10QSB 1 a05-9501_110qsb.htm 10QSB

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-QSB

ý		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		For the Quarterly Period Ended April 2, 2005.

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		For the transition period from to

Commission File No. 1-6635

INNOVATIVE MICRO TECHNOLOGY, INC.

(Exact name of registrant as specified in its charter)

Delaware		95-1950506
(State or other jurisdiction of incorporation or organization)		(I. R. S. Employer Identification No.)

75 Robin Hill Road, Goleta, California 93117

(Address of principal executive offices)

Issuer’s telephone number: (805) 681-2800

Check whether the issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý No o

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS

Check whether the registrant filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court.

Yes ý No o

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 6,953,880 shares of $.0001 par value common stock as of May 13, 2005. In addition, the Company has outstanding 1,000,000 shares of Series A-1 Convertible Preferred Stock, which is currently convertible into 5,666,700 shares of common stock at the option of the holders.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

The unaudited financial statements included in this report have been prepared by Innovative Micro Technology, Inc. (the “Company” or “IMT”) pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The unaudited condensed financial statements and selected notes included therein should be read in conjunction with the audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-KSB for the fiscal year ended October 2, 2004.

The following unaudited financial statements reflect all adjustments, consisting only of normal and recurring adjustments, which, in the opinion of management, are necessary to present fairly the financial position and results of operations for the periods presented.

INNOVATIVE MICRO TECHNOLOGY, INC.

Statements of Operations - Unaudited

(In thousands, except per share data)

	Three Months Ended April 2, 2005			Three Months Ended March 27, 2004			Six Months Ended April 2, 2005			Six Months Ended March 27, 2004

Net revenue
MEMS and Other	$	1,686		$	2,074		$	5,588		$	4,622
Rental Income	136			132			268			263
	1,822			2,206			5,856			4,885

Cost of revenues
MEMS and Other (including stock-based compensation of $47 for the periods ended March 27, 2004)	2,513			2,515			6,055			5,606
Expenses applicable to rental income	35			36			70			66
	2,548			2,551			6,125			5,672
Gross profit (loss)	(726		)	(345		)	(269		)	(787		)

Research and development expenses (including stock-based compensation of $40 for the periods ended March 27, 2004)	42			160			120			361
Selling, general and administrative expenses (including stock-based compensation of $70 for the periods ended March 27, 2004)	397			385			839			1,148

Total operating expenses	439			545			959			1,509

Loss from operations	(1,165		)	(890		)	(1,228		)	(2,296		)

Interest income	47			2			48			3
Interest expense	(281		)	(280		)	(581		)	(559		)
Other income, net	8			6			16			90

Other expense	(226		)	(272		)	(517		)	(466		)
Loss before provision for income taxes	(1,391		)	(1,162		)	(1,745		)	(2,762		)
Provision for income taxes	6			7			12			17

Net loss	(1,397		)	(1,169		)	(1,757		)	(2,779		)
Preferred stock dividends	(174		)	—			(174		)	—
Net loss available to common stockholders	$	(1,571	)	$	(1,169	)	$	(1,931	)	$	(2,779	)

Net loss per share:
Loss per common share- basic and diluted	$	(0.14	)	$	(0.17	)	$	(0.21	)	$	(0.41	)
Weighted average number of common shares outstanding:
Common shares- basic and diluted	11,173			6,937			9,055			6,837

The accompanying Selected Notes to Condensed Financial Statements are an integral part of these condensed statements.

INNOVATIVE MICRO TECHNOLOGY, INC.

Balance Sheets - Unaudited

(In thousands, except share and par value data)

	Apr 2, 2005			Oct 2, 2004
ASSETS

Current Assets:
Cash	$	13,017		$	429
Accounts receivable, net	1,218			1,159
Accounts receivable, related party	14			128
Costs in excess of billings for development projects	55			33
Prepaid expenses and other	388			278
Total current assets	14,692			2,027
Property, plant and equipment, at cost	20,593			20,342
Less-accumulated depreciation	(3,743		)	(3,163		)
Total property, plant and equipment	16,850			17,179

Other assets	248			293
Total assets	$	31,790		$	19,499

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities:
Current portion of long-term debt	$	9,018		$	1,688
Accounts payable and accrued expenses	611			916
Accrued payroll and benefits	803			576
Billings in excess of costs for development projects	1,183			595
Billings in excess of costs for development projects- related party	—			693
Other current liabilities	360			305
Total current liabilities	11,975			4,773
Long-term debt, net	188			9,112
Other liabilities	90			90

