10,282                  | )          | $                                      | 0.45       |   |
| Granted                     |       | 253,000                  |       | $                                      | 0.40       |   |
| Exercised                   |       | (29,000                  | )          | $                                      | 0.08       |   |
| Balances, December 31, 2005 |       | 1,433,691                |       | $                                      | 0.64       |   |

 

The following table summarizesinformation about fixed price stock options outstanding at December 31,2005:

 
| ** **          | ** ** | ** **                             | ** ** | **Options Outstanding**                        | ** ** | **Options Exercisable**    | ** ** |
|---------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| **Range  of**       | ** ** | **Options  Outstanding  December 31,** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise** | ** ** | **Number  Exercisable at  December 31,** | ** ** | **Weighted  Average  Exercise** | ** ** |
| **Exercise Prices** | ** ** | **2005**                               | ** ** | **(Months)**                                        | ** ** | **Price**                       | ** ** | **2005** | ** ** | **Price** | ** ** |
|                |       |                                   |       |                                                |       |                            |       |   |   |   |   |
| $0.05 - $0.24       |       | 259,000                                |       | 87                                                  |       | $                               | 0.05       |   | 259,000 |   | $ | 0.05 |   |
| $0.25 - $0.624      |       | 622,200                                |       | 84                                                  |       | $                               | 0.37       |   | 456,871 |   | $ | 0.36 |   |
| $0.625 - $0.99      |       | 72,491                                 |       | 33                                                  |       | $                               | 0.84       |   | 72,491 |   | $ | 0.84 |   |
| $1.00 - $2.24       |       | 435,000                                |       | 101                                                 |       | $                               | 1.03       |   | 290,002 |   | $ | 1.03 |   |
| $2.25 - $3.375      |       | 13,500                                 |       | 26                                                  |       | $                               | 2.45       |   | 13,500 |   | $ | 2.55 |   |
| $3.376- $4.4375     |       | 23,000                                 |       | 17                                                  |       | $                               | 4.44       |   | 23,000 |   | $ | 4.44 |   |
| $4.4376 - $5.1875   |       | 8,500                                  |       | 18                                                  |       | $                               | 4.89       |   | 8,500 |   | $ | 4.89 |   |
|                |       |                                   |       |                                                |       |                            |       |   |   |   |   |   |   |
| Total               |       | 1,433,691                              |       | 85                                                  |       | $                               | 0.64       |   | 1,123,364 |   | $ | 0.21 |   |
|                     |            |                                        |            |                                                     |            |                                 |            |  |  |  |  |  |  |  |

 

**Warrants**

In connection with the issuance ofdebt to a stockholder in January 2002, the Company granted five-year warrantsto purchase 250,000 shares of the Company’s common stock at an exercise priceof $0.25 per share, exercisable immediately, and have a ten year expiration. Thewarrants were valued using the Black Scholes model pricing model. The value wasdetermined to be immaterial.

 

48

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**9.**                          Income Taxes

** **

The following table sets forth thecomponents of the tax-affected deferred tax assets at December 31, 2005 and2004:

 
| ** **                                                              | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|-------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| Net operating losses available for carry forward (expire  2009 to 2023) |       | $           | 10,856,000 |        | $          | 10,849,000 |   |
|                                                                    |       |        |       |        |       |   |   |
| Other future deductible temporary differences, net                      |       | 1,049,000   |       | 1,139,000   |       |
|                                                                    |       |        |       |        |       |
| Net deferred tax asset before valuation allowance                       |       | 11,905,000  |       | 11,988,000  |       |
|                                                                    |       |        |       |        |       |
| Valuation allowance                                                     |       | (11,905,000 | )          | (11,988,000 | )          |
|                                                                    |       |        |       |        |       |
|                                                                    |       | $           | —     |        | $          | — |   |

 

The Company has established avaluation allowance for any tax benefits for which management believes, basedon the relative weight of currently available evidence, that it is “more likelythan not” that the related net deferred tax asset will not be realized. TheCompany has net operating loss carryforwards for federal income tax purposes ofapproximately $29,000,000. Under the Internal Revenue Code, certain stocktransactions, including sales of stock and the granting of warrants to purchasestock, may limit the amount of net operating loss carry forwards that may beutilized on an annual basis to offset taxable income in future periods.

 

Reconciliation of the income taxcomputed at the federal statutory rate to the actual income tax provision is asfollows:

 
| ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
|                                       |       |     |       |     |       |
| Income tax (benefit)                       |       | $        | 77,000     |     | $          | (44,000 | ) |
| Deferred tax assets                        |       | (84,000  | )          | —   |       |
| Increase (decrease) in valuation allowance |       | 7,000    |       | 44,000   |       |
|                                       |       |     |       |     |       |
| Income tax provision                       |       | $        | —     |     | $          | — |   |

 

The Company used the effective taxrates of 34% federal and 6% state in computing income tax expense (benefit).

 

**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 Companymay make 401(k) matching contributions and profit sharing contributions at thediscretion of the Board of Directors. The Company’s 401(k) matchingcontributions and profit sharing contributions for the years endedDecember 31, 2005 and 2004 were $17,000 and $17,000, respectively.

