**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION****Washington, D. C. 20549**

**FORM10-K/A**

**(AmendmentNo. 1)**
| **(Mark One)**                                                                                                                      | ** **                                                                                     |
|-------------------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------|
| ** **                                                                                                                          | ** **                                                                                     |
| **x**                                                                                                                               | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                |                                                                                           |
| **For the  fiscal year ended: December 31, 2005**                                                                                   |
|                                                                                                                                |                                                                                           |
| **OR**                                                                                                                              |
| ** **                                                                                                                          | ** **                                                                                     |
| **o**                                                                                                                               | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
| ** **                                                                                                                          |                                                                                           |
| **For the  transition period from                   to** |
|                                                                                                                                |                                                                                           |

** **

**Commissionfile number: 0-11668**

** **

**Photonic Products Group, Inc.**(Exact name of registrant asspecified in its charter)
| **New Jersey**                                                | **22-2003247**                          |
|---------------------------------------------------------------|-----------------------------------------|
| State or other jurisdiction of  incorporation or organization | (I. R. S.  Employer Identification No.) |
| ** **                                                    | ** **                              |
| ** **                                                    | ** **                              |
| **181  Legrand Avenue, Northvale, NJ**                        | **07647**                               |
| (Address of  principal executive offices)                     | (Zip Code)                              |

Registrant’s telephonenumber, including area code  **201-767-1910**

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

|                          | ** ** | **Name of each  exchange** |
|--------------------------|------------|----------------------------|
| **Title of each  class** | ** ** | **on which  registered**   |
|                     |       |                       |

Securitiesregistered pursuant to section 12(g) of the Act:**Common stock, par value $.01 Per Share**

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule405 of the Securities Act. Yes  o.      No x.

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.  Yes  o.      No x.

Note — Checking the boxabove will not relieve any registrant required to file reports pursuant toSection 13 or 15(d) of the Exchange Act from their obligations under thoseSections.

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.
|  |   | Yes | x | No | o |
|--|--------|-----|---|----|---|

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K (§ 229.405 of thischapter) is not contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statements incorporatedby reference in Part III of this Form 10-K or any amendment to this Form10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of accelerated filer and largeaccelerated filer in Rule 12b2 of the Exchange Act. (Check one):
| Large accelerated filer  o | Accelerated  filer   o | Non-accelerated  filer  x |
|--------------------------------------|---------------------------------------|-------------------------------------|

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).
|  |   | Yes | o | No | x |
|--|--------|-----|---|----|---|

State the aggregate market value of the voting andnon-voting common equity held by non-affiliates computed by reference to theprice at which the common equity was last sold, or the average bid and askedprice of such common equity, as of the last business day of the registrant’smost recently completed second fiscal quarter. $3,657,500

**Note.**If a determinationas to whether a particular person or entity is an affiliate cannot be madewithout involving unreasonable effort and expense, the aggregate market valueof the common stock held by non-affiliates may be calculated on the basis ofassumptions reasonable under the circumstances, provided that the assumptionsare set forth in this Form.

Indicate the numberof shares outstanding of each of the registrant’s classes of common stock, asof the latest practicable date.

Common Shares outstandingas of March 25, 2006[7,433,634]

 

----

Photonic ProductsGroup, Inc.

INDEX
|               | Explanatory Note **                                                                                                |   |
|---------------|--------------------------------------------------------------------------------------------------------------------|--------|
| **Part I**    |                                                                                                               |   |
| ** **    |                                                                                                               |   |
| Item 1.       | Business                                                                                                           |   |
|          |                                                                                                               |   |
| Item 1A.      | Risk Factors**                                                                                                     |   |
|          |                                                                                                               |   |
| Item 1B.      | Unresolved Staff Comments                                                                                          |   |
|          |                                                                                                               |   |
| Item 2.       | Properties                                                                                                         |   |
|          |                                                                                                               |   |
| Item  3.      | Legal  Proceedings                                                                                                 |   |
|          |                                                                                                               |   |
| Item 4.       | Submission of Matters to a Vote of Security Holders                                                                |   |
|          |                                                                                                               |   |
| **Part II**   |                                                                                                               |   |
|          |                                                                                                               |   |
| Item 5.       | Market for Registrant’s Common Equity and Related  Stockholder Matters and Issuer Purchased Equity Securities |   |
|          |                                                                                                               |   |
| Item 6.       | Selected Financial Data                                                                                            |   |
|          |                                                                                                               |   |
| Item 7.       | Management’s Discussion and Analysis of Financial  Condition and Results of Operation                         |   |
|          |                                                                                                               |   |
| Item 7A.      | Quantitative and Qualitative Disclosures about Market  Risk                                                        |   |
|          |                                                                                                               |   |
| Item 8.       | Financial Statements and Supplementary Data                                                                        |   |
|          |                                                                                                               |   |
| Item 9.       | Changes in and Disagreements with Accountants on Accounting  and Financial Disclosure                              |   |
|          |                                                                                                               |   |
| Item 9A       | Controls and Procedures **                                                                                         |   |
|          |                                                                                                               |   |
| Item  9B      | Other  Information                                                                                                 |   |
|          |                                                                                                               |   |
| **Part  III** |                                                                                                               |   |
|          |                                                                                                               |   |
| Item 10.      | Directors and Executive Officers of the Registrant                                                                 |   |
|          |                                                                                                               |   |
| Item 11.      | Executive Compensation                                                                                             |   |
|          |                                                                                                               |   |
| Item 12.      | Security Ownership of Certain Beneficial Owners and  Management                                                    |   |
|          |                                                                                                               |   |
| Item 13.      | Certain Relationships and Related Transactions                                                                     |   |
|          |                                                                                                               |   |
| Item 14.      | Principal Accounting Fees and Services                                                                             |   |
|          |                                                                                                               |   |
| **Part IV**   |                                                                                                               |   |
|          |                                                                                                               |   |
| Item 15       | Exhibits and Financial Statement Schedules ***                                                                     |   |
|          |                                                                                                               |   |
| Signatures    |                                                                                                               |   |

 

----

Note: Page F-1 followsPage 48.

** Section amended fromOriginal Filing

*** See Note 2 on PageF-11

----

**ExplanatoryNote**

This Amendment No. 1 on Form 10-K/A (“Form 10-K/A”) to our AnnualReport on Form 10-K for the year ended December 31, 2005, initially filed withthe U.S. Securities and Exchange Commission (“SEC”) on March 31, 2006 (“OriginalFiling”), reflects the disclosure of events unknown to the Company at the timeof the original filing.  In the Company’sForm 10-Q filed on May 15, 2006 the Company reported that its internal controlsfor monitoring the use and reporting of charges on the Company’s debit cardwere not adequate and it was taking steps to remedy that inadequacy, includinglimiting the use of the debit card.  TheCompany stated that it did not believe that this internal control issue had anymaterial impact on the Company’s financial statements based upon what had beenuncovered.

The Audit Committee of the Company’s Board of Directors followed thediscovery with respect to internal control inadequacies by conducting aninternal investigation through an independent forensic accounting specialist.  On May 16, 2006, William Miraglia steppeddown as the Company’s chief financial officer, following the appointment ofWilliam Foote as new chief financial officer, but remained employed in anon-officer capacity.  From that time,Mr. Miraglia was restricted from using the Company debit card which hadpreviously been under his direct control. In the course of its investigations, the Audit Committee discovered thatMr. Miraglia’s use of the  Company’sdebit card for unauthorized and personal charges was more widespread thaninitially discovered.  On May 18, 2006,Mr. Miraglia was suspended with pay and barred from access to the Company’sfacilities and records while the investigation proceeded.

The investigation revealed that over a period of approximately sixyears, Mr. Miraglia had used the Company’s debit card for unauthorized andpersonal transactions, and had, also, initiated and signed for other unapprovedpersonal expenditures by company check. In total, unauthorized and unapproved expenses of a personal nature,from June 2000 to May 2006,  wereapproximately $860,000.  As a result ofthis information, Mr. Miraglia was terminated for cause from employment withthe Company on June 14, 2006.

On June 26, 2006, the Company filed Form 8-K to provide an update onthese events.  The Company has reviewedthe results of the investigation and performed an additional review of thetransactions and concluded that all material charges, although unapproved andunauthorized, had been reflected as part of the Company’s expenses in theappropriate periods.  Based on itsinvestigation and findings, the Company has concluded that none of the paymentsdescribed above, either individually or in total, require a restatement to theCompany’s previously reported net income or earnings per share in any of theaffected periods.

The Company has filed a claim to recover a portion of these lossesunder its employee dishonesty insurance policy, to the extent permitted as aresult of policy limits on time and amounts of coverage.  This claim has been settled and the companyhas recovered $300,000 from our insurance carrier, which is the policylimit.  In addition, Mr. Miraglia hassigned an agreement to make restitution to the Company.  To date, he has repaid $5,000.  In light of a number of factors, the Companydoes not believe that any significant further recoveries from Mr. Miraglia arelikely in the foreseeable future.  TheCompany is considering pursuing other remedies.

This Amendment No. 1 on Form 10-K/A is provided to update Part I — RiskFactors, Part II- Item 9A Controls and Procedures, and includeadditional information and disclosure about the final results of the AuditCommittee’s investigation, including the amount of these expenditures in therespective periods, discussed herein in Note 2 of the Notes to the FinancialStatements.

For the convenience of the reader, this Form 10-K/A sets forth theentire Form 10-K which was originally prepared and relates to the Company as ofDecember 31, 2005. However, this Form 10-K/A only amends and restates theOriginal Filing for the Items described above, and for other relatedinformation.  No attempt has been made tomodify or update other disclosures presented in our Original Filing of Form 10-K,including the Financial Statements, except as indicated in the foregoingdiscussion.  Accordingly, except for theforegoing amended information, this Form 10-K/A continues to speak as of March31, 2006 (the Original Filing date of the Form 10-K), and does not reflect anyevents occurring after the filing of our Form 10-K and does not modify orupdate those disclosures affected by other subsequent events.  Unless otherwise stated, the information inthis Form 10-K/A not affected by such current amendments is unchanged andreflects the disclosures made at the time of the Original Filing.

1

----

#### **PART I**

**Caution Regarding ForwardLooking Statements**

This Annual Report contains forward-looking statements as that term isdefined in the federal securities laws. The Company wishes to insure that any forward-looking statements areaccompanied by meaningful cautionary statements in order to comply with theterms of the safe harbor provided by the Private Securities Litigation ReformAct of 1995.  The events described in theforward-looking statements contained in this Annual Report may not occur.  Generally, these statements relate tobusiness plans or strategies, projected or anticipated benefits or otherconsequences of the Company’s plans or strategies, projected or anticipatedbenefits of acquisitions made by the Company, projections involving anticipatedrevenues, earnings, or other aspects of the Company’s operating results.  The words “may”, “will”, “expect”, “believe”,“anticipate”, “project”, “plan”, “intend”, “estimate”, and “continue”, andtheir opposites and similar expressions are intended to identifyforward-looking statements.  The Companycautions you that these statements are not guarantees of future performance orevents and are subject to a number of uncertainties, risks, and otherinfluences, many of which are beyond the Company’s control, that may influencethe accuracy of the statements and the projections upon which the statementsare based.  Factors which may affect theCompany’s results include, but are not limited to, the risks and uncertaintiesdiscussed in Items 1A, 7 and 7A.  Any oneor more of these uncertainties, risks, and other influences could materiallyaffect the Company’s results of operations and whether forward-lookingstatements made by the Company ultimately prove to be accurate.  Readers are further cautioned that theCompany’s financial results can vary from quarter to quarter, and the financialresults for any period may not necessarily be indicative of futureresults.  The foregoing is not intendedto be an exhaustive list of all factors that could cause actual results todiffer materially from those expressed in forward-looking statements made bythe Company.  The Company’s actualresults, performance and achievements could differ materially from thoseexpressed or implied in these forward-looking statements.  The Company undertakes no obligation topublicly update or revise any forward looking statements, whether from newinformation, future events, or otherwise.

The following discussion and analysis should be read in conjunctionwith the Company’s consolidated financial statements and the notes theretopresented elsewhere herein.  Thediscussion of results should not be construed to imply any conclusion that suchresults will necessarily continue in the future.

**Item 1.**                                                        **Business**

Photonic Products Group, Inc. (the “Company” or “PPGI”), incorporatedin 1973, develops, manufactures and markets products and services for use indiverse Photonics industry sectors via its multiple business units.  Prior to its name change in September, 2003,PPGI was named and did business solely as Inrad, Inc.

The Company had announced in 2002 that it was implementing its plan totransform the Company from a single business unit into a portfolio ofbusinesses serving the Photonics industry. Company management, the Board of Directors, and shareholders approvedthe name change in 2003, reinforcing the transformation of the Company’sbusiness model into that of a portfolio of business units whose brandedproducts conform to the paradigm: Products Enabling PhotonicsTM.

In November 2003, the Company concluded its first acquisition, that ofthe assets and certain liabilities of Laser Optics, Inc. of Bethel, CT.  Laser Optics, Inc. was a custom optics andoptical coating services provider, in business since 1966.  PPGI integrated the Bethel team and theiroperations into the Company’s Northvale, NJ operations in mid-2004, combiningthem with Inrad’s custom optics and optical coating product lines under theLaser Optics name.

In October 2004 the Company completed its second acquisition of acomplementary business with the purchase of 100% of the stock of MRC PrecisionMetal Optics, Inc. of Sarasota, FL.  MRCOptics, now a wholly-owned subsidiary of PPGI, is a fully integrated precisionmetal optics and diamond-turned aspheric optics manufacturer, specializing inCNC and single point diamond machining, optical polishing, plating, berylliummachining, and opto-mechanical design and assembly services.

PPGI’s business units’ products continue, at present, to fall into twoproduct categories: optical components (including standard and custom opticalcomponents and assemblies, crystals, and crystal components), and laseraccessories (including wavelength conversion products and Pockel’s Cells(optical shutters) that employ nonlinear crystals to perform the function ofwavelength conversion).  Currently, itsoptical components product lines and services are brought to market via threePPGI business units: INRAD, Laser Optics, and MRC Optics.  Laser accessories are brought to market byINRAD.

In summary, the Company is at present an optical component,subassembly, and sub-system supplier to major original equipment manufacturersand researchers in the Photonics industry. PPGI expects that in the future itsproducts may also include other product categories.

2

----

Administrative, engineering and manufacturing operations are housed atpresent in a 42,000 square foot building located in Northvale, New Jersey,about 15 miles northeast of New York City, and in a 25,000 square foot buildinglocated in Sarasota, FL.  Theheadquarters of the Company are located within its Northvale, NJ facility.

Custom optic manufacturing is at present a major product area forPPGI.  The Company specializes inhigh-end precision components.  It develops,manufactures and delivers precision custom optics and thin film optical coatingservices via its Laser Optics and MRC Precision Optics branded businessunits.  Glass, metal, and crystalsubstrates are processed using modern manufacturing equipment and techniques toprepare and polish substrates, deposit optical thin films, and assemblesub-components, thereby producing optical components used in advanced Photonicsystems of many kinds.  The majority ofcustom optical components and optical coating services supplied are used ininspection and process control systems, in defense and aerospaceelectro-optical systems, in laser system applications, in industrial scanners,and in medical system applications.

The Company also currently develops, manufactures, and deliverssynthetic optical crystals, optical crystal components, and laser accessoriesvia its INRAD brand.  It grows syntheticcrystals with electro-optic (EO), non-linear and optical properties for use inboth its standard products and custom products. The majority of crystals, crystal components and laser accessoriessupplied are used in laser systems, defense EO systems, and in R&Dapplications by researchers within corporations, universities, and nationallaboratories.

The Company has been implementing its plan to assemble a portfolio ofbusinesses serving the Photonics industry, and is engaged from time to time inexploratory strategic merger and acquisition discussions.  The Company is also engaged from time to timein discussions regarding the raising of capital to finance its growth. TheCompany’s policy is to not comment on such exploratory discussions, due totheir indefinite nature.

The following table summarizes the Company’s product sales by productcategories during the past three years:

 
| ** **           | ** ** | **Years Ended December 31,** | ** ** |
|----------------------|------------|---------------------------------------------|------------|
| ** **           | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Category**         | ** ** | **Sales**                                   | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** |
| Optical  Components* |       | $                                           | 12,279,000 |   | 89 |   | $ | 7,877,000 |   | 85 |   | $ | 4,469,000 |   | 83 |   |
| Laser  Accessories   |       | 1,506,000                                   |       | 11 |   | 1,345,000 |   | 15 |   | 893,000 |   | 17 |   |
| TOTAL**              |       | $                                           | 13,785,000 |   | 100 |   | $ | 9,222,000 |   | 100 |   | $ | 5,362,000 |   | 100 |   |

----

* a) 2003 Optical Component sales included $78,000from operations acquired from Laser Optics, Inc.

   b) 2004 Optical Component sales include $901,000from the Company’s new MRC Optics subsidiary.

 **     Not included above are(non-product) contract R&D sales of approximately $26,000 in 2003.

**Products Manufactured bythe Company**

**Optical Components**

# b)                                    CustomOptics and Optical Coating Services

Manufacturing of high-performance custom optics is at present a majorproduct area for PPGI, and is addressed in the marketplace principally via itsLaser Optics and its MRC Optics business units.

The Laser Optics business unit was formed in 2003 via the combinationof INRAD’s Northvale, NJ based custom optics and optical coating servicesoperations and those of the former Laser Optics, Inc. of Bethel, CT.  The Company had been active in the fieldsince 1973, and Laser Optics, Inc. since 1966.

The “new” Laser Optics provides custom products.  It specializes in the manufacture of opticalcomponents, optical coatings (ultra-violet wavelengths through infra-redwavelengths) and subassemblies for military, industrial, process control,photonic instrument, and medical end-use. Planar, prismatic and spherical components are fabricated from glassesof all kinds and crystals of most kinds, including fused silica, quartz,infra-red materials (including germanium, zinc selenide and zinc sulfide),calcite, magnesium fluoride and silicon. Component types include mirrors, lenses, prisms, waveplates, polarizingoptics, monochrometers, x-ray mirrors, and cavity optics for lasers.

To meet performance requirements, most optical components andsub-assemblies require thin film coatings on their surfaces.  Depending on the design, optical coatings canrefract, reflect, or transmit specific wavelengths.  Laser Optics coating service specialtiesinclude high laser damage resistance, infra-red, polarizing, high reflective,anti-reflective, and coating to complex custom

3

----

requirements on a wide range of substratematerials.  Laser Optics both coatscustomer furnished components and components it manufactures.  Coating deposition process technologiesemployed included electron beam, thermal, and ion assist.

MRC Optics, established in 1983 is a fully integrated precision metaloptics and optical assembly manufacturer. The Company provides high quality precision CNC and diamond machining,polishing, plating, beryllium machining, and opto-mechanical design andassembly services. MRC has developed custom processes to support prototypesthrough high rate production quantities of large flat mirrors, thermally stableoptical mirrors***,***reflectiveporro prisms, low RMS surface finish polished mirrors, diamond machined andprecision aspheric and plano mirrors, and arc-second accuracy polygons andmotor assemblies.  Optical platingspecialties include void-free gold and electroless nickel.

# c)                                     Crystalsand Crystal Components

PPGI produces and brings to market crystals and crystal components viaits INRAD business unit.  Certainsynthetic crystals, because of their internal structure, have unique optical,non-linear, or electro-optical properties. Electro-optic and nonlinear crystal devices can alter the intensity,polarization or wavelength of a laser beam. Developing growth processes for high quality synthetic crystals andmanufacturing and design processes for crystal components lies at the heart ofthe INRAD product line.  Syntheticcrystals currently in production include Nickel Sulfate, Lithium Niobate, BetaBarium Borate, Alpha Barium Borate, KDP, deuterated KDP and Zinc GermaniumPhosphide, among others.

The INRAD crystals and crystal components product lines also includecrystalline filter materials, including patent protected materials, that haveunique transmission and absorption characteristics that enable them to be usedin critical applications in defense systems such as missile warningsensors.  Other crystal components, bothstandard and custom, are used in laser applications research and in commerciallaser systems to change the wavelength of laser light.

INRAD has developed and manufactures a line of Q-switches, PockelsCells (optical shutters) and associated electronics, and has been active inthis field since 1973.  Pockels cells areused in applications that require the fast switching of the polarizationdirection of a beam of light.  These usesinclude Q-switching of laser cavities (i.e., to generate laser output pulses),coupling light into and out from regenerative amplifiers, and light intensitymodulation.  These devices are sold on anOEM basis to laser manufacturers and individually to researchers.

INRAD Pockels Cell products include the following:

·                  Singlecrystal and dual crystal KD*P Pockels Cells

·                  PKC-21 andPKC-02

·                  9 mm through50 mm apertures

·                  Singlecrystal Lithium Niobate Pockels Cells

·                  PLC-01

·                  8.5 mmthrough 10.5 mm apertures

·                  Singlecrystal and dual crystal BBO Pockels Cells

·                  PBC-03

·                  2.5 mm x 2.5mm through 2.5 mm x 7 mm sizes

·                  Electronicdrivers

·                  Gimbalmounts

**Laser Accessories**

PPGI designs, manufactures, and brings to market a line of harmonicgeneration laser accessories via its INRAD business unit.

# a)                                     HarmonicGeneration Systems

Harmonic generation systems enable the users of lasers to convert thefundamental frequency of the laser to another frequency required for a specificend use.  Harmonic generators arecurrently used in spectroscopy, semiconductor processing, medical lasers,optical data storage and scientific research.

Many commercial lasers have automatic tuning features, allowing them toproduce a range of frequencies.  TheINRAD Autotracker, when used in conjunction with these lasers, automaticallygenerates tunable ultraviolet light or infrared light for use in spectroscopicapplications.

4

----

Products offered for such nano-second laser systems include thefollowing:

·                  AT-III — anAutotracker with servo controlled tuning

·                  5-304 —temperature-stabilized crystals

·                  Harmonicseparators — for ultra-violet (UV), infra-red (IR), and second frequency mixing(SFM)

TheCompany produces a Harmonic Generator, the 5-050, for use with ultra-fastlasers having pulsewidths in the femtosecond and picosecond regime.  This product is sold on an OEM basis tomanufacturers of ultra fast lasers and to researchers in the scientificcommunity.