Preferred stock, $.0001 par value, authorized 2,500,000 shares, Series A redeemable preferred stock, 1,000,000 shares issued and outstanding (aggregate liquidation value of $14,290, including accrued and unpaid dividends of $123)	13,243			—

Stockholders’ Equity:
Preferred stock, $.0001 par value, authorized 2,500,000 shares, Series A-1 convertible preferred stock, 1,000,000 shares issued and outstanding (aggregate liquidation value of $2,833)	2,613			—
Common stock, $.0001 par value, 25,000,000 shares authorized, 6,953,880 shares issued at April 2, 2005 and 6,937,443 shares issued at October 2, 2004	1			1
Paid-in capital	23,144			23,056
Accumulated deficit	(19,464		)	(17,533		)
Total stockholders’ equity	6,294			5,524
Total liabilities and stockholders’ equity	$	31,790		$	19,499

The accompanying Selected Notes to Condensed Financial Statements are an integral part of these condensed balance sheets.

INNOVATIVE MICRO TECHNOLOGY, INC.

Statements of Cash Flows - Unaudited

(In thousands)

	Six Months Ended April 2, 2005			Six Months Ended March 27, 2004
Cash Flows from Operating Activities:
Net loss	$	(1,757	)	$	(2,779	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	580			578
Employee restricted stock amortization	—			157
Induced conversion of professional notes	—			203
Changes in assets and liabilities:
Accounts receivable, net	55			108
Costs in excess of billings on development projects	(22		)	(8		)
Prepaid expenses and other	(110		)	23
Other assets	45			106
Accounts payable and accrued expenses	(305		)	29
Accrued payroll and benefits	227			21
Billings in excess of costs on development projects	588			(272		)
Billings in excess of costs on development projects- related party	(693		)	(536		)
Other current liabilities	55			119
Net cash flows used in operating activities	(1,337		)	(2,251		)

Cash Flows from Investing Activities:
Purchases of property, plant and equipment	(251		)	—
Net cash flows used in investing activities	(251		)	—

Cash Flows from Financing Activities:
Proceeds from sale of redeemable preferred stock	17,000			—
Proceeds from sale of common stock	88			894
Equity issuance costs	(1,318		)	—
Proceeds from loan	—			1,500
Repayment of debt	(1,594		)	(2,482		)
Net cash flows provided by (used in) financing activities	14,176			(88		)

Net (decrease) increase in cash	12,588			(2,339		)
Cash at beginning of period	429			2,463
Cash at end of period	$	13,017		$	124

Supplemental Cash Flow Data:
Interest paid	$	532		$	559
Income taxes paid	$	12		$	13

Supplemental disclosure on non-cash financing activity:

Preferred stock dividends	$	174		$	—
Conversion of professional notes payable to common stock	$	—		$	2,757

The accompanying Selected Notes to Condensed Financial Statements are an integral part of these condensed statements.

Selected Notes to Financial Statements

(Unaudited)

April 2, 2005

Note A: Basis of Presentation

The Company has incurred net losses and losses from operations for each quarter since 1999. The Company filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code in January 2000 (the “Chapter 11 Reorganization”) and, on emergence from bankruptcy, all of the previously issued and outstanding common stock was canceled without consideration to the holders. The Company incurred a net loss of $1.4 million and $1.8 million for the three and six months ended April 2, 2005. It expects to continue to incur substantial operating losses for the foreseeable future, and it cannot predict the extent of the future losses or when it may become profitable. Even if the Company does achieve profitability, it may not be able to sustain or increase profitability in the future. The Company expects to incur increasing sales and marketing, research and development and general and administrative expenses. As a result, it will need to significantly increase its revenues to achieve profitability. Although the Company’s revenues have increased, the growth may not continue at the current rate or at all.

In order to fund that growth, on January 25, 2005, the Company privately sold equity securities to an investor group made up of Investor Growth Capital Limited, BA Venture Partners and Miramar Venture Partners (the “Investor Group”). The Investor Group invested a total of $17.0 million in the Company in exchange for 1,000,000 shares of redeemable preferred stock, Series A, 1,000,000 shares of convertible preferred stock, Series A-1 and warrants for the purchase of up to 500,000 shares of common stock, exercisable only if the Company fails to meet certain performance targets, at a purchase price of $0.30 per share. In connection with the transaction, the Company paid a fee of approximately $1.1 million to its financial advisors, W.R. Hambrecht & Co. LLC (“WRH”) and issued to WRH a warrant to purchase up to 113,333 shares of common stock at a price of $3.00 per share. The net proceeds to the Company were approximately $15.7 million.

