NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Nature of Business

Organization and operations

Electric & Gas Technology, Inc.("the Company" or "ELGT") was organized under the laws of the State of Texas on March 18, 1985, to serve as a holding company for operating subsidiary corporations. The Company continued in this manner until 2004, at which time the decision was made for the corporate entity to become more actively involved in the management of subsidiary operations with the objective being a more synergistic use of technical resources and operating capabilities. Near the end of fiscal 2004, the Company relocated all its operations, including corporate staff, into a single 144,000 square foot facility which it already occupied. In addition to achieving improvements in communications and utilization of resources, this also allowed the Company to proceed with the sale of three commercial property locations.

The history of the Company's progression, including acquisition and divestiture activities is as follows:

In 1985, the Company (i) acquired from Commercial Technology, Inc. "COMTEC"), an affiliated company, all of the stock of Reynolds Equipment Company ("Reynolds") for stock of the Company and (ii) acquired from a subsidiary of COMTEC all of the stock of Retech, Inc. ("Retech") [formerly Test Switch Technology, Inc.("Test Switch"), formerly Superior Technology, Inc. ("Superior")] for stock of the Company.

In 1988, the Company acquired 85% (and subsequently 100%) of the stock of Data Automation Company, Inc. ("DAC") from Video Science Technology, Inc., formerly an affiliate of COMTEC and of the Company. DAC owned 100% of Domac Plastics, Inc. ("Domac") and Logic Design Metals, Inc. ("Logic"). Domac and Logic were subsequently sold. During 1992 Logic merged into DAC, its parent, and DAC changed its name to Logic Design Metals, Inc. and is referred to herein as "Logic".

In 1992, Fridcorp Plastics, Inc. ("Fridcorp") was acquired for stock of the Company. Fridcorp was subsequently sold in December 1997.

In 1992, Hydel Enterprises, Inc. ("Hydel") [formerly Stelpro Limited ("Stelpro")] was acquired for cash and stock of the Company. In 1995, Hydel acquired all of the outstanding capital stock of Hydel Engineering Limited ("Hydel Engineering") for cash and notes payable. In July 2004, substantially all of the assets of Hydel were sold for cash.

In 1992, Superior Magnetics, Inc. ("SMI") was formed by the Company to acquire the operating assets of the business operations of Denison Magnetics of Texas Instruments Incorporated, which was purchased for cash and deferred payments.

In 1996, the Company incorporated Atmospheric Water Technology, Inc. (Formerly Atmospheric and Magnetics Technology, Inc.) ("AWT") to undertake the Company's venture into the water industry.

In January of 2003, the Company acquired the assets of Garland Manufacturing Company and changed the name to Logic Metals Technology, Inc. ("LMT").

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Nature of Business (continued)

The Company presently is the owner of 100% of Reynolds, 80% of LMT, and 91.5% of AWT. Through its subsidiaries, the Company operates in three distinct business segments: (1) Utilities Products, (2) Contract Manufacturing and (3) Water Production. In the Utilities sector, the Company designs, manufactures and markets products for natural gas measurement, metering and odorization. In the Contract Manufacturing sector, the Company provides metals fabrication and assembly for a diverse customer base, including telecom and networking cabinetry, electrical controls, and other functional and aesthetic sheet metal applications. In Water Production, the Company has developed a line of products that extract water from the atmosphere, and filter and purify it for drinking purposes. However, the Company is not actively pursuing the sale of the Watermaker(TM) products, but rather is seeking a proactive partner to assume the responsibilities of marketing and production. The Company's Headquarters are located at 3233 W. Kingsley Road, Garland, Texas, 75041. Its telephone number is
(972) 870-3223 and its facsimile number is (972)271-8925.

