**Exhibit 21.1**

 

**SUBSIDIARIES OF PHOTONIC PRODUCTS GROUP,INC.***

 

The following is a list ofthe Subsidiaries of Photonic Products Group, Inc.:

 
| **NAME**                         | ** ** | **STATE OF  INCORPORATION** | ** ** | **NAMES UNDER WHICH  SUCH SUBSIDIARIES DO  BUSINESS** |
|----------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|
| MRC PRECISION METAL OPTICS. INC. |       | Florida                     |       | MRC OPTICS                                            |
| Laser Optics Holdings, Inc.      |       | New Jersey                  |       | Laser Optics                                          |

 

1

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**PHOTONIC PRODUCTS GROUP, INC.AND SUBSIDIARIES**

 

**REPORT ON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS**

 

**THREE YEARS ENDED DECEMBER 31, 2004**

 

**CONTENTS**

 

 
| Report of Independent Registered Public  Accounting Firm                                          |   |
|---------------------------------------------------------------------------------------------------|--------|
|                                                                                              |   |
| Consolidated balance sheets as of December 31, 2004 and 2003                                      |   |
|                                                                                              |   |
| Consolidated statements of operations for  the three years ended December 31, 2004                |   |
|                                                                                              |   |
| Consolidated statements of shareholders’  equity for the three years ended December 31, 2004 |   |
|                                                                                              |   |
| Consolidated statements of cash flows for  the three years ended December 31, 2004                |   |
|                                                                                              |   |
| Notes to consolidated financial statements                                                        |   |
|                                                                                              |   |
| Report of Independent Registered Certified  Public Accountants on supplemental schedule           |   |
|                                                                                              |   |
| Schedule II – Valuation and Qualifying  Accounts                                             |   |

 

F-1

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Report of Independent Registered PublicAccounting Firm 

 

 

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

 

We have audited the accompanyingconsolidated balance sheets of Photonic Products Group, Inc. and Subsidiariesas of December 31, 2004 and 2003, and the related consolidated statements ofoperations, shareholders’ equity and cash flows for the three years endedDecember 31, 2004.  These consolidatedfinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

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

 

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofPhotonic Products Group, Inc. and Subsidiaries as of December 31, 2004 and 2003and the results of their operations and their cash flows for the three yearsthen ended, in conformity with accounting principles generally accepted in theUnited States of America.

 

 

HOLTZ RUBENSTEIN REMINICK LLP

 

 

Melville, New YorkFebruary 28, 2005

 

F-2

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**PHOTONIC PRODUCTS GROUP, INC AND SUBSIDIARIES**

** **

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                   | ** ** | **2004**         | ** ** | **2003** | ** ** |
| **Assets**                                                                                                                                   |       |             |       |   |   |
| **Current assets:**                                                                                                                          |       |             |       |   |   |
| Cash and cash equivalents                                                                                                                    |       | $                | 1,393,507  |   | $ | 1,282,160 |   |
| Accounts receivable (after allowance for  doubtful accounts of $40,000 in 2004 and 2003)                                                     |       | 1,447,994        |       | 973,415 |   |
| Inventories                                                                                                                                  |       | 2,479,074        |       | 2,219,116 |   |
| Unbilled contract costs                                                                                                                      |       | —           |       | 191,767 |   |
| Other current assets                                                                                                                         |       | 87,540           |       | 76,941 |   |
| **Total Current Assets**                                                                                                                     |       | 5,408,115        |       | 4,743,399 |   |
| **Plant and equipment:**                                                                                                                     |       |             |       |   |   |
| ** **                                                                                                                                   |       |             |       |   |   |
| Plant and equipment at cost                                                                                                                  |       | 12,018,865       |       | 9,824,498 |   |
| Less: Accumulated depreciation and  amortization                                                                                             |       | (7,255,427       | )          | (6,572,278 | ) |
| Total plant and equipment                                                                                                                    |       | 4,763,438        |       | 3,252,220 |   |
| **Precious Metals**                                                                                                                          |       | 309,565          |       | 309,565 |   |
| **Goodwill**                                                                                                                                 |       | 1,727,971        |       | — |   |
| **Intangible Assets, net of accumulated  amortization of $32,425 and $0, respectively**                                                      |       | 1,067,449        |       | 443,750 |   |
| **Other Assets**                                                                                                                             |       | 250,097          |       | 102,187 |   |
| **Total Assets**                                                                                                                             |       | $                | 13,526,634 |   | $ | 8,851,121 |   |
|                                                                                                                                         |       |             |       |   |   |
| **Liabilities and Shareholders’ Equity**                                                                                                |       |             |       |   |   |
| **Current Liabilities:**                                                                                                                     |       |             |       |   |   |
|                                                                                                                                         |       |             |       |   |   |
| Notes payable -Other                                                                                                                         |       | $                | 226,146    |   | $ | 68,292 |   |
| Accounts payable and accrued liabilities                                                                                                     |       | 2,189,744        |       | 993,150 |   |
| Customer advances                                                                                                                            |       | 385,714          |       | — |   |
| Current obligations under capital leases                                                                                                     |       | 300,813          |       | 99,664 |   |
| **Total Current Liabilities**                                                                                                                |       | 3,102,417        |       | 1,161,106 |   |
|                                                                                                                                         |       |             |       |   |   |
| **Related Party Convertible and Secured Notes  Payable**                                                                                     |       | 5,200,000        |       | 4,200,000 |   |
| **Notes Payable - Other**                                                                                                                    |       | 794,379          |       | 116,728 |   |
| **Capital Lease Obligations**                                                                                                                |       | 464,709          |       | 88,848 |   |
| **Total Liabilities**                                                                                                                        |       | 9,561,505        |       | 5,566,682 |   |
|                                                                                                                                         |       |             |       |   |   |
| **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 7,186,794 issued at December 31, 2004 and 5,445,903 issued  at December 31, 2003 |       | 71,868           |       | 54,459 |   |
| Capital in excess of par value                                                                                                               |       | 11,035,561       |       | 9,534,523 |   |
| Accumulated deficit                                                                                                                          |       | (9,727,350       | )          | (8,889,593 | ) |
|                                                                                                                                         |       | 3,980,079        |       | 3,299,389 |   |
| Less - Common stock in treasury, at cost  (4,600 shares)                                                                                     |       | (14,950          | )          | (14,950 | ) |
| **Total Shareholders’ Equity**                                                                                                          |       | 3,965,129        |       | 3,284,439 |   |
| **Total Liabilities & Shareholders’  Equity**                                                                                       |       | $                | 13,526,634 |   | $ | 8,851,121 |   |

 

See Notes to Consolidated FinancialStatements

 