On January 25, 2005, the Company used approximately $1.6 million of the net proceeds to repay all indebtedness under a Secured Promissory Note issued to L-3 Communications Corporation (“L-3”). The remainder of the net proceeds of the transaction will be used for general working capital needs and other corporate purposes.

Operating results for the three and six months ended April 2, 2005 are not necessarily indicative of the results that may be expected for the year ending October 1, 2005. For further information, refer to the consolidated financial statements and footnotes thereto, included in the Company’s Annual Report on Form 10-K for the year ended October 2, 2004.

Note B: Related Party Transaction

On March 15, 2004, the Company entered into an agreement for a Secured Promissory Note (the “Note”) in the original principal amount of $1.5 million with L-3 Communications Corporation (“L-3”), a principal stockholder of the Company. On January 25, 2005, the Company used approximately $1.6 million of the net proceeds from its $17.0 million private equity sale with the Investor Group to repay the Note, including all accrued interest. The Company is a subcontractor to L-3 for a long-term government contract to produce gyroscopes and accelerometers for use in inertial navigation.

The Company had $14.0 thousand in accounts receivable from L-3 as of April 2, 2005.

Note C: Debt

The Company settled two claims during the Chapter 11 Reorganization that were secured by its owned real properties. One of these claims is a property mortgage of $9.6 million due on November 24, 2005. The mortgage requires interest-only payments at a 12% annual interest rate. The other claim was for delinquent property taxes of $0.9 million. The settlement requires semi-annual principal and interest payments on November 1 and May 1 of each year with an 8% annual interest rate. The final payment is due on November 1, 2006.

On February 14, 2003, the Company completed the sale of its Hollister property at a price of $6.2 million, recognizing a gain of $0.6 million. The proceeds of the sale were used to pay off the Company’s first mortgage of $5.4 million. The balance of the sales proceeds were used to pay down the Company’s second mortgage, which is collateralized by both of its properties, from $9.6 million to $8.8 million. The remaining $8.8 million mortgage is secured by the Company’s Robin Hill property.

The Chapter 11 Reorganization provided for the treatment of the unpaid professional persons involved in the reorganization process. The total amount owed to these professional persons as of the Effective Date was $4.1 million. The Bankruptcy Code provides that each of the Professional Persons, which consist of the law firms and investment bankers employed by the Company during the Chapter 11 Reorganization, is entitled to be paid cash, in full, at the Effective Date in an amount equal to their Professional Person’s Allowed Administrative Claim. In consideration for each Professional Person waiving this right and agreeing to accept a convertible note, the Plan provided for each Professional Person to have an Allowed Administrative Claim as of the Effective Date. On September 30, 2003, the Company paid $2.4 million in cash and issued 368,113 shares of Common Stock, 16,437 warrants for the purchase of Common Stock at a price of $5.35 and 68,777 warrants for the purchase of Common Stock at a price of $7.29 to cancel these Professional Notes. This transaction cancelled $4.1 million in notes and $1.0 million in accrued interest. The Company issued 91,826 shares of Common Stock at $5.35 per share, which was below the original notes conversion price of $8.20. This reduced price plus warrants to purchase additional common stock were offered to induce each holder to take a reduced amount of cash for their final agreement with the Company. The Company recognized approximately $0.2 million of expense in the first fiscal quarter of 2004 related to this transaction.

The Company’s long-term debt is summarized below, reflecting the transactions above (in thousands):

	April 2, 2005
Property Mortgage	$	8,830
Property Taxes	376
	9,206
Less - Current portion	(9,018		)
Total	$	188

Note D: Stock-Based Compensation

The Company accounts for stock-based awards to employees under the recognition and measurement principles of APB No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company has adopted the disclosure-only provisions of FAS No. 123. Accordingly, no stock-based employee compensation cost is reflected in net loss, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. Had compensation cost for the Company’s stock option plan been determined based on the fair value at the grant date for awards for the three and six month periods ended April 2, 2005 and March 27, 2004, consistent with the provisions of FAS No. 123, the Company’s net loss and loss per share would have been increased to the pro forma amounts indicated below:

(in thousands, except per share amounts)

	Three Months Ended April 2, 2005			Three Months Ended March 27, 2004			Six Months Ended April 2, 2005			Six Months Ended March 27, 2004