# b)                                    LaserPulse Measurement Instruments

The Company marketed, through December 31, 2005, a line ofAutocorrelators that measure extremely short laser pulses.  Autocorrelators are used for measuring laserpulses from ultrafast lasers, with pulse durations in the picosecond andfemtosecond ranges. INRAD had pioneered the design, manufacture, andintroduction of autocorrelators as accessories for the emerging field ofultrafast lasers back in 1979. In 2000, INRAD joined forces with AngewandtePhysik & Electronik, GmbH of Berlin, Germany, (A.P.E.) and became thesource for supply of products manufactured by A.P.E. to customers in theAmericas, Israel, and selected other markets. Effective January 1, 2006, theCompany and A.P.E. ended their alliance in this field.  At the present time the Company does notoffer Autocorrelators for sale in the market place.

**Research and Development**

Company-funded research expenditures during the years ended December31, 2005, 2004, and 2003 were $20,000, $98,000, and $154,000, 0.4%, 1.1%, and2.9% of net product sales, respectively.

During 2005 and 2004, the Company narrowed its focus of internalresearch and development efforts onto improving certain crystal growthprocesses, and on improving manufacturing process technologies for opticalcomponents.  Technical resources werefocused on supporting the integration of Laser Optics into Northvale operationsand ramp-up of production rates within Northvale operations and Sarasotaoperations.  As a result, internalR&D expenditures were at historically low levels in 2005 and 2004.

**Markets**

In 2005, 2004 and 2003 the Company’s product sales were made tocustomers in the following market areas:

 
| **Market**                                | ** ** | **2005**           | ** **           | **2004**           | ** ** | **2003**            | ** ** |
|-------------------------------------------|------------|--------------------|----------------------|--------------------|------------|---------------------|------------|
| Defense/Aerospace                         |       | $                  | 8,352,000 (60   | )%                 | $          | 4,127,000 (45  | )%         | $ | 2,321,000 (43 | )% |
| Process control  & metrology          |       | 3,259,000 (24 | )%                   | 1,817,000 (20 | )%         | 844,000 (16    | )%         |
| Laser systems  (non-military)             |       | 1,044,000 (8  | )%                   | 1,753,000 (19 | )%         | 1,066,000 (20  | )%         |
| Universities  & National laboratories |       | 522,000 (4    | )%                   | 763,000 (8    | )%         | 641,000 (11    | )%         |
| Other                                     |       | 608,000 (4    | )%                   | 662,000 (8    | )%         | 516,000 (9     | )%         |
| Total                                     |       | $                  | 13,785,000 (100 | )%                 | $          | 9,222,000 (100 | )%         | $ | 5,388,000 (100 | )% |

 

Major market sectors served by the Company include defense/aerospace,process control & metrology, laser systems (non-military), telecomm, universitiesand national laboratories, and various other markets not separatelyclassified.  The “defense/aerospace” areaconsists of sales to OEM defense systems and subsystems manufacturers,manufacturers of non-military satellite-based systems and subsystems, anddirect sales to governments where the products have the same end-use.  The “process control and metrology” areaconsists of customers who are OEM manufacturers of capital equipment used inmanufacturing and quality assurance, such as in semiconductor (i.e., chip)fabrication and testing.  The “lasersystems” market area consists principally of customers who are OEMmanufacturers of industrial, medical, and R&D lasers.  “Universities and National Laboratories”consists of product sales to researchers. The “Other” category represents sales to market areas that, while theymay be the object of penetration plans by the Company, are not currently largeenough to list individually, and as well sales through third parties for whomthe end-use sector is not known.

The Company is a provider of optical components, both specialty crystalcomponents and high precision custom optical components for customers in theaerospace and defense electro-optical systems sector.  End-use applications include military laser systems,military electro-optical systems, satellite-based systems, and missile warningsensors and systems intended to protect aircraft.  The dollar volume of shipments of productwithin this sector depends in large measure on the U.S. Defense Department budgetand its priorities, that of foreign governments, the timing of their release ofcontracts to their prime equipment and systems contractors, and

5

----

the timing of competitive awards from this customercommunity to the Company.  In thepost-9/11 era, government spending priorities for such systems have risensharply and deployment of new systems has been accelerated, as hasrefurbishment of fielded systems.  TheCompany’s sales of products to this customer sector continued their upwardtrend in 2005, increasing by 102% in dollar terms in 2005 from 2004, to 60% oftotal Company sales.  The defense andaerospace sector offers continued opportunities for the Company’s capabilitiesin precision optics.

Demand in the Process Control and Metrology (semiconductor tools)market for the Company’s products rebounded in 2004 from a protracted and deepcyclical downturn in capital spending for new tools and instruments in 2002 and2003.  Sales in 2005 increased 79% oversales in 2004, representing 24% of total Company sales.  The optical and x-ray inspection segment ofthe semiconductor industry offers continued opportunities for the Company’scapabilities in precision optics, crystal products, and monochrometers.

The Company serves the laser industry as an OEM supplier of standardand custom optical components and laser accessories. Within the Laser Systemscustomer sector, sales in 2005 declined 40% from sales in 2004, representing 8%of total revenues and reflecting a return to 2003 sales levels. Sales in 2004had been up 64% from the prior year on a surge of demand from both old and newcustomers for the Company’s laser accessory products. The Company continues toseek to acquire complementary products to broaden its laser accessory and laseroptical components product lines.

Sales to customers within the University and National Laboratoriesmarket sector decreased in 2005, now representing 4% of total revenues.  Sales to this sector have been in the$500,000 to $750,000 range historically, now representing a smaller percentageof total revenues.

Export sales, primarily to customers in countries within Europe, theNear East and Japan, amounted to 14%, 12%, 19% of product sales in 2005, 2004and 2003, respectively.  No foreigncustomer accounted for more than 10% of product sales in 2005, 2004, or 2003.

In 2005, two U.S. customers accounted for 13% and 14%, respectively, ofsales. The two customers are each divisions of defense industry primecontractors who manufacture electro-optical systems under multi-year productioncontracts for the U.S. and allied foreign governments. In 2004, the two U.S.customers each accounted for 12% of sales, and one customer accounted for 10%of sales.    The latter customermanufactures process control and metrology systems.  In the short-term the loss of any of thesecustomers would have a significant negative impact on the company and itsbusiness units.  In 2003, one U.S.customer accounted for 16% of total sales, and one U.S. customer accounted for 10%of total sales.  Both customers are defenseindustry prime contractors who manufacture electro-optical systems undermulti-year production contracts for the U.S. and foreign governments.

**Long-Term Contracts**

Certain of the Company’s orders from customers provide for periodicdeliveries at fixed prices over a period that may be greater than oneyear.  In such cases, as in most othercases as well, the Company attempts to obtain firm price commitments from itssuppliers for the materials necessary to fulfill the order.

**Marketing and BusinessDevelopment**

The Company’s two Northvale, NJ-based business units market theirproducts domestically through their own sales and marketing teams, led by theVice President - Marketing and Sales. Independent sales agents are used in countries in major non-U.S.markets, including Canada, Europe, the Near East and Japan and domestically inthe west coast region of the USA.

The Company’s MRC Optics subsidiary markets its products domesticallythrough their own sales and marketing team, led by the MRC Vice President ofMarketing and Business Development

Trade show participation and Internet-based marketing and promotion arecoordinated at the Corporate level.

**Backlog**

The Company’s order backlog as of December 31, 2005 was $7,857,000,more than 95% of which is shippable during fiscal year 2006.  The Company’s order backlog as of December31, 2004 was $6,433,000.  The Company’sorder backlog as of December 31, 2003 was $2,286,000.

**Competition**

Within each product category in which the Company’s business units areactive, there is competition.

6

----

Changes in the Photonics industry have had an effect on suppliers ofcustom optics.  As end users haveintroduced products requiring large volumes of optical components, suppliershave responded either by carving out niche product areas or by ramping up theirown manufacturing capacity and modernizing their manufacturing methods to meethigher volume run rates.  Many customoptics manufacturers lack in-house thin film coating capability.  As a result, there are fewer well-rounded competitorsin the custom optics arena, but they are equipped with modern facilities andprogressive manufacturing methods.  TheCompany has judiciously deployed capital towards modernizing its facility, andhas staffed the manufacturing group with individuals with comprehensiveexperience in manufacturing management, manufacturing engineering, advancedfinishing processes, thin-film coating processes, and capacity expansion.  The Company competes on the basis of providingconsistently high quality products, establishing strong customer relations, andcontinuously improving its labor productivity, cost structure, and productcycle times.

Competition for the Company’s systems is limited, but competitors’products are generally lower priced.  TheCompany’s systems are considered to be high end and generally offer acombination of features not available elsewhere.  Because of the Company’s in-house crystalgrowth capability, the Company’s staff is knowledgeable about matchingappropriate crystals to given applications.

For the crystal product area, price, quality, delivery, and customerservice are market drivers.  Many of theCompany’s competitors are overseas and can offer significantly reduced pricingfor some crystal species.  The Companyhas been able to retain and grow its customer base by providing the quality andcustomer service needed by OEM customers. On many occasions, the quality of the crystal component drives theultimate performance of the component or instrument into which it isinstalled.  Thus, quality and technicalsupport are considered to be valuable attributes for a crystal supplier bymany, but not all, OEM customers.

Although price is the principal factor in many product categories,competition is also based on product design, product performance, customerconfidence, quality, delivery, and customer service.  The Company is a sole-source supplier ofproducts to many major customers. Based on its performance to date, the Companybelieves that it can continue to compete successfully, although no assurancescan be given in this regard.

**Employees**

As of December 31, 2005, the Company had 102 full-time employees.

**Patents and Licenses**

The Company relies on its manufacturing and technological expertise,rather than on patents, to maintain its competitive position in theindustry.  The Company takesprecautionary and protective measures to safeguard its design and technical andmanufacturing data, and relies on nondisclosure agreements with its employeesto protect its proprietary information.

**Regulation**

Foreign sales of certain of the Company’s products may require exportlicenses from the United States Department of Commerce or Department ofState.  Such licenses are generallyavailable to all but a limited number of countries and are obtained when necessary.  One product, representing less than 1% ofCompany sales in 2005 and 2004, and less than 4% of Company sales in 2003,required U.S. State Department export approval and the required approvals weregranted.

There are no federal regulations nor any unusual state regulations thatdirectly affect the sale of the Company’s products other than thoseenvironmental compliance regulations that generally affect companies engaged inmanufacturing operations in New Jersey and Florida.

**Item 1A.**                                               **Risk Factors**

# a)                                     Manyof the Company’s customer’s industries are cyclical

The Company’s business is significantly dependent on the demand itscustomers experience for their products. Many of their end users are in industries that historically haveexperienced a cyclical demand for their products, The industries include butare not limited to, the defense electro-optics industry and the manufacturersof process control capital equipment for the semiconductor tools industry, As aresult, demand for the Company’s products and its financial results ofoperations are subject to cyclical fluctuations.

# b)                                    TheCompany faces competition

The Company encounters substantial competition from other companiespositioned to serve the same market sectors that the Company serves.  Some competitors may have financial,technical, capacity, marketing or other resources more extensive than ours,

7

----

or may be able to respond more quickly than theCompany can to new or emerging technologies and other competitivepressures.  Some competitors have manufacturingoperations in low-cost labor regions such as the far-east and eastern-Europeand can offer products at lower price than the Company.  The Company may not be successful in winningorders against the Company’s present or future competitors.

# c)                                     Asgeneral economic conditions deteriorate, the Company’s financial results suffer

Significant economic downturns or recessions in the United States orEurope could adversely affect the Company’s business, by causing a temporary orlonger term decline in demand for the Company’s goods and services.  Additionally, the Company’s revenues andearnings may be affected by general economic factors, such as excessiveinflation, currency fluctuations and employment levels.

# d)                                    TheCompany’s business success depends on its ability to recruit and retain keypersonnel

The Company’s existing business and its expansion plans depend on theexpertise, experience, and continuing services of certain scientists,engineers, production and management personnel, and on the Company’s ability torecruit additional personnel.  There iscompetition for the services of these personnel, and there is no assurance thatthe Company will be able to retain or attract the personnel necessary for itssuccess, despite the Company’s effort to do so.  The loss of the services of the Company’s keypersonnel could have a material adverse affect on its business, on its resultsof operations, or on its financial results.

# e)                                     TheCompany has incurred operating losses for two of the past three years and net lossesfor each of the past three years

The Company had income from operations of $358,000 in 2005 but hadsustained operating losses of $(410,000) in 2004, and $(1,654,000) in2003.  Net losses for the 3 years were$(11,000) in 2005, $(673,000) in 2004 and $(1,777,000) in 2003. The Company hasbeen following a strategy of growing via acquisition into a portfolio ofPhotonics businesses, and in this period had required capital both to fundworking capital needs and to acquire businesses.  The Company borrowed $1,000,000 via asubordinated convertible note to a major investor in December 2002 providingworking capital during this period, and borrowed $2,500,000 million via asubordinated convertible note to finance acquisitions.  Additionally, the Company has long-term debtin the form of a secured promissory note in the amount of $1,700,000 as well toa major investor, and the Company raised over $1,170,000 via a privateplacement of stock in 2004. The Company cannot establish lending lines frombanking institutions at this time due to its prior net losses, absent a longerrecent history of profitable fiscal quarters. In December 2005, the Companyinitiated a financing arrangement with a major shareholder and debt holder inthe amount of $700,000 to fund acquisition of capital assets needed to absorbgrowth opportunities. The funds were received in February 2006.

If the Company continues to sustain losses, the Company would be put atrisk, since there are no assurances that the Company would be able to obtain additionalfinancing it would require to continue to implement growth-by-acquisition or tosupply the working capital needs of its existing operations.

# f)                                       TheCompany may not succeed in acquiring complementary businesses or in integratingacquired businesses

The Company’s business strategy includes expanding its productioncapacities, product lines and market reach through both internal growth andacquisition of complementary businesses. The Company may not succeed in finding or completing acquisitions of suchbusinesses, nor can the Company be assured that it will be able to raise thefinancial capital needed for such acquisitions. Acquisitions may result in substantial per share financial dilution ofthe Company’s Common Stock from the issuance of equity securities.  They may also result in the taking on of debtand contingent liabilities, and amortization expenses related to intangibleassets acquired, any of which could have a material adverse affect on theCompany’s business, financial condition or results of operations.  Also, acquired businesses may be experiencingoperating losses.  Any acquisition willinvolve numerous risks, including difficulties in the assimilation of theacquired company’s people, operations and products, uncertainties associated withoperating in new markets and working with new customers, and the potential lossof the acquired company’s key employees. To date, the Company has had limited experience in acquiring orintegrating businesses.

# g)                                    TheCompany depends on, but may not succeed in, developing and acquiring newproducts and****processes

In order to meet the Company’s strategic objectives, the Company mustcontinue to develop, manufacture and market new products, and to develop newprocesses and to improve existing processes. As a result, the Company expects to continue to make investments inresearch and development and to continue to consider from time to time thestrategic acquisition of businesses, products, or technologies complementary tothe Company’s business.  There can be noassurance that the Company will be able to develop and introduce new productsor enhancements to its existing products and processes in a way that achievesmarket acceptance or other pertinent targeted results.  Nor can the Company be sure that it will besuccessful in acquiring complementary businesses, products, ortechnologies.  Nor can there be assurancethat the Company will have the human or financial resources to pursue orsucceed in such activitites.

8

----

# h)                                    TheCompany’s operations may be adversely affected if it fails to keep pace withindustry developments

The Company serves industries and market sectors which will be affectedby future technological developments. The introduction of products or processes utilizing new developmentscould render the Company’s existing products or processes obsolete orunmarketable.  The Company’s continuedsuccess will depend upon its ability to develop and introduce on a timely andcost-effective basis new products, processes, and manufacturing capabilitiesthat keep pace with developments and address increasingly sophisticatedcustomer requirements.

# i)                                        TheCompany’s manufacturing processes require products from limited sources ofsupply

The Company utilizes many relatively uncommon materials and compoundsto manufacture its products.  Examplesinclude optical grade quartz, specialty optical glasses, scarce natural andmanmade crystals, and high purity chemical compounds.  Failure of the Company’s suppliers to deliversufficient quantities of these necessary materials on a timely basis, or todeliver contaminated or inferior quality materials, or to markedly increasetheir prices could have an adverse effect on the Company’s business, despiteits efforts to secure long term commitments from the Company’s suppliers.  Adverse results might include reducing theCompany’s ability to meet commitments to its customers, compromising theCompany’s relationship with its customers, adversely affecting the Company’sability to meet expanding demand for its products, or causing the Company’sfinancial results to deteriorate.

# j)                                        Productyield problems and product defects that are not detected until products are inservice could increase the Company’s costs and/or reduce its revenues

Changes in the Company’s own or in its suppliers’ manufacturingprocesses, or the use of defective or contaminated materials by the Company,could result in an adverse effect on its ability to achieve acceptablemanufacturing yields, delivery performance, and product reliability.  To the extent that the Company does notachieve such yields, delivery performance or product reliability, its business,operating results, financial condition and customer relationships could be adverselyaffected.  Additionally, the Company’scustomers may discover defects in the Company’s products after the productshave been put into service in their systems. In addition, some of the Company’s products are combined by the Company’scustomers with products from other vendors, which may contain defects, makingit difficult and costly to ascertain whose product carries liability.  Any of the foregoing developments couldresult in increased costs and warranty expenses, loss of customers, diversion oftechnical resources, legal action by the Company’s customers, or damage to theCompany’s reputation.

# k)                                     Internationalsales account for a significant portion of revenues

Sales to customers in countries other than the United States accountedfor approximately 14%, 12% and 19% of revenues during the years ended December31, 2005, 2004, and 2003, respectively. The Company anticipates that international sales will continue toaccount for a significant portion of the Company’s revenues for the foreseeablefuture.  In particular, although theCompany’s international sales are denominated in U.S. dollars, currencyexchange fluctuations in countries where the Company does business could have amaterial adverse effect on its business, financial condition or results ofoperations, by making the Company less price-competitive than foreignmanufacturers.

# l)                                        TheCompany may not be able to fully protect its intellectual property

The Company does not currently hold any material patents applicable toits most important products or manufacturing processes.  The Company relies on a combination of tradesecret and employee non-competition and nondisclosure agreements to protect itsintellectual property rights.  There canbe no assurance that the steps the Company takes will be adequate to preventmisappropriation of the Company’s technology. In addition, there can be no assurance that, in the future, thirdparties will not assert infringement claims against the Company.  Asserting the Company’s rights or defendingagainst third-party claims could involve substantial expense, thus materiallyand adversely affecting the Company’s business, results of operations orfinancial condition.

# m)                                  TheCompany’s stock price may fluctuate widely

Many factors, including, but not limited to, future announcementsconcerning the Company, its competitors or customers, as well as quarterlyvariations in operating results, announcements of technological innovations,seasonal or other variations in anticipated or actual results of operations,changes in earnings estimates by analysts or reports regarding the Company’sindustries in the financial press or investment advisory publications, couldcause the market price of the Company’s stock to fluctuate substantially.  In addition, the Company’s stock price mayfluctuate widely for reasons which may be unrelated to operating results.  These fluctuations, as well as generaleconomic, political and market conditions such as recessions, militaryconflicts, or market or market-sector declines, may materially and adverselyaffect the market price of the Company’s Common Stock.  In addition, any information concerning theCompany, including projections of future operating results, appearing ininvestment advisory publications or on-line bulletin boards or otherwiseemanating from a source other than the Company could in the future contributeto volatility in the market price of the Company’s Common Stock.

9

----

# n)                                    TheCompany has experienced certain material weaknesses in our internal controlover financial reporting

Subsequent to the preparation of our consolidated financial statementsfor the year ended December 31, 2005, certain material weaknesses becameevident to our management with the discovery that our former Chief FinancialOfficer had incurred and paid for unauthorized and personal expenses throughthe Company.  This discovery showed thatinternal controls for monitoring the use and reporting of charges on theCompany’s debit card and with respect to the Company’s handling ofdisbursements by check were inadequate. A material weakness is a significantdeficiency in one or more of the internal control components that alone or inthe aggregate precludes our internal controls from reducing to an appropriatelylow level the risk that material misstatements in our financial statements willnot be prevented or detected on a timely basis.

In light of the foregoing discoveries resulting from the investigationand from management’s review of its internal control procedures, the AuditCommittee directed the Company to take a number of steps to strengthen itsinternal controls, including (a) recall and cancellation of the corporate debitcard and (b) implementation of a policy requiring two authorized signatures onall checks in amounts of $5,000 or more. These changes have been implemented. The Company has extended this policy to all wire transfers initiatedfrom its bank.  In addition, a jointmeeting with the accounting staff, the Chief Executive Officer and the newChief Financial Officer was conducted to review internal controls andprocedures, to promote a control environment that emphasizes appropriatejudgment, skepticism and objectivity and to reinforce each employee’sresponsibility to report unusual or suspicious financial transactions to anindependent officer or member of the Audit Committee.

Other initiatives to further strengthen internal controls are currentlybeing assessed and implemented by the Company. These include but are not limited to: (i) establishing a written ethicspolicy to cover all employees which supplements the existing policy that coverssenior financial executives and members of the Board of Directors, (ii)improving internal procedures for reporting suspected ethics violations, (iii)extending the requirement for written approval of business expenses to allcorporate officers’ expense reports and, (iv) identification and documentationof all critical internal controls within an Internal Control Policies andProcedures Manual.

We believe that these corrective steps enable us to conclude that thematerial weaknesses in internal controls over financial reporting, asidentified above, have been remediated.

**Item 1B.****                                               UnresolvedStaff Comments**

 

There were no unresolved Staff comments as of March 15, 2006.

**Item 2.****                                                        Properties**

 

Administrative, engineering and manufacturing operations are housed atpresent in a 42,000 square foot building located in Northvale and in a 25,000square foot building located in Sarasota, FL. The headquarters of the Company are located within its Northvale, NJfacility.

PPGI, INRAD and Laser Optics occupy approximately 42,000 square feet ofspace located at 181 Legrand Avenue, Northvale, New Jersey pursuant to a netlease expiring on October 31, 2006.  PPGIhas an option to renew the Northvale lease for an additional term of fiveyears.  In November 2003, the Companyexercised its option to lease 11,000 square feet of additional adjoining spacein the same building, which brought the total square feet of leased spaceoccupied by PPGI in Northvale, New Jersey to its present 42,000 square feet.  In 2003, Laser Optics Holdings, Inc., aSubsidiary of the Company, acquired the rights to the lease of 8,000 squarefeet of space in Bethel, CT, formerly occupied by Laser Optics, Inc., uponpurchase of the assets of Laser Optics, Inc. This lease expired in May of 2004 coincident with the Company’s vacatingthat facility and relocating the assets of Laser Optics, Inc. to its Northvaleoperations center.