F-3

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**PHOTONIC PRODUCTS GROUP, INC AND SUBSIDIARIES**

** **

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                                    | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                    | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                          |       |                         |       |   |   |   |   |
| **REVENUES**                                                                  |       |                         |       |   |   |   |   |
| Net sales                                                                     |       | $                            | 9,221,857  |   | $ | 5,388,184 |   | $ | 5,569,118 |   |
|                                                                          |       |                         |       |   |   |   |   |
| **COST AND EXPENSES**                                                         |       |                         |       |   |   |   |   |
| Cost of goods sold                                                            |       | 6,618,506                    |       | 3,917,123 |   | 4,662,599 |   |
| Selling, general and administrative expense                                   |       | 2,916,056                    |       | 2,389,547 |   | 2,276,495 |   |
| Internal research and development expense                                     |       | 97,685                       |       | 153,843 |   | 134,424 |   |
| Special charges                                                               |       | —                       |       | 582,000 |   | — |   |
|                                                                          |       | 9,632,247                    |       | 7,042,513 |   | 7,073,518 |   |
|                                                                          |       |                         |       |   |   |   |   |
| **OPERATING LOSS**                                                            |       | (410,390                     | )          | (1,654,329 | ) | (1,504,400 | ) |
| ** **                                                                    |       |                         |       |   |   |   |   |
| **OTHER INCOME (EXPENSE)**                                                    |       |                         |       |   |   |   |   |
|                                                                          |       |                         |       |   |   |   |   |
| Interest expense                                                              |       | (358,940                     | )          | (270,946 | ) | (135,001 | ) |
| Interest income                                                               |       | —                       |       | 4,781 |   | 10,883 |   |
| Other                                                                         |       | 49                           |       | 8,950 |   | 13,126 |   |
|                                                                          |       | (358,887                     | )          | (257,215 | ) | (110,992 | ) |
|                                                                          |       |                         |       |   |   |   |   |
| **LOSS BEFORE INCOME TAX BENEFIT (PROVISION) AND  PREFERRED STOCK DIVIDENDS** |       | (769,277                     | )          | (1,911,544 | ) | (1,615,392 | ) |
|                                                                          |       |                         |       |   |   |   |   |
| **INCOME TAX BENEFIT (PROVISION)**                                            |       | 96,344                       |       | 134,235 |   | (100,580 | ) |
| ** **                                                                    |       |                         |       |   |   |   |   |
| **NET (LOSS)**                                                                |       | (672,937                     | )          | (1,777,309 | ) | (1,715,972 | ) |
| ** **                                                                    |       |                         |       |   |   |   |   |
| **PREFERRED STOCK DIVIDENDS**                                                 |       | (164,820                     | )          | (53,600 | ) | (120,600 | ) |
| ** **                                                                    |       |                         |       |   |   |   |   |
| **NET LOSS APPLICABLE TO COMMMON SHAREHOLDERS**                               |       | $                            | (837,757   | ) | $ | (1,830,909 | ) | $ | (1,836,572 | ) |
| ** **                                                                    |       |                         |       |   |   |   |   |
| **NET LOSS PER COMMON SHARE-BASIC**                                           |       | $                            | (0.15      | ) | $ | (0.35 | ) | $ | (0.35 | ) |
| ** **                                                                    |       |                         |       |   |   |   |   |
| **NET LOSS PER COMMON SHARE-DILUTED**                                         |       | $                            | (0.15      | ) | $ | (0.35 | ) | $ | (0.35 | ) |
|                                                                          |       |                         |       |   |   |   |   |
| **WEIGHTED AVERAGE SHARES OUTSTANDING BASIC  AND DILUTED**                    |       | 5,710,354                    |       | 5,287,849 |   | 5,210,322 |   |

** **

See notes to consolidated financial statements

 

F-4

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**PHOTONIC PRODUCTS GROUP, INC. ANDSUBSIDIARIES**

** **

**CONSOLIDATED STATEMENT OF SHAREHOLDERS’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, 2001** | ** ** | **5,135,603**                 | ** ** | **$**                       | **51,356** | ** **           | **500**    | ** **           | **$**      | **500,000**     | ** ** | **2,100**     | ** ** | **$**                  | **2,100,000** | ** **     | **9,331,194** | ** ** | **$** | **(5,222,112** | **)** | **$** | **(14,950** | **)** | **$** | **6,745,488** | ** ** |
|                            |       |                          |       |                        |       |                 |       |                 |       |            |       |          |       |                   |          |           |          |   |   |   |   |
| 401K contribution               |       | 14,037                        |       | 140                         |       | —               |       | —               |       | —          |       | —        |       | 20,222                 |          | —         |          |   |   | 20,362 |   |
|                            |       |                          |       |                        |       |                 |       |                 |       |            |       |          |       |                   |          |           |          |   |   |   |   |
| Dividend on  Preferred Stock    |       | 134,000                       |       | 1,340                       |       | —               |       | —               |       | —          |       | —        |       | 119,260                |          | (120,600       | )             |   |   | — |   |
|                            |       |                          |       |                        |       |                 |       |                 |       |            |       |          |       |                   |          |           |          |   |   |   |   |
| Net loss for the  year          |       | —                        |       | —                      |       | —               |       | —               |       | —          |       | —        |       | —                 |          | (1,715,972     | )             | — |   | (1,715,972 | ) |
|                            |       |                          |       |                        |       |                 |       |                 |       |            |       |          |       |                   |          |           |          |   |   |   |   |
| **Balance,  December 31, 2002** | ** ** | **5,283,640**                 | ** ** | **52,836**                  | ** ** | **500**              | ** ** | **500,000**          | ** ** | **2,100**       | ** ** | **2,100,000** | ** ** | **9,470,676**          | ** **    | **(7,058,684** | **)**         | **(14,950** | **)** | **5,049,878** | ** ** |
|                            |       |                          |       |                        |       |                 |       |                 |       |            |       |          |       |                   |          |           |          |   |   |   |   |
| 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  period        |       | —                        |       | —                      |       | —               |       | —               |       | —          |       | —        |       | —                 |          | (1,777,309     | )             | — |   | (1,777,309 | ) |
|                            |       |                          |       |                        |       |                 |       |                 |       |            |       |          |       |                   |          |           |          |   |   |   |   |
| **Balance,  December 31, 2003** | ** ** | **5,445,903**                 | ** ** | **54,459**                  | ** ** | **500**              | ** ** | **500,000**          | ** ** | **2,100**       | ** ** | **2,100,000** | ** ** | **9,534,523**          | ** **    | **(8,889,593** | **)**         | **(14,950** | **)** | **3,284,439** | ** ** |
|                            |       |                          |       |                        |       |                 |       |                 |       |            |       |          |       |                   |          |           |          |   |   |   |   |
| 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**     | ** ** | **$**                  | **2,100,000** | ** **     | **$**         | **11,035,561** | ** ** | **$** | **(9,727,350** | **)** | **$** | **(14,950** | **)** | **$** | **3,965,129** | ** ** |
|                                 |            |                               |            |                             |            |                      |            |                      |            |                 |            |               |            |                        |               |                |               |  |  |  |  |  |  |  |  |  |  |  |

 

**See notes to consolidated financial statement**s

 