Net loss available to common stockholders— as reported	$	(1,571	)	$	(1,169	)	$	(1931	)	$	(2,779	)
Less — fair value of stock-based employee compensation expense	(280		)	(288		)	(559		)	(573		)
Net loss available to common stockholders— pro forma	$	(1,851	)	$	(1,457	)	$	(2,490	)	$	(3,352	)
Net loss per share (basic and diluted) — as reported	$	(0.14	)	$	(0.17	)	$	(0.21	)	$	(0.41	)
Net loss available to common stockholders per share (basic and diluted) — pro forma	$	(0.17	)	$	(0.21	)	$	(0.27	)	$	(0.49	)

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for the grants:

	Three Months Ended April 2, 2005		Three Months Ended March 27, 2004		Six Months Ended April 2, 2005		Six Months Ended March 27, 2004

Risk free interest rate	3.70	%	3.71	%	3.70	%	3.71	%
Expected life	4 years		4 years		4 years		4 years
Expected volatility	63	%	68	%	63	%	68	%

Note E: Net Income (Loss) Per Common Share

The Company applies SFAS No. 128, “Earnings per Share,” which requires the disclosure of basic and diluted net income or loss per share for all current and prior periods. Basic net income or loss per common share is computed by dividing net income or loss available to common stockholders by the weighted average number of common shares outstanding during each year. Diluted net income or loss per common share reflects the maximum dilution, based on the average price of our common stock each period and is computed similarly to basic income or loss per share except that the denominator is increased to include the number of additional shares that would have been outstanding if potentially dilutive stock options and warrants had been exercised.

Basic and diluted net loss per share computed in accordance with SFAS 128 for the three and six months ended April 2, 2005 and March 27, 2004 are as follows:

(in thousands, except per share amounts)

	Three Months Ended April 2, 2005			Three Months Ended March 27, 2004			Six Months Ended April 2, 2005			Six Months Ended March 27, 2004

BASIC AND DILUTED EPS
Net loss available to common stockholders	$	(1,571	)	$	(1,169	)	$	(1,931	)	$	(2,779	)
Denominator: weighted average common shares outstanding	11,173			6,937			9,055			6,837
Net loss available to common stockholders per share - basic and diluted	$	(0.14	)	$	(0.17	)	$	(0.21	)	$	(0.41	)

The following potentially dilutive securities were outstanding at April 2, 2005 and were not included above because to do so would be anti-dilutive: options to purchase 1,846,724 shares of common stock at prices ranging from $0.30 to $5.35, warrants to purchase 700,000 shares of common stock at a price of $7.29 per share with a term of thirty six months ending August 1, 2005, warrants to purchase 350,000 shares of common stock at a price of $7.29 per share with a term of thirty six months ending September 3, 2006 and warrants to purchase 68,777 of common stock at a price of $7.29 per share with a term of thirty six months ending September 30, 2006. Additionally, in connection with the January 25, 2005 Investor Group transaction, the Company issued warrants for the purchase of up to 500,000 shares of common stock, exercisable only if the Company fails to meet certain performance targets in 2005, at a purchase price of $0.30 per

share and a warrant to WRH to purchase up to 113,333 shares of common stock at a price of $3.00 per share. The warrants provided to the subordinated note claimants pursuant to the Plan (the “Plan Warrants”) expired on December 16, 2004.

The following potentially dilutive securities were outstanding at March 27, 2004 and were not included above because to do so would be anti-dilutive: options to purchase 1,711,501 shares of common stock at prices ranging from $5.00 to $5.35, warrants to purchase 700,000 shares of common stock at a price of $7.29 per share with a term of thirty six months ending August 1, 2005, warrants to purchase 83,500 shares of common stock at a price of $5.35 per share with a term of eighteen months ending March 3, 2005, warrants to purchase 350,000 shares of common stock at a price of $7.29 per share with a term of thirty six months ending September 3, 2006, warrants to purchase 16,437 of common stock at a price of $5.35 with a term of eighteen months ending March 30, 2005 and warrants to purchase 68,777 of common stock at a price of $7.29 per share with a term of thirty six months ending September 30, 2006. The shares issuable on the exercise of the warrants provided to the subordinated note claimants pursuant to the Plan (the “Plan Warrants”) are not considered potential dilutive securities, because when the Plan Warrants are exercised the Company will exercise its rights to repurchase an equal number of shares at the same price under call options executed by certain stockholders in accordance with the Plan. The call options remain in force for as long as the Plan Warrants are exercisable, and the certificates for the shares subject to the call options bear a legend that restricts their trading specifically to ensure the Company’s ability to exercise the call options.

Note F: Significant Accounting Policies and New Accounting Pronouncements

Significant Accounting Policies

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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Management believes that these estimates and assumptions provide a reasonable basis for the fair presentation of the financial statements.