PPGI’s MRC Optics subsidiary occupies approximately 25,000 square feetof space located at 6405 Parkland Drive, Sarasota, FL pursuant to a net leaseexpiring on August 31, 2006.  MRC Opticshas negotiated terms for renewal of that lease, an offer from the landlord isin-hand and is under management review.

The facilities are adequate to meet current and future projected productionrequirements.

The total rent in 2005 for these leases was approximately$525,000.  The Company also paid realestate taxes and insurance premiums that totaled approximately $95,000 in 2005.

**Item 3.****                                                        LegalProceedings**

There are no legal proceedings involving the Company as of the datehereof.

10

----

**Item 4.****                                                        Submissionof Matters to a Vote of Security Holders**

Not Applicable.

**PART II**

**Item 5.****                                                        Marketfor Registrant’s Common Equity and Related Stockholder Matters**

# a)                                     MarketInformation

The Company’s Common Stock, par value $0.01 per share, is traded on theOTC Bulletin Board under the symbol PHPG.

The following table sets forth the range of closing prices for theCompany’s Common Stock in each fiscal quarter from the quarter ended March 31,2004 through the quarter ended December 31, 2005, as reported by the NationalAssociation of Securities Dealers NASDAQ System.  Such over-the-counter quotations reflectinter-dealer prices, without retail mark-up, mark-down or commission and maynot necessarily represent actual transactions.

|                                   | ** ** | **Price** | ** ** |
|-----------------------------------|------------|-----------|------------|
| ** **                        | ** ** | **High**  | ** ** | **Low** | ** ** |
|                              |       |      |       |   |   |
| Quarter ended  December 31, 2005  |       | 1.45      |       | .90 |   |
|                              |       |      |       |   |   |
| Quarter ended  September 30, 2005 |       | 0.98      |       | .75 |   |
|                              |       |      |       |   |   |
| Quarter ended  June 30, 2005      |       | 1.00      |       | .65 |   |
|                              |       |      |       |   |   |
| Quarter ended  March 31, 2005     |       | 1.40      |       | 1.05 |   |
|                              |       |      |       |   |   |
| Quarter ended  December 31, 2004  |       | 1.60      |       | .70 |   |
|                              |       |      |       |   |   |
| Quarter ended  September 30, 2004 |       | 1.50      |       | .65 |   |
|                              |       |      |       |   |   |
| Quarter ended  June 30, 2004      |       | 2.00      |       | .46 |   |
|                              |       |      |       |   |   |
| Quarter ended March 31,  2004     |       | .65       |       | .37 |   |

 

As of March 21, 2006 the Company’s stock price was $1.25 per share.

# b)                                    Shareholders

As of March 24, 2006, there were approximately 230 owners ofrecord of the Common Stock.  The numberof record owners of common stock was approximated based upon the Shareholders’Listing provided by the Company’s Transfer Agent.

# c)                                     Dividends

The Company did not pay any cash dividends on its Common Stock duringthe years ended December 31, 2005, 2004 and 2003.  The Company paid a dividend of 134,000 sharesof Common Stock on its Series A and Series B convertible preferred stock in2005, valued at $134,000.  The Companypaid a dividend of 134,000 shares of Common Stock on its Series A and Series Bconvertible preferred stock in 2004, valued at $165,000.  The Company paid a dividend of 134,000 sharesof Common Stock on its Series A and Series B convertible preferred stock in2003, valued at $54,000. Payment of cash dividends will be at the discretion ofthe Company’s Board of Directors and will depend, among other factors, upon theearnings, capital requirements, operations and financial condition of theCompany.  The Company does not anticipatepaying cash dividends in the immediate future.

# d)                                    RecentSales of Unregistered Securities and Registration of Securities

There were no sales of unregistered securities, nor were any sales ofsecurities registered during 2005.

11

----

**Item 6.****                                                        SelectedFinancial Data**

The following data is qualified in its entirety by the financialstatements presented elsewhere in this Annual Report on Form 10-K.
| ** **                                           | ** ** | **As of December 31, or**                | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                           | ** ** | **For the Year Ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **2005**                                                     | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                                 |       |                                                         |       |       |       |       |       |   |   |   |   |
| Revenues                                             |       | $                                                            | 13,785,057 |       | $          | 9,221,857  |       | $ | 5,388,184 |   | $ | 5,569,118 |   | $ | 8,075,205 |   |
| Net (loss)  profit                                   |       | (11,398                                                      | )          | (672,937   | )          | (1,777,309 | )          | (1,715,972 | ) | 43,634 |   |
|                                                 |       |                                                         |       |       |       |       |       |   |   |   |   |
| Net (loss)  profit applicable to common shareholders |       |                                                         |       |       |       |       |       |   |   |   |   |
| Basic                                                |       | (.02                                                         | )          | (.15       | )          | (.35       | )          | (.35 | ) | (.02 | ) |
| Diluted                                              |       | (.02                                                         | )          | (.15       | )          | (.35       | )          | (.35 | ) | (.02 | ) |
|                                                 |       |                                                         |       |       |       |       |       |   |   |   |   |
| Weighted average  shares                             |       |                                                         |       |       |       |       |       |   |   |   |   |
| Basic                                                |       | 7,218,244                                                    |       | 5,710,354  |       | 5,287,849  |       | 5,210,322 |   | 5,046,666 |   |
| Diluted                                              |       | 7,218,244                                                    |       | 5,710,354  |       | 5,287,849  |       | 5,210,322 |   | 5,046,666 |   |
| Dividends paid                                       |       | 134,000                                                      |       | 164,820    |       | 53,600     |       | 120,600 |   | 155,000 |   |
| Total assets                                         |       | 13,481,021                                                   |       | 13,526,634 |       | 8,851,121  |       | 8,508,925 |   | 8,599,072 |   |
| Long-term  obligations                               |       | 5,963,411                                                    |       | 6,459,088  |       | 4,405,576  |       | 1,188,512 |   | 287,170 |   |
| Shareholders’ equity                            |       | 3,929,407                                                    |       | 3,965,129  |       | 3,284,439  |       | 5,049,879 |   | 6,745,489 |   |
|                                                      |            |                                                              |            |            |            |            |            |  |  |  |  |  |  |  |  |  |

 

The Company completed the acquisition of the stock of MRC PrecisionMetal Optics, Inc. in mid-October 2004. Also, the Company completed the acquisition of Laser Optics, Inc.’sassets and liabilities at the end of November 2003.  The comparability of information in theselected financial data is aided by details provided in the managementdiscussion, which attribute certain portions of revenue growth in 2004 to thesetwo acquisitions.

**Item 7.****                                                        Management’sDiscussion and Analysis of Financial Condition and Results of Operation**

**CriticalAccounting Policies**

The Company’s significant accounting polices are described in Note 1 ofthe consolidated financial statements, that were prepared in accordance withaccounting principles generally accepted in the United States of America.  In preparing the Company’s financialstatements, the Company made estimates and judgments that affect the results ofits operations and the value of assets and liabilities the Companyreports.  The Company’s actual resultsmay differ from these estimates.

The Company believes that the following summarizes critical accountingpolices that require significant judgments and estimates in the preparation ofthe Company’s consolidated financial statements.

**RevenueRecognition**

The Company records revenue when a product is shipped.  Losses on contracts are recorded whenidentified. The Company, from time to time, may recognize revenue using thepercentage of completion method for certain long term manufacturingprojects.  No revenues in 2005 wereaccounted for using the percentage of completion method.

**AccountsReceivable**

The Company records an allowance for doubtful accounts receivable as acharge against earnings for revenue for items that have been reviewed and carrya risk of non-collection in the future. The Company has not experienced a non-collection of accounts receivablematerially affecting the results of operations.

**Inventory**

The Company records a reserve for slow moving inventory as a chargeagainst earnings for all products on hand that have not been sold to customersin the past twelve months.  An additionalreserve is recorded for product on hand that may not be sold to customerswithin the upcoming twelve months.

12

----

From time to time, estimated costs are recorded as a charge againstearnings based on known circumstances where it is probable that a manufacturingcost over run has been incurred or is expected to be incurred and the amountcan be reasonably estimated.

**Results of Operations**

The following table summarizes the Company’s product sales by productcategories during the past three years:

 
| ** **           | ** ** | **Years Ended December 31** | ** ** |
|----------------------|------------|--------------------------------------------|------------|
| ** **           | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Category**         | ** ** | **Sales**                                  | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** |
| Optical  Components* |       | $                                          | 12,279,000 |   | 89 |   | $ | 7,877,000 |   | 85 |   | $ | 4,469.000 |   | 83 |   |
| Laser  Accessories   |       | 1,506,000                                  |       | 11 |   | 1,345,000 |   | 15 |   | 898,000 |   | 17 |   |
| TOTAL**              |       | $                                          | 13,785,000 |   | 100 |   | $ | 9,222,000 |   | 100 |   | $ | 5,367,000 |   | 100 |   |

 

----

* a)  2003Optical Component sales included $78,000 from operations acquired from LaserOptics, Inc.

   b)  2004Optical Component sales include $901,000 from the Company’s new MRC Opticssubsidiary.

 **   Notincluded above are (non-product) contract R&D sales of approximately$26,000 in 2003.

The following table sets forth, for the past three years, thepercentage relationship of statement of operations categories to totalrevenues.

|                                               | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                     |       |                                        |       |   |   |   |   |
| Product sales                                 |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Costs and expenses:                           |       |                                        |       |   |   |   |   |
| Cost of goods sold                            |       | 72.2                                        | %          | 71.9 | % | 72.7 | % |
| Gross profit margin                           |       | 27.8                                        | %          | 28.1 | % | 27.3 | % |
| Selling, general  and administrative expenses |       | 25.0                                        | %          | 31.5 | % | 44.3 | % |
| Internal  research and development            |       | 0.1                                         | %          | 1.1 | % | 2.9 | % |
| Special charges                               |       | 0                                           | %          | 0 | % | 10.8 | % |
| Profit/(Loss)  from operations                |       | 3.0                                         | %          | (4.5 | )% | (30.6 | )% |
| Net Loss                                      |       | (0.1                                        | )%         | (7.3 | )% | (32.9 | )% |

 

**Revenues**

Total revenues were approximately $13,785,000, $9,222,000, and$5,388,000 in 2005, 2004 and 2003, respectively.  Revenues increased 49% in 2005 to $13,785,000,from $9,222,000 in 2004, aided by strong ending backlog in 2004 and strong neworder intake throughout 2005. Additionally, sales in 2005 included a second year of twelve full monthsof revenues from legacy Laser Optics, Inc. lines of business acquired inNovember of 2003, synergies from the combination and integration of LaserOptics and Inrad custom optics operations in 2004, and twelve full months ofrevenues from the Company’s MRC Optics subsidiary, acquired in October of 2004.2004 sales had been up 71% from 2003 sales.

Examining these results by customer industry sector:

Sales to the Defense/Aerospace sector continuedtheir three year upward trend in 2005, increasing by 102% in dollar terms in2005 from 2004, to 60% of total Company sales. A majority of sales at the Company’s MRC Optics subsidiary are tocustomers in this sector, and 2005 represented a full twelve months of revenuecontribution from that subsidiary. 2005 sales to the sector were $8,352,000 ascompared with $4,127,000 in 2004. Salesin 2003 were $2,321,000, up 34% from 2002. Increased military spending on electro-optical systems and R&D inthe post-9/11 era combined with strategic re-positioning by the Company hasboosted demand for the Company’s products. Sales to this sector accounted for 60%, 45%, and 43%, of total sales in2005, 2004, and 2003, respectively.

Revenues from customers in the Process Control and Metrology (ie.semiconductor tools, instruments) sector in 2005 increased 79% over sales in2004, to $3,259,000 from $1,817,000, now representing 24% of total Companysales. A large fraction of this growth is due to inclusion of a full twelvemonths of sales to this sector by the Company’s MRC Optics subsidiary. Sales inthe sector had rebounded in 2004 from a protracted and deep cyclical downturnin capital spending for new tools and instruments in 2002 and 2003.  Revenues rose to $1,817,000 in 2004 from $844,000 in 2003, up115%.  The optical and x-rayinspection segment of the semiconductor industry offers continued opportunitiesfor the Company’s capabilities in precision optics, crystal products, andmonochrometers. Sales to this sectoraccounted for 24%, 20%, and 16% of total sales in 2005, 2004, and 2003,respectively.

13

----

Revenues decreased in the non-military LaserSystems sector, declining 40% in 2005 to $1,044,000 from $1,753,000 in2004, and now representing 8% of total revenues. Sales here in 2005 reflect areturn to 2003 sales levels. The similar sales level in 2003 then represented20% of sales and now represent 8% of sales, as total Company sales have grownby 155% since 2003. Sales in 2004 had been up 64% from the prior year on asurge of demand from customers for the Company’s laser accessory products andcertain optical components. This demand declined in 2005 to pre 2004 levels.Reasons included decline in sales of one customer’s product line, acquisitionof another customer by a larger corporation with in-house resources for theproduction of the product, and a general decline in demand for harmonicgenerators. . Sales to thissector accounted for 8%, 19%, 20%, of total sales in 2005, 2004, and 2003,respectively.

Sales to customers within the University and National Laboratoriesmarket sector decreased in 2005, representing 4% of total revenues.  Sales to this sector have been in the$500,000 to $750,000 range historically, now representing a smaller percentageof total revenues.

Sales to customers in “Other” (i.e. non-separately classified) sectorswere $608,000 in 2005 as compared with $659,000 in 2004. Sales in 2004 were up4% from $458,000 in 2003.  Sales in thesesectors have accounted for 4%, 8%, and 9% of total sales in 2005, 2004, and2003, respectively.

New orders in 2005 were $15,308,000, as compared with $11,240,000 in2004. 2005 results include a full year of new orders from the Company’s MRCOptics subsidiary, as compared with only partial year contributions from newlyacquired MRC Optics of $530,000 in 2004. New orders in 2004 had increased to$11,240,000 from $6,018,000 in 2003, up 85% from those in 2003. Order intake in2005 was especially strong in 2005 from customers in the Defense/Aerospace, andProcess Control and Metrology sectors.

The annualized product book-to-bill ratio for 2005 was 1.11 as comparedwith 1.22 in 2004.. The annualized product book-to-bill ratio for 2004 net ofthe MRC Optics acquisition, was 1.28. The annualized product book to bill ratioin 2003 had been greater than 1.0 for the first time in three years at 1.1,reflecting a positive change overall across all market sectors served.

The Company’s backlog of product orders as of December 31, 2005was approximately $7,876,000, up 22% from December 31, 2004. The Company’send of year backlogs in 2004 and 2003 were $6,433,000 and$2,286,000,respectively.

**Cost of Goods Sold andGross Profit Margin**

As a percentage of product sales, cost of goods sold was 72.2%, 71.9%,and 72.7% for the years ended December 31, 2005, 2004 and 2003,respectively. Gross profit margin as a percentage of product sales was 27.8%,28.1%, and 27.3%, for 2005, 2004, and 2003, respectively.

In 2005, the cost of goods sold remained relatively constant, as apercentage, to 2004 levels. Sales increased by 49%, while cost of goods soldincreased by 51%. Theincrease in the total cost of goods sold in 2005 in comparison to 2004 was theresult of increased costs for material and personnel associated with theincreased sales volumes and the inclusion of MRC Optics costs as well as sales.

Gross margins for the Company in 2005 represent the combined resultsfrom its two centers of operation: Northvale, NJ (site of INRAD and LaserOptics) and Sarasota, FL, site of MRC Optics.

Gross margins from the Company’s Northvale operations continued theiryear-over-year improvement in 2005, the second year following the integrationof the acquired operations of Connecticut-based Laser Optics into Northvale.During the period, labor productivity rose, economies of scale, and costcontrols there resulted in increases in gross profit margin during 2005.

2005 represented the first full year of fiscal contribution fromoperations at the Company’s Sarasota-based MRC Optics subsidiary, where grossmargins in 2005 lagged those in Northvale significantly. Negative gross marginsat our new MRC Optics subsidiary during the first quarter, were followed byimproved margins during the remainder of the year, as sales volumes there roseby 35% year over year. Problem vendors were replaced with qualified newsuppliers, and capacity constraints were eased with the addition of these newvendors, new personnel and new equipment resources that were brought on line,and key manufacturing processes were re-optimized for use of higherproductivity methods.

In 2004, the cost of goods sold remained relatively constant, as apercentage, to 2003 levels. Sales increased by over 71%. However, fixed costsfor facilities related expenditures and depreciation also increased and alongwith increases in variable costs for labor and material created a situation inwhich cost of sales remained at the same relative percentage for the year.

Fixed costs are a major component of the Company’s total coststructure. Management and the Board of Directors decided to reduce such costsin 2002 only up to the point where further reductions would impede the Company’sability to perform for its current customers or to rebound in the futurewhen macroeconomic conditions improved, and to invest in new operations andlines of

14

----

business. This philosophy continued throughout 2003and 2004, and enabled the Company to be well-positioned with its operations tomanufacture and deliver the goods that are behind the growth that hascharacterized 2004 and 2005.

Costs of most purchased components have been relatively stable in 2005,2004, and 2003. However, unit costs of certain raw materials such as crystalquartz, high grade optical glasses, nickel and gold plating solutions haveincreased significantly in the past year.

**Selling, General andAdministrative Expenses**

Selling, general and administrative expenses as a percentage of saleswere 25.0%, 31.5%, and 44.3% in 2005, 2004, and 2003, respectively.

Selling, general and administrative expenses in 2005 increased indollar terms from those in 2004 by $534,000, or 18.3%, while sales increased by49%, resulting in a drop in the SG&A cost as a percentage of sales. Theincrease in SG&A expenditures reflected the first full year of costs fromthe Company’s MRC Optics subsidiary, acquired in October of 2004.

Selling, general and administrative expenses in 2004 increased$526,000, or 22% compared to 2003, while revenues increased 71%, resulting in adrop in the SG&A cost as a percentage of sales. The increase in SG&Acosts in 2004 was attributable to a full year of costs for the newly acquiredLaser Optics operations and two and one half months of costs incurred as aresult of the MRC acquisition. Also adding to the increase were the restorationof salaries for executive personnel to pre-2002 levels and increased costs forcommissions that resulted from the higher sales volume in 2004.

**Internal Research andDevelopment Expenses**

Company-funded research expenditures during the years endedDecember 31, 2005, 2004, and 2003 were $20,000, $98,000, and $154,000,0.4%, 1.1%, and 2.9% of net product sales, respectively.

During 2005 and 2004, the Company narrowed its focus of internalresearch and development efforts onto improving certain crystal growthprocesses, and on improving manufacturing process technologies for opticalcomponents. Technical resources were focused on supporting the integration ofLaser Optics into Northvale operations and ramp-up of production rates withinNorthvale operations and Sarasota operations. As a result, internal R&Dexpenditures were at historically low levels in 2005 and 2004.

**Special Charges**

During 2003, the Company acquired the assets and liabilities of LaserOptics, Inc. A strategic decision was made at that time to relocate theassets and employees from Bethel, CT to Northvale, NJ and to combine the LaserOptics, Inc. business lines with the Custom Optics business line. The entitycreated by this combination is now a PPGI business unit called Laser Optics.The assets acquired and employees were relocated to Northvale, NJ intoconsolidated operations during the spring of 2004. The costs of relocatingemployees included relocation costs, stay on bonuses and relocation bonuses,that were accrued in 2003. The accrual amounted to $107,000 ($0.02 per share ona basic and diluted basis) and has been included in the consolidated statementof operations as a special charge.

During 2003 the Company determined that there was excess inventory,relative to forecasted future needs, of certain crystals and solutions. Basedon this determination, a reserve was taken in the amount of $475,000 ($0.09 pershare on a basic and diluted basis) in order to recognize the diminished futureeconomic benefit of the inventory. The increased reserve has been included inthe consolidated statement of operations as a special charge.

**Operating Income**

The profit from operations in 2005 was $358,000 compared to anoperating loss of $(410,000) in 2004 and $(1,654,000) in 2003. The improvedperformance was a direct result of the success of management’s acquisitionprogram and an overall strengthening of business from existing and newcustomers.

Losses in 2003 were due to slackened and continuing weak demand inmajor market sectors served by the Company and its products. These lossesoccurred despite strict cost containment measures, and they were absorbed. Thecost containment program implemented by management and the Board stopped short,by design, of impeding the ability of the Company’s operations toperform again in the future, or of impeding the Company’s ability to findnew customers for its products. Management’s efforts to restore profitabilityto operations through 2005 have been focused on building the Company’s topline, driving improvements in operations, and through continued focus onbusiness development and selling activities.

15

----

**Other Income and Expenses**

Interest expense increased over prior periods due to the assumption ofMRC debt. The Company’s average borrowings in 2005 and 2004 were approximately$6,500,000 versus $4,500,000 in 2003. In 2003, borrowing needs increased dueprincipally to obtaining the capital needed for the acquisition made during2003. A subordinated convertible note was placed for acquisition purposes.Interest on the secured and convertible notes is accrued, and payment is dueupon the maturity of the notes. Also during 2003, a secured note replaced allof the Company’s prior bank debt.

During 2005, the Company sold approximately 60% of platinum inventory,deemed to be non-productive and in excess, for net proceeds of $314,000. Thetransaction resulted in a gain of $136,000. The proceeds were used to augmentcash reserves that were required to support working capital needs at mid-year.

**Liquidity and CapitalResources**

In December of 2005, a major shareholder and debt holder agreed toprovide the Company with $700,000 in financing to fund the acquisition ofcertain capital assets required for expanded capabilities to meet customerdemand. The Note was executed and the funds received in February 2006. Theterms for the Note call for the amount to be repaid in equal monthlyinstallments, including interest & principal, commencing March 2006,until maturity in March 2013. The Note bears an annual interest rate of6.75%.

At the end of the fourth quarter of 2002, the Company received$1,000,000 in proceeds from the issuance of a Subordinated ConvertiblePromissory Note. The Note, originally due in January 2006, has beenextended to December 31, 2008 and bears an interest rate of 6%. Interestaccrues yearly and along with principal may be converted into CommonStock, (and/or securities convertible into common shares). The note isconvertible into 1,000,000 Units consisting of 1,000,000 shares of Common Stockand Warrants to acquire 750,000 shares of Common Stock at a price of $1.35 pershare. The Holder of the Note is a related party to a major shareholder of theCompany.