In order to meet the Company's cash requirements without suffering significant shareholder dilution, the decision was made during fiscal 2004 to sell substantially all of the assets of the Company's Canadian subsidiary, Hydel. This transaction was completed with the proceeds from the sale being approximately $4,000,000 (USD). These proceeds significantly improved the Company's balance sheet and allowed it to, among other things, reduce debt and trade payables, enter into a much more attractive banking facility with an operating line better suited to its needs, and obtain the necessary equipment leasing to support its expansion goals. All together these actions place the Company in a much better position to achieve its goals of revenue and profitability growth.

ELGT has recently entered into an asset based credit facility which provides for a working line of up to $1,750,000. Management believes that this is sufficient to support the Company's current growth requirements. However, management believes that carefully chosen acquisitions could significantly accelerate its growth plans, and that the actions taken in fiscal 2004 have better positioned it to attract target companies as well as investment capital that may be needed to support those plans. There can, of course, be no assurances that the Company will be successful in raising additional investment or working capital, if needed, and failure to do so would slow its growth.

2. Accounting Policies

A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.

Basis of Accounting

The accounts are maintained and the consolidated financial statements have been prepared using the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. Accounting policies (continued)

Reclassifications

Certain reclassifications have been made to the 2003 consolidated financial statements to conform to the 2004 presentation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported revenues and expenses. Actual results may well vary from the estimates that are used.

Cash Equivalents

For purposes of the statement of cash flows, the Company considers any short-term cash investments with an original maturity of three months or less to be a cash equivalent.

Accounts Receivable

The Company performs periodic credit evaluations of its customers' financial condition and extends credit to virtually all of its customers on an uncollateralized basis. Credit losses to date have been insignificant and within management's expectations. The Company provides an allowance for doubtful accounts that is based upon a review of outstanding receivables, historical collection information, and existing economic conditions. Normal accounts receivable are due 30 days after the issuance of the invoice. Receivables past due more than 120 days are considered delinquent. Delinquent receivables are written off based on individual credit evaluation and specific circumstances of the customer. As of July 31, 2004, management has recorded an allowance for bad debts of $20,094. In the event of complete non-performance by the Company's customers, the maximum exposure to the Company is the outstanding accounts receivable balance at the date of non-performance.

Inventories

Inventories, consisting of raw materials, work-in-process and finished goods, are stated at the lower of cost or market as determined by the first-in, first-out method.

Depreciation and Amortization

Depreciation and amortization are provided in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives. Leasehold improvements are amortized over the lives of the respective leases or the service lives of the improvements whichever is shorter. Leased property under capital leases is amortized over the lives of the respective leases or over the service lives of the assets for those leases which substantially transfer ownership. The straight-line method of depreciation is followed for newly acquired assets and straight-line and accelerated methods have been used for older assets for financial reporting purposes, accelerated methods are used for tax purposes.

                                                                  Years
                                                                  -----
Machinery and equipment                                           3 -15
Buildings and improvements                                        4 -33
Furniture, fixtures and equipment                                 3 -10

Research and Development Costs

In accordance with Statements of Financial Accounting Standards ("SFAS") No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, all costs incurred to establish the technological feasibility are research and development costs. In accordance with this provision, the Company has expensed approximately $217,000 of research and development related expenses from inception through February 2003. The costs that were expensed related to the creation a working model from the white paper created by the engineer, mainly related to the labor of the technicians and programmers, with a small portion being related to various computer components. The Company reached technological feasibility in February 2003 and a working model was the product's first independent usage. Costs incurred subsequent to February 2003 aggregating $65,842 and $132,000 for the year ended July 31, 2004, and 2003, respectively, for such software development have been capitalized and will be amortized over a 5 year period.

Income Taxes

Deferred income taxes are determined using the liability method in accordance with SFAS No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.

Earnings (Loss) Per Share

Basic earnings (loss) per share is calculated by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if accounts or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. For the years ended July 31, 2004 and 2003, dilutive earnings (loss) per common share is not presented since there exist no dilutive common stock equivalents.