Depreciation and Amortization Policies: Plant, property and equipment are accounted for on a historical cost basis and are depreciated or amortized over their estimated useful lives using the straight-line method except for leasehold improvements, which are amortized over the shorter of the estimated useful life or the life of the lease.

Estimated useful lives are as follows:

		Average Useful Life
Buildings		25 Years
Manufacturing equipment		3 - 5 Years
Other equipment		1 - 5 Years
Building improvements		10 Years

The Company follows the policy of capitalizing expenditures that materially increase asset lives. Maintenance and minor replacements are charged to operations when incurred. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts, and any resulting gain or loss is included in results of operations.

Long-lived Assets: The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that an asset’s carrying value may exceed the undiscounted expected future cash flows to be derived from that asset. Whenever undiscounted expected future cash flows are less than the carrying value, the asset will be reduced to an amount equal to the net present value of the expected future cash flows and an impairment loss will be recognized.

Costs in Excess of Billings on Development Projects: These amounts reflect the excess of accumulated costs over the billings as defined in the completed contract method of accounting for long-term contracts. Costs in excess of billings at April 2, 2005 were minimal related to capitalized costs under the completed contract method of accounting, as described below.

Billings in Excess of Costs on Development Projects: These amounts reflect the excess of billings over the accumulated costs as defined in the completed contract method of accounting for long-term contracts. Billings in excess of costs at April 2, 2005 were approximately $1.2 million related to capitalized costs under the completed contract method of accounting, as described below.

Revenue Recognition and Warranty Policies: The Company uses the completed contract method of accounting for its product development projects due to the inability to accurately estimate percentage of completion during performance of the contract. Costs are capitalized during the project and recorded as cost of revenue at its completion along with the recognition of revenue. Losses on projects are recognized as they are determined. The Company’s MEMS development contracts include milestones that require delivery of engineering reports, wafers and/or dies. The Company’s MEMS development contracts are determined to be complete after all contract milestones have been completed, reviewed and accepted by the customer. Santa Barbara Tool & Die delivers a finished product to the customer and revenue is recognized after both the product is shipped and title passes. IMT Analytical has service related revenue and this revenue is recognized upon completion of the service for the customer.

The Company’s MEMS development contracts do not have any rights of return. Santa Barbara Tool & Die and IMT Analytical did not have any sales returns in the three and six months ended April 2, 2005 and March 27, 2004. The Company’s warranty policy provides for the replacement of defective parts when the customer’s return request is approved within thirty days of the original shipment date. To date, warranty costs have not been significant and the Company does not have a reserve for returns.

A portion of the Company’s facilities are leased to tenants under long-term contracts. The terms of the leases expire within the next two years with renewal options. Rental income is recorded on a straight-line basis.

Fair Value of Financial Instruments: The carrying amounts of cash, customer receivables, trade accounts payable and other accrued liabilities approximate their fair value because of their short maturity. The carrying amount of approximately $8.8 million of the Company’s mortgage indebtedness at April 2, 2005 has an interest rate of 12% and is carried at its full value. The 8% interest rate on $0.4 million of debt due on delinquent property taxes is at rates below the Company’s current cost of capital determined by its mortgage indebtedness. The fair value of the debt would be $0.3 million based on the Company’s cost of capital of 12%.

Net Loss per Common Share: Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding. Diluted net loss per share is computed by dividing net loss by the sum of the weighted average number of common shares outstanding for the period plus the assumed exercise of all potentially dilutive securities. However, in computing diluted net loss per share, the exercise price of the Company’s outstanding potentially dilutive securities would have an antidilutive effect and, accordingly, they were excluded from the computation.

Research and Development Expenses: The Company is actively engaged in basic technology and applied research and development programs which are designed to develop new products and product applications and related manufacturing processes. The costs of these programs are classified as research and development expenses and are charged to operations as incurred.

Income Taxes: Income taxes are computed using the liability method. The provision for income taxes includes income taxes payable for the current period and the deferred income tax consequences of transactions that have been recognized in the Company’s financial statements or income tax returns. The carrying value of deferred income tax assets is determined based on an evaluation of whether the realization of such assets is more likely than not. Temporary differences result primarily from accrued liabilities, valuation allowances, depreciation and amortization, and state franchise taxes. The valuation allowance is reviewed periodically to determine the amount of deferred tax asset considered realizable. A valuation allowance has been recorded in the full amount of all deferred tax assets, because the Company does not have a basis to conclude that it is more likely than not that it will realize the deferred tax assets.