In the second quarter of 2002, the Company secured an asset loan fromWachovia Bank. In January 2003 the Company was in violation of certainfinancial covenants required under the loan agreements. As a result WachoviaBank sold both the asset based loan and working capital revolver to APC Investments.In June of 2003, the Company paid off the loan held by APC with $1,700,000in proceeds received from the issuance of a Secured Promissory Note that isheld by a major investor in the Company. The Secured Promissory Note was for aperiod of 36 months and bears interest at the rate of 6% per annum. TheCompany’s Board of Directors approved the issuance of 200,000 warrants toClarex, Ltd. as a fee for the issuance of the Note and in the 2nd quarter of2004 approved the issuance of an additional 200,000 warrants as a fee forextending the note to September 30, 2007. The note was subsequentlyextended to December 31, 2008 without issuance of warrants or any otherconsideration. The warrants are exercisable at $0.425 per share and $1.08 per share,respectively, approximately a 20% discount to market, and expire inMarch 2008 and May 2008. The Note is secured by all assets of theCompany.

At the end of the fourth quarter of 2003, the Company received$1,500,000 in proceeds from the issuance of a Subordinated ConvertiblePromissory Note. The Note, originally due in January 2006, has beenextended to December 31, 2008 and bears an interest rate of 6%. Interestaccrues yearly and along with principal may be converted into CommonStock, and/or securities convertible into Common Stock. The note is convertibleinto 1,500,000 Units consisting of 1,500,000 shares of Common Stock andWarrants to acquire 1,125,000 shares of Common stock at a price of $1.35 pershare. The Holder of the Note is a major shareholder of the Company. Theproceeds from the Note were used in the Company’s acquisition program.

In April 2004, the Company received $1,000,000 in proceeds fromthe issuance of a Subordinated Convertible Promissory Note. The Note is due inMarch 2007 and bears an interest rate of 6%. Interest accrues yearly andalong with principal may be converted into Common Stock, (and/orsecurities convertible into common shares). The note is convertible into1,000,000 Units consisting of 1,000,000 shares of Common Stock and Warrants toacquire 750,000 shares of Common Stock at a price of $1.35 per share. TheHolder of the Note is a major shareholder of the Company.

During the 2nd quarter of 2004, the Company entered into an agreementwith an investment banking firm to raise equity via a private placementaccordance with Regulation D that was not registered with the Securities andExchange Commission. In July 2004 the Company issued 1,581,000 Unitsconsisting of 1,581,000 shares and warrants to acquire an additional 1,185,750shares at $1.35 per share. In addition, 262,276 Warrants were issued to CasimirCapital, LP, the placement agent for the private placement. Casimir Capitalearned commissions of $142,391 as the underwriter of this private placement.This private placement resulted in net proceeds to the Company of approximately$1,173,000. The funds were utilized in the furtherance to the company’s M&Aprogram, capital equipment purchases and to meet general working capitalrequirements. The issued shares and shares underlying warrants weresubsequently registered under an S-1 Registration filing.

Capital expenditures, including internal labor and overhead charges,for the years ended December 31, 2005, 2004 and 2003 were approximately$454,000, $1,014,000, and $101,000, respectively. Capital expenditures in 2005were used for the build up of

16

----

tooling for new customer requirements and for theacquisition of equipment. A major portion of the 2004 capital expenditures werefor the relocation and integration of the Laser Optics Bethel operations intothe Northvale facility. Approximately $600,000 was used in this facilityrearrangement and expansion, including $190,000 of capitalized internal laborand overhead. Additional large capital expenditures for the year included acertain production-critical machine tool, upgraded coating equipment in theLaser Optics business unit, and metrology equipment and computer hardware andsoftware upgrades. Capital expenditures in 2003 were used for expansion andrenovation of facilities and for the acquisition of equipment. The expenditureswere financed in part from capital raised in the 2000 private offering ofSeries B convertible preferred stock and in part by the asset loansecured in the second quarter of 2002.

A summary of the Company’s contractual cash obligations atDecember 31, 2005 is as follows:
| **Contractual Obligations**    | ** ** | **Total** | ** ** | **Less than  1 Year** | ** ** | **1-3 Years** | ** ** | **3-5  Years** | ** ** | **Greater  Than 5  Years** | ** ** |
|-------------------------------------|------------|-----------|------------|---------------------------------|------------|--------------------|------------|----------------|------------|---------------------------------|------------|
| Notes payable                       |       | $         | 1,700,000  |                            | $          | —             |       | $              | 1,700,000  |                            | $          |   |   | — |   |
| Convertible  notes payable          |       | 3,500,000 |       | —                          |       | 3,500,000          |       |           |       | —                          |       |
| Note  payable-other                 |       | 779,483   |       | 260,697                         |       | 168,612            |       | 20,385         |       | 329,789                         |       |
| Operating leases                    |       | 418,312   |       | 418,312                         |       |               |       | —         |       | —                          |       |
| Capital leases  including interest  |       | 565,468   |       | 293,224                         |       | 272,244            |       |           |       | —                          |       |
| Total  contractual cash obligations |       | $         | 6,963,263  |                            | $          | 972,233            |       | $              | 5,640,856  |                            | $          | 20,385 |   | $ | 329,789 |   |
|                                     |            |           |            |                                 |            |                    |            |                |            |                                 |            |  |  |  |  |  |

 

**Overview of FinancialCondition**

As shown in the accompanying financial statements, the Company reporteda net loss of approximately ($11,000) in 2005, ($673,000) in 2004, and($1,777,000) in the year ended December 31, 2003. During the past threeyears, the Company’s working capital requirements were met by additionalborrowings from a major shareholder, the issuance of secured and subordinatedconvertible notes and the issuance of common and preferred stock toshareowners.

Net cash provided by operations was $360,000 in 2005. Thepositive operating cash flow for 2005 and the positive operating cash flow of$632,000 in 2004 resulted from the sharply higher level of sales, whichresulted in lower operating losses than in prior years, and availability ofcustomer milestone payments on certain long term contracts. Operating cash flowin 2005 was lower than in the prior year due to, in part, the need to fundincreases in accounts receivable resulting from the higher sales levels and to lowgross margins at its new MRC Optics subsidiary during the first half of 2005.Net cash used in operations was ($283,000) in 2003. In 2003, $3,200,000 ofsecured and convertible notes were issued to both replace bank debt and for usein the Company’s acquisition program. In June of 2003, demand was made bya lender to pay approximately $1,700,000 in settlement of bank debts that werein technical default due to a violation of certain financial covenants. TheCompany issued a Secured Note, payable to an affiliate of a major shareholderand used the proceeds to satisfy the demand for payment.

In April 2004, the Company issued a $1,000,000 SubordinatedConvertible Promissory Note to a major shareholder. In July 2004 theCompany raised approximately $1,173,000, net, via a private equity offering.Proceeds from this note and the private equity placement were used in thefurtherance of the Company’s merger and acquisition program.

In October of 2003, the Company issued a $1,500,000 SubordinatedConvertible Promissory Note to a major shareholder. Proceeds from this notewere used in the furtherance of the Company’s merger and acquisition program.

In December 2002, the Company received $1,000,000 in proceeds fromthe issuance of a Subordinated Convertible Promissory Note to a related partyof a major shareholder. The Company did so anticipating continued distressedmarket conditions during 2003 and it used the proceeds from the note to meetits working capital needs in 2003.

The Company has made progress in transforming itself into a portfolioof businesses serving the Photonics industry. The Company assesses merger andacquisition opportunities from time to time, and seeks financing from time totime in the private equity and public equity financial markets. The Company’sfirst acquisition was completed in November 2003 and the necessary capitalwas raised in-part via a $1,500,000 subordinated convertible note.Additional financing was obtained in 2004 via placement of a $1,000,000convertible note proceeds of approximately $1,173,000 from a private placementof units consisting of the Company’s common stock and warrants. These fundswere earmarked for acquisitions and capital expenditures, and were partiallyused to complete its second acquisition in 2004.

Where possible, the Company will continue to increase sales, and reduceexpenses and cash requirements to improve future operating results and cashflows. Management expects that cash flow from operations and use of availablecash reserves will provide adequate liquidity for the Company’s operations in2006.

17

----

No assurances can be given that the Company will be able to identifyand acquire appropriate targets for acquisition or merger, or to raise thecapital required for any such acquisition. Additional capital from financingswould be needed if it were to make further acquisitions.

**Item 7A.**                                               **Quantitative and Qualitative Disclosures AboutMarket Risk**

The Company believes that it has limited exposure to changes ininterest rates from investments in certain money market accounts. The Companydoes not utilize derivative instruments or other market risk sensitiveinstruments to manage exposure to interest rate changes. The Company believesthat a hypothetical 100 basis point adverse move in interest rates along theentire interest rate yield curve would not materially affect the fair value ofthe Company’s interest sensitive money market accounts at December 31,2005.

**Item 8.**                                                        **Financial Statements and Supplementary Data**

The financial statements and supplementary financial informationrequired to be filed under this Item are presented commencing on page F-1of the Annual Report on Form 10-K, and are incorporated herein byreference.

**Item 9.**                                                        **Changes In and Disagreements With Accountants onAccounting and Financial Disclosure**

None

**Item 9A.**                                               **Controls and Procedures**

**Background to Mattersrelated to Controls and Procedures Resulting in Filing of 10-K/A**

In the Company’s Form 10-Q filed on May 15, 2006, the Company reportedthat its internal controls for monitoring the use and reporting of charges onthe Company’s debit card were not adequate, and that it was taking steps toremedy that inadequacy, including limiting use of that card.  The Company stated that it did not believethat this internal control issue had any material impact on the Company’sfinancial statements based upon what had been uncovered.

On June 26, 2006, the Company filed Form 8-K which provided additionalinformation and an update on the situation, including some of the itemsdiscussed below.

On May 16, 2006, William Miraglia stepped down as the Company’s chieffinancial officer, preceding the appointment of William Foote as new chieffinancial officer, but remained employed as controller of the Company in anon-officer capacity.  From that time,Mr. Miraglia no longer had access to the use of the Company’s debit card, whichhad previously been under his direct control. Meanwhile, the Audit Committee of the Company’s Board of Directorsfollowed the discovery with respect to internal control inadequacies byconducting an internal investigation via an independent forensic accountingspecialist.  As a result, the Companydiscovered more widespread use by William Miraglia of its debit card forunauthorized and personal charges, several instances of unauthorized paymentsby check for non-business personal expenses, and other unauthorizedtransactions.  Mr. Miraglia was suspendedwith pay and barred from access to the Company’s facilities and records whilethe investigation proceeded.

The internal investigation was completed and a final report waspresented by the independent forensic accounting specialist to the auditcommittee on July 26, 2006. The investigation discovered that over a period ofapproximately six years, from the second quarter of 2000 through the secondquarter of 2006, Mr. Miraglia had engaged in unauthorized and personaltransactions totaling $860,000.  Thisincluded unauthorized charges on the Company’s debit card of approximately$711,000.

In addition, the investigation by the audit committee revealedinadequate internal controls with respect to the Company’s handling ofdisbursements by check.  It discoveredthat Mr. Miraglia made payments totaling $94,500, by check, to the IRS withrespect to a personal tax levy against him over a period of approximately twoyears (third quarter 2004 through second quarter 2006), in addition to, otherunapproved payments and misappropriation of funds totaling approximately$36,000.  As a result of the foregoingdiscoveries, Mr. Miraglia was terminated for cause from his employment with theCompany on June 14, 2006.

The investigation concluded that Mr. Miraglia acted alone and there wasno evidence implicating any other employees in these or any other unauthorizedand personal transactions.  The resultsof this investigation have been reviewed with our Company auditors

It was also discovered that Mr. Miraglia had created a controlenvironment that contributed to the failure of Company employees charged withcertain financial and accounting duties to exercise appropriate judgment,skepticism and objectivity in detecting and preventing these unauthorizedpersonal transactions by Mr. Miraglia.

18

----

The Company has filed a claim to recover a portion of these lossesunder its employee dishonesty insurance policy, to the extent permitted as aresult of policy limits on time and amounts of coverage.  This claim has been settled and the companyhas recovered $300,000 from our insurance carrier, which is the policylimit.  In addition, Mr. Miraglia hassigned an agreement to make restitution to the Company.  To date, he has repaid $5,000.  In light of a number of factors, the Companydoes not believe that any significant further recoveries from Mr. Miraglia arelikely in the foreseeable future.  TheCompany is considering pursuing other remedies.

**Disclosure controls andprocedures**

The Company carried out an evaluation, with the participation of theCompany’s management, including the Company’s Chief Executive Officer and thecurrent Chief Financial Officer, of the effectiveness of the Company’sdisclosure controls and procedures pursuant to Securities Exchange ActRule 13a-15, as of the end of the period covered by this Annual Report onForm 10-K/A.  Disclosure controls andprocedures are designed to ensure that the information required to be disclosedby us in the reports we file or submit under the Exchange Act is recorded,processed, summarized and reported on a timely basis and that such informationis accumulated and reported to management, including our CEO and CFO, asappropriate.

At the time of the filing our Annual Report on Form 10-K (OriginalFiling for the year ended December 31, 2005, our Chief Executive Officer andformer Chief Financial Officer concluded that our disclosure controls andprocedures were effective as of December 31, 2005.  Subsequent to that evaluation, our ChiefExecutive Officer and current CFO concluded that our disclosure controls werenot effective in ensuring that information required to be disclosed in thereports that the Company files or submits under the Securities Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the SEC’s rules and forms, as of December 31, 2005, because of theinternal control inadequacies discussed below. Based upon the substantial work performed during the period after thedate of the Original Filing and through the investigation process , managementhas concluded that the Company’s consolidated financial statements for theperiods covered by and included in this Annual Report on Form 10-K/A are fairlystated in all material respects.

**Changes in internalcontrols over financial reporting**

In light of the foregoing discoveries resulting from the investigationand from management’s review of its internal control procedures,, the AuditCommittee directed the Company to take a number of steps to strengthen itsinternal controls, including (a) recall and cancellation of the corporate debitcard and (b) implementation of a policy requiring two authorized signatures onall checks in amounts of $5,000 or more. These changes have been implemented. The Company has extended this policy to all wire transfers initiatedfrom its bank.  In addition, a jointmeeting with the accounting staff, the Chief Executive Officer and the newChief Financial Officer was conducted to review internal controls andprocedures, to promote a control environment that emphasizes appropriatejudgment, skepticism and objectivity and to reinforce each employee’sresponsibility to report unusual or suspicious financial transactions to anindependent officer or member of the Audit Committee.

Other initiatives to further strengthen internal controls are currentlybeing assessed and implemented by the Company. These include but are not limited to: (i) establishing a written ethicspolicy to cover all employees which supplements the existing policy that coverssenior financial executives and members of the Board of Directors, (ii)improving internal procedures for reporting suspected ethics violations,(iii)  extending the requirement for thewritten approval of business expenses to corporate officers’ expense reportsand, (iv) identification and documentation of all critical internal controlswithin an Internal Control Policies and Procedures Manual.

Except as stated above, there were no other changes in our internalcontrol over financial reporting that occurred during our last fiscal year towhich this Annual Report on Form 10-K/A relates that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

**Item 9B**                                                  **Other Information**

None.

19

----

**PART III**

**Item 10.**                                                 **Directors and Executive Officers of the Registrant**

**Directors of theRegistrant**

The following table sets forth the name and age of each director of theCompany, the period during which each such person has served as a director andthe positions and business experience of each such person:
|                           | ** ** | ** ** | ** ** | **Positions; Business**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|---------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Name and Age**          | ** ** | **Since**  | ** ** | **Experience**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| John C. Rich,  68         |       | 2000       |       | Chairman of the  Board of Directors (September 2004 to Present)  Director (2000 to August 2004)  Vice President/General Manager (1999-2002) Power Electronics Division,  C&D  technologies  President (1990-1999), Raytheon/GM Hughes Optical Systems  Vice President (1983-1989), Perkin Elmer Microlithography, Electro-Optics,  and  Systems  Colonel, Commander, Air Force Avionics Laboratory and Air Force Weapons  Laboratory                                                                                                                                                                                                                       |
| Daniel Lehrfeld,  62      |       | 1999       |       | Director

President and  Chief Executive Officer (2000-present),  President and Chief Operating Officer (1999-2000),  Vice President/General Manager (1995-1999)  Raytheon/GM Hughes Electro-Optics Center,  President (1989-1991)  New England Research Center, (subsidiary)  Deputy General Manager (1989-1995) &  Director, Business Development, International Business,  Operations, Cryogenic Products  Magnavox Electronic Systems E. Coast Div.,  Deputy Sector Director & Program Director  Philips Laboratories Briarcliff  North American Philips subs. Philips Electronics NV,  Group Leader/Project Leader  Grumman Aerospace Corporation |
| Luke P. LaValle, Jr. |       | 2006       |       | Director                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 63                        |       |       |       | President and  CEO, American Capital Management Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|                           |       |       |       | Past senior  investment officer, United States Trust Company of NY                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|                           |       |       |       | Lt. Colonel, US  Army Reserve (Ret.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| Thomas H.  Lenagh,        |       | 1998       |       | Director — (September 2004 to Present)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 80                        |       |       |       | Chairman of the  Board of Directors (May 2000 — August 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                      |       |       |       | Management  Consultant (1990 - Present)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|                      |       |       |       | Past Chairman  and CEO, Systems Planning Corporation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|                      |       |       |       | Financial Vice  President, the Aspen Institute                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|                      |       |       |       | Treasurer and  Chief Investment Officer, The Ford Foundation Captain, US Navy Reserve

(ret.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| Jan M. Winston            |       | 2000       |       | Director                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 69                        |       |       |       | Principal  (1997-Present) Winston Consulting,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|                           |       |       |       | Division  Director/General Manager (1981-1997) IBM Corporation. Executive positions  held in Development, Finance and Marketing.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

 

The directors hold office for staggered terms of three years.

20

----

 

**Executive Officers of theRegistrant**

The following table sets forth the name and age of each executiveofficer of the Company, the period during which each such person has served asan executive officer and the positions with the Company held by each suchperson:
| **Name and Age**         | ** ** | **Since** | ** ** | **Position With the Company**                          |
|--------------------------|------------|-----------|------------|--------------------------------------------------------|
|                     |       |      |       |                                                   |
| Daniel Lehrfeld,  62     |       | 1999      |       | President and Chief Executive Officer                  |
|                     |       |      |       |                                                   |
| William S.  Miraglia, 56 |       | 1999      |       | Vice President, Chief Financial Officer and  Secretary |
|                     |       |      |       |                                                   |
| Devaunshi  Sampat, 53    |       | 1999      |       | Vice President — Marketing Communication          |

 

Daniel Lehrfeld has served as Chief Executive Officer and Presidentsince May 2000. He joined the Company in 1999 as President and ChiefOperating Officer. Prior to joining the Company, Mr. Lehrfeld held theposition of Vice President and General Manager of Electro-Optic Systems, adivision, successively,of the Raytheon, GM/Hughes Electronics and Magnavox Electronic SystemsCorporations. He has also held executive positions with Philips LaboratoriesBriarcliff and Grumman Aerospace Corporation. Mr. Lehrfeld holds B.S. andM.S. degrees from Columbia University School of Engineering and Applied Scienceand an M.B.A. degree from the Columbia Graduate School of Business.

William S. Miraglia joined the Company as Secretary and Chief FinancialOfficer in June 1999.  Previously, heheld the position of Vice President of Finance for a division of UNC, Inc., aNew York Stock Exchange aviation company. Prior to his last position, Mr. Miraglia has held management positionsin the aerospace industry and in public accounting.  He holds a B.B. A. from Pace University  and an M.B.A. from Long Island University.

Devaunshi Sampat joined the Company in 1998. In 1999 she was appointedVice President of Marketing and Sales. In 2003 she also assumed the title ofVice President for Marketing Communications for PPGI. Prior to joining theCompany, Ms. Sampat held sales management positions within the Photonicsindustry with Princeton Instruments and Oriel Instruments. Ms. Sampatholds a B.S. in Medical Technology from the University of Bridgeport.

Each of the executive officers has been elected by the Board ofDirectors to serve as an officer of the Company until the next election ofofficers, as provided by the Company’s by-laws.

**Committees of the Boardof Directors**

Composition of the Board of Directors*.*In October of 2005, the Boardagreed unanimously to discontinue the Executive Committee, for reasons of thesmall size of the Board and the frequent number of Board meetings customarilyheld. At the same time the Board agreed to make each outside director a memberof each Committee.

Since the adoption of the Sarbanes-Oxley Act in July 2002, therehas been a growing public and regulatory focus on the independence ofdirectors. Requirements relating to independence are imposed by theSarbanes-Oxley Act with respect to members of the Audit Committee. The Board ofDirectors has determined that the members of the Audit Committee satisfy allsuch definitions of independence.

Audit Committee*.*Thomas Lenagh, Chairman. The AuditCommittee is empowered by the Board of Directors to, among other things, serveas an independent and objective party to monitor the Company’s financialreporting process, internal control system and disclosure control system,review and appraise the audit efforts of the Company’s independent accountants,assume direct responsibility for the appointment, compensation, retention andoversight of the work of the outside auditors and for the resolution ofdisputes between the outside auditors and the Company’s management regardingfinancial reporting issues, and provide an open avenue of communication amongthe independent accountants, financial and senior management, and the Company’sBoard of Directors.

Audit Committee Financial Expert*.*The Board of Directors of the Companyhas determined that Mr. John Rich is an “audit committee financial expert”,as such term is defined by the SEC. Mr. Rich, as well as Mr. ThomasLenagh, Mr. Luke P. LaValle and Mr. Jan Winston, have been determinedto be “independent” within the meaning of SEC regulations.

Compensation Committee. Mr. Jan Winston,Chairman. The Compensation Committee reviews, approves and makesrecommendations to the Board of Directors on matters regarding the compensationof the executives of the Company.

21

----

Nominating Committee. Mr. Frank Wiedeman throughAugust 1, 2005, Chairman, Mr. John Rich, Chairman (acting). TheNominating Committee makes recommendations to the Board of Directors for theselection of individuals to be nominated to the Board of Directors.

Executive Committee. Discontinued during 2005.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) of the Securities Exchange Act of 1934 requiresthe Company’s directors and officers, and persons who own more than 10% of aregistered class of the Company’s equity securities, to file initialreports of ownership and reports of changes in ownership with the Securitiesand Exchange Commission. These persons are required by the Securities andExchange Commission to furnish the Company with copies of all Section 16(a) reportsthat they file. Based solely on the Company’s review of these reports andwritten representations furnished to the Company, the Company believes that in2005 each of the reporting persons complied with these filing requirements.