Stock-Based Compensation

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. Accounting policies (continued)

Stock-based compensation is determined in accordance with SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 defines a fair value based method of accounting for an employee stock option or similar equity instrument and encourages all entities to adopt that method of accounting for all of their employee stock compensation plans. Under the fair value based method, compensation cost is measured at the grant date based on the value of the award. However, SFAS No. 123 also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by the Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees.

Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock. Entities electing to remain with the accounting in APB Opinion No. 25 are required to make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied. The Company has elected to measure compensation cost for options issued to employees under APB Opinion No. 25. Options issued to non-employees are measured in accordance with SFAS No. 123.

Revenue and Expense Recognition

The Company recognizes revenue when title passes to its customers upon shipment of its products for final delivery. Expenses are recognized in the period in which incurred.

Foreign Currency Translation

The financial statements are presented in United States dollars. In accordance with SFAS No. 52, Foreign Currency Translation, foreign denominated monetary assets and liabilities are translated to their United States dollar equivalents using foreign exchange rates which prevailed at the balance sheet date. Revenue and expenses are translated at average rates of exchange during the year. Related translation adjustments are reported as a separate component of shareholders' equity, whereas gains or losses resulting from foreign currency transactions are included in results of operations. During the year ended July 31, 2004, the Company sold its foreign subsidiary. The foreign currency translation adjustment was recognized as part of the loss on sale of discontinued operations.

Comprehensive Income

The Company reports comprehensive income in accordance with the provisions of SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for the reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive loss consists of an accumulated net loss comprised of foreign currency translation adjustments and pension liability adjustment and is presented in the accompanying consolidated statement of changes in stockholders' equity. SFAS No. 130 requires only additional disclosures in the financial statements; it does not affect the Company's financial position or results of operations.

Impairment of Long-Lived Assets

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. Accounting policies (continued)

The Company periodically evaluates the net realizable value of long-lived assets, including property, equipment and investments, relying on a number of factors, including operating results, business plans, economic projections and anticipated future cash flows. Impairment is assessed by evaluating the estimated undiscounted cash flows over the asset's remaining life. If estimated cash flows are insufficient to recover the investment, an impairment loss is recognized.

Product Warranties

The Company offers a two and four year warranty for certain utility products. The specific terms and conditions of those warranties vary depending upon the product sold. The Company provides a basic limited warranty, including parts and labor, for those products for two or four years. The Company's warranty expense has been minimal.

Shipping and Handling Costs

In accordance with the Emerging Issue Task Force ("EITF") issue 00-10, "Accounting for Shipping and Handling Fees and Costs", the Company includes shipping and handling fees billed to customers as a credit (offset) to shipping costs in operating expenses and shipping and handling costs associated with outbound freight in operating expenses in the accompanying consolidated statements of operations. The shipping and handling costs associated with outbound freight in operating expenses were approximately $32,000 and $37,000 for the fiscal years ended July 31, 2004 and 2003 respectively.

Affiliates

The Company is affiliated with various entities (together, the "Affiliates"). The Affiliates are primarily owned by the Company's Chairman, S. Mort Zimmerman, and his family. See Note 12 for discussion of related-party transaction with the Affiliates.

3. Inventories

Inventories consisted of the following at July 31, 2004:

Raw materials                        $  576,080
Work-in-process                         128,259
Finished goods                          362,367
                                     ----------
                                     $1,066,706
                                     ==========

4                                   Property, Plant and Equipment

        Buildings and improvements                  $   139,278
        Machinery and equipment                       1,644,155
        Furniture, fixtures & equipment                 574,807
                                                    -----------
                                                      2,358,240
        Less accumulated depreciation                (1,015,117)
                                                    -----------

        Net plant, property and equipment           $ 1,343,123
                                                    ===========


5.    Notes Payable

Notes payable consisted of the following at July 31, 2004.