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS 123R “Share-Based Payment,” a revision to FASB No. 123, SFAS 123R replaces existing requirements under SFAS No. 123 and APB Opinion NO. 25, and requires public companies to recognize the cost of employee services received in exchange for equity instruments, based on the grant-date fair value of those instruments, with limited exceptions. SFAS 123R also affects the pattern in which compensation cost is recognized, the accounting for employee share purchase plans, and the accounting for income tax effects of share-based payment transactions. For small-business filers, SFAS 123R will be effective for interim periods beginning after December 15, 2005. The Company is currently determining what impact the proposed statement would have on its results of operations and financial position.

Note G: Segments of Business:

Under SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” “operating segments” are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company has four reportable operating segments: micro-electro-mechanical systems (“MEMS”), Santa Barbara Tool & Die, IMT Analytical and Rental Income.

MEMS devices are made using modern wafer-processing technology, similar to that used in making silicon electronic devices. The factor that distinguishes MEMS devices is that they are designed to include moving parts, hence the “mechanical” part of the name. Common uses for MEMS devices are automotive air-bag sensors (accelerometers), pressure and airflow sensors, and inkjet printer heads. Santa Barbara Tool and Die is a machine, model and die shop manufacturing high-precision parts and tooling for its customers. IMT Analytical is an analytical lab that uses the Company’s specialized testing equipment to analyze samples submitted by customers for dimension, material makeup, and material crystal properties. The Company learned in October 2003 that it may have been infringing upon the service mark of another firm operating in the same business area under the name of Insight Analytical Labs, Inc. The Company changed Insight Analytical’s name to IMT Analytical in the first fiscal quarter of 2004. The Company has approximately 51,000 square feet of building space available to lease. As of April 2, 2005, approximately 34,000 square feet were under long-term lease arrangements and the payments received are reported as Rental Income.

The Company’s management evaluates performance of each segment primarily on the net sales and gross profit (loss). Research and development and general and administrative expenses are not allocated to and/or among the segments.

The following table represents net sales, gross profit (loss) and long-lived assets by segment (in thousands):

	MEMS			Santa Barbara Tool and Die		IMT Analytical		Rental Income		United States Total
Three Months Ended:
April 2, 2005
Net sales	$	1,297		$	370	$	19	$	136	$	1,822
Intercompany Sales	$	4		$	43	$	74	$	—	$	—
Gross profit (loss)	$	(972	)	$	102	$	43	$	101	$	(726	)
Long Lived Assets	$	14,331		$	155	$	12	$	2,352	$	16,850

Three Months Ended:
March 27, 2004
Net sales	$	1,756		$	304	$	14	$	132	$	2,206
Intercompany Sales	$	1		$	26	$	93	$	—	$	—
Gross profit (loss)	$	(523	)	$	51	$	31	$	96	$	(345	)
Long Lived Assets	$	15,138		$	97	$	35	$	2,472	$	17,742

Six Months Ended:
April 2, 2005
Net sales	$	4,823		$	709	$	56	$	268	$	5,856
Intercompany Sales	$	9		$	76	$	139	$	—	$	—
Gross profit (loss)	$	(717	)	$	162	$	88	$	198	$	(269	)
Long Lived Assets	$	14,331		$	155	$	12	$	2,352	$	16,850

Six Months Ended:
March 27, 2004
Net sales	$	4,043		$	540	$	39	$	263	$	4,885
Intercompany Sales	$	3		$	43	$	160	$	—	$	—
Gross profit (loss)	$	(1,064	)	$	66	$	14	$	197	$	(787	)
Long Lived Assets	$	15,138		$	97	$	35	$	2,472	$	17,742

The Company had approximately $0.3 million in purchases of property, plant and equipment in the first six months of fiscal 2005 compared to no purchases in the first six months of fiscal 2004.

The Company’s foreign sales for the first six months of both fiscal 2005 and 2004 were all to a customer in Japan. The following table displays domestic and foreign revenue (in thousands):

($000’s)	Three Months Ended April 2, 2005		Three Months Ended March 27, 2004		Six Months Ended April 2, 2005		Six Months Ended March 27, 2004

Revenue
Domestic	$	1,586	$	2,140	$	5,104	$	4,454
Foreign	236		66		752		431
Total	$	1,822	$	2,206	$	5,856	$	4,885

The Company had three customers with sales greater than 10% of its total sales for the first six months of fiscal 2005. They individually accounted for 28%, 14% and 13% of the Company’s total sales for the period.