F-5

----

** **

**PHOTONIC PRODUCTS GROUP, INC AND SUBSIDIARIES**

** **

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                   | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                         |       |                         |       |   |   |   |   |
| **Cash flows from operating activities:**                                    |       |                         |       |   |   |   |   |
| Net (loss) profit                                                            |       | $                            | (672,937   | ) | $ | (1,777,309 | ) | $ | (1,715,972 | ) |
|                                                                         |       |                         |       |   |   |   |   |
| **Adjustments to reconcile net loss to cash used  in operating activities:** |       |                         |       |   |   |   |   |
| Depreciation and amortization                                                |       | 713,080                      |       | 566,764 |   | 508,510 |   |
| Deferred taxes                                                               |       | —                       |       | — |   | 100,000 |   |
| 401K common stock contribution                                               |       | 12,945                       |       | 11,870 |   | 20,362 |   |
| Allowance for uncollectible accounts                                         |       | —                       |       | — |   | (14,000 | ) |
| Inventory reserve                                                            |       | 372,106                      |       | 475,000 |   | — |   |
| **Changes in assets and liabilities:**                                       |       |                         |       |   |   |   |   |
| Accounts receivable                                                          |       | (10,756                      | )          | 244,670 |   | 268,132 |   |
| Inventories                                                                  |       | (486,535                     | )          | (319,892 | ) | 273,953 |   |
| Unbilled contract costs                                                      |       | 191,767                      |       | 149,774 |   | 50,215 |   |
| Other current assets                                                         |       | (10,599                      | )          | 7,656 |   | 59,691 |   |
| Other assets                                                                 |       | 28,133                       |       | 102,097 |   | 3,329 |   |
| Accounts payable and accrued liabilities                                     |       | 599,590                      |       | 255,987 |   | (361,055 | ) |
|                                                                         |       |                         |       |   |   |   |   |
| Customer advances                                                            |       | (105,291                     | )          | — |   | — |   |
| Total adjustments                                                            |       | 1, 304,440                   |       | 1,493,926 |   | 909,137 |   |
| **Net cash provided by (used in) operating  activities**                     |       | 631,503                      |       | (283,383 | ) | (806,835 | ) |
|                                                                         |       |                         |       |   |   |   |   |
| **Cash flows from investing activities:**                                    |       |                         |       |   |   |   |   |
| Capital expenditures                                                         |       | (1,013,569                   | )          | (101,045 | ) | (553,556 | ) |
| Cash used for business acquisition, net                                      |       | (732,000                     | )          | (183,780 | ) | — |   |
|                                                                         |       |                         |       |   |   |   |   |
| **Net cash used in investing activities**                                    |       | (1,745,569                   | )          | (284,825 | ) | (553,556 | ) |
|                                                                         |       |                         |       |   |   |   |   |
| **Cash flows from financing activities:**                                    |       |                         |       |   |   |   |   |
| Net proceeds from issuance of common stock                                   |       | 1,172,984                    |       |   |   |   |   |
| Proceeds from secured notes payable                                          |       |                         |       | 1,700,000 |   | 1,125,991 |   |
| Proceeds from senior convertible debentures                                  |       | 1,000,000                    |       | 1,500,000 |   | 1,000,000 |   |
| Principal payments of notes payable                                          |       | (847,907                     | )          | (727,425 | ) | (72,452 | ) |
| Principal payments of bank debt                                              |       |                         |       | (1,678,623 | ) | — |   |
| Principal payments of capital lease  obligations                             |       | (99,664                      | )          | (98,658 | ) | (87,023 | ) |
|                                                                         |       |                         |       |   |   |   |   |
| **Net cash provided by financing activities**                                |       | 1,225,413                    |       | 695,294 |   | 1,966,516 |   |
|                                                                         |       |                         |       |   |   |   |   |
| **Net increase (decrease) in cash and cash  equivalents**                    |       | 111,347                      |       | 127,086 |   | 606,125 |   |
|                                                                         |       |                         |       |   |   |   |   |
| **Cash and cash equivalents at beginning of  the year**                      |       | 1,282,160                    |       | 1,155,074 |   | 548,949 |   |
|                                                                         |       |                         |       |   |   |   |   |
| **Cash and cash equivalents at end of the  year**                            |       | $                            | 1,393,507  |   | $ | 1,282,160 |   | $ | 1,155,074 |   |

 

F-6

----

 

**PHOTONIC PRODUCTS GROUP, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**THREE YEARS ENDED DECEMBER 31, 2004**

 

**1.****                          Natureof Business and Summary of Significant Accounting Policies**

 

a.         Nature of Operations

 

PHOTONICPRODUCTS GROUP, Inc. and Subsidiaries (the “Company”, formerly known as Inrad,Inc.) is a manufacturer of crystals, crystal devices, electro-optic and opticalcomponents, and sophisticated laser subsystems and instruments.  The Company’s principal customers includecommercial instrumentation companies and OEM laser manufacturers, researchlaboratories, government agencies, and defense contractors.  The Company’s products are sold domesticallyusing its own sales staff, and in major overseas markets, principally Europeand the Far East, using independent sales agents.

 

b.        Principles of consolidation

 

Theaccompanying consolidated financial statements include the accounts of theCompany and its wholly-owned Subsidiaries. Upon consolidation, all intercompany accounts and transactions areeliminated.

 

c.         Allowancefor doubtful accounts

 

Managementmust make estimates of the uncollectability of accounts receivable.  Management specifically analyzes accountsreceivable and analyzes historical bad debts, customer concentrations, customercredit-worthiness, current economic trends and changes in customer paymentterms when evaluating the adequacy of the allowance for doubtful accounts.

 

d.        Depreciationand amortization

 

Depreciationis computed using the straight-line method over the estimated useful lives ofthe related assets.  Amortization ofleasehold improvements is computed using the straight-line method over theestimated useful lives of the related assets, 3-7 years, or the remaining termof the lease, 10 years, whichever is shorter. Maintenance and repairs of property and equipment are charged tooperations and major improvements are capitalized.  Upon retirement, sale or other disposition ofproperty and equipment, the cost and accumulated depreciation are eliminatedfrom the accounts and gain or loss is included in operations.

 

e.         Inventories

 

Inventories,including certain precious metals consumed in the manufacturing process, arestated at the lower of cost (first-in, first-out method) or market.

 

f.           Income taxes

 

Deferredtax assets and liabilities are determined based on differences betweenfinancial reporting and tax bases of assets and liabilities, and are measuredusing the enacted tax rates and laws that will be in effect when thedifferences are expected to reverse.

 

g.        Impairmentof long-lived assets

 

Inaccordance with SFAS No. 144, long-lived assets, such as property, plant andequipment and purchased intangibles subject to amortization, are reviewed forimpairment whenever events or changes in 

 

F-7

----

 

circumstancesindicate that 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 estimate undiscountedfuture 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 longer depreciated.  The assets and liabilities of a disposedgroup classified as held for sale would be presented separately in theappropriate asset and liability sections of the balance sheet.  Management has determined that for FY 2004all asset values recorded on the books of the Company represent the fair valueof the assets.

 

Goodwilland intangible assets not subject to amortization are tested in December ofeach year for impairment and are tested for impairment more frequently ifevents 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.

 

h.        AcquiredGoodwill and Intangible assets

 

Acquiredintangible assets and goodwill consists of goodwill approximating $1,728,000and other intangible assets, principally of non-contractual customerrelationships that approximated $1,067,000. The intangible assets are amortized on a straight-line basis over theassets’ estimated useful life up to 14 years. The Company periodically evaluates whether events or circumstances haveoccurred indicating the carrying amount of intangible assets may not berecoverable.  When factors indicate thatintangible assets should be evaluated for possible impairment, the Company usesan estimate of the associated undiscounted future cash flows compared to therelated carrying amount of assets to determine if an impairment loss should berecognized.

 

Thegross carrying amount of intangible assets as of December 31, 2004 was$1,067,000 and $444,000 as of December 31, 2003.  Accumulated amortization related tointangible assets approximates $32,000 as of December 31, 2004 and $0 as ofDecember 31, 2003.  Amortization expensewas approximately $32,000 and $0 for the years ended December 31, 2004 and 2003respectively.  Aggregate amortization forthe five succeeding years ending December 31, 2005 through December 31, 2010approximates $380,000, accumulating at the rate of $76,000 per year, weightedaverage life.

 

Thechanges in the carrying amounts of goodwill, by acquisition, for the year endedDecember 31, 2004, are as follows:

 
| ** **   | ** ** | **Balance  Jan. 1 2004** | ** ** | **Goodwill Additions** | ** ** | **Purchase Price   Adjustment** | ** ** | **Balance  Dec. 31, 2004** | ** **    |
|--------------|------------|--------------------------|------------|------------------------|------------|---------------------------------|------------|----------------------------|---------------|
| Laser Optics |       | $                        | —     |                   |       |                            | $          | 311,572                    |          | $ | 311,572 |   |
|         |       |                     |       |                   |       |                            |       |                       |          |
| MRC          |       | $                        | —     |                   | $          | 1,416,339                       |       |                       |          | $ | 1,416,339 |   |
|         |       |                     |       |                   |       |                            |       |                       |          |
| Total        |       | $                        | —     |                   | $          | 1,416,339                       |       | $                          |  311,572 |   | $ | 1,727,911 |   |

 

F-8

----

 

Thefollowing schedule details the Company’s intangible asset balance by majorasset class.

 
| ** **           | ** ** | **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 |   |

 
| ** **           | ** ** | **At  December 31, 2003**   | ** ** |
|----------------------|------------|-----------------------------|------------|
| ** **           | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** |
|                 |       |                        |       |   |   |   |   |
| Customer-related     |       | $                           | 221,875    |   | $ | — |   | $ | 221,875 |   |
| Completed technology |       | 146,438                     |       | — |   | 146,438 |   |
| Trademarks           |       | 75,438                      |       | — |   | 75,438 |   |
|                 |       |                        |       |   |   |   |   |
| Total                |       | $                           | 443,750    |   | $ | — |   | $ | 443,750 |   |