**Code of Ethics**

The Company has adopted a Code of Ethics that applies to the Company’sprincipal executive officer, principal financial officer, principal accountingofficer or controller (or persons performing similar functions). A copy of suchCode of Ethics has been filed as Exhibit 14.1 to this Annual Report onForm 10-K.

**Item 11.**                                                 **Executive Compensation**

**Summary of Cash andCertain Other Compensation**

The following table sets forth, for the years ended December 31,2005, 2004 and 2003, the cash compensation paid by the Company and itsSubsidiaries, with respect to the Company’s Chief Executive Officer and otherofficer, whose total annual salary and bonus exceeded $100,000, for servicesrendered in all capacities as an executive officer during such period:

**Summary Compensation Table**
|                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Securities** | ** ** |
|------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|
| ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Underlying** | ** ** |
| ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Stock**      | ** ** |
| **Name and Principal Position** | ** ** | **Year**   | ** ** | **Salary** | ** ** | **Bonus**  | ** ** | **Options**    | ** ** |
| Daniel Lehrfeld,                               |       | 2005       |       | $          | 183,000    |       | N/A        |           | 0          |   |
| President and                                  |       | 2004       |       | $          | 183,000    |       | N/A        |           | 200,000    |   |
| Chief Executive Officer                        |       | 2003       |       | $          | 156,000    |       | N/A        |           | 85,000     |   |
| Devaunshi  Sampat,                             |       | 2005       |       | $          | 165,000    |       | N/A        |           | 20,000     |   |
| Vice President,                                |       | 2004       |       | $          | 171,000    |       | N/A        |           | 20,000     |   |
| Marketing Comm.                                |       | 2003       |       | $          | 105,000    |       | N/A        |           | 50,000     |   |
| William Miraglia                               |       | 2005       |       | $          | 126,000    |       | N/A        |           | 15,000     |   |
| Vice President,                                |       | 2004       |       | $          | 126,000    |       | N/A        |           | 25,000     |   |
| Chief Financial Officer and  Secretary         |       | 2003       |       | $          | 101,000    |       | N/A        |           | 40,000     |   |

 

The Company is party to an employment agreement with Mr. DanLehrfeld, President and CEO, that provides for a minimum annual salary duringits term, and severance benefits under certain conditions that include a changeof control of the Company.

The aggregate minimum commitment under this agreement is as follows:

| Year Ending      | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| **December 31,** | ** ** | ** ** | ** ** |
| 2006                  |       | $185,000   |       |
| 2007                  |       | $185,000   |       |
| 2008                  |       | $185,000   |       |
| 2009                  |       | $185,000   |       |

 

Should Mr. Lehrfeld be terminated without cause during thiscontract period, he would be entitled to one year’s salary payable in one lumpsum within 30 days of termination.

22

----

There is an SEC requirement to report officer received perquisites orother personal benefits in excess of the lesser of $50,000 or 10% of suchindividual’s reported salary and bonus. During fiscal years 2005, 2004 and2003, respectively, no officer received any such perquisites or other personalbenefits, nor were any granted.

**Compensation of Directors**

Fees for non-employee directors were $500 during fiscal year 2005 andfiscal year 2004 for each board meeting attended, and $250 during 2005 and 2004for each conference call meeting in which they participated. The board agreedto defer payment of fees to its directors after October, 2005 in the interestof conserving cash. The total deferral amounted to $5,500 that is expected tobe paid in 2006. Each non-employee director received 11,000 stock options,exercisable at $1.03, in 2005 and 20,000 stock options, exercisable at $.50 in2004.

**Compensation CommitteeInterlocks and Insider Participation**

The following directors of the Company served as members of theCompensation Committee of the Company’s Board of Directors during 2005:  Mr. Frank Wiedeman, throughAugust 1, 2005, Mr. Jan Winston, Mr. Luke LaValle andMr. John Rich. None of these individuals are officers or employees of theCompany. Officer’s compensation is guided by overall job performance and themarket salaries for those positions for companies of the same relative size andwithin industries similar to the Company’s industry, as well as relativity toother salaries within the Company.

**Option Exercises andHoldings**

The following table provides information concerning options exercisedduring 2005 and the value of unexercised options held by each of the executiveofficers named in the Summary Compensation Table at December 31, 2005.

**Option Grants in LastFiscal Year**

Shown below is information on grants of stock options pursuant to the2000 Equity Compensation plan during the Fiscal year ended December 31,2005 to the officers named below:
|                  | ** ** | **Individual Grants**                                                   | ** ** | **Alternative  to Grant  Date Value  (a)**                                      | ** ** |
|------------------|------------|------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|
| **Name**         | ** ** | **Number of   Securities   Underlying Options  Granted** | ** ** | **% of Total   Options  Granted to  Employees  in Fiscal  Year** | ** ** | **Expiration  or Base  Price  ($/Sh)** | ** ** | **Expiration  Date** | ** ** | **Grant Date   Payment  Value ($)** | ** ** |
| Dan Lehrfeld     |       | 0                                                                            |       | 0                                                                                         | %          |   |   |   |   | $ | 0 |   |
| Devaunshi Sampat |       | 20,000                                                                       |       | 14.3                                                                                      | %          | $ | 1.03 |   | Jan 2015 |   | $ | 20,600 |   |
| William Miraglia |       | 15,000                                                                       |       | 10.8                                                                                      | %          | $ | 1.03 |   | Jan 2015 |   | $ | 15,450 |   |

----

(a)                                  Based on agrant date present value of $1.03, derived using the Black-Scholes optionpricing model with the following assumptions: Volatility of 210.54%, Risk free rate of return of 5.20%, Dividend Yieldof 0% and a 10 year option life.

**Aggregated OptionExercises in Last fiscal Year and Fiscal Year end Option Values**
|                  | ** ** | **Shares  Acquired  on  Exercise** | ** ** | **Value**    | ** ** | **Number of  Securities Underlying  Unexercised Options  at December 31, 2005  (# of shares)** | ** ** | **Value of  In-the-Money Options at  December 31, 2005 ($)(1)** | ** ** |
|------------------|------------|------------------------------------|------------|--------------|------------|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Name**         | ** ** | **(# shares)**                | ** ** | **Realized** | ** ** | **Exercisable**                                                                                     | ** ** | **Unexercisable**                                                    | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Daniel Lehrfeld  |       | 0                                  |       | 0            |       | 731,550                                                                                             |       | 73,450                                                               |       | 363,275 |   | 36,725 |   |
| Devaunshi Sampat |       | 0                                  |       | 0            |       | 159,580                                                                                             |       | 41,420                                                               |       | 119,165 |   | 20,710 |   |
| William Miraglia |       | 0                                  |       | 0            |       | 119,280                                                                                             |       | 34,720                                                               |       | 81,890 |   | 17,360 |   |

----

(1)                                  Basedon $1.50 per share, the closing price of the Company’s Common Stock, asreported by the OTC Bulletin Board, on December 31, 2005

No stock appreciationrights were granted during the fiscal year ended December 31, 2005.

23

----

**Item 12.**                                                 **Security Ownership of Certain Beneficial Ownersand Management**

The following table presents certain information with respect to thesecurity ownership of the directors and named executive officers of the Companyand the security ownership of each individual or entity known by the Company tobe the beneficial owner of more than 5% of the Company’s Common Stockoutstanding (7,282,898 shares) as of March 23, 2006. Percentages thatinclude ownership of options or convertible securities are calculated assumingexercise or conversion by each individual or entity of the options, (including “out-of-the-moneyoptions”), or convertible securities owned by each individual or entityseparately without considering the dilutive effect of option exercises and securityconversions by any other individual or entity. The Company has been advisedthat all individuals, or entities, listed have the sole power to vote anddispose of the number of shares set opposite their names in the table. Unlessotherwise indicated, the address of each beneficial owner is c/o PhotonicProducts Group, Inc., 181 Legrand Avenue, Northvale, New Jersey 07674.
| Name and Address of Beneficial Owner | ** ** | **Number of shares** | ** ** | **Percent of  Common Stock** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------|------------|----------------------------------------|------------|
| Clarex, Ltd. &  Welland Ltd.                         |       | 9,971,914                      | (1)        | 67.8                                   | %          |
| Scotia House                                                  |       |                           |       |                                   |       |
| 404 East Bay Street                                           |       |                           |       |                                   |       |
| Nassau, Bahamas                                               |       |                           |       |                                   |       |
| The estate of Warren  Ruderman                                |       | 1,172,000                      |       | 16.1                                   | %          |
| 45 Duane Lane                                                 |       |                           |       |                                   |       |
| Demarest, NJ 07627                                            |       |                           |       |                                   |       |
| Daniel Lehrfeld                                               |       | 896,350                        | (2)        | 11.1                                   | %          |
| Thomas Lenagh                                                 |       | 209,540                        | (3)        | 2.8                                    | %          |
| The estate of Frank Wiedeman                                  |       | 168,400                        | (4)        | 2.3                                    | %          |
| John Rich                                                     |       | 63,840                         | (5)        | 0.9                                    | %          |
| Jan Winston                                                   |       | 53,440                         | (6)        | 0.7                                    | %          |
| William Miraglia                                              |       | 129,720                        | (7)        | 1.8                                    | %          |
| Devaunshi Sampat                                              |       | 171,180                        | (8)        | 2.3                                    | %          |
| Directors and Executive  Officers as a group (7 persons)      |       | 1,692,470                      | (9)        | 19.5                                   | %          |

----

(1)                                  Including900,000 shares issuable within 60 days on conversion of convertible preferredstock, 3,500,000 shares subject to convertible promissory notes at a conversionof $1.00, and 3,025,000 warrants exercisable as follows: 2,625,000 at $1.35,200,000 at $1.08 and 200,000 at $.425.

(2)                                  Including731,550 shares subject to options exercisable within 60 days and 48,000 sharesissuable within 60 days on conversion of convertible preferred stock

(3)                                  Including122,640 shares subject to options exercisable within 60 days.

(4)                                  Including90,000 shares subject to options exercisable or convertible within 60 days.

(5)                                  Including12,000 shares issuable within 60 days on conversion of convertible preferredstock and 47,640 shares subject to options exercisable within 60 days.

(6)                                  Including4,000 shares issuable within 60 days on conversion of convertible preferredstock and 47,640 shares subject to options exercisable within 60 days.

(7)                                  Including7,200 shares issuable within 60 days on conversion of convertible preferredstock and 119,280 shares subject to options exercisable within 60 days.

(8)                                  Including8,000 shares issuable within 60 days on conversion of convertible preferredstock and 159,850 shares subject to options exercisable within 60 days.

(9)                                  Including79,200 shares issuable within 60 days on conversion of convertible preferredstock and 1,318,330 shares subject to options exercisable within 60 days.

**Equity Compensation PlanInformation**

The following table gives information about the Company’s Common Stockthat may be issued upon the exercise of options, warrants and rights underthe Company’s Key Employee Compensation Plan and the Company’s 2000 EquityCompensation Program, as of December 31, 2005. These plans were theCompany’s only equity compensation plans in existence as of December 31,2005.

24

----

 
| Plan Category                                      | ** ** | **(a)  Number of Securities to  be Issued Upon Exercise  of Outstanding Options,  Warrants and Rights** | ** ** | **(b)  Weighted-Average  Exercise Price of  Outstanding Options,  Warrants and Rights** | ** ** | **(c)  Number of Securities  Remaining Available for  Future Issuance Under  Equity Compensation  Plans (Excluding  Securities Reflected in  Column (a)** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity Compensation Plans  Approved by Shareholders     |       | 2,577,860                                                                                                                                                 |       | $                                                                                                                | 1.18       |                                                                                                                                                                                                             | 3,422,140  |   |
| Equity Compensation  Plans Not Approved by Shareholders |       | —                                                                                                                                                    |       | —                                                                                                           |       | —                                                                                                                                                                                                           |       |
|                                                         |       |                                                                                                                                                      |       |                                                                                                             |       |                                                                                                                                                                                                             |       |
| Total                                                   |       | 2,577,860                                                                                                                                                 |       | $                                                                                                                | 1.18       |                                                                                                                                                                                                             | 3,422,140  |   |

 

**Item 13.**                                                 **Certain Relationships and Related Transactions**

During the years ended December 31, 2005, 2004 and 2003,approximately 1%, 3%, and 3%, respectively of the Company’s net product saleswere through a foreign agent, in which the estate of Warren Ruderman, aprincipal shareholder has an investment. Terms of sales to this foreign agentwere substantially the same as to unrelated foreign agents.

In December 2005 the Company initiated a financing arrangementwith Clarex, Ltd. a major shareholder and debt holder in the amount of$700,000, to fund acquisition of capital assets needed to absorb growthopportunities. The funds were received in February 2006.

During 2005 two notes due to Clarex, Ltd., a shareowner and debt holderhad their maturity dates extended from January 31, 2006 toDecember 31, 2008.

**Item 14.**                                                 **Principal Accounting Fees and Services**

In accordance with the requirements of the Sarbanes-Oxley Act of 2002 and the AuditCommittee’s charter, all audit and audit-related work and all non-auditwork performed by the Company’s independent accountants is approved in advanceby the Audit Committee, including the proposed fees for such work. The AuditCommittee is informed of each service actually rendered.

Audit Fees*.*Audit fees billed or expected to be billed to the Companyby the Company’s principal accountantfor the audit of the financial statements included in the Company’s AnnualReports on Form 10-K, and reviews of the financial statements included inthe Company’s Quarterly Reports on Form 10-Q, for the years endedDecember 31, 2005 and 2004 totaled approximately $110,000 and $98,500, respectively.

Audit-Related Fees*.*The Company was billed $0 and $0 by the Company’s principal accountantfor the fiscal years ended December 31, 2005 and 2004, respectively, forassurance and related services that are reasonably related to the performanceof the audit or review of the Company’s financial statements and are notreported under the caption *Audit Fees*above.

Tax Fees*.*The Company was billed an aggregate of $10,000 and $8,500by the Company’s principal accountantfor the fiscal years ended December 31, 2005 and 2004, respectively, fortax services, principally the preparation of income tax returns.

All Other Fees*.*In 2004 the Company incurred approximately $125,000 infees in connection with activities related to the MRC acquisition duediligence, audit of MRC, 8-K filing, S-8 registration and S-1 registration forresale of common stock issued as a result of the private equity offering.

Applicable law and regulations provide an exemption that permitscertain services to be provided by the Company’s outside auditors even if theyare not pre-approved. The Company has not relied on this exemption at any timesince the Sarbanes-Oxley Act was enacted. All other fees have been pre-approvedby the Audit Committee of the Board of Directors.

#### **PART IV**

**Item 15.**                                                 **Exhibits and Financial Statement Schedules**

**(a) (1)     FinancialStatements.**

Reference is made to the Index to Financial Statements and FinancialStatement Schedule on Page F-1.

**(a) (2)     FinancialStatement Schedule.**

25

----

Reference is made to the Index to Financial Statements and FinancialStatement Schedule on Page F-1.

All other schedules have been omitted because the required informationis not present or is not present in amounts sufficient to require submission ofthe schedule, or because the information required is included in the FinancialStatements or Notes thereto.

**(a) (3)     Exhibits.**
| Exhibit No. | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                            |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              |       | Stock Purchase Agreement between Photonic Products  Group, Inc., MRC Precision Metal Optics and Frank E. Montone  (incorporated by reference to Exhibit 2.1 to the Company’s Current  Report on Form 8-K filed with the Securities and Exchange Commission on  October 25, 2004)** |
| 3.1              |       | Restated Certificate of Incorporation of Photonics  Products Group, Inc. (incorporated by reference to Exhibit 3.1 to  the Company’s Registration Statement on Form S-1 filed with the  Securities and Exchange Commission on August 25, 2004)**                                             |
| 3.2              |       | By-Laws of Photonic Products Group, Inc.  (incorporated by reference to Exhibit 3.2 to the Company’s Registration  Statement on Form S-1 filed with the Securities and Exchange Commission  on August 25, 2004)**                                                                            |
| 4.1              |       | Specimen Common Stock Certificate (incorporated by  reference to Exhibit 4.1 to the Company’s Registration Statement on  Form S-1 filed with the Securities and Exchange Commission on  August 25, 2004)**                                                                                        |
| 4.2              |       | Form of Warrants issued pursuant to  June 2004 Private Placement (incorporated by reference to  Exhibit 4.2 to the Company’s Registration Statement on Form S-1  filed with the Securities and Exchange Commission on August 25, 2004)**                                                |
| 4.3              |       | Form of Placement Agent Warrants issued  pursuant to June 2004 Private Placement (incorporated by reference to  Exhibit 4.3 to the Company’s Registration Statement on Form S-1  filed with the Securities and Exchange Commission on August 25, 2004)**                                |
| 4.4              |       | Promissory Note Dated June 30, 2003 held by  Clarex, Ltd. (incorporated by reference to Exhibit 4.4 to the Company’s  Registration Statement on Form S-1 filed with the Securities and  Exchange Commission on August 25, 2004)**                                                            |
| 4.5              |       | Subordinated Convertible Promissory Note dated  April 1, 2004 held by Clarex, Ltd. (incorporated by reference to  Exhibit 4.5 to the Company’s Registration Statement on Form S-1  filed with the Securities and Exchange Commission on August 25, 2004)**                                   |
| 4.6              |       | Subordinated Convertible Promissory Note dated  October 31, 2003 held by Clarex, Ltd. (incorporated by reference to  Exhibit 4.6 to the Company’s Registration Statement on Form S-1  filed with the Securities and Exchange Commission on August 25, 2004)**                                |
| 4.7              |       | Subordinated Convertible Promissory Note dated  December 31, 2002 held by Welland, Ltd. (incorporated by reference to  Exhibit 4.7 to the Company’s Registration Statement on Form S-1  filed with the Securities and Exchange Commission on August 25, 2004)**                              |
| 4.8              |       | Warrant dated March 31, 2004 issued to Clarex,  Ltd. (incorporated by reference to Exhibit 10.2 to the Company’s Registration  Statement on Form S-1 filed with the Securities and Exchange Commission  on August 25, 2004)**                                                                |
| 4.9              |       | Warrant dated May 19, 2004 issued to Clarex,  Ltd. (incorporated by reference to Exhibit 10.3 to the Company’s  Registration Statement on Form S-1 filed with the Securities and  Exchange Commission on August 25, 2004)**                                                                  |
| 10.1             |       | 2000 Equity Compensation Program (incorporated by  reference to Exhibit 10.1 to the Company’s Registration Statement on  Form S-1 filed with the Securities and Exchange Commission on August 25,  2004)**                                                                                        |
| 10.2             |       | Daniel Lehrfeld Employment Contract, dated  October 20, 1999 (incorporated by reference to Exhibit 10.4 to the  Company’s Registration Statement on Form S-1 filed with the Securities  and Exchange Commission on August 25, 2004)**                                                        |
| 14.1             |       | Code of Ethics**                                                                                                                                                                                                                                                                                                      |
| 21.1             |       | List of Subsidiaries**                                                                                                                                                                                                                                                                                                |
| 23.1             |       | Consent of Holtz Rubenstein Reminick LLP Independent  Auditors                                                                                                                                                                                                                                                        |
| 31.1             |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                              |
| 31.2             |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                              |
| 32.1             |       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                         |
| 32.2             |       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                         |

----

**             Previouslyfiled with Original Filing

26

----

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.
|        | PHOTONIC PRODUCTS GROUP, INC. |
|--------|------------------------------------|
|   |                               |   |
|   |                               |   |
|   | By:                                | /s/ Daniel Lehrfeld |
|   |                               | Daniel Lehrfeld |
|   |                               | Chief Executive Officer |
|   |                               |   |
|   | Dated: September 29, 2006          |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.
| Signature            | ** ** | **Title**               | ** ** | **Date**            |
|----------------------|------------|-------------------------|------------|---------------------|
|                 |       |                    |       |                |
|                 |       |                    |       |                |
| /s/ John Rich        |       | Chairman of the Board   |       | September 29,  2006 |
| John Rich            |       | of Directors            |       |                |
|                 |       |                    |       |                |
|                 |       |                    |       |                |
| /s/ Daniel Lehrfeld  |       | President, Chief        |       | September 29,  2006 |
| Daniel Lehrfeld      |       | Executive Officer       |       |                |
|                 |       | and Director            |       |                |
|                 |       |                    |       |                |
|                 |       |                    |       |                |
| /s/ Luke P. Lavalle  |       | Director                |       | September 29,  2006 |
| Luke P. Lavalle      |       |                    |       |                |
|                 |       |                    |       |                |
|                 |       |                    |       |                |
| /s/ Thomas Lenagh    |       | Director                |       | September 29,  2006 |
| Thomas Lenagh        |       |                    |       |                |
|                 |       |                    |       |                |
|                 |       |                    |       |                |
| /s/ Jan Winston      |       | Director                |       | September 29,  2006 |
| Jan Winston          |       |                    |       |                |
|                 |       |                    |       |                |
|                 |       |                    |       |                |
| /s/ William J. Foote |       | Chief Financial Officer |       | September 29,  2006 |
| William J. Foote     |       | and Secretary           |       |                |

 

27

----

 

**PHOTONICPRODUCTS GROUP , INC. AND SUBSIDIARIES**

**REPORTON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS**

**THREEYEARS ENDED DECEMBER 31, 2005**

**CONTENTS**

 
| Report of Independent  Registered Public Accounting Firm                                          |   |   |   |
|---------------------------------------------------------------------------------------------------|--------|--------|--------|
|                                                                                              |   |   |   |
| Consolidated  balance sheets as of December 31, 2005 and 2004                                     |   |   |   |
|                                                                                              |   |   |   |
| Consolidated  statements of operations for the three years ended December 31, 2005                |   |   |   |
|                                                                                              |   |   |   |
| Consolidated statements of shareholders’ equity for  the three years ended December 31, 2005 |   |   |   |
|                                                                                              |   |   |   |
| Consolidated statements of cash flows for the three  years ended December 31, 2005                |   |   |   |
|                                                                                              |   |   |   |
| Notes to consolidated financial statements                                                        |   |   |   |
|                                                                                              |   |   |   |
| Report of Independent Registered Certified Public  Accountants on supplemental schedule           |   |   |   |
|                                                                                              |   |   |   |
| Schedule II — Valuation and Qualifying Accounts                                              |   |   |   |

 

F-1

----

 

Report of Independent Registered Public AccountingFirm

Board of Directors andShareholdersPhotonic Products Group, Inc. and SubsidiariesNorthvale, New Jersey

We have audited the accompanying consolidated balance sheets ofPhotonic Products Group, Inc. and Subsidiaries as of December 31, 2005 and2004, and the related consolidated statements of operations, shareholders’equity and cash flows for the three years ended December 31, 2005.  These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States of America).  Those standards require that we plan andperform the audits to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated financial positionof Photonic Products Group, Inc. and Subsidiaries as of December 31, 2005 and2004 and the results of their operations and their cash flows for the threeyears ended December 31, 2005, in conformity with accounting principlesgenerally accepted in the United States of America.