(a) Note payable, bank Reynolds consists of a line of credit with a maximum loan amount of $400,000, payable on demand; bearing interest at the bank's prime rate plus 2.00%; secured by trade receivables and inventories, and guaranteed by Dan Zimmerman, an officer of the Company.
(b) Note payable, bank LMT consists of a line of credit with a maximum loan amount of $450,000, payable on demand; bearing interest at the bank's prime rate plus 2.00%; secured by trade receivables and inventories, guaranteed by the president of LMT, S. Mort Zimmerman, an officer of the Company and by Interfederal Capital, Inc., an affiliate.
(c) A note payable to a bank as the result of the loss of a lawsuit. The note matures in July of 2005, and consists of interest only payments with an annual rate of 7.00%. (d) A note payable to an individual bearing interest at an annual rate of 24.00% due upon funding of the sale of Hydel.

Information relating to short-term borrowing is as follows:

Balance at end of year                        $1,486,698
Maximum borrowing                             $1,509,936
Average balance                               $1,041,882
Average effective interest rate                     5.7%

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5. Notes Payable (continued)

Maximum borrowings are the maximum amount of aggregate short-term borrowing outstanding at any month end during the year. The average short-term borrowings were computed by dividing the aggregate borrowing for the year by the number of days the borrowings were outstanding during the year. The weighted average rate was computed by dividing the average borrowing into total interest on short-term borrowing.

6. Long-term Obligations

Long-term obligations consist of the following at July 31, 2004:

Mortgage note payable due in monthly payments of principal and interest at 2.75% above prime from October 10, 1994 over twenty years. Guaranteed by the Small Business Administration. (a) $312,291

Note payable to a bank bearing interest at 5.2%, due in
monthly principal and interest installments of $9,118 until November 4, 2007, secured by a certificate of deposit. Subsequent to July 31, 2004, the certificate of deposit was converted to cash and the proceeds were used to pay this note payable balance in full. (a) 334,853

Note payable to a bank, bearing interest at 5.44%, due in monthly installments of $5,854 until March 5, 2006, secured by certain equipment. Guaranteed by an officer of ELGT and an officer of LMT and Interfederal Capital, Inc. an affiliate. (c) 282,867

Note payable to bank bearing interest at an effective rate of 5.5%, principal and interest are due in monthly installments of $10,357 until July 2007, secured by certain equipment. Face amount of loan is $322,493 (c) 344,154

Note payable (unsecured) to an individual, imputed interest at an effective rate of 5.5%, principal and interest are due in monthly installments of $1,000 until January 2010. (c) 56,842

Mortgage payable to a bank bearing interest at 6.27%, principal and interest are due in monthly installments of $3,186 until February 2018, secured by the building.
Guaranteed by Dan Zimmerman, an officer of the Company. (b) 372,124

Various other installment notes and
capitalized lease obligations                     12,277
                                             -----------

Total amount of obligations                    1,715,408

Less current maturities                         (298,172)
                                              -----------

                                              $ 1,417,236
                                              ===========

The prime rate was 4.25% at July 31, 2004.

The aggregate annual principal payments are as follows:

        Year Ending July 31,

      2005                                         $  298,172
      2006                                            507,609
      2007                                            278,291
      2008                                             92,517
      2009                                             59,445
      Thereafter                                      479,374
                                                   ----------
      Total                                        $1,715,408
                                                   ==========

(a) ELGT
(b) Reynolds

(c) LMT

7. Accrued Liabilities

Accrued liabilities consisted of the following at July 31, 2004.

Payroll                                   $307,270
Vacation pay                                57,329
Taxes                                       51,417
Interest                                    17,800
Miscellaneous                              227,081
                                           -------

Total accrued liabilities                 $660,897
                                          ========

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. Commitments and Contingencies

During the year ended July 31, 2004, the Company entered into an agreement to lease a building owned by an affiliate at a rate of $30,000 per month on a month to month basis. The rent due was calculated retroactively from January 1, 2003 through July 31, 2004. Rent expense for the years ended July 31, 2004 and 2003 was $481,600 and $126,000 respectively.

See note 12.