 

i.            Stock-basedcompensation

 

TheCompany accounts for stock-based compensation arrangements in accordance withthe provisions of Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees, and accounts for stock issued forservices provided by other than employees in accordance with and complies withthe 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 thedisclosure-only provisions of Statement of Financial Accounting Standard No.123, “Accounting for Stock-Based Compensation” (“FASB 123”) in accounting forits employee stock options.  Accordingly,no compensation expense has been recognized. Had the Company recorded compensation expense for the stock optionsbased on the fair value at the grant date for awards, consistent with theprovisions of FASB 123, the Company’s net income (loss) and net income (loss)per share applicable to common shareholders would have changed to the followingpro forma amounts:

 

F-9

----

 
| ** ** | ** **                                       | ** ** | **Years Ended**  | ** ** |
|------------|--------------------------------------------------|------------|------------------|------------|
| ** ** | ** **                                       | ** ** | **December 31,** | ** ** |
| ** ** | ** **                                       | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
|       |                                             |       |             |       |   |   |   |   |
| Net Loss:  |                                             |       |             |       |   |   |   |   |
|       | As reported                                      |       | $                | (672,937   | ) | $ | (1,777,309 | ) | $ | (1,715,972 | ) |
|       | Less: Stock based employee compensation  expense |       | (237,565         | )          | (76,555 | ) | (352,012 | ) |
|       | Pro forma                                        |       | $                | (910,502   | ) | $ | (1,853,864 | ) | $ | (2,067,984 | ) |
|       |                                             |       |             |       |   |   |   |   |   |   |   |
|       | Loss per share:                                  |       |             |       |   |   |   |   |
|       | Basic:                                           |       |             |       |   |   |   |   |
|       | As reported                                      |       | $                | (.15       | ) | $ | (.35 | ) | $ | (.35 | ) |
|       | Pro forma                                        |       | $                | (.19       | ) | $ | (.36 | ) | $ | (.42 | ) |
|       | Diluted:                                         |       |             |       |   |   |   |   |
|       | As reported                                      |       | $                | (.15       | ) | $ | (.35 | ) | $ | (.35 | ) |
|       | Pro forma                                        |       | $                | (.19       | ) | $ | (.36 | ) | $ | (.42 | ) |

 

The fair value of each option grant isestimated on the date of grant using the Black-Scholes option-pricingmodel.  The following range ofweighted-average assumptions were used for grants during the years endedDecember 31, 2004, 2003 and 2002:

 
| ** **              | ** ** | **Years Ended**  | ** ** |
|-------------------------|------------|------------------|------------|
| ** **              | ** ** | **December 31,** | ** ** |
| ** **              | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
|                    |       |             |       |   |   |   |   |
| Dividend yield          |       | 0.00             | %          | 0.00 | % | 0.00 | % |
| Volatility              |       | 166.32           | %          | 127.16 | % | 128.11 | % |
| Risk-free interest rate |       | 5.2              | %          | 5.2 | % | 5.2 | % |
| Expected life           |       | 10 years         |       | 10 years |   | 10 years |   |

 

j.            Revenuerecognition

 

TheCompany records revenue, other than on contractual type work, when a product isshipped.  Revenue on contractual typework is accounted for using the percentage-of-completion method, wherebyrevenue and profits are recognized throughout the performance of the contracts.  Percentage-of-completion is determined byrelating the actual cost of work performed to date to the estimated total costfor each contract.  Losses on contractsare recorded when identified.

 

k.         Internalresearch and development costs

 

Internalresearch and development costs are charged to expense as incurred.

 

l.            Preciousmetals

 

Preciousmetals not consumed in the manufacturing process are valued at cost, cost beingdetermined on the first-in, first-out basis.

 

m.      Use ofestimates

 

Thepreparation of financial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual amounts could differ from thoseestimates.

 

F-10

----

 

n.        Advertisingcosts

 

Advertisingcosts are charged to operations when the advertising first takes place.  Included in selling, general andadministrative expenses are advertising costs of $28,000, $32,000 and $62,000for the years ended December 31, 2004, 2003 and 2002.

 

o.        Statementsof cash flows

 

Forpurposes of the consolidated statements of cash flows, the Company considersall highly liquid debt instruments purchased with a maturity of three months orless to be cash equivalents.

 

Interestpaid during the years ended December 31, 2004, 2003 and 2002 was $63,460,$114,946 and $135,001, respectively.

 

Incometaxes paid were $1,200 in 2004, $580 in 2003, $1,000 in 2002.

 

p.        Concentrationof risk

 

TheCompany invests its excess cash in deposits and money market accounts withmajor financial institutions and in commercial paper of companies with strong creditratings.  Generally, the investmentsmature within ninety days, and therefore, are subject to little risk.  The Company has not experienced lossesrelated to these investments.

 

Theconcentration of credit risk in the Company’s accounts receivable is mitigatedby the Company’s credit evaluation process, reasonably short collection termsand the geographical dispersion of revenue. The Company generally does not require collateral.

 

TheCompany utilizes many relatively uncommon materials and compounds tomanufacture its products.  Therefore, anyfailure 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.

 

q.        Net Loss percommon share

 

Thebasic net loss per share is computed using weighted average number of commonshares outstanding for the applicable period. The diluted loss per share is computed using the weighted average numberof common shares plus common equivalent shares outstanding, except if theeffect on the per share amounts, including equivalents, would be anti-dilutive.

 

r.           Shipping andhandling costs

 

TheCompany has included freight out as a component of selling, general andadministrative expenses that amounted to $30,950 in 2004, $26,643 in 2003 and$30,242 in 2002.  When applicable theCompany bills its customers for freight costs.

 

s.         Recentlyissued accounting pronouncements

 

InNovember 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment ofARB No. 43, Chapter 4.”  SFAS No. 151amends the guidance in ARB Bo. 43, “Inventory Pricing,” for abnormal amounts ofidle facility expense, freight, handling costs, and wasted material (spoilage)requiring that those items be recognized as current-period expenses regardlessof whether they meet the criterion of “so abnormal.”  This statement also requires that allocationof fixed production overheads to the costs of conversion be based on the normalcapacity of the production facilities. The statement is effective for inventory costs incurred during thefiscal years beginning after June 15, 2005. The Company has always allocated production overheads to the costs ofconversion based on the normal capacity of the production facilities therefore,management does not expect this statement to have a material impact on theCompany’s consolidated financial position or results of operations.

 

InDecember 2004, The FASB issued SFAS No. 153, “Exchange of Nonmonetary Assets,an amendment of APB Opinion No. 29.” APB Opinion No. 29, “Accounting forNonmonetary

 

F-11

----

 

Transactions,”is based on the principle that exchanges of nonmonetary assets should bemeasured based on the fair value of the assets exchanged.  SFAS No. 153 amends APB Opinion No. 29,eliminating the exception to fair value accounting for nonmonetary exchanges ofsimilar productive assets and replaces it with a general exception to fairvalue accounting of nonmonetary exchanges that do not have commercialsubstance.  A nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected tochange significantly as a result of the exchange.  The statement is effective for no monetaryasset exchanges occurring in fiscal periods beginning after June 15, 2005.  Management does not expect this statement tohave a material impact on the Company’s consolidated financial position orresults of operations.

 

In December2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-based Payment” thatwill require the Company to expense costs related to share-based paymenttransaction with employees. With limited exceptions, SFAS No. l23(R) requiresthat the fair value of share-based payments to employees be expensed over theperiod service is received and eliminates the ability to account for theseinstruments under the intrinsic value method prescribed by APB No. 25, andallowed under the original provisions of SFAS No. 123. SFAS No. 123(R) becomesmandatorily effective for the Company on July 1, 2005. SFAS No. 123(R) allowsfor either prospective recognition of compensation expense or retrospectiverecognition, which may be back to the original issuance of SFAS No. 123 or onlyto interim periods in the year of adoption. The Company is currently evaluatingthese transition methods.