HOLTZ RUBENSTEIN REMINICKLLP

Melville, New YorkFebruary 24, 2006, except for Note 2, as to which the date is September 29,2006.

 

F-2

----

 

 

**PHOTONICPRODUCTS GROUP, INC AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **Assets**                                                                                                                                   |       |                  |       |   |   |
| **Current assets:**                                                                                                                          |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                    |       | $                     | 1,156,563  |   | $ | 1,393,507 |   |
| Accounts receivable (after allowance for doubtful  accounts of $15,000 in 2005 and $88,000 in 2004)                                          |       | 2,265,934             |       | 1,447,994 |   |
| Inventories                                                                                                                                  |       | 2,423,879             |       | 2,479,074 |   |
| Other current assets                                                                                                                         |       | 153,723               |       | 87,540 |   |
| **Total Current Assets**                                                                                                                     |       | 6,000,099             |       | 5,408,115 |   |
| **Plant and equipment:**                                                                                                                     |       |                  |       |   |   |
| Plant and equipment at cost                                                                                                                  |       | 12,472,480            |       | 12,018,865 |   |
| Less: Accumulated depreciation and amortization                                                                                              |       | (8,143,592            | )          | (7,255,427 | ) |
| Total plant and equipment                                                                                                                    |       | 4,328,888             |       | 4,763,438 |   |
| **Precious  Metals**                                                                                                                         |       | 130,732               |       | 309,565 |   |
| **Goodwill**                                                                                                                                 |       | 1,869,646             |       | 1,727,971 |   |
| **Intangible  Assets, net of accumulated amortization of $112,602 and $32,425, respectively**                                                |       | 987,272               |       | 1,067,449 |   |
| **Other  Assets**                                                                                                                            |       | 164,384               |       | 250,096 |   |
| **Total Assets**                                                                                                                             |       | $                     | 13,481,021 |   | $ | 13,526,634 |   |
|                                                                                                                                         |       |                  |       |   |   |
| **Liabilities and Shareholders’  Equity**                                                                                               |       |                  |       |   |   |
| **Current Liabilities:**                                                                                                                     |       |                  |       |   |   |
|                                                                                                                                         |       |                  |       |   |   |
| Current portion of notes payable -Other                                                                                                      |       | $                     | 260,697    |   | $ | 226,146 |   |
| Accounts payable and accrued liabilities                                                                                                     |       | 2,426,692             |       | 2,189,744 |   |
| Customer advances                                                                                                                            |       | 652,264               |       | 385,714 |   |
| Current obligations under capital leases                                                                                                     |       | 248,550               |       | 300,813 |   |
| **Total Current Liabilities**                                                                                                                |       | 3,588,203             |       | 3,102,417 |   |
|                                                                                                                                         |       |                  |       |   |   |
| **Related  Party Convertible and Secured Notes Payable**                                                                                     |       | 5,200,000             |       | 5,200,000 |   |
| **Notes  Payable — Other, net of current portion**                                                                                      |       | 518,786               |       | 794,379 |   |
| **Capital  Lease Obligations, Net of Current Obligation**                                                                                    |       | 244,625               |       | 464,709 |   |
| **Total Liabilities**                                                                                                                        |       | 9,551,614             |       | 9,561,505 |   |
|                                                                                                                                         |       |                  |       |   |   |
| **Commitments**                                                                                                                              |       | —                |       | — |   |
|                                                                                                                                         |       |                  |       |   |   |
| **Shareholders’ equity:**                                                                                                               |       |                  |       |   |   |
| 10% convertible preferred stock, Series A no par  value; 500 shares issued and outstanding                                                   |       | 500,000               |       | 500,000 |   |
|                                                                                                                                         |       |                  |       |   |   |
| 10% convertible preferred stock, Series B no par  value; 2,100 shares issued and outstanding                             |       | 2,100,000             |       | 2,100,000 |   |
|                                                                                                                                         |       |                  |       |   |   |
| Common stock:  $.01 par value; 60,000,000 authorized shares 7,287,398 issued at December 31,  2005 and 7,186,794 issued at December 31, 2004 |       | 72,862                |       | 71,868 |   |
| Capital in excess of par value                                                                                                               |       | 11,145,243            |       | 11,036,561 |   |
| Accumulated deficit                                                                                                                          |       | (9,873,748            | )          | (9,728,350 | ) |
|                                                                                                                                         |       | 3,944,357             |       | 3,980,079 |   |
|                                                                                                                                         |       |                  |       |   |   |
| Less — Common  stock in treasury, at cost (4,600 shares)                                                                                |       | (14,950               | )          | (14,950 | ) |
| **Total Shareholders’ Equity**                                                                                                          |       | 3,929,407             |       | 3,965,129 |   |
| **Total  Liabilities & Shareholders’ Equity**                                                                                       |       | $                     | 13,481,021 |   | $ | 13,526,634 |   |

 

See Notes toConsolidated Financial Statements

 

F-3

----

 

 

**PHOTONICPRODUCTS GROUP, INC AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                                    |       | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                          |       |                                        |       |   |   |   |   |
| **REVENUES**                                                                  | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                     |       | $                                           | 13,785,057 |   | $ | 9,221,857 |   | $ | 5,388,184 |   |
|                                                                          |       |                                        |       |   |   |   |   |
| **COST AND EXPENSES**                                                         | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of goods sold                                                            |       | 9,956,125                                   |       | 6,618,506 |   | 3,917,123 |   |
| Selling, general and administrative expense                                   |       | 3,450,224                                   |       | 2,916,056 |   | 2,389,547 |   |
| Internal research and development expense                                     |       | 20,279                                      |       | 97,685 |   | 153,843 |   |
| Special charges                                                               |       | —                                      |       | — |   | 582,000 |   |
|                                                                          |       | 13,426,628                                  |       | 9,632,247 |   | 7,042,513 |   |
|                                                                          |       |                                        |       |   |   |   |   |
| **OPERATING  PROFIT (LOSS)**                                                  |       | 358,429                                     |       | (410,390 | ) | (1,654,329 | ) |
|                                                                          |       |                                        |       |   |   |   |   |
| **OTHER INCOME (EXPENSE)**                                                    | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                                          |       |                                        |       |   |   |   |   |
| Interest expense                                                              |       | (504,509                                    | )          | (358,940 | ) | (266,165 | ) |
| Gain on sale of precious metals                                               |       | 135,931                                     |       | — |   |   |   |
| Other                                                                         |       | (1,249                                      | )          | 49 |   | 8,950 |   |
|                                                                          |       | (369,827                                    | )          | (358,891 | ) | (257,215 | ) |
|                                                                          |       |                                        |       |   |   |   |   |
| **LOSS  BEFORE INCOME TAX BENEFIT (PROVISION) AND PREFERRED STOCK DIVIDENDS** |       | (11,398                                     | )          | (769,281 | ) | (1,911,544 | ) |
|                                                                          |       |                                        |       |   |   |   |   |
| **INCOME  TAX BENEFIT (PROVISION)**                                           |       |                                        |       | 96,344 |   | 134,235 |   |
|                                                                          |       |                                        |       |   |   |   |   |
| **NET  (LOSS)**                                                               |       | (11,398                                     | )          | (672,937 | ) | (1,777,309 | ) |
|                                                                          |       |                                        |       |   |   |   |   |
| **PREFERRED  STOCK DIVIDENDS**                                                |       | (134,000                                    | )          | (164,820 | ) | (53,600 | ) |
|                                                                          |       |                                        |       |   |   |   |   |
| **NET  LOSS APPLICABLE TO COMMMON SHAREHOLDERS**                              |       | $                                           | (145,398   | ) | $ | (837,757 | ) | $ | (1,830,909 | ) |
|                                                                          |       |                                        |       |   |   |   |   |
| **NET  LOSS PER COMMON SHARE-BASIC**                                          |       | $                                           | (0.02      | ) | $ | (0.15 | ) | $ | (0.35 | ) |
|                                                                          |       |                                        |       |   |   |   |   |
| **NET  LOSS PER COMMON SHARE-DILUTED**                                        |       | $                                           | (0.02      | ) | $ | (0.15 | ) | $ | (0.35 | ) |
|                                                                          |       |                                        |       |   |   |   |   |
| **WEIGHTED AVERAGE SHARES  OUTSTANDING BASIC AND DILUTED**                    |       | 7,218,244                                   |       | 5,710,354 |   | 5,287,849 |   |

 

See notes toconsolidated financial statements

 

F-4

----

 

**PHOTONICPRODUCTS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENT OFSHAREHOLDERS’ EQUITY**

 
| ** **                      | ** ** | ** **            | ** ** | ** **          | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | **Capital in** | ** ** | ** **    | ** ** | ** **             | ** **     | **Total**      | ** **     |
|---------------------------------|------------|-----------------------|------------|---------------------|------------|--------------------------|------------|--------------------------|------------|---------------------|------------|---------------|------------|------------------------|----------------|----------------|----------------|
| ** **                      | ** ** | **Common Stock** | ** ** | **(Series A)** | ** ** | **(Series B)**      | ** ** | **excess of**       | ** ** | ** **          | ** ** | **Treasury**  | ** ** | **Shareholders’** | ** **     |
| ** **                      | ** ** | **Shares**            | ** ** | **Amount**          | ** ** | **Shares**               | ** ** | **Amount**               | ** ** | **Shares**          | ** ** | **Amount**    | ** ** | **par value**     | ** **     | **Deficit**    | ** **     | **Stock** | ** ** | **Equity** | ** ** |
| **Balance, December 31, 2002**  | ** ** | **5,283,640**         | ** ** | **$**               | **52,836** | ** **               | **500**    | ** **               | **$**      | **500,000**         | ** ** | **2,100**     | ** ** | **$**                  | **2,100,000**  | ** **     | **$**          | **9,471,676** | ** ** | **$** | **(7,059,684** | **)** | **$** | **(14,950** | **)** | **$** | **5,048,878** | ** ** |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| 401K contribution               |       | 28,263                |       | 283                 |       | —                   |       | —                   |       | —              |       | —        |       | 11,587                 |           | —         |           | — |   | 11,870 |   |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Dividend on Preferred Stock     |       | 134,000               |       | 1,340               |       | —                   |       | —                   |       | —              |       | —        |       | 52,260                 |           | (53,600        | )              | — |   | — |   |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Net loss for the year           |       | —                |       | —              |       | —                   |       | —                   |       | —              |       | —        |       | —                 |           | (1,777,309     | )              | — |   | (1,777,309 | ) |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| **Balance, December 31, 2003**  | ** ** | **5,445,903**         | ** ** | **54,459**          | ** ** | **500**                  | ** ** | **500,000**              | ** ** | **2,100**           | ** ** | **2,100,000** | ** ** | **9,535,523**          | ** **     | **(8,890,593** | **)**          | **(14,950** | **)** | **3,283,439** | ** ** |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| 401K contribution               |       | 25,891                |       | 259                 |       |                     |       |                     |       |                |       |          |       | 12,686                 |           |           |           |   |   | 12,945 |   |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Dividend on Preferred Stock     |       | 134,000               |       | 1,340               |       |                     |       |                     |       |                |       |          |       | 163,480                |           | (164,820       | )              |   |   | 0 |   |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Common stock private placement  |       | 1,581,000             |       | 15,810              |       |                     |       |                     |       |                |       |          |       | 1,157,174              |           |           |           |   |   | 1,172,984 |   |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Warrants issued to lender       |       |                  |       |                |       |                     |       |                     |       |                |       |          |       | 167,698                |           |           |           |   |   | 167,698 |   |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Net loss for the period         |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           | (672,937       | )              |   |   | (672,937 | ) |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| **Balance, December 31, 2004**  | ** ** | **7,186,794**         | ** ** | **71,868**          | ** ** | **500**                  | ** ** | **500,000**              | ** ** | **2,100**           | ** ** | **2,100,000** | ** ** | **$**                  | **11,036,561** | ** **     | **(9,728,350** | **)** | **(14,950** | **)** | **3,964,129** | ** ** |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Dividend on preferred stock     |       | 39,200                |       | 380                 |       |                     |       |                     |       |                |       |          |       | 38,808                 |           | (134,000       | )              |   |   | (94,812 | ) |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Accelerated stock options       |       |                  |       |                |       |                     |       |                     |       |                |       |          |       | 21,398                 |           |           |           |   |   | 21,398 |   |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Common stock private placement  |       |                  |       |                |       |                     |       |                     |       |                |       |          |       | (19,690                | )              |           |           |   |   | (19,690 | ) |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| 401K contribution               |       | 61,404                |       | 614                 |       |                     |       |                     |       |                |       |          |       | 68,166                 |           |           |           |   |   | 68,780 |   |
|                            |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           |           |           |   |   |   |   |
| Net loss for the period         |       |                  |       |                |       |                     |       |                     |       |                |       |          |       |                   |           | (11,398        | )              |   |   | (11,398 | ) |
| ** **                      | ** ** | ** **            | ** ** | ** **          | ** ** | ** **               | ** ** | ** **               | ** ** | ** **          | ** ** | ** **    | ** ** | ** **             | ** **     | ** **     | ** **     | ** ** | ** ** | ** ** | ** ** |
| **Balance,  December 31, 2005** | ** ** | **7,287,398**         | ** ** | **$**               | **72,862** | ** **               | **500**    | ** **               | **$**      | **500,000**         | ** ** | **2,100**     | ** ** | **$**                  | **2,100,000**  | ** **     | **$**          | **11,145,243** | ** ** | **$** | **(9,873,748** | **)** | **$** | **(14,950** | **)** | **$** | **3,928,407** | ** ** |

 

See notes to consolidated financial statements

 

F-5

----

 

 

**PHOTONICPRODUCTS GROUP, INC AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                   | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                   | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities:**                                   | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net (loss)                                                                   |       | $                                           | (11,398    | ) | $ | (672,937 | ) | $ | (1,777,309 | ) |
|                                                                         |       |                                        |       |   |   |   |   |
| **Adjustments  to reconcile net loss to cash used in operating activities:** | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Depreciation and amortization                                                |       | 1,025,074                                   |       | 713,080 |   | 566,764 |   |
| Gain on sale of precious metal                                               |       | (135,931                                    | )          | — |   | — |   |
| 401K common stock contribution                                               |       | 68,780                                      |       | 12,945 |   | 11,870 |   |
| Stock option acceleration expense                                            |       | 21,398                                      |       | — |   | — |   |
| Change in allowance for doubtful accounts                                    |       | 73,000                                      |       |   |   |   |   |
| Inventory reserve                                                            |       | (254,526                                    | )          | 372,106 |   | 475,000 |   |
| **Changes in assets and liabilities:**                                       | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accounts receivable                                                          |       | (744,939                                    | )          | (10,756 | ) | 244,670 |   |
| Inventories                                                                  |       | 309,720                                     |       | (486,535 | ) | (319,892 | ) |
| Unbilled contract costs                                                      |       | —                                      |       | 191,767 |   | 149,774 |   |
| Other current assets                                                         |       | (66,184                                     | )          | (10,599 | ) | 7,656 |   |
| Other assets                                                                 |       | 28,981                                      |       | 28,133 |   | 102,097 |   |
| Accounts payable and accrued liabilities                                     |       | 81,740                                      |       | 599,590 |   | 255,987 |   |
| Customer advances                                                            |       | 110,546                                     |       | (105,291 | ) | — |   |
| Total adjustments                                                            |       | 371,659                                     |       | 1, 304,440 |   | 1,493,926 |   |
| **Net cash provided by (used in) operating  activities**                     |       | 360,261                                     |       | 631,503 |   | (283,383 | ) |
|                                                                         |       |                                        |       |   |   |   |   |
| **Cash  flows from investing activities:**                                   | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital expenditures                                                         |       | (453,615                                    | )          | (1,013,569 | ) | (101,045 | ) |
| Proceeds from sale of precious metals                                        |       | 314,764                                     |       |   |   |   |   |
| Cash used for business acquisition, net                                      |       | —                                      |       | (732,000 | ) | (183,780 | ) |
|                                                                         |       |                                        |       |   |   |   |   |
| **Net cash used in investing activities**                                    |       | (138,851                                    | )          | (1,745,569 | ) | (284,825 | ) |
|                                                                         |       |                                        |       |   |   |   |   |
| **Cash  flows from financing activities:**                                   | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net (uses) proceeds from issuance of common stock                            |       | (19,492                                     | )          | 1,172,984 |   |   |   |
| Proceeds from secured notes payable                                          |       |                                        |       |   |   | 1,700,000 |   |
| Proceeds from senior convertible debentures                                  |       |                                        |       | 1,000,000 |   | 1,500,000 |   |
| Principal payments of notes payable                                          |       | (166,515                                    | )          | (847,907 | ) | (727,425 | ) |
| Principal payments of bank debt                                              |       |                                        |       |   |   | (1,678,623 | ) |
| Principal payments of capital lease obligations                              |       | (272,347                                    | )          | (99,664 | ) | (98,658 | ) |
|                                                                         |       |                                        |       |   |   |   |   |
| **Net cash (used in) provided by financing  activities**                     |       | (458,354                                    | )          | 1,225,413 |   | 695,294 |   |
|                                                                         |       |                                        |       |   |   |   |   |
| **Net  (decrease) increase in cash and cash equivalents**                    |       | (236,944                                    | )          | 111,347 |   | 127,086 |   |
|                                                                         |       |                                        |       |   |   |   |   |
| **Cash  and cash equivalents at beginning of the year**                      |       | 1,393,507                                   |       | 1,282,160 |   | 1,155,074 |   |
|                                                                         |       |                                        |       |   |   |   |   |
| **Cash and cash equivalents at  end of the year**                            |       | $                                           | 1,156,563  |   | $ | 1,393,507 |   | $ | 1,282,160 |   |

 

 

F-6

----

 

**PHOTONICPRODUCTS GROUP, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**THREE YEARS ENDED DECEMBER 31, 2005**

**1.             Nature of Business and Summary of SignificantAccounting Policies**

## b.                                      Natureof Operations

PHOTONIC PRODUCTS GROUP, Inc. and Subsidiaries (the “Company”, formerlyknown as Inrad, Inc.) is a manufacturer of crystals, crystal devices,electro-optic and optical components, and sophisticated laser subsystems andinstruments.  The Company’s principalcustomers include commercial instrumentation companies and OEM lasermanufacturers, research laboratories, government agencies, and defensecontractors.  The Company’s products aresold domestically using its own sales staff, and in major overseas markets,principally Europe and the Far East, using independent sales agents.

## c.                                       Principlesof consolidation

The accompanying consolidated financial statements include the accountsof the Company and its wholly-owned Subsidiaries.  Upon consolidation, all intercompany accountsand transactions are eliminated.

## d.                                      Allowancefor doubtful accounts

Management must make estimates of the collectability of accountsreceivable.  Management specificallyanalyzes accounts receivable and analyzes historical bad debts, customerconcentrations, customer credit-worthiness, current economic trends and changesin customer payment terms when evaluating the adequacy of the allowance fordoubtful accounts.

## e.                                       Depreciationand amortization

Depreciation is computed using the straight-line method over theestimated useful lives of the related assets. Amortization of leasehold improvements is computed using thestraight-line method over the estimated useful lives of the related assets, 3-7years, or the remaining term of the lease, 10 years, whichever is shorter.  Maintenance and repairs of property andequipment are charged to operations and major improvements arecapitalized.  Upon retirement, sale orother disposition of property and equipment, the cost and accumulateddepreciation are eliminated from the accounts and gain or loss is included inoperations.

## f.                                         Inventories

Inventories, including certain precious metals consumed in themanufacturing process, are stated at the lower of cost (first-in, first-outmethod) or market.

## g.                                      Incometaxes

Deferred tax assets and liabilities are determined based on differencesbetween financial reporting and tax bases of assets and liabilities, and aremeasured using the enacted tax rates and laws that will be in effect when thedifferences are expected to reverse.

## h.                                      Impairmentof long-lived assets

In accordance with SFAS No. 144, long-lived assets, such as property,plant and equipment and purchased intangibles subject to amortization, arereviewed for impairment whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and usedis measured by a comparison of the carrying amount of an asset to estimateundiscounted future cash flows expected to be generated by the asset.  If the carrying amount of an asset exceedsits estimated future cash flows, an impairment charge is recognized by theamount by which the carrying amount of the asset exceeds the fair value of theassets.  Assets to be disposed of wouldbe separately presented in the balance sheet and reported at the lower of thecarrying amount or fair value less costs to sell and are no longerdepreciated.  The assets and liabilitiesof a disposed group classified as held for sale would be presented separatelyin the appropriate asset and liability sections of the balance sheet.

Goodwill and intangible assets not subject to amortization are testedin December of each year for impairment and are tested for impairment morefrequently if events and circumstances indicate that the assets might be impaired.  An impairment loss is recognized to theextent that the carrying amount exceeds the asset’s fair value.

F-7

----

 

## i.                                          AcquiredGoodwill and Intangible assets

Acquired intangible assets and goodwill consists of goodwillapproximating $1,870,000 and other intangible assets, principally ofnon-contractual customer relationships that approximated $987,000.  The intangible assets are amortized on astraight-line basis over the assets’ estimated useful life up to 14 years.  The Company periodically evaluates whetherevents or circumstances have occurred indicating the carrying amount ofintangible assets may not be recoverable. When factors indicate that intangible assets should be evaluated forpossible impairment, the Company uses an estimate of the associated undiscountedfuture cash flows compared to the related carrying amount of assets todetermine if an impairment loss should be recognized.

The gross carrying amount of intangible assets as of December 31, 2005and as of December 31, 2004 was $1,100,000. Accumulated amortization related to intangible assets approximates$113,000 as of December 31, 2005 and $32,000 as of December 31, 2004.  Amortization expense was approximately$81,000 for the year ended December 31, 2005 and $32,000 for the year endedDecember 31, 2004.  Aggregateamortization for the five succeeding years ending December 31, 2006 throughDecember 31, 2011 approximates $405,000, accumulating at the rate of $81,000per year. The weighted average lives of the Company’s intangible assets is 14 years.