Litigation

Other

Reynolds has no insurance against risk of loss that may result from product liability. Management considers such potential losses as remote; accordingly, no provision has been made in the consolidated financial statements for any claims or possible claims that may arise.

Concentration of Credit Risk

The Company invests its cash and certificates of deposit primarily in deposits with major banks. Certain deposits are in excess of federally insured limits. The Company has not incurred losses related to its cash.

The Company sells a broad range of products to the electric and gas utility industries, and performs contract manufacturing for electronics and communications companies in the form of sheet metal forming and assembly. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base. As of July 31, 2004, approximately 49%and 17% of the accounts receivable balance is due from two customers. Ongoing credit evaluations of customers' financial condition are performed and, generally, no collateral is required. The Company maintains reserves for potential credit losses and such losses have not exceeded management's expectations.

Fair Value of Financial Instruments:

The estimated fair value amounts have been determined by the Company, using available market information and appropriate valuation methodologies. The fair value of financial instruments classified as current assets or liabilities including cash and cash equivalents, receivables and accounts payable approximate carrying value due to the short maturity of the instruments. The fair value of short-term and long-term debt approximate carrying value based on their effective interest rates compared to current market rates.

---------------------------------------------------------------------
                                 2004                 2003
                                 ----                 ----
---------------------------------------------------------------------
Customer A                        41%                 21%
---------------------------------------------------------------------
Customer B                        14%                  *
---------------------------------------------------------------------

* Less than 10%

10. Benefit Plans

Retech sponsored a defined benefit pension plan that covered all of its hourly employees. The plan called for benefits to be paid to eligible employees at retirement based upon years of service and compensation rates near retirement. Retech's policy is to fund pension expenses accrued.

Pension expense for the years ended July 31,:

                                                2004        2003
                                            ---------   ---------
Interest cost                               $  75,509   $  73,323
Actual return on assets held for the plan      74,534     (12,702)
Distribution to an affiliate                     --       100,000
Net amortization of prior service cost,
  transition liability and net gain             9,328      14,401
                                            ---------   ---------

Pension expense                             $ 159,371   $ 175,022
                                            =========   =========

The following sets forth the funded status of the plan and the amounts shown in the accompanying consolidated balance sheet at July 31, 2004:

Pension benefit obligations:
Vested                                                        $ 1,277,619
Non-vested                                                           --
                                                              -----------

Projected benefit obligation                                    1,277,619
Fair value of assets held in plan                                 266,095
                                                              -----------
Unfunded excess of projected benefit obligation
   over plan assets                                           $ 1,011,524

Unrecognized net transition obligation                        $      --
Unrecognized prior service costs                                     --
Unrecognized net loss                                           1,410,689
Pension (asset) liability recognized                             (399,165)
                                                              -----------

Accrued pension liability                                     $ 1,011,524
                                                              ===========
                                      F-22

Fair value of Plan asset at beginning of year          $ 293,712
Actual return on Plan assets                             (74,536)
Distribution to an affiliate                                --
Company contributions                                    100,652
Benefits paid                                            (53,733)
                                                       ---------
Fair value of Plan assets at end of year               $ 266,095
                                                       =========

The following is a summary of the components of net benefit cost for each year:

                                                           2004         2003
                                                        ---------    ---------

Interest cost                                           $  75,509    $  73,323
Expected return on Plan assets                            (29,467)     (32,274)
Amortization of prior service cost                          9,326       14,401
Amortization losses/gains                                  50,807       43,095
                                                        ---------    ---------

Net periodic benefit cost                               $ 106,175    $  98,545
                                                        =========    =========

The Company has recognized a minimum pension liability for the under-funded plan. The minimum liability is equal to the excess of the projected benefit obligation over plan assets. A corresponding amount is recognized as either an intangible asset or reduction of stockholders' equity. The Company recorded liabilities of $1,410,689 and $1,177,342, intangible assets of $0 and $9,326 and a stockholders' equity reduction of $1,410,689 and $1,168,016 as of July 31, 2004 and 2003, respectively. The Company must make its minimum required contribution of $218,359 to the plan no later than April 30, 2005.