 

The FinancialAccounting Standards Board (FASB) issued interpretation No. 46 (FIN 46), “Consolidationof Variable Interest Entities,” in January 2003, and amended the Interpretationin December 2003.  FIN 46 requires aninvestor with a majority of the variable interests (primary beneficiary) in avariable interest entity (VIE) to consolidate the entity and also requiresmajority and significant variable interest investors to provide certaindisclosures.  A VIE is an entity in whichthe voting equity investors do not have a financial controlling interest, orthe equity investment at risk, is sufficient to finance the entity’s activitieswithout receiving additional subordinated financial support from the otherparties.  Development-stage entities thathave sufficient equity invested to finance the activities they are currentlyengaged in and entities that are businesses, as defined in the Interpretation,are not considered VIE’s.  The provisionsof FIN. 46 were effective immediately for all arrangements entered into withnew VIE’s created after January 31, 2003. The adoption of FIN No. 46 did not have a material impact on the Company’sconsolidated financial position and results of operations in FY 2004.

 

t.           Comprehensiveincome (loss)

 

Comprehensiveincome (loss) refers to revenue, expenses, gains and losses that undergenerally accepted accounting principles are included in comprehensive incomebut are excluded from net income as these amounts are recorded directly as anadjustment to stockholders’ equity.  AtDecember 31, 2004 and 2003, there were no such adjustments.

 

**2.****                         ****Inventories**

 

Inventories are comprised of the following:

 
| ** **                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|------------------|------------|
| ** **                                                    | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                                          |       |             |       |   |   |
| Raw materials                                                 |       | $                | 579,123    |   | $ | 543,116 |   |
| Work in process, including manufactured  parts and components |       | 1,420,038        |       | 1,275,000 |   |
| Finished goods                                                |       | 479,913          |       | 401,000 |   |
|                                                          |       | $                | 2,479,074  |   | $ | 2,219,116 |   |

 

F-12

----

 

**3.****                          Propertyand Equipment**

 

Property and equipment are comprised of the following:

 
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|------------------|------------|
| ** **                                      | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Office and computer equipment                   |       | $                | 984,657    |   | $ | 919,725 |   |
| Machinery and equipment                         |       | 9,161,285        |       | 7,544,364 |   |
| Leasehold improvements                          |       | 1,872,923        |       | 1,360,409 |   |
|                                            |       | 12,018,865       |       | 9,824,498 |   |
| Less accumulated depreciation and  amortization |       | 7,255,427        |       | 6,572,278 |   |
|                                            |       | $                | 4,763,438  |   | $ | 3,252,220 |   |

 

**4.****                          SubordinatedConvertible Promissory Notes**

 

In April 2004, the Company received$1,000,000 in proceeds from the issuance of a Subordinated ConvertiblePromissory Note.  The Note is due inMarch 2007 and bears an interest rate of 6%.  Interest accrues yearly and along withprincipal may be converted into Common Stock, (and/or securities convertibleinto common shares).  As a result of theJune 2004 private placement, the note is convertible into 1,000,000 Unitsconsisting of 1,000,000 shares of Common Stock and Warrants to acquire 750,000shares of Common Stock at a price of $1.35 per share.  The Holder of the Note is a major shareholderof the Company.

 

In 2003, the Company issued aSubordinated Convertible Promissory Note for proceeds of $1,500,000.  The note was amended in 2004 to clarify itsconversion features.  The Holder of theNote is a major Shareholder and Debt Holder of the Company.  The note bears interest at the rate of 6% perannum and has a maturity date of January 31, 2006.  The note is convertible into common shares(and/or securities convertible into common shares) of the Company.  As a result ofthe June 2004 private placement, the note is convertible into 1,500,000 Unitsconsisting of 1,500,000 shares of Common Stock and Warrants to acquire1,125,000 shares of Common Stock at a price of $1.35 per share.  The Holder of the Note is a major shareholderof the Company.  The proceeds from theNote are intended for use in the Company’s acquisition program.

 

In June 2003, the Company received$1,700,000 from a major Shareholder and Debt Holder of the Company.  The proceeds of the note were used to payoutstanding bank debt.  The note issecured by the assets of the Company.  The note bears interest at the rate of 6% perannum and is due December 2008.

 

In 2002, theCompany issued a Subordinated Convertible Promissory Note for proceeds of$1,000,000.  The note was amended in 2004to clarify its conversion features.  Thenote bears interest at the rate of 6% per annum and has a maturity date ofJanuary 31, 2006.  The note isconvertible into common shares (and/or securities convertible into commonshares) of the Company.  Asa result of the June 2004 private placement, 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.  The Holder of the Note is a related party toa major Shareholder of the Company.

 

**5.****                          NotesPayable Other**

 

As part of thepurchase price of MRC on October 19, 2004 a $175,000 Note was issued to thesole shareholder of the company.  Thenote bears interest at the rate of 6% per annum and is payable annually   on the anniversary of the closing date.  On the second anniversary of the ClosingDate, $50,000 of the Note amount shall be due and payable.  The remaining portion of the Note along withany accrued unpaid interest shall be paid in full on October 19, 2009.  Three notes, totaling $295,725, were assumedfrom note holders of MRC.  The notes bearinterest rates from 6.0% to 10.5% and are payable from 2 to 4 years.  A Note payable to the SBA was alsoassumed.  The Note in the amount of$390,497 bears interest at the rate of 4.0% and is due in 2032.

 

F-13

----

 

At the time ofthe purchase of Laser Optics, Inc., the Company converted certain liabilitiesto notes payable.  Notes totaling$100,728 were issued to former officers of Laser Optics, Inc. for back pay andunreimbursed business expenses.  Thesenotes are for a three year period and carry an interest rate defined as theprime rate in the United States as published in the Wall Street Journal.  A note in the amount of $86,777 was issued tothe former landlord for back rent.  It isa 36-month note with an interest rate of 2% per annum.  At the time of the closing a former officerof Laser Optics, Inc. received a $15,000 prepayment on his note.  All note balances are payable monthlycommencing January 2004.

 

Notespayable other consist of the following:

 
| ** **                                                                                                                                                  | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                                  | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Notes payable other, payable in aggregate monthly  installments of $20,000, including interest at rates ranging from 2.0% to  10.5% expiring in April 2032, |       | $                | 1,020,525  |   | $ | 185,020 |   |
| Less current portion                                                                                                                                        |       | 226,146          |       | 68,292 |   |
| Long-term debt, excluding current portion                                                                                                                   |       | $                | 794,349    |   | $ | 116,728 |   |

 

Notespayable other, mature as follows:

 
| 2005       |   | $       | 226,146   |   |
|------------|--------|---------|-----------|--------|
| 2006       |   | 238,415 |      |
| 2007       |   | 60,854  |      |
| 2008       |   | 14,628  |      |
| 2009       |   | 134,623 |      |
| 2010       |   | 9,997   |      |
| Thereafter |   | 335,862 |      |
|       |   | $       | 1,020,525 |   |

 

**6.****                          AccountsPayable and Accrued Expenses**

 

                                    Accountspayable and accrued expenses are comprised of the following:

 
| ** **                                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|------------------|------------|
| ** **                                    | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Trade accounts payable and accrued  purchases |       | $                | 837,830    |   | $ | 318,090 |   |
| Accrued vacation                              |       | 347,357          |       | 251,794 |   |
| Accrued payroll                               |       | 197,639          |       | 92,391 |   |
| Accrued interest                              |       | 433,433          |       | 156,000 |   |
| Accrued relocation costs                      |       | 179,825          |       | 107,000 |   |
| Accrued expenses - other                      |       | 193,661          |       | 67,875 |   |
|                                          |       | $                | 2,189,745  |   | $ | 993,150 |   |

 

**7.****                          CapitalLeases**

 

                                    Capitalleases consist of the following:

 
| ** **                                                                                                                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Capital leases, payable in aggregate  monthly installments of $33,000, including interest at rates ranging from 11.0%  to 11.6% expiring through October 2010 |       | $                | 765,522    |   | $ | 188,512 |   |
| Less current portion                                                                                                                                          |       | 300,813          |       | 99,664 |   |
| Long-term debt, excluding current portion                                                                                                                     |       | $                | 464,709    |   | $ | 88,848 |   |

 

F-14

----

 

Maturities of capital leases are asfollows:

 
| **Year Ending**                    | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| **December 31,**                   | ** ** | ** ** | ** ** |
|                               |       |       |       |
| 2005                               |       | 376,464    |       |
| 2006                               |       | 278,020    |       |
| 2007                               |       | 199,319    |       |
| 2008                               |       | 49,144     |       |
| 2009                               |       | —     |       |
| Total minimum payments             |       | 902,952    |       |
|                               |       |       |       |
| Less amounts representing interest |       | 137,430    |       |
|                               |       |       |       |
| Present value of minimum payments  |       | $          | 765,522    |   |
|                                    |            |            |            |  |

 

Capitallease obligations are collateralized by property and equipment with cost andrelated accumulated depreciation approximating $1,244,000 and $204,000respectively at December 31, 2004.