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

Statements in this discussion that are not historical are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. “Forward looking statements” may be identified by the use of the words such as “believe,” “expect,” “intends,” “estimate,” “anticipate,” “project,” “will,” and similar expressions. These forward-looking statements speak only as of the date hereof. All of the forward-looking statements are based on estimates and assumptions made by management of the Company, which, although believed to be reasonable, are inherently uncertain and difficult to predict. Therefore, undue reliance should not be placed upon such estimates. Such forward-looking statements are subject to a variety of risks and uncertainties, including those discussed below under the heading “Risk Factors Affecting Our Business” and elsewhere in this Quarterly Report on Form 10-QSB, which could cause actual results to differ materially from those anticipated by the Company’s management. These factors include, but are not limited to the following: the Company’s ability to make the transition to volume production of MEMS products; the Company’s history of losses and bankruptcy; changing technology; competition; the Company’s ability to protect intellectual property, fluctuations in the Company’s quarterly and annual operating results; lack of an active trading market for the Company’s Common Stock; risks related to international transactions; environmental laws and regulations, supplies of raw materials; the concentration of control of the Company with a small group of stockholders; anti-takeover provisions of the Company’s charter and Delaware law; and general economic and political uncertainty.

Overview

The following discussion presents information about the financial condition, liquidity and capital resources, and results of operations of the Company. This information should be read in conjunction with interim, unaudited financial statements included with this report and the notes thereto, and the audited financial statements and the notes thereto as reported on the Company’s Annual Report on Form 10-KSB for the fiscal year ended October 2, 2004.

The Company designs and manufactures micro-electro-mechanical systems (“MEMS”) for the telecommunications, inertial navigation, bio-technical, microfluidics and biomedical industries, and is broadening into the wireless communication industry. MEMS devices are made using modern wafer-processing technology, similar to that used in making silicon electronic devices. The factor that distinguishes MEMS devices is that they are generally designed to include moving parts, hence the “mechanical” part of the name.

Prior to January of 2000, the Company’s principal business was the manufacturing of magnetic recording heads for use in the disk drive industry. The Company filed for protection under Chapter 11 of the U.S. bankruptcy code in January 2000, and emerged from bankruptcy with the effectiveness of its Reorganization Plan under Chapter 11 of the U.S. Bankruptcy Code (the “Plan”) in November 2001. During the reorganization period, the Company reorganized its operations from manufacturing magnetic recording heads solely for the disk drive industry to manufacturing MEMS, operating in a number of industry sectors.

The Company owns a 30,000 square foot wafer fabrication facility that was originally developed for its magnetic recording head business. Without modification, the facility is capable of manufacturing advanced design MEMs in commercial volumes using six-inch wafers. However, the facility is currently used mainly for making prototypes and for new product development. This results in significant unused capacity and sales that do not support the high fixed costs of operating a wafer fabrication facility. The Company began the transition to limited volume production of some MEMs products in the second quarter of fiscal 2005.

The Company intends to operate its MEMs business primarily on a foundry basis, producing and assisting in the design of end-users components under contract. The Company also expects to develop and produce its own proprietary devices.

The Company has three additional lines of business, which are: Santa Barbara Tool and Die, a machine, model and die shop; IMT Analytical, an analytical lab; and leasing of excess space in its owned facility under long-term lease contracts. Santa Barbara Tool and Die and IMT Analytical are strategic parts of the core company, in that their services are used to make the core business more competitive, and both use their capacity that exceeds the Company’s core requirements to provide services to outside customers.

The Company has incurred operating losses for each quarter since 1999. These losses are a result of the level of the current MEMS-related revenue, which predominantly derive from orders for delivery of prototypes and new product development. The revenue for the second fiscal quarter of 2005 was predominantly related to the Company’s customer development projects. These include a telecommunications switch, a display used in small electronic devices and an accelerometer for use in inertial navigation. Additional revenue was contributed by Santa Barbara Tool & Die, IMT Analytical and leasing of excess space in the Company’s owned facility under long-term lease contracts. The Company plans to begin using its excess capacity and offset its high fixed costs by transitioning from prototype and product development orders to the product qualification phase and ultimately to high-volume production orders with its customers. This process depends in part on the general development and acceptance of MEMS technology industry-wide, the success of the Company’s customers’ products and the ability to transition to high-volume production. While the Company is devoting significant engineering resources to these efforts, there can be no assurances that the Company will succeed in securing high-volume production orders. To the extent that the Company is unable to do so, there would be a material adverse effect on the Company’s operating results and liquidity.