During the fiscal year ending July 31, 2003, Interfederal Capital borrowed $100,000 from the Retech pension plan. The Company has not recorded the loan, nor has the plan assets included such loan.

Retech will terminate this plan upon funding its pension liability. The plan assets consist of common stock equities and government securities administered by the trust department of Comerica Bank, Dallas, Texas.

The assumed long-term rate of investment return and the interest rate for obligations used in determining the actuarial present value of accumulated plan benefits was 8.0% and 6.0% at July 31, 2004 and 8.0% and 6.50% at July 31, 2003, respectively.

The Company has discontinued contributions to the defined contribution (401-k) plan.

--------------------- -----------------------
2005                                $ 51,000
--------------------- -----------------------
2006                                  56,000
--------------------- -----------------------
2007                                  63,000
--------------------- -----------------------
2008                                  73,000
--------------------- -----------------------
2009                                  88,000
--------------------- -----------------------

The Company has an Incentive Stock Option Plan. The option price must be at least 100% of the fair market value of the common stock at the time options are granted. If the person to whom the option is granted is more than a 10% shareholder of the Company, the option price must be at least 110% of the fair market value of the stock at the time options are granted. No employee may be granted options in any calendar year greater than a value of $100,000, plus certain carry-over allowances from the previous years, as defined in the Plan. Each option becomes exercisable only after two years continued employment following the date the option is granted. The Plan provides for 400,000 shares of common stock.

There are currently no options outstanding.

                                                          2004         2003
                                                        ---------    ---------
Expected provision (benefit) for federal income taxes   $(754,000)   $(248,000)
Prior years taxes (Refund)                                   --           --
Unavailable loss carrybacks                               754,000      248,000
                                                        ---------    ---------

Income taxes (benefit)                                  $    --      $    --
                                                        =========    =========

The Company files a consolidated tax return with its U.S. subsidiaries. The Company has a net operating loss carry-forward of approximately $6,700,000, which will expire from 2015 to 2018.

The components of the net deferred tax (assets) liability included in the consolidated balance sheet are as follows at July 31, 2004:

Net operating loss carryforward                    $(2,600,000)
Depreciation                                           188,000
Provision for losses                                (1,150,000)
Valuation allowance                                  3,562,000
                                                   -----------
                                                   $     --
                                                   ===========

The Company has provided a valuation allowance against its deferred tax asset as it has determined that it is more likely than not the temporary differences will not be utilized for tax purposes.

12. Related Party Transactions

The following is a summary of advances to and from affiliated companies at July 31,:

Interfederal Capital, Inc.                                           $ 258,609
IFC Industries                                                          43,589
M&M Trans Exchange                                                     364,989
Comtec, Inc.                                                            18,014
                                                                     ---------
Total receivable from affiliates                                       685,201

Glauber Management                                                     (57,348)
S. Mort Zimmerman                                                     (333,699)
Daniel A. Zimmerman                                                    (22,500)
                                                                     ---------
Total due to affiliates                                               (413,547)
                                                                     ---------
Total                                                                $ 271,654
                                                                     =========

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. Related Party Transactions (continued)

Interfederal Capital, Inc. (Interfederal), a Texas corporation, is owned by S. Mort Zimmerman and his four (4) children. The Company paid Interfederal $0, and $82,800 in management fees for the years ended July 31, 2004 and 2003, respectively. The fees were included in S. Mort Zimmerman's annual compensation. The Company leased facilities owned by Interfederal at a rate of $30,000 per month, calculated retroactively. Marketable securities with a fair market value of $56,965 were sold to Interfederal. Accumulated borrowings for the year ended July 31, 2004 was $258,609.

Interfederal has guaranteed LMT's line of credit and equipment loan that were obtained during the year ended July 31, 2003.