 

**8.****                         ****Income Taxes**

 

A reconciliation of the income taxprovision (benefit) computed at the statutory Federal income tax rate to thereported amount follows:

 
| ** **                                          | ** ** | **Year Ended   December 31,** | ** ** |
|-----------------------------------------------------|------------|-------------------------------|------------|
| ** **                                          | ** ** | **2004**                      | ** ** | **2003** | ** ** | **2002** | ** ** |
| Federal statutory rate                              |       | 34                            | %          | 34 | % | 34 | % |
| Tax provision (benefit) at Federal statutory  rates |       | $                             | (228,797   | ) | $ | (604,255 | ) | $ | (549,233 | ) |
| Loss in  excess of available benefit                |       | 228,797                       |       | 604,255 |   | 549,233 |   |
| Change in valuation allowance                       |       |                          |       |   |   | 100,000 |   |
| State taxes                                         |       | (96,344                       | )          | (134,235 | ) | 580 |   |
|                                                |       | $                             | (96,344    | ) | $ | (134,235 | ) | $ | 100,580 |   |

 

At December 31, 2004, the Company has Federaland State net operating loss carryforwards for tax purposes of approximately$8,801,000 and $21,000, respectively. The tax loss carryforwards expire at various dates through 2024.

 

The State of New Jersey has enacted a programthat allows new or emerging technology and biotechnology businesses to selltheir unused Net Operating Loss (NOL) carryover to any corporation for at least75% of the value of the tax benefits.  In2004, the Company sold $1,550,800 of their NOL for $96,344.

 

Internal Revenue Code Section 382 placesa limitation 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 50percentage point change in ownership occurs. Accordingly, the actual utilization of the net operating loss andcarryfowards 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.

 

F-15

----

 

The benefit (provision) for income taxesconsists of the following:

 
| ** ** | ** ** | **Years Ended**  | ** ** |
|------------|------------|------------------|------------|
| ** ** | ** ** | **December 31,** | ** ** |
| ** ** | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
|       |       |             |       |   |   |   |   |
| Current:   |       |             |       |   |   |   |   |
| State      |       | $                | 96,344     |   | $ | 134,235 |   | $ | (580 | ) |
| Deferred:  |       |             |       |   |   |   |   |
| Federal    |       | —           |       | — |   | (100,000 | ) |
| State      |       | —           |       | — |   | — |   |
|       |       |             |       |   |   |   |   |
| Total      |       | $                | 96,344     |   | $ | 134,235 |   | $ | (100,580 | ) |

 

Deferredtax assets (liabilities) comprise the following:

December31,

 
| ** **                | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------|------------|------------|------------|------------|------------|
| Inventory reserves        |       | $          | 332,000    |       | $          | 240,000 |   |
| Vacation liabilities      |       | 118,000    |       | 101,000    |       |
| Other                     |       | 116,000    |       | 32,000     |       |
| Depreciation              |       | 102,000    |       | (21,000    | )          |
| Loss carryforwards        |       | 2,992,000  |       | 2,996,000  |       |
| Gross deferred tax assets |       | 3,660,000  |       | 3,348,000  |       |
| Valuation allowance       |       | (3,660,000 | )          | (3,348,000 | )          |
|                      |       |       |       |       |       |
|                      |       | $          | —     |       | $          | — |   |

 

**9.****                                      RelatedParty Transactions**

 

During the years ended December 31, 2004,2003 and 2002, approximately 3%, 3%, and 4%, respectively of the Company’s netproduct sales were through a foreign agent, in which Warren Ruderman, aprincipal shareholder has an investment. Terms of sales to this foreign agent were substantially the same as tounrelated foreign agents.

 

During 2004, Clarex, LTD., a shareownerand debt holder received a 6% Convertible Promissory Note for $1,000,000 dueMarch 2007.  In March 2004, Clarex, LTDreceived 200,000 warrants for offering the 2003 $1,700,000 secured promissorynote and an additional 200,000 warrants for extending the maturity date of theNote to December 2008.

 

During 2003, Clarex, LTD. a shareownerand debt holder received a 6% Secured Promissory Note for $1,700,000 dueDecember 2005.  In October 2003, Clarex,LTD received a $1,500,000, 6% Convertible Promissory Note due January 2006.

 

During 2002, Welland Ltd., a relatedparty to Clarex, Ltd., received a 6% Subordinated Convertible Promissory Note dueJanuary 31, 2006, resulting in proceeds to the Company of $1,000,000.

 

**10.****                              ****Commitments**

 

a.     Leasecommitment

 

The Company occupies approximately 42,000square feet of space located at 181 Legrand Avenue, Northvale, New Jerseypursuant to a net lease expiring on October 31, 2006.  The Company has an option to renew theNorthvale lease for an additional term of five years.

 

The Company’s MRC Optics subsidiaryoccupies approximately 25,000 square feet of space located at 6405 ParklandDrive, Sarasota, FL pursuant to a net lease expiring on August 31, 2006. MRC Optics does not currently have an optionto renew the lease.

 

F-16

----

 

Rentalexpense was approximately $370,000, $238,000 and $224,000 in 2004, 2003 and 2002,respectively, and real estate taxes were $64,000, $41,000 and $39,000 in 2003,2002, and 2001, respectively.

 

Future minimum annual rentals are payable asfollows:

 
| **Year Ending**  | ** ** | ** ** | ** ** |
|------------------|------------|------------|------------|
| **December 31,** | ** ** | ** ** | ** ** |
| 2005             |       | $          | 375,000    |   |
| 2006             |       | $          | 385,000    |   |
| 2007             |       | $          | 395,000    |   |

 

b.        Retirementplans

 

The Company maintains a 401(k) savings planfor all eligible employees (as defined in the plan).  The 401(k) plan allows employees tocontribute from 1% to 15% of their compensation on a salary reduction, pre-taxbasis.  The 401(k) plan also providesthat the Company, at the discretion of the Board of Directors, may matchemployee contributions.  The Companycontributed $69,061 in the form of 62,085 shares of the Company’s common stockin 2004, distributed in March 2005.  TheCompany contributed $12,945 in the form of 25,891 shares of the Company’scommon stock in 2003, distributed in March 2004.

 

c.         Employmentagreements

 

The Company is party to an employmentagreement with an officer that provides for a minimum annual salary.  The aggregate minimum commitment under thisagreement is as follows:

 
| **Year Ending**  | ** ** | ** ** | ** ** |
|------------------|------------|------------|------------|
| **December 31,** | ** ** | ** ** | ** ** |
| 2005             |       | $          | 175,000    |   |
| 2006             |       | $          | 175,000    |   |
| 2007             |       | $          | 175,000    |   |
| 2008             |       | $          | 175,000    |   |

 

Should the agreement be terminated withoutcause during the term of the contract, the officer would be entitled to oneyear’s salary.