The changes in the carrying amounts of goodwill, by acquisition, forthe year ended December 31, 2004, are as follows:
| ** **   | ** ** | **Balance  Jan. 1, 2005** | ** ** | **Goodwill Additions** | ** ** | **Purchase Price  Adjustment** | ** ** | **Balance  Dec. 31, 2005** | ** ** |
|--------------|------------|-------------------------------------|------------|-----------------------------|------------|-------------------------------------|------------|--------------------------------------|------------|
| Laser Optics |       | $                                   | 311,572    |                        |       |                                |       |                                 | $          | 311,572 |   |
|         |       |                                |       |                        |       |                                |       |                                 |       |
| MRC          |       | $                                   | 1,416,399  |                        |       |                                | $          | 141,675                              |       | $ | 1,558,074 |   |
|         |       |                                |       |                        |       |                                |       |                                 |       |
| Total        |       | $                                   | 1,727,971  |                        |       |                                | $          | 141,675                              |       | $ | 1,869,646 |   |

 

The following schedule details the Company’s intangible asset balanceby major asset class.
| ** **            | ** ** | **At December 31, 2005** | ** ** |
|-----------------------|------------|-----------------------------------------|------------|
| ** **            | ** ** | **Gross Carrying  Amount**         | ** ** | **Accumulated   Amortization** | ** ** | **Net Carrying   Amount** | ** ** |
|                  |       |                                    |       |   |   |   |   |
| Customer-related      |       | $                                       | 549,937    |   | $ | (56,301 | ) | $ | 493,636 |   |
| Completed  technology |       | 362,958                                 |       | (37,159 | ) | 325,799 |   |
| Trademarks            |       | 186,979                                 |       | (19,142 | ) | 167,837 |   |
|                  |       |                                    |       |   |   |   |   |
| Total                 |       | $                                       | 1,099,874  |   | $ | (112,602 | ) | $ | 987,272 |   |

 
| ** **            | ** ** | **At December 31, 2004** | ** ** |
|-----------------------|------------|-----------------------------------------|------------|
| ** **            | ** ** | **Gross Carrying  Amount**         | ** ** | **Accumulated   Amortization** | ** ** | **Net Carrying   Amount** | ** ** |
|                  |       |                                    |       |   |   |   |   |
| Customer-related      |       | $                                       | 549,937    |   | $ | (16,213 | ) | $ | 533,725 |   |
| Completed  technology |       | 362,958                                 |       | (10,700 | ) | 352,258 |   |
| Trademarks            |       | 186,979                                 |       | (5,512 | ) | 181,466 |   |
|                  |       |                                    |       |   |   |   |   |
| Total                 |       | $                                       | 1,099,874  |   | $ | (32,425 | ) | $ | 1,067,449 |   |

 

## j.                                          Stock-basedcompensation

The Company accounts for stock-based compensation arrangements inaccordance with the provisions of Accounting Principles Board (“APB”) OpinionNo. 25, Accounting for Stock Issued to Employees, and accounts for stock issuedfor services provided by other than employees in accordance with and complieswith the disclosure provisions of SFAS No. 123, Accounting for Stock-BasedCompensation.  Under APB No. 25,compensation expense is based on the difference, if any, on the date of thegrant, between the fair value of the Company’s stock and the exerciseprice.  A new measurement date forpurposes of determining compensation is established when there is a substantivechange to the terms of an underlying option.

(ii) The Company has elected the disclosure-only provisions ofStatement of Financial Accounting Standard No. 123, “Accounting for Stock-BasedCompensation” (“FASB 123”) in accounting for its employee stock options.  Accordingly, no compensation expense has beenrecognized.  Had the Company recordedcompensation expense for the stock options based on the fair

F-8

----

 

value at the grant date for awards, consistent withthe provisions of FASB 123, the Company’s net income (loss) and net income(loss) per share applicable to common shareholders would have changed to thefollowing pro forma amounts:
| ** **                                                                                                            | ** ** | **Years Ended**  | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                            | ** ** | **December 31,** | ** ** |
| ** **                                                                                                            | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Loss:                                                                                                             |       |                  |       |   |   |   |   |
| As reported                                                                                                           |       | $                     | (11,398    | ) | $ | (672,937 | ) | $ | (1,777,309 | ) |
| Add: tock-based employee Compensation included in  reported net income, net of related tax effects                    | S          | 21,398                |       | — |   | — |   |
| Less: Stock based employee compensation expense  determined under fair value based method, net of related tax effects |       | (140,630              | )          | (237,565 | ) | (76,555 | ) |
| Pro forma                                                                                                             |       | $                     | (130,630   | ) | $ | (910,502 | ) | $ | (1,853,864 | ) |
|                                                                                                                  |       |                  |       |   |   |   |   |
| Loss per share:                                                                                                       |       |                  |       |   |   |   |   |
| Basic:                                                                                                                |       |                  |       |   |   |   |   |
| As reported                                                                                                           |       | $                     | (.02       | ) | $ | (.15 | ) | $ | (.35 | ) |
| Pro forma                                                                                                             |       | $                     | (.02       | ) | $ | (.19 | ) | $ | (.36 | ) |
| Diluted:                                                                                                              |       |                  |       |   |   |   |   |
| As reported                                                                                                           |       | $                     | (.02       | ) | $ | (.15 | ) | $ | (.35 | ) |
| Pro forma                                                                                                             |       | $                     | (.02       | ) | $ | (.19 | ) | $ | (.36 | ) |

 

The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option-pricing model. The following range of weighted-average assumptions were used for grantsduring the years ended December 31, 2005, 2004 and 2003:
| ** **               | ** ** | **Years Ended**  | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **December 31,** | ** ** |
| ** **               | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                     |       |                  |       |   |   |   |   |
| Dividend yield           |       | 0.00                  | %          | 0.00 | % | 0.00 | % |
| Volatility               |       | 210.54                | %          | 166.32 | % | 127.16 | % |
| Risk-free  interest rate |       | 5.2                   | %          | 5.2 | % | 5.2 | % |
| Expected life            |       | 10 years         |       | 10 years |   | 10 years |   |

 

## k.                                       Revenuerecognition

The Company records revenue, other than on contractual type work, whena product is shipped.  Revenue oncontractual type work is accounted for using the percentage-of-completionmethod, whereby revenue and profits are recognized throughout the performanceof the contracts. Percentage-of-completion is determined by relating the actual cost ofwork performed to date to the estimated total cost for each contract.  Losses on contracts are recorded whenidentified.

## l.                                          Internalresearch and development costs

Internal research and development costs are charged to expense asincurred.

## m.                                    Preciousmetals

Precious metals not consumed in the manufacturing process are valued atcost, cost being determined on the first-in, first-out basis.

## n.                                      Useof estimates

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions 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 period.  Actual amounts coulddiffer from those estimates.

F-9

----

 

## o.                                      Advertisingcosts

Advertising costs are charged to operations when the advertising firsttakes place.  Included in selling,general and administrative expenses are advertising costs of $34,000, $28,000and $32,000 for the years ended December 31, 2005, 2004 and 2003.

## p.                                      Statementsof cash flows

For purposes of the consolidated statements of cash flows, the Companyconsiders all highly liquid debt instruments purchased with a maturity of threemonths or less to be cash equivalents.

Interest paid during the years ended December 31, 2005, 2004 and 2003was $183,000, $194,000 and $63,000, respectively.

Income taxes paid were $7,000 in 2005, $1,200 in 2004, $580 in 2003.

In 2005, non- cash transactions resulting from the exchange of debt forstock amounted to $59,200.

In 2005, non- cash transactions resulting from goodwill adjustmentsamounted to $141,675.

## q.                                      Concentrationof risk

The Company invests its excess cash in deposits and money marketaccounts with major financial institutions and in commercial paper of companieswith strong credit ratings.  Generally,the investments mature within ninety days, and therefore, are subject to littlerisk.  The Company has not experiencedlosses related to these investments.

The concentration of credit risk in the Company’s accounts receivableis mitigated by the Company’s credit evaluation process, reasonably shortcollection terms and the geographical dispersion of revenue.  The Company generally does not requirecollateral.

The Company utilizes many relatively uncommon materials and compoundsto manufacture its products.  Therefore,any failure by its suppliers to deliver materials of an adequate quality andquantity could have an adverse effect on the Company’s ability to meet thecommitments of its customers.

## r.                                         NetLoss per common share

The basic net loss per share is computed using weighted average numberof common shares outstanding for the applicable period.  The diluted loss per share is computed usingthe weighted average number of common shares plus common equivalent sharesoutstanding, except if the effect on the per share amounts, includingequivalents, would be anti-dilutive.  Theweighted average number of common shares plus common equivalent sharesoutstanding was 9,565,564.

## s.                                       Shippingand handling costs

The Company has included freight out as a component of selling, generaland administrative expenses that amounted to $32,000 in 2005, $31,000 in 2004and $27,000 in 2003.  When applicable theCompany bills its customers for freight costs.

## t.                                         Recentlyissued accounting pronouncements

In June 2005, the FASB issued SFAS No. 154, “Accounting Changes andError Corrections - a replacement of APB Opinion No. 20 and FASB Statement No.3, (“SFAS 154”).  SFAS 154 replaces APBOpinion No. 20, “Accounting Changes” (“APB 20”), and SFAS No. 3, “ReportingAccounting Changes in Interim Financial Statements”.  SFAS 154 requires retrospective applicationto prior periods’ financial statements of a voluntary change in accountingprinciple unless it is impracticable to determine either the period-specificeffects or the cumulative effects of the change.  APB 20 previously required that mostvoluntary changes in accounting principle be recognized by including in netincome in the period of the change the cumulative effect of changing to the newaccounting principle.  This standardgenerally will not apply with respect to the adoption of new accountingstandards, as new accounting standards usually include specific transitionprovisions, and will not override transition provisions contained in new orexisting accounting literature.  SFAS 154is effective for fiscal years beginning after December 15, 2005, and earlyadoption is permitted for accounting changes and error corrections made inyears beginning after the date that SFAS 154 was issued.  The Company does not expect that the adoptionof SFAS 154 on January 1, 2006 will have a significant effect on its financialcondition or results of operations.

F-10

----

 

On December 21, 2004, the Financial Accounting Standards Board (“FSAB”)issued FASB Staff Position No. FAS 109-1, “Application of FASB Statement No. 109,Accounting for Income Taxes, to the Tax Deduction on Qualified ProductionActivities Provided by the American Jobs Creation Act of 2004” (FSP No 109-1”),and FASB Staff Position No. FAS 109-2, “Accounting and Disclosure Guidance forthe Foreign Earnings Repatriation Provision within the American Jobs CreationAct of 2004” (“FSP No. 109-2”).  Thesestaff positions provide accounting guidance on how companies should account forthe effects of the American Jobs Creation Act of 2004 that was signed into lawon October 22, 2004.  FSP No. 109-1states that the tax deduction for domestic manufacturing activities from thislegislation should be accounted for as a “special deduction” and reduce taxexpense in the period(s) the amounts are deductible on the tax returns, not asan adjustment of recorded deferred tax assets and liabilities.  FSP No. 109-2 gives a company additional timeto evaluate the effects of the legislation on any plan for reinvestment orrepatriation of foreign earnings for purposes of applying FASB Statement No.109.  The Company has determined that itwill not repatriate any undistributed foreign earnings under the new taxlegislation and, therefore, the legislation as it relates to the undistributedforeign earnings will not have an effect on the Company’s consolidatedfinancial statements.

In December 2004, the FASB issued SFAS No. 123(R), “Share-BasedPayment.”  This statement replaces SFASNo. 123, “Accounting for Stock-Based Compensation” and supersedes APB No. 25. “Accountingfor Stock Issued to Employees.”  SFAS123(R) requires all stock-based compensation to be recognized as an expense inthe financial statements and that such cost be measured according to thegrant-date fair value of the stock options or other equity instruments.  SFAS 123(R) will be effective for the firstannual period beginning after June 15, 2005. Additionally, in March 2005, the Securities and Exchange Commissionstaff issued Staff Accounting Bulletin No. 107, “Share-Based Payment” (SAB No.107), which provides additional guidance on certain implementation issues withrespect to SFAS No. 123(R).  While theCompany currently provides the pro forma disclosures required by SFAS No. 148, “Accountingfor Stock-Based Compensation - Transition and Disclosure,” on a quarterly basis(see “Note 1 - Accounting for Stock-Based Compensation”), it is currentlyevaluating the impact this statement will have on its consolidated financialstatements.  Unrecognized stock-basedcompensation expense related to unvested options as of December 31, 2005 was$131,000.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs - anamendment of ARB No. 43, Chapter 4” (“SFAS No. 151”).  SFAS No. 151 requires all companies torecognize a current-period charge for abnormal amounts of idle facilityexpense, freight, handling costs and wasted materials.  This statement also requires that theallocation of fixed production overhead to the costs of conversion be based onthe normal capacity of the production facilities.  SFAS No. 151 will be effective for fiscalyears beginning after June 15, 2005.  TheCompany is currently evaluating the effect that this statement will have on itsconsolidated financial statements.

## u.                                      Comprehensiveincome (loss)

Comprehensive income (loss) refers to revenue, expenses, gains andlosses that under generally accepted accounting principles are included incomprehensive income but are excluded from net income as these amounts arerecorded directly as an adjustment to stockholders’ equity.  At December 31, 2005 and 2004, there were nosuch adjustments.

**2.             Impact of Unauthorized Personal Transactions byFormer CFO**

As discussed in the Explanatory Note to Form 10-K/A and in Item 9aControls and Procedures, the results of an investigation by our Audit Committeethrough an independent forensic accounting specialist revealed that over aperiod of approximately six years, from the second quarter of 2000 through thesecond quarter of 2006, the Company’s former Chief Financial Officer, WilliamMiraglia, had engaged in unauthorized and personal transactions totaling$860,000.  This included unauthorizedcharges on the Company’s debit card of approximately $711,000.  In addition, the investigation discoveredthat Mr. Miraglia made payments totaling $94,500, by check to the IRS withrespect to a personal tax levy against him over a period of approximately twoyears (third quarter 2004 through second quarter 2006), in addition to, otherunapproved payments and misappropriation of funds totaling approximately$36,000.  As a result of the foregoingdiscoveries, Mr. Miraglia was terminated for cause from his employment with theCompany on June 14, 2006.

F-11

----

 

A summary of unauthorized personal transactions which occurred fromapproximately the second quarter of 2000 through the second quarter of 2006,follows:
| ** **                                         | ** ** | **QUARTER ENDED** | ** ** | ** **       | ** ** |
|----------------------------------------------------|------------|------------------------|------------|------------------|------------|
| ** **                                         | ** ** | **March 31**      | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** | **TOTAL** | ** ** |
|                                               |       |                   |       |             |       |   |   |   |   |   |   |
| From the second  quarter 2000 to December 31, 2000 |       | $                      | n/a        |             | $          | 1,000 |   | $ | 24,000 |   | $ | 25,000 |   | $ | 50,000 |   |
| From January 1,  2001 to December 31, 2001         |       | 31,000                 |       | 50,000           |       | 17,000 |   | 15,000 |   | 113,000 |   |
| From January 1,  2002 to December 31, 2002         |       | 20,000                 |       | 21,000           |       | 8,000 |   | 16,000 |   | 66,000 |   |
| From January 1,  2003 to December 31, 2003         |       | 15,000                 |       | 32,000           |       | 54,000 |   | 29,000 |   | 130,000 |   |
| From January 1,  2004 to December 31, 2004         |       | 44,000                 |       | 43,000           |       | 67,000 |   | 81,000 |   | 235,000 |   |
| From January 1,  2005 to December 31, 2005         |       | 39,000                 |       | 62,000           |       | 52,000 |   | 55,000 |   | 209,000 |   |
| Total through December 31, 2005                    |       |                   |       |             |       |   |   |   |   | $ | 803,000 |   |
| From January 1,  2006 to June 30, 2006             |       | 47,000                 |       | 10,000           |       | n/a |   | n/a |   | 57,000 |   |
| Total Unauthorized Personal Transactions           |       |                   |       |             |       |   |   |   |   | $ | 860,000 |   |
|                                                    |            |                        |            |                  |            |  |  |  |  |  |  |  |  |  |  |  |

 

Mr. Miraglia recorded these transactions primarily through journalentries prepared and entered by himself into the Company’s accounts.  The transactions were reflected as Selling,General and Administrative expenses. Although the transactions were unauthorized and personal in nature,based upon a review of the accounting treatment of individual transactions, theCompany has concluded that all material charges have been reflected as part ofthe reported expenses, reported net income, earnings per share and cashflows  in the appropriate periods.

**3.         Inventories**

Inventories are comprised of the following:
| ** **                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                                          |       |                  |       |   |   |
| Raw materials                                                 |       | $                     | 616,000    |   | $ | 579,000 |   |
| Work in process,  including manufactured parts and components |       | 1,350,000             |       | 1,420,000 |   |
| Finished goods                                                |       | 458,000               |       | 480,000 |   |
|                                                          |       | $                     | 2,424,000  |   | $ | 2,479,000 |   |

 

**4.         Property and Equipment**

Property andequipment are comprised of the following:
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Office and  computer equipment                  |       | $                     | 1,067,000  |   | $ | 985,000 |   |
| Machinery and  equipment                        |       | 9,505,000             |       | 9,161,000 |   |
| Leasehold  improvements                         |       | 1,900,000             |       | 1,873,000 |   |
|                                            |       | 12,472,000            |       | 12,019,000 |   |
| Less accumulated  depreciation and amortization |       | 8,143,000             |       | 7,255,000 |   |
|                                            |       | $                     | 4,329,000  |   | $ | 4,764,000 |   |

 

**5.         Subordinated Convertible PromissoryNotes**

In April 2004, the Company received $1,000,000 in proceeds from theissuance of a Subordinated Convertible Promissory Note.  The Note is due in March 2007 and bearsan interest rate of 6%.  Interest accruesyearly and along with principal may be converted into Common Stock, (and/orsecurities convertible into common shares). As a result of the June 2004 private placement, the note is convertibleinto 1,000,000 Units consisting of 1,000,000 shares of Common Stock andWarrants to acquire 750,000 shares of Common Stock at a price of $1.35 pershare.  The Holder of the Note is a majorshareholder of the Company.

 

F-12

----

 

In 2003, the Company issued a Subordinated Convertible Promissory Notefor proceeds of $1,500,000.  The note wasamended in 2004 to clarify its conversion features.  The Holder of the Note is a major Shareholderand Debt Holder of the Company.  The notebears interest at the rate of 6% per annum and has a maturity date of December31, 2008.  The note was extended from itsoriginal maturity date of January 31, 2006. The note is convertible into common shares (and/or securitiesconvertible into common shares) of the Company. As a result of the June 2004 private placement, the note is convertibleinto 1,500,000 Units consisting of 1,500,000 shares of Common Stock andWarrants to acquire 1,125,000 shares of Common Stock at a price of $1.35 pershare.  The Holder of the Note is a majorshareholder of the Company.  The proceedsfrom the Note are intended for use in the Company’s acquisition program.

In June 2003, the Company received $1,700,000 from a major Shareholderand Debt Holder of the Company.  Theproceeds of the note were used to pay outstanding bank debt.  The note is secured by the assets of theCompany.  The note bears interest at therate of 6% per annum and is due December 2008.

In 2002, the Company issued a Subordinated Convertible Promissory Note forproceeds of $1,000,000.  The note wasamended in 2004 to clarify its conversion features.  The note bears interest at the rate of 6% perannum and has a maturity date of December 31, 2008.  The note was extended from its originalmaturity date of January 31, 2006.  Thenote is convertible into common shares (and/or securities convertible intocommon shares) of the Company.  As a result of the June 2004 private placement,the note is convertible into 1,000,000 Units consisting of 1,000,000 shares ofCommon Stock and Warrants to acquire 750,000 shares of Common Stock at a priceof $1.35 per share.  The Holder ofthe Note is a related party to a major Shareholder of the Company.

**6.           Notes Payable Other**

As part of the purchase price of MRC on October 19, 2004, a $175,000Note was issued to the sole shareholder of the company.  The note bears interest at the rate of 6% perannum and is payable annually   on theanniversary of the closing date.  On thesecond anniversary of the Closing Date, $50,000 of the Note amount shall be dueand payable.  The remaining portion ofthe Note along with any accrued unpaid interest shall be paid in full onOctober 19, 2009.  Three notes, totaling$295,725, were assumed from note holders of MRC.  The notes bear interest rates from 6.0% to10.5% and are payable from 2 to 4 years. During FY 2005 two of the notes totaling $199,525 were exchanged for twonotes totaling $125,000, 80,000 shares of common stock of the Company and60,000 warrants convertible into 60,000 shares of common stock at $1.35 pershare. A Note payable to the SBA was also assumed.  The Note in the amount of $390,497 bearsinterest at the rate of 4.0% and is due in 2032.

At the time of the purchase of Laser Optics, Inc., the Companyconverted certain liabilities to notes payable. Notes totaling $100,728 were issued to former officers of Laser Optics,Inc. for back pay and unreimbursed business expenses.  These notes are for a three year period andcarry an interest rate defined as the prime rate in the United States aspublished in the Wall Street Journal.  Anote in the amount of $86,777 was issued to the former landlord for backrent.  It is a 36-month note with aninterest rate of 2% per annum.  At thetime of the closing a former officer of Laser Optics, Inc. received a $15,000prepayment on his note.  All notebalances are payable monthly commencing January 2004.