Interfederal Capital Industries, Inc. ("IFC") a Texas corporation and a subsidiary of Interfederal, has net balances due to the Company of $43,589 for the year ended July 31, 2004.

Electric & Gas Technology, Inc. occupies a facility owned by Interfederal Capital on a month-to-month basis and paid rent of $481,600 and $126,000 for the years ended July 31, 2004 and 2003, respectively. The Company has an agreement, subject to certain conditions, to purchase the building currently occupied by LMT and AWT at an estimated cost of $3.2 million from Interfederal Capital.

M&M TransExchange, Inc. ("M&M"), a Texas corporation, wholly owned by S. Mort Zimmerman has balances due to the Company of $364,989 for the year ended July 31, 2004.

The payable to S. Mort Zimmerman of $333,699 for the year ended July 31, 2004 is the accrued but unpaid balance due for compensation.

Comtec, Inc., a Texas corporation and a subsidiary of Interfederal, has a balance due of $18,014 for the year ended July 31, 2004.

Glauber Management, Inc. ("Glauber") is wholly owned by S. Mort Zimmerman. The Company has net payable to Glauber of $57,348 at the year ended July 31, 2004.

The Company has pledged a certificate of deposit in the amount of $100,000 for a loan in the name of DOL, Inc., a publicly held corporation in which Electric & Gas Technology, Inc. owns a one-third equity interest.

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. Segment Information

The Company operates principally in three industries: Utilities, Contract Manufacturing and Water Production. Operations in the Utilities industry involve the development, manufacture, and sale of gas meters, gas measurement equipment and other equipment for the utility industry. The Contract Manufacturing segment provides contract metal fabrication and assembly for a variety of industries, but with a focus on the telecom and utilities industries. Operations in the Water Production industry involve equipment to extract, filtrate and enhance water from the atmosphere.

Following is a summary of segment information for the years ended July 31,:

                                                         2004           2003
                                                     -----------    -----------
Sales to unaffiliated customers:
  Water Production                                   $    80,307    $   474,431
  Utilities                                            1,819,205      2,613,235
  Contract Manufacturing                               4,536,303      2,210,334
                                                     -----------    -----------
                                                     $ 6,435,815    $ 5,298,000
Operating income (loss):
  Water Production                                   $  (273,395)   $    32,799
  Utilities                                             (404,080)       143,461
  Contract Manufacturing                                 357,753       (280,787)
                                                     -----------    -----------
                                                        (319,722)      (104,527)
General corporate expenses                            (1,722,911)      (806,349)
Other income (expense), net                             (473,642)      (576,714)
                                                     -----------    -----------
Loss from continuing operations                       (2,516,275)    (1,487,590)
Discontinued operations                                 (474,366)       257,366
                                                     -----------    -----------
                                                     $(2,990,641)   $(1,230,224)
                                                     ===========    ===========
Identifiable assets:
  Water Production                                   $     2,863
  Utilities                                            1,847,608
  Contract Manufacturing                               2,533,267
                                                     -----------
Total Segment assets                                   4,383,738
General corporate assets                                 768,302
                                                     -----------
Total assets of Continuing operations                  5,152,040
Assets of discontinued operations                      3,731,209
                                                     -----------
                                                                    $ 8,883,249
                                                                    ===========
Capital expenditures:
  Water Production                                   $      --      $       950
  Utilities                                               69,678        150,036
  Contract Manufacturing                                  62,625        599,471
  General corporate                                        4,985           --
                                                     -----------    -----------
                                                     $   137,288    $   750,457
                                                     ===========    ===========
Depreciation and amortization:
  Water Production                                   $       351    $       351
  Utilities                                               79,546         41,450
  Contract Manufacturing                                 194,207         94,300
  General corporate                                       16,251         22,051
                                                     -----------    -----------
                                                     $   290,355    $   158,152
                                                     ===========    ===========

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. Segment Information (continued)

Operating income (loss) represents sales less operating expenses for each segment and excludes income and expenses of a general corporate nature. Identifiable assets by segment are those assets that are used in the Company's operations within that industry but exclude investments in other industry segments. General corporate assets consist principally of corporate cash, receivables from affiliates, investments and furniture and fixtures within the corporate offices.