 

**11.****                  ****Product Sales, Foreign Sales and Sales to MajorCustomers**

 

The following table summarizes theCompany’s product sales by product categories during the past three years:

 
| ** **          | ** ** | **Year Ended December 31** | ** ** |
|---------------------|------------|----------------------------|------------|
| ** **          | ** ** | **2004**                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Category**        | ** ** | **Sales**                  | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** |
| Optical Components* |       | $                          | 7,877,000  |   | 85 |   | $ | 4,469,000 |   | 83 |   | $ | 4,325,905 |   | 79 |   |
| Laser Accessories   |       | 1,345,000                  |       | 15 |   | 893,000 |   | 17 |   | 1,155,816 |   | 21 |   |
| TOTAL**             |       | $                          | 9,222,000  |   | 100 |   | $ | 5,362,000 |   | 100 |   | $ | 5,481,721 |   | 100 |   |

 

----

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

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

**c)         Notincluded above are (non-product) contract R&D sales of approximately$26,000 and $87,000 in 2003 and 2002, respectively.

 

F-17

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Export sales, primarily to approximatelysixteen customers in six countries within Europe, Asia and Canada, amounted to12%, 19% and 19% of net product sales in 2004, 2003 and 2002, respectively.

 

Noforeign customer accounted for more than 10% of product sales in 2004, 2003 or2002.  In 2004, three U.S. customersaccounted for 16%, 12%, and 10% of total product sales.  In 2003, two U.S. customers accounted for16.0% and 10.0% of total sales.  In 2002one U.S. customer accounted for 13.4% of total sales.

 

**12.****                  ****Shareholders’ Equity**

 

a.         Privateplacement :

 

Duringthe 2nd quarter of 2004, the Company entered into an agreement with aninvestment banking firm to raise equity via a private placement that was notregistered with the Securities and Exchange Commission.  In July 2004.  The Company issued 1,581,000 Units consistingof 1,581,000 shares and warrants to acquire an additional 1,185,750 shares at$1.35 per share.  Casimir Capital, LP,the placement agent for the private placement received  $142,391 for their services or 9% of thegross proceeds.  In addition, CasimirCapital received 262,276 Warrants.  Thisprivate placement resulted in net proceeds to the Company of approximately$1,173,000.  The funds are to be utilizedin the furtherance to the Company’s M&A program, capital equipmentpurchases and to meet general working capital requirements.  The issued shares and shares underlying thewarrants were subsequently registered under an SEC approved S-1 Registrationfiling.

 

b.        Commonshares reserved at December 31, 2004, are as follows:

 
| Common Shares Preferred        |   |      |   |
|--------------------------------|--------|-----------|--------|
| 1991 Stock option plan         |   | 314,500   |   |
| 2000 Stock option plan         |   | 6,000,000 |   |
| Convertible preferred stock    |   | 1,340,000 |   |
| Subordinated convertible notes |   | 3,500,000 |   |
| Warrants                       |   | 4,473,026 |   |

 

c.         Preferredstock

 

The Company has authorized 1,000,000shares of preferred stock, no par value, which the Board of Directors has theauthority to issue from time to time in a series.  The Board of Directors also has the authorityto fix, before the issuance of each series, the number of shares in each seriesand the designation, preferences, rights and limitations of each series.  Series A consist of 500 shares at a statedvalue of $1,000 per share convertible into common shares at the rate of $1.00per share.  Series B consist of 2,100shares at a stated value of $1,000 per share convertible into common shares atthe rate of $2.50 per share.

 

For the years ended December 31, 2004, 2003and 2002, the Company paid a common stock dividend on preferred stock equal to$165,000, $54,000 and $121,000, respectively.

 

d.        Stockoptions

 

TheCompany has adopted two stock option plans that provide for the granting ofoptions to employees, officers, directors, and others who render services tothe Company.  Under these plans in theaggregate, options to purchase no more than 6,000,000 shares of common stockmay be granted, at a price that may not be less than the fair market value pershare.

 

The Equity Compensation Program authorizesthe issuance of incentive stock options. At the annual Shareholders’ meeting held in 2004, shareholders’ approveda recommendation by the Board to increase the number of options to be grantedunder the 2000 Equity Compensation Program, from 4,000,000 to 6,000,000.  The 2000 equity compensation plan expires inAugust 2010.

 

F-18

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A summary of the status of the Company’sprogram as of December 31, 2004, 2003 and 2002, and changes during the yearsthen ended is presented below:

 
| ** **                                                   | ** ** | **Years Ended**  | ** ** |
|--------------------------------------------------------------|------------|------------------|------------|
| ** **                                                   | ** ** | **December 31,** | ** ** |
| ** **                                                   | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Fixed Stock Options**                                      | ** ** | **Shares**       | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding, beginning of year                               |       | 1,449,100        |       | $ | 1.42 |   | 1,173,800 |   | $ | 1.69 |   | 698,600 |   | $ | 2.20 |   |
| Granted                                                      |       | 680,000          |       | 0.74 |   | 299,900 |   | 0.50 |   | 475,200 |   | 0.94 |   |
| Exercised                                                    |       | —           |       | — |   | — |   | — |   | — |   | — |   |
| Expired                                                      |       | —           |       | — |   | — |   | — |   | — |   | — |   |
| Forfeited                                                    |       | (7,500           | )          | .50 |   | (24,600 | ) | 2.26 |   | — |   | — |   |
| Outstanding, end of year                                     |       | 2,121,600        |       | 1.21 |   | 1,449,100 |   | 1.42 |   | 1,173,800 |   | 1.69 |   |
| Options exercisable, end of year                             |       | 1,301,047        |       | 1.53 |   | 881,424 |   | 1.88 |   | 402,163 |   | .98 |   |
| Weighted-average fair values of options granted  during year |       |             |       | $ | .67 |   |   |   | $ |  .48 |   |   |   | $ | .91 |   |

 

Warrants outstanding expirefrom 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 |   |

 

**12.****                   Shareholders’Equity**

 

The following table summarizes informationabout stock options outstanding at December 31, 2004:

 
| ** **                    | ** ** | **Options Outstanding**  | ** ** | **Options Exercisable**                             | ** ** |
|-------------------------------|------------|--------------------------|------------|-----------------------------------------------------|------------|
| **Range of   Exercise Price** | ** ** | **Number   Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number   Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| ** **                    | ** ** | ** **               | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| $0.50 - $2.00                 |       | 1,964,500                |       | 8.42  yrs.                                          |       | $ | 1.01 |   | 1,143,947 |   | $ | 1.23 |   |
| $3.00 - $5.00                 |       | 157,100                  |       | 6.27 yrs.                                           |       | $ | 3.72 |   | 157,100 |   | $ | 3.72 |   |

 

F-19

----

 

**13.****                  ****Fair Value of FinancialInstruments**

 

Themethods and assumptions used to estimate the fair value of the followingclasses 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-term debt, including the currentportion, for notes payable and subordinated convertible debentures, wasestimated using a discounted cash flow analysis, based on the Company’s assumedincremental borrowing rates for similar types of borrowing arrangements.  The carrying amount of variable and fixedrate debt at December 31, 2004 approximates fair value.