 

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**11.**                   SignificantCustomer Information

** **

The Company’s major customersaccounted for the following percentages of net sales:

 
| ** ** | ** ** | ** **          | ** ** | **2005**   | ** ** | ** ** | ** ** | **2004**   | ** ** | ** ** | ** ** |
|------------|------------|---------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** ** | ** ** | ** **          | ** ** | **Amount** | ** ** | **%**      | ** ** | **Amount** | ** ** | **%**      | ** ** |
|       |       |                |       |       |       |       |       |       |       |       |       |
| Customer A |       | Net Sales           |       | $          | 3,373,257  |       | 42         |       | $          | 2,198,158  |       | 30 |   |
|       |       | Accounts Receivable |       | $          | 376,806    |       | 37         |       | $          | 155,013    |       | 27 |   |
|       |       |                |       |       |       |       |       |       |       |       |       |
| Customer B |       | Net Sales           |       | $          | 1,039,926  |       | 13         |       | $          | 1,207,999  |       | 16 |   |
|       |       | Accounts Receivable |       | $          | 182,196    |       | 18         |       | $          | 11,819     |       | 2 |   |

 

**12.**                   EnvironmentalContingency

** **

The Company has undertaken a Phase I and Phase IIenvironmental assessment of its manufacturing facility. Soil boring andgroundwater work indicated the presence of potentially hazardous substances andpetroleum products within the soil and groundwater located beneath the site. TheCompany notified the applicable regulatory agency (the Minnesota PollutionControl Agency), and worked with that agency to resolve these issues. Groundwater investigation occurred quarterly during 2004 and concluded December 7,2004. The Minnesota Pollution Control Agency issued a determination to take nofurther action. All reserves related to this issue have been released.

 

13.                     **Sublease on Building**

 

On March 31, 2003, the Company subleased approximately30,000 square feet of its facility to an unrelated party for 18 months. Thesublease provided an annual income of $4.55 per square foot, or $149,081 peryear. On November 1, 2004, the Company did not renew the previous sublease andinstead subleased the approximate 30,000 square feet to Activar, Inc., acorporation principally owned by a major shareholder and director of theCompany, 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 for annual income of $12.00 per squarefoot, or $24,000 per year.

 

The Company has netted sublease income as part of costof goods sold and general and administrative expenses on the statement ofoperations. Total sublease income was approximately $204,000 and $140,000 forthe years ended December 31, 2005 and 2004, respectively.

 

*Theremainder of this page is intentionally left blank.*

 

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**MAGSTARTECHNOLOGIES, INC.**

 

**EXHIBITINDEX TO ANNUAL REPORT**

**ON FORM10-KSB**

 

**For theFiscal Year Ended December 31, 2005**

 
| **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)                     |
|         |       |                                                                                                                               |       |                                                                                                                                                       |
| 101          |       | 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)      |
|         |       |                                                                                                                               |       |                                                                                                                                                       |
| 10.2         |       | 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) |
|         |       |                                                                                                                               |       |                                                                                                                                                       |
| 10.3         |       | 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) |
|         |       |                                                                                                                               |       |                                                                                                                                                       |
| 10.4         |       | 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)                    |
|         |       |                                                                                                                               |       |                                                                                                                                                       |
| 10.5         |       | 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)                    |

 

51

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| **Item No.** | ** ** | **Item**                                                                                                                                                                                                                  | ** ** | **Method of Filing**                                                                                                                              |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|              |       |                                                                                                                                                                                                                      |       |                                                                                                                                                        |
| 10.6              |       | 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)                      |
|              |       |                                                                                                                                                                                                                      |       |                                                                                                                                                        |
| 10.7              |       | 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)                      |
|              |       |                                                                                                                                                                                                                      |       |                                                                                                                                                        |
| 10.8              |       | 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)                      |
|              |       |                                                                                                                                                                                                                      |       |                                                                                                                                                        |
| 10.9              |       | 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)                      |
|              |       |                                                                                                                                                                                                                      |       |                                                                                                                                                        |
| 10.10             |       | $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)                      |
|              |       |                                                                                                                                                                                                                      |       |                                                                                                                                                        |
| 10.11             |       | 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) |
|              |       |                                                                                                                                                                                                                      |       |                                                                                                                                                        |
| 10.12             |       | 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)     |
|              |       |                                                                                                                                                                                                                      |       |                                                                                                                                                        |
| 10.13             |       | 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)    |
|              |       |                                                                                                                                                                                                                      |       |                                                                                                                                                        |
| 10.14             |       | 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)    |

 

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| **Item No.** | ** ** | **Item**                                                                                                             | ** ** | **Method of Filing**                                                                                                                                        |
|--------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** ** | ** **                                                                                                           | ** ** | ** **                                                                                                                                                  |
| 10.15        |       | 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) |
|         |       |                                                                                                                 |       |                                                                                                                                                        |
| 10.16        |       | 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) |
|         |       |                                                                                                                 |       |                                                                                                                                                        |
| 10.17        |       | 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) |
|         |       |                                                                                                                 |       |                                                                                                                                                        |
| 10.18        |       | 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)                        |
|         |       |                                                                                                                 |       |                                                                                                                                                        |
| 10.19        |       | 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)                        |
|         |       |                                                                                                                 |       |                                                                                                                                                        |
| 10.20        |       | 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)                      |
|         |       |                                                                                                                 |       |                                                                                                                                                        |
| 10.21        |       | 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)                  |
|         |       |                                                                                                                 |       |                                                                                                                                                        |
| 10.22        |       | 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)                  |
|         |       |                                                                                                                 |       |                                                                                                                                                        |
| 10.23        |       | 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)                    |
|         |       |                                                                                                                 |       |                                                                                                                                                        |
| 10.24        |       | Second Amended  and Restated Credit Agreement dated as of June 30, 2005                                              |       | Incorporated by  reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-QSB,  dated June 30, 2005 (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)                   |

 

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| **Item No.** | ** ** | **Item**                                                                                             | ** ** | **Method of Filing**                                                                                                                      |
|--------------|------------|------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                 |       |                                                                                                                                      |
| 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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