14. Acquisition

On January 1, 2003, the Company acquired 80% of the shares in LMT in exchange for 400,000 shares of the Company's common stock. The common stock was valued at $.43 per share, which was 60% of the average trading price for the month of December 2002. LMT is involved in metal fabrication. The financial results of LMT are included in the Contract Manufacturing segment. The acquisition was recorded under the purchase method, whereby LMT's net assets were recorded at estimated fair value and its operations have been reflected in the statements of operations since that date. The allocation of purchase price is as follows:

Assets:
Cash                                    $   38,548
Accounts receivable                        446,513
Inventories                                318,866
Equipment                                  709,649
                                        ----------
      Total assets                      $1,513,576

Liabilities:
Notes payable                           $  250,000
Accounts payable                           420,979
Accrued expenses                            86,517
Long-term debt                             570,834
Minority interest                           11,846
                                        ----------
          Net investment                $  173,400
                                        ==========

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. Discontinued operations

During the third quarter of fiscal 2004, the Company committed to pursue the disposition of the Canadian subsidiary, Hydel, within a one year timeframe. On July 30, 2004, the Company sold the assets of Hydel for $3,731,209. The sale of this subsidiary is accounted for as discontinued operations, in accordance with FAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" and, accordingly, amounts in the consolidated financial statements for all periods shown, reflect discontinued operations accounting. Revenue from discontinued operations was $8.4 million and $8.3 million for the years ended July 31, 2004 and 2003, respectively. Income (loss) from discontinued operations, net of taxes was ($474,366) and $257,366 for the years ended July 31, 2004 and 2003, respectively. For fiscal 2004, the loss from discontinued operations includes a $668,795 charge to reduce the carrying value of these assets and liabilities to their estimated fair market value, less costs to sell. Fair value is determined by using quoted market prices, when available, or other accepted valuation techniques. Any corporate expenses previously allocated to the discontinued operations have been absorbed by the remaining continuing operations, resulting in a restatement of operating income for the Contract Manufacturing, Utilities and Water Production segments.

On July 30, 2004, the assets of these discontinued operations consisting primarily of inventory, machinery and equipment were sold for $3,731,209. The proceeds were received by the Company in August 2004 and September 2004. As of July 31, 2004, the net assets of these discontinued operations was $1,213,853.

16. Assets held for sale.

During the fourth quarter of fiscal 2004, the Company actively began marketing for sale, the corporate facility, located in Dallas, Texas and the Reynolds' facility, located in Garland, Texas, in an effort to consolidate operations and reduce costs. In addition, the Company also included in assets held for sale, an idle facility located in Paris, Texas.

The total carrying value of the assets held for sale as of July 31, 2004 is $752,865 and is included in long-term assets.

The following is the carrying value of assets held for sale and the corresponding liabilities at July 31, 2004:

                Carrying         Current        Long-term         Total
                 value         liabilities     liabilities     Liabilities
               ----------      ----------      ----------      ----------
Corporate
building       $  221,133      $  459,936      $     --        $  459,936
Garland
building           84,622          14,954         357,171         372,125
Paris
building          447,110          21,468         290,823         312,291
               ----------      ----------      ----------      ----------
Total          $  752,865      $  496,358      $  647,994      $1,144,352
               ==========      ==========      ==========      ==========

ELECTRIC & GAS TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17. Fourth Quarter Results

During the fourth quarter of 2004, the Company closed the sale of essentially all of the assets of Hydel Enterprise, Inc for a total cash price of $3,731,209, which was paid in August and September of 2004. Hydel was the Canadian subsidiary manufacturing electrical meter boxes, pole line equipment and pressed metal products.