 

**14.****                   QuarterlyData** (Unaudited)

 

Summary quarterly results were as follows:

 
| **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       |       | (0.1       | )          |
| Net Income (loss) per share - Diluted (a) |       | (0.09     | )          | (0.08      | )          | .01       |       | (0.1       | )          |
|                                           |            |           |            |            |            |           |            |            |            |  |  |  |  |

 
| **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     | )          | (0.01      | )          |
| Net loss per share - Diluted (a) |       | (0.07     | )          | (0.09      | )          | (0.07     | )          | (0.01      | )          |
|                                  |            |           |            |            |            |           |            |            |            |  |  |  |  |

 

----

(a)          Quarterly income per share amounts may nottotal to the annual amounts due to changes in weighted-average sharesoutstanding during the year.

 
| **Year 2002**                      | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
|------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|------------|------------|
|                               |       |      |       |       |       |      |       |       |       |
| Net sales                          |       | $         | 1,220,465  |       | 1,685,964  |      | 1,344,569  |       | 1,318,120  |   |
| Gross profit                       |       | 46,599    |       | 425,675    |       | 237,553   |       | 196,691    |       |
| Net (loss)                         |       | (476,688  | )          | (201,609   | )          | (409,056  | )          | (628,619   | )          |
| Net income per share - Basic (a)   |       | (0.09     | )          | (0.06      | )          | (0.08     | )          | (0.12      | )          |
| Net income per share - Diluted (a) |       | (0.09     | )          | (0.06      | )          | (0.08     | )          | (0.12      | )          |
|                                    |            |           |            |            |            |           |            |            |            |  |

 

**15.****                   SpecialCharges**

 

During 2003, the Company accrued certainexpenses related to the relocation of 17 employees from Bethel, CT to itsfacility in Northvale, NJ.  The specialcharges accrued amounted to $107,000 ($.02 per share on a basic and dilutedbasis) and included the costs for permanent relocation, stay on bonuses andrelocation bonuses, anticipated to be expended in the next fiscal year.

 

During 2003, the Company determined thatthere was excess inventory, relative to forecasted future needs, of certaincrystals and solutions.  Based on thisdetermination, a reserve was taken in the amount of $475,000 ($.09 per share ona basic and diluted basis) in order to recognize the diminished future economicbenefit of the inventory.

 

**16.****                   Acquisition**

 

In October 2004, the Company acquired100% of the stock of MRC Precision Optics, Inc. a metal optics manufacturerlocated in Sarasota, Florida.

 

F-20

----

 

The assets acquired and liabilitiesassumed were recorded at estimated fair values as determined by the Company’smanagement based on information currently available and on current assumptionsas to future operations.  The Company hasobtained independent appraisals of the fair values of the acquired property,plant & equipment.  A summary of theassets acquired and liabilities assumed in the acquisition follows: 

 

THESE ESTIMATES ARE PRELIMINARY AS PERTAINTO INTANGIBLE ASSETS AND GOODWILL

 
| Estimated fair values:        |   |       |    |
|-------------------------------|--------|------------|---------|
| Current Assets                |   | $          | 418,798 |   |
| Property Plant and equipment  |   | 1,189,142  |    |
| Intangible Assets             |   | 653,631    |    |
| Goodwill                      |   | 1,418,893  |    |
| Total Assets Acquired         |   | 3,680,464  |    |
| Current Liabilities assumed   |   | (1,068,130 | )       |
| Long Term Liabilities assumed |   | (2,087,334 | )       |
| Net assets acquired           |   | $          | 525,000 |   |

 

The operations of MRC were included inthe consolidated financial statements as of October 19, 2004.

 

The following proforma results weredeveloped assuming the acquisition of MRC occurred January 1, 2003.

 
| ** **                       | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|
|                             |       |       |       |       |       |
| Revenue                          |       | $          | 11,314,000 |       | $          | 8,655,000 |   |
| Net loss                         |       | (1,012,000 | )          | (2,271,000 | )          |
| Basic and diluted loss per share |       | $          | (.18       | )          | $          | (.43 | ) |

 

MRC was acquired in accordance with theCompany’s strategy to grow via acquisition of Photonics companies servingdiverse industries, expanding the reach and breadth of critical componentproducts and services PPGI provides to industry.  MRC met various PPGI acquisition criteria,which include reasonable expectations for positive earnings and cash flowwithin one year of the acquisition and reputation for high quality andperformance in the customer space.

 

Several factors contributed thedetermination of the negotiated purchase price and deal structure.  Among them were the value of assets acquiredand liabilities assumed, historical EBITDA and projected EBITDA.

 

PPGI included the financial results ofMRC in its consolidated 2004 financial results from the date of the purchase,October 19, 2004 through December 31, 2004.

 

As a contingent portion of the deal, Mr.Frank Montone is eligible to receive payments of up to $60,000 per year basedon goals for annual and cumulative cash flow that will be generated by theoperations of MRC for five years commencing January 1, 2005.

 

In November 2003, the Company acquiredthe assets and liabilities of Laser Optics, Inc. an optical manufacturing andthin films coating operation.  Capitalassets along with the employees of Laser Optics, Inc, were relocated fromBethel, CT to the Company’s facility in Northvale, NJ during the second quarterof 2004.

 

The assets acquired and liabilitiesassumed were recorded at estimated fair values as determined by the Company’smanagement based on information currently available and on current assumptionsas to future operations.  The Company hasobtained independent appraisals of the fair values of the acquired property,plant & equipment.  A summary of theassets acquired and liabilities assumed in the acquisition follows:

 

F-21

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| Estimated fair values      |   |       |    |
|----------------------------|--------|------------|---------|
| Assets acquired            |   | $          | 849,725 |   |
| Liabilities assumed        |   | (1,158,422 | )       |
| Intangible assets acquired |   | 446,000    |    |
| Net assets acquired        |   | $          | 182,303 |   |

 

As a result of the acquisition, theCompany plans to incur integration expenses for the incremental costs toconsolidate activities at the Northvale, NJ location.  Generally accepted accounting principlesrequire that integration expenses that are associated with future revenues andhave future economic benefit must be expensed as incurred (see footnote 15).

 

During 2004, the Company reviewed aportion of the Laser Optics business unit dealing with catalogue sales ofoptics.  A determination was made that,since Laser Optics was a contract manufacturer, this product line did not fitthe business model for this unit.  Salesof catalog optics for FY 2004 were approximately $93,000 and resulted primarilyfrom optics manufactured, subsequent to the acquisition, for specific customerneeds.  As a result, there was relativelylittle movement of catalog inventory acquired as a result of the Laser Optics,Inc. acquisition in 2003.  The Company iscurrently in the process of identifying those former customers for catalogoptics who fit a pattern of an OEM purchaser. The current strategy calls for these customers to place blanket ordersfor optics they require as opposed to buying minimum amounts from stock.

 

As a result of this shift in strategy itwas determined that approximately $312,000 of catalog optics inventory acquiredin the asset purchase, in 2003 be reclassified to goodwill in October of 2004.

 

F-22

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REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTANTS ONSUPPLEMENTAL SCHEDULE

 

The audits referred to in ourreport dated February 28, 2005 relating to the consolidated financialstatements of Photonic Products Group, Inc. and subsidiaries, which iscontained in Item 8 in the Form 10K, include the audits of the financialstatement schedule listed in the accompanying Schedule II for the years endedDecember 31, 2004, 2003 and 2002.  Thisfinancial statement schedule is the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on this financial statement schedule based upon our audits.

 

It is our opinion suchfinancial statement schedule presents fairly, in all material respects, theinformation set forth therein.

 

 

HoltzRubenstein Reminick, LLP

Melville, NY

 

February 28,2005

 

F-23

----

 

Schedule II –Valuationand Qualifying Accounts

 

PHOTONIC PRODUCTS GROUP, INC.

SCHEDULE II 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, 2004       |       | $                                    | 40,000     |                                           |       |                  |       |           |       |                           | $          | 40,000 |   |
| Year ended December 31, 2003       |       | 40,000                               |       |                                           |       |                  |       |           |       | 40,000                         |       |
| Year Ended December 31, 2002       |       | 54,000                               |       |                                           |       |                  |       | 14,000         |       | 40,000                         |       |
|                               |       |                                 |       |                                           |       |                  |       |           |       |                           |       |
| Reserve for Inventory Obsolescence |       |                                 |       |                                           |       |                  |       |           |       |                           |       |
| Year ended December 31, 2004       |       | $                                    | 600,000    |                                           | $          | 392,000               |       |           |       |                           |       | $ | 992,000 |   |
| Year ended December 31, 2003       |       | 125,000                              |       | 475,000                                        |       |                  |       |           |       | 600,000                        |       |
| Year Ended December 31, 2002       |       | 125,000                              |       |                                           |       |                  |       |           |       | 125,000                        |       |
|                                    |            |                                      |            |                                                |            |                       |            |                |            |                                |            |  |  |  |

 

F-24

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