Notes payableother consist of the following:

|                                                                                                                                                                                                                     | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                          | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Notes payable  other, payable in aggregate including interest at monthly installments of  $20,000 rates ranging from 2.0% to 10.5% expiring in April 2032, and a once  yearly payment including interest of $60,500 |       | $                     | 779,483    |   | $ | 1,020,525 |   |
| Less current portion                                                                                                                                                                                                |       | 260,697               |       | 226,146 |   |
| Long-term debt,  excluding current portion                                                                                                                                                                          |       | $                     | 518,786    |   | $ | 794,379 |   |

 

Notes payableother, mature as follows:

| 2006       |   | $       | 260,697 |   |
|------------|--------|---------|---------|--------|
| 2007       |   | 15,182  |    |
| 2008       |   | 15,916  |    |
| 2009       |   | 137,514 |    |
| 2010       |   | 9,998   |    |
| Thereafter |   | 340,176 |    |
|       |   | $       | 779,483 |   |

 

F-13

----

 

**7.         Accounts Payable and AccruedExpenses**

Accounts payable and accrued expenses are comprised of the following:

|                                               | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Trade accounts  payable and accrued purchases |       | $                     | 668,352    |   | $ | 837,830 |   |
| Accrued vacation                              |       | 335,153               |       | 347,357 |   |
| Accrued payroll                               |       | 217,653               |       | 197,639 |   |
| Accrued interest                              |       | 748,048               |       | 433,433 |   |
| Accrued  relocation costs                     |       | —                |       | 179,825 |   |
| Accrued bonus                                 |       | 53,990                |       | — |   |
| Accrued common  stock payable                 |       | 155,200               |       | — |   |
| Accrued 401K  common stock contribution       |       | 140,689               |       | 60,659 |   |
| Accrued expenses  — other                |       | 107,607               |       | 133,001 |   |
|                                          |       | $                     | 2,426,692  |   | $ | 2,189,744 |   |

 

**8.         Capital Lease Obligations**

Capital lease obligations consist of the following:

|                                                                                                                                                               | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Capital leases,  payable in aggregate monthly installments of $23,000, including interest at  rates ranging from 11.0% to 11.6% expiring through October 2008 |       | $                     | 493,175    |   | $ | 765,522 |   |
| Less current  portion                                                                                                                                         |       | 248,550               |       | 300,813 |   |
|                                                                                                                                                          |       |                  |       |   |   |
| Long-term debt,  excluding current portion                                                                                                                    |       | $                     | 244,625    |   | $ | 464,709 |   |

 

Maturities of capitalleases are as follows:

 

| Year Ending                         | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------|------------|
| **December 31,**                    | ** ** | ** ** | ** ** |
|                                |       |       |       |
| 2006                                |       | 293,224    |       |
| 2007                                |       | 223,100    |       |
| 2008                                |       | 49,144     |       |
| Total minimum payments              |       | 565,468    |       |
| Less amounts  representing interest |       | 72,293     |       |
|                                |       |       |       |
| Present value of  minimum payments  |       | $493,175   |       |

 

Capital lease obligations are collateralized by property and equipmentwith cost and related accumulated depreciation approximating $858,000 and$139,000 at December 31, 2005.

**9.         Income Taxes**

A reconciliation of the income tax provision (benefit) computed at thestatutory Federal income tax rate to the reported amount follows:

|                                                    | ** ** | **Year Ended**   | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **December 31,** | ** ** |
| ** **                                         | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Federal statutory rate                             |       | 34                    | %          | 34 | % | 34 | % |
| Tax provision (benefit) at Federal statutory rates |       | $                     | (3,876     | ) | $ | (228,797 | ) | $ | (604,255 | ) |
| Loss in excess  of available benefit               |       | 3,876                 |       | 228,797 |   | 604,255 |   |
| State taxes                                        |       | 0                     |       | (96,344 | ) | (134,235 | ) |
|                                               |       | $                     | 0          |   | $ | (96,344 | ) | $ | (134,235 | ) |

 

At December 31, 2005, the Company has Federal and State net operatingloss carry forwards for tax purposes of approximately $9,805,000 and$1,002,000, respectively. The tax loss carry forwards expire at various datesthrough 2025.

F-14

----

 

The State of New Jersey has enacted a program that allows new oremerging technology and biotechnology businesses to sell their unused NetOperating Loss (NOL) carryover to any corporation for at least 75% of the valueof the tax benefits. In 2004, the Company sold $1,550,800 of their NOL for$96,344.

Internal Revenue Code Section 382 places alimitation on the utilization of Federal net operating loss and other creditcarryforwards when an ownership change, as defined by the tax law, occurs.Generally, this occurs when a greater than 50 percentage point change inownership occurs. Accordingly, the actual utilization of the net operating lossand carryfowards for tax purposes may be limited annually to a percentage(approximately 6%) of the fair market value of the Company at the time of anysuch ownership change.

The benefit (provision) for income taxes consists of the following:

|            | ** ** | **Years Ended**  | ** ** |
|------------|------------|-----------------------|------------|
| ** ** | ** ** | **December 31,** | ** ** |
| ** ** | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
|       |       |                  |       |   |   |   |   |
| Current:   |       |                  |       |   |   |   |   |
| State      |       | $                     |       |   | $ | 96,344 |   | $ | 134,235 |   |
| Deferred:  |       |                  |       |   |   |   |   |
| Federal    |       | —                |       | — |   |   |   |
| State      |       | —                |       | — |   | — |   |
|       |       |                  |       |   |   |   |   |
| Total      |       | $                     | 0          |   | $ | 96,344 |   | $ | 134,235 |   |

 

Deferredtax assets (liabilities) comprise the following:

 

| December 31,          | ** ** | ** ** | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------|------------|------------|------------|------------|------------|------------|------------|
|                       |       |       |       |       |       |       |       |
| Inventory  reserves        |       | 283,000    |       | $          | (79,000    | )          | $          | 332,000 |   |
| Vacation  liabilities      |       | 127,000    |       | (2,000     | )          | 118,000    |       |
| Section 263A  adjustment   |       | 19,000     |       | 14,000     |       | 116,000    |       |
| Depreciation               |       | (83,000    | )          | 51,000     |       | 102,000    |       |
| Loss carry  forwards       |       | 3,424,000  |       | 2,993,000  |       | 2,992,000  |       |
| Gross deferred  tax assets |       | 3,936,000  |       | 2,977,000  |       | 3,660,000  |       |
| Valuation  allowance       |       | (3,936,000 | )          | (2,977,000 | )          | (3,660,000 | )          |
|                       |       |       |       |       |       |       |       |
|                       |       | $          | —     |       | $          | —     |       | $ | — |   |
|                            |            |            |            |            |            |            |            |  |  |  |

 

**10.          Related Party Transactions**

During the years ended December 31, 2005, 2004 and 2003, approximately1%, 3%, and 3%, respectively of the Company’s net product sales were through aforeign agent, in which Warren Ruderman, a principal shareholder has aninvestment. Terms of sales to this foreign agent were substantially the same asto unrelated foreign agents.

In December 2005 the Company initiated a financing arrangement with amajor shareholder and debt holder in the amount of $700,000 to fund acquisitionof capital assets needed to absorb growth opportunities. The funds werereceived in February 2006.

During 2005 two notes due to Clarex, LTD., a shareowner and debt holderhad their maturity dates extended from January 31, 2006 to December 31, 2008.

During 2004, Clarex, LTD., a shareowner and debt holder received a 6%Convertible Promissory Note for $1,000,000 due March 2007. In March 2004,Clarex, LTD received 200,000 warrants for offering the 2003 $1,700,000 securedpromissory note and an additional 200,000 warrants for extending the maturitydate of the Note to December 2008.

During 2003, Clarex, LTD. a shareowner and debt holder received a 6%Secured Promissory Note for $1,700,000 due December 2005, that was subsequentlyextended to December 31, 2008. In October 2003, Clarex, LTD received a$1,500,000, 6% Convertible Promissory Note due January 2006. that wassubsequently extended to December 31, 2008.

During 2002, Welland Ltd., a related party to Clarex, Ltd., received a6% Subordinated Convertible Promissory Note due January 31, 2006, that wassubsequently extended to December 31, 2008, resulting in proceeds to theCompany of $1,000,000.

F-15

----

 

**11.**                               **Commitments**

## a.                                       Leasecommitment

The Company occupies approximately 42,000 square feet of space locatedat 181 Legrand Avenue, Northvale, New Jersey pursuant to a net lease expiringon October 31, 2006. The Company has an option to renew the Northvale lease foran additional term of five years.

The Company’s MRC Optics subsidiary occupies approximately 25,000square feet of space located at 6405 Parkland Drive, Sarasota, FL pursuant to anet lease expiring on August 31, 2006. MRC Optics has negotiated preliminaryterms for a renewal of that lease, but does not currently have an option inplace to renew the lease.

Rental expense was approximately $525,000, $370,000 and $238,000 in2005, 2004 and 2003, respectively, and real estate taxes were $95,000, $64,000and $41,000 in 2005, 2004 and 2003, respectively.

Future minimum annual rentals are payable as follows:

 

| Year Ending      | ** ** | ** ** | ** ** |
|------------------|------------|------------|------------|
| **December 31,** | ** ** | ** ** | ** ** |
| 2006             |       | $418,000   |       |

 

## b.                                      Retirementplans

The Company maintains a 401(k) savings plan for all eligible employees(as defined in the plan). The 401(k) plan allows employees to contribute from1% to 15% of their compensation on a salary reduction, pre-tax basis. The401(k) plan also provides that the Company, at the discretion of the Board ofDirectors, may match employee contributions. The Company contributed $141,519in the form of 144,836 shares of the Company’s common stock in 2005,distributed in March 2006. The Company contributed $68,166 in the form of61,404 shares of the Company’s common stock in 2004, distributed in March 2005.

## c.                                       Employmentagreements

The Company is party to an employment agreement with an officer thatprovides for a minimum annual salary. The aggregate minimum commitment underthis agreement is as follows:

| Year Ending      | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| **December 31,** | ** ** | ** ** | ** ** |
| 2006                  |       | $          | 175,000    | ** ** |
| 2007                  |       | $          | 175,000    |   |
| 2008                  |       | $          | 175,000    |   |
| 2009                  |       | $          | 175,000    |   |

 

Should the agreement be terminated without cause during the term of thecontract, the officer would be entitled to one year’s salary.

**12.**          **Product Sales, ForeignSales and Sales to Major Customers**

Thefollowing table summarizes the Company’s product sales by product categoriesduring the past three years:

 
| **Year Ended December 31,** | ** ** | **2005**  | ** ** | **2004** | ** ** | **2003**  | ** ** |
|--------------------------------------------|------------|-----------|------------|----------|------------|-----------|------------|
| **Category**                               | ** ** | **Sales** | ** ** | **%**    | ** ** | **Sales** | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** |
| Optical  Components*                       |       | $         | 12,279,000 |     | 89         |      | $          | 7,860,000 |   | 85 |   | $ | 4,469,000 |   | 83 |   |
| Laser  Accessories                         |       | 1,506,000 |       | 11       |       | 1,362,000 |       | 15 |   | 893,000 |   | 17 |   |
| TOTAL**                                    |       | $         | 13,785,000 |     | 100        |      | $          | 9,222,000 |   | 100 |   | $ | 5,362,000 |   | 100 |   |

----

* a)  2003 Optical Component sales included $78,000from operations acquired from Laser Optics, Inc.

  b)  2004 Optical Component sales include $901,000from the Company’s new MRC Optics subsidiary.

**  Not included above are (non-product)contract R&D sales of approximately $26,000 in 2003.

Export sales, primarily to approximately sixteen customers in sixcountries within Europe, Asia and Canada, amounted to 14%, 12% and 19% of netproduct sales in 2005, 2004 and 2003, respectively.

F-16

----

 

No foreign customer accounted for more than 10% of product sales in2005, 2004 or 2003. In 2005 two U.S. customers accounted for 13% and 14% oftotal product sales. In 2004, three U.S. customers accounted for 12%, 12%, and10% of total product sales. In 2003, two U.S. customers accounted for 16.0% and10.0% of total sales.

**13.          Shareholders’ Equity**

## a.                                       Commonshares reserved at December 31, 2005, are as follows:

| Common Shares Preferred         |   |      |   |
|---------------------------------|--------|-----------|--------|
| 1991 Stock  option plan         |   | 302,500   |   |
| 2000 Stock  option plan         |   | 6,000,000 |   |
| Convertible  preferred stock    |   | 1,340,000 |   |
| Subordinated  convertible notes |   | 3,500,000 |   |
| Warrants                        |   | 4,473,026 |   |

 

## b.                                      Preferredstock

The Company has authorized 1,000,000 shares of preferred stock, no parvalue, which the Board of Directors has the authority to issue from time totime in a series. The Board of Directors also has the authority to fix, beforethe issuance of each series, the number of shares in each series and thedesignation, preferences, rights and limitations of each series. Series Aconsist of 500 shares at a stated value of $1,000 per share convertible intocommon shares at the rate of $1.00 per share. Series B consist of 2,100 sharesat a stated value of $1,000 per share convertible into common shares at therate of $2.50 per share.

For the years ended December 31, 2005, 2004 and 2003, the Company paida common stock dividend on preferred stock equal to $134,000, $165,000 and$54,000, respectively.

## c.                                       Stockoptions

The Company has adopted two stock option plans that provide for thegranting of options to employees, officers, directors, and others who renderservices to the Company. Under these plans in the aggregate, options topurchase no more than 6,000,000 shares of common stock may be granted, at aprice that may not be less than the fair market value per share.

The Equity Compensation Program authorizes the issuance of incentivestock options. At the annual Shareholders’ meeting held in 2004, shareholders’approved a recommendation by the Board to increase the number of options to begranted under the 2000 Equity Compensation Program, from 4,000,000 to6,000,000. The 2000 equity compensation plan expires in August 2010.

A summary of the status of the Company’s stock option program as ofDecember 31, 2005, 2004 and 2003, and changes during the years then ended ispresented below:
| ** **                                                   | ** ** | **Years Ended**  | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                   | ** ** | **December 31,** | ** ** |
| ** **                                                   | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                   | ** ** | ** **            | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                   | ** ** | ** **            | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                   | ** ** | ** **            | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| **Fixed Stock Options**                            | ** ** | **Shares**            | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| Outstanding, beginning of year                               |       | 2,121,600             |       | $ | 1.21 |   | 1,449,100 |   | $ | 1.42 |   | 1,173,800 |   | $ | 1.69 |   |
| Granted                                                      |       | 139,500               |       | 1.03 |   | 680,000 |   | 0.74 |   | 299,900 |   | 0.50 |   |
| Exercised                                                    |       | —                |       | — |   | — |   | — |   | — |   | — |   |
| Expired                                                      |       | (2000                 | )          | 1.25 |   | — |   | — |   | — |   | — |   |
| Forfeited                                                    |       | (68,800               | )          | 1.18 |   | (7,500 | ) | .50 |   | (24,600 | ) | 2.26 |   |
| Outstanding, end of year                                     |       | 2,190,300             |       | 1.18 |   | 2,121,600 |   | 1.21 |   | 1,449,100 |   | 1.42 |   |
| Options  exercisable, end of year                            |       | 1,666,124             |       | 1.43 |   | 1,301,047 |   | 1.53 |   | 881,424 |   | 1.88 |   |
| Weighted-average  fair values of options granted during year |       |                  |       | $ | 1.03 |   |   |   | $ | .67 |   |   |   | $ | .48 |   |

 

F-17

----

 

Warrantsoutstanding expire from March 2008 to July 2009 as per the below schedule:
| **Shares** | ** ** | **Exercisable through** | ** ** | **Exercise Price** | ** ** | **Fair Value** | ** ** |
|------------|------------|------------------------------|------------|-------------------------|------------|---------------------|------------|
| 1,448,026  |       | July  2009                   |       | $                       | 1.35       |                | $          | 1.29 |   |
| 200,000    |       | May  2008                    |       | $                       | 1.08       |                | $          | .42 |   |
| 200,000    |       | March  2008                  |       | $                       | .425       |                | $          | .42 |   |
| 80,000     |       | July 2009                    |       | $                       | 1.35       |                | $          | 1.31 |   |

 

The following table summarizes information about stock optionsoutstanding at December 31, 2005:
| ** **              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **              | ** ** | ** **                   | ** ** | **Weighted**                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **                   | ** ** | **Average**                  | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **              | ** ** | ** **                   | ** ** | **Remaining**                | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**       | ** ** | **Number**                   | ** ** | **Contractual**              | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Exercise Price** | ** ** | **Outstanding**              | ** ** | **Life**                     | ** ** | **Price** | ** ** | **Outstanding** | ** ** | **Price** | ** ** |
| $0.50 - $2.00           |       | 2,049,200                    |       | 6.99 yrs.                    |       | $ | 1.01 |   | 2,073,610 |   | $ | 1.27 |   |
| $3.00 - $5.00           |       | 141,100                      |       | 4.95 yrs.                    |       | $ | 3.57 |   | 504,250 |   | $ | 3.70 |   |

 

**14.          FairValue of Financial Instruments**

The methods and assumptions used to estimate the fair value of thefollowing classes of financial instruments were:

*Current Assets and Current Liabilities:*  The carrying amount of cash, currentreceivables and payables and certain other short-term financial instrumentsapproximate their fair value.

*Long-Term Debt:*  The fair value of the Company’s long-termdebt, including the current portion, for notes payable and subordinatedconvertible debentures, was estimated using a discounted cash flow analysis,based on the Company’s assumed incremental borrowing rates for similar types ofborrowing arrangements. The carrying amount of variable and fixed rate debt atDecember 31, 2005 approximates fair value.

**15           Quarterly Data** (Unaudited)

Summary quarterly results were as follows:
| **Year 2005**                              | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
|-------------------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|------------|------------|
|                                            |       |      |       |       |       |      |       |       |       |
| Net sales                                       |       | $         | 3,233,846  |       | $          | 3,107,079 |       | $          | 3,581,339  |   | $ | 3,862,793 |   |
| Gross profit                                    |       | 597,601   |       | 745,376    |       | 1,105,767 |       | 1,380,188  |       |
| Net Income  (loss)                              |       | (374,884  | )          | (286,248   | )          | 307,524   |       | 342,210    |       |
| Net Income  (loss) per share — Basic (a)   |       | (0.05     | )          | (0.06      | )          | .04       |       | .05        |       |
| Net Income (loss) per  share — Diluted (a) |       | (0.05     | )          | (0.06      | )          | .03       |       | .03        |       |
|                                                 |            |           |            |            |            |           |            |            |            |  |  |  |  |

 
| **Year 2004**                              | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
|-------------------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|------------|------------|
|                                            |       |      |       |       |       |      |       |       |       |
| Net sales                                       |       | $         | 1,805,802  |       | $          | 1,917,221 |       | $          | 2,582,372  |   | $ | 2,916,372 |   |
| Gross profit                                    |       | 277,393   |       | 532,589    |       | 846,991   |       | 946,377    |       |
| Net Income  (loss)                              |       | (489,393  | )          | (264,722   | )          | 95,167    |       | (13,430    | )          |
| Net Income  (loss) per share — Basic (a)   |       | (0.09     | )          | (0.08      | )          | .01       |       | (0.2       | )          |
| Net Income (loss) per  share — Diluted (a) |       | (0.09     | )          | (0.08      | )          | .01       |       | (0.2       | )          |
|                                                 |            |           |            |            |            |           |            |            |            |  |  |  |  |

 
| **Year 2003**                     | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
|----------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|------------|------------|
|                                   |       |      |       |       |       |      |       |       |       |
| Net sales                              |       | $         | 1,200,853  |       | $          | 1,147,117 |       | $          | 1,405,663  |   | $ | 1,634,551 |   |
| Gross profit                           |       | 279,963   |       | 201,856    |       | 285,690   |       | 228,552    |       |
| Net loss                               |       | (357,857  | )          | (438,187   | )          | (380,473  | )          | (600,792   | )          |
| Net loss per  share — Basic (a)   |       | (0.07     | )          | (0.09      | )          | (0.07     | )          | (0.04      | )          |
| Net loss per share —  Diluted (a) |       | (0.07     | )          | (0.09      | )          | (0.07     | )          | (0.04      | )          |
|                                        |            |           |            |            |            |           |            |            |            |  |  |  |  |

 

**16.          Special Charges**

During 2003, the Company accrued certain expenses related to therelocation of 17 employees from Bethel, CT to its facility in Northvale, NJ.The special charges accrued amounted to $107,000 ($.02 per share on a basic anddiluted basis) and included the costs for permanent relocation, stay on bonusesand relocation bonuses, anticipated to be expended in the next fiscal year.

F-18

----

 

During 2003, the Company determined that there was excess inventory,relative to forecasted future needs, of certain crystals and solutions. Basedon this determination, a reserve was taken in the amount of $475,000 ($.09 pershare on a basic and diluted basis) in order to recognize the diminished futureeconomic benefit of the inventory.

REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLICACCOUNTANTS ON SUPPLEMENTAL SCHEDULE

The audits referred to in our report dated February 24, 2006, exceptfor Note 2, as to which the date is September 29, 2006 relating tothe consolidated financial statements of Photonic Products Group, Inc. andsubsidiaries, which is contained in Item 8 in the Form 10-K/A, include theaudits of the financial statement schedule listed in the accompanying ScheduleII for the years ended December 31, 2005, 2004 and 2003. This financialstatement schedule is the responsibility of the Company’s management. Ourresponsibility is to express an opinion on this financial statement schedulebased upon our audits.

It is our opinion such financial statement schedule presents fairly, inall material respects, the information set forth therein.
| Holtz Rubenstein Reminick  LLP |
|--------------------------------|
| Melville, NY                   |
|                           |
| September 29,  2006            |
|                           |
|                           |

 

F-19

----

 

Schedule II —Valuationand Qualifying Accounts

 

PHOTONIC PRODUCTS GROUP,INC.

SCHEDULEII VALUATION AND QUALIFYING ACCOUNTS

(in thousands)
| ** **                          | ** ** | **Balance at  Beginning  of Period** | ** ** | **Charged  (Credited)  to Cost and  Expenses** | ** ** | **Acquired  Balance** | ** ** | **Deductions** | ** ** | **Balance  at End of  Period** | ** ** |
|-------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------|------------|----------------|------------|------------------------------------------|------------|
| Allowance for  Doubtful Accounts    |       |                                           |       |                                                     |       |                  |       |           |       |                                     |       |
| Year ended  December 31, 2005       |       | $                                              | 40,000     |                                                     |       |                  |       |           | $          | 25,000                                   |       | $ | 15,000 |   |
| Year ended  December 31, 2004       |       | $                                              | 40,000     |                                                     |       |                  |       |           |       |                                     | $          | 40,000 |   |
| Year Ended  December 31, 2003       |       | $                                              | 40,000     |                                                     |       |                  |       |           |       |                                     | $          | 40,000 |   |
|                                |       |                                           |       |                                                     |       |                  |       |           |       |                                     |       |
| Reserve for  Inventory Obsolescence |       |                                           |       |                                                     |       |                  |       |           |       |                                     |       |
| Year ended  December 31, 2005       |       | $                                              | 807,000    |                                                     | $          | (61,000               | )          |           |       |                                     |       | $ | 746,000 |   |
| Year ended  December 31, 2004       |       | $                                              | 992,000    |                                                     | $          | (185,000              | )          |           |       |                                     |       | $ | 807,000 |   |
| Year ended December 31,  2003       |       | $                                              | 600,000    |                                                     | $          | 392,000               |       |           |       |                                     |       | $ | 992,000 |   |
|                                     |            |                                                |            |                                                          |            |                       |            |                |            |                                          |            |  |  |  |  |

 

F-20

----