On January 25, 2005, the Company privately sold equity securities to the Investor Group. In this transaction (the “Private Equity Transaction”), the Investor Group invested a total of $17.0 million in the Company in exchange for 1,000,000 shares of redeemable preferred stock, Series A, 1,000,000 shares of convertible preferred stock, Series A-1 and warrants for the purchase of up to 500,000 shares of common stock, exercisable only if the Company fails to meet certain performance targets, at a purchase price of $0.30 per share. In connection with the transaction, the Company paid a fee of approximately $1.1 million to its financial advisors, W.R. Hambrecht & Co. LLC (“WRH”) and issued to WRH a warrant to purchase up to 113,333 shares of common stock at a price of $3.00 per share. The net proceeds to the Company were approximately $15.7 million. On January 25, 2005, the Company used approximately $1.6 million of the net proceeds to repay all of its indebtedness under the Note issued to L-3. The remainder of the net proceeds will be used for general working capital needs and other corporate purposes.

The Company expects to use the net proceeds of the Private Equity Transaction primarily in pursuit of its strategy to transition to high volume production. No commitments or allocations have been made at this time, but anticipated uses include the following: equipment, tooling and staff to support increased manufacturing; maintenance and improvement to the existing production line; increased marketing of the Company’s foundry services, and purchases of raw materials and other inventory to fulfill customer orders.

Until applied to specific purposes, the Company expects to invest the net proceeds of the Private Equity Transaction in short- and medium-term interest bearing accounts at insured institutions and government-issued debt securities. The value of these highly liquid investments is reported under “cash and cash equivalents” on the Company’s balance sheet.

Critical Accounting Policies

Application of accounting policies requires management to make judgments and estimates about the amounts reflected in the financial statements. Management uses historical experience and all available information to make these estimates and judgments, although differing amounts would be reported if the assumptions and estimates changed. Estimates are used for, but not limited to, revenue recognition and cost of sales, the accounting for the allowance for doubtful accounts, inventory allowances, impairment costs and other special charges, depreciation and amortization, sales returns, warranty costs, taxes, and contingencies. Management has identified the following accounting policies as critical to an understanding of our financial statements and as areas most dependent on management’s judgment and estimates.

The Company’s MEMS development contracts do not have any rights of return. Santa Barbara Tool & Die and IMT Analytical did not have any sales returns in the three and six months ended April 2, 2005 and March 27, 2004. The Company’s warranty policy provides for the replacement of defective parts when a customer’s return request is submitted and approved within 30 days of the original shipment date. To date, warranty costs have not been significant and the Company does not have a reserve for returns.

expected future cash flows are less than the carrying value, the asset will be reduced to an amount equal to the net present value of the expected future cash flows and an impairment loss will be recognized.

Recent Accounting Pronouncements

Overview

The following discussion presents information about the financial condition, liquidity and capital resources, and results of operations of the Company. This information should be read in conjunction with the audited financial statements and the notes thereto as reported on the Company’s Annual Report on Form 10-KSB for the fiscal year ended October 2, 2004 and the interim, unaudited financial statements and the notes thereto included with this quarterly report on form 10-QSB.

Results of Operations

Three Months Ended April 2, 2005 Compared to Three Months Ended March 27, 2004

Net Revenue. Net revenue was $1.8 million for the second quarter of fiscal 2005 compared to $2.2 million for the same period of fiscal 2004. The sales for the second fiscal quarter of 2005 consisted of $1.3 million of MEMS-related business, $0.4 million from the combination of Santa Barbara Tool and Die and IMT Analytical and $0.1 million from leasing of space to tenants. The sales decline, as compared to the same quarter of fiscal 2004, was due to a decrease in the level of completed contracts in the MEMS-related portion of the business. The sales for the fiscal 2004 period consisted of $1.8 million of MEMS, $0.3 million from the combination of Santa Barbara Tool and Die and IMT Analytical and $0.1 million from leasing of space to tenants. The Company completed phase I of its long-term contract with the U.S. Defense

Advanced Research Project Agency for prototype development for rapid and efficient isolation of human hematopoietic stem cells for medical and defense applications for a value of $1.1 million in the second fiscal quarter of 2004.

Gross Loss. Gross loss was $0.7 million or cost exceeded revenue by 39.8% for the second fiscal quarter of 2005 compared to a gross loss of $0.3 million or costs in excess of revenue of 15.6% for the second fiscal quarter of 2004. The fiscal 2005 period saw the MEMS portion of the business generate a gross loss of $1.0 million, the combination of Santa Barbara Tool and Die and IMT Analytical generated a $0.2 million gross profit and leasing of space to tenants provided a $0.1 million gross profit. In the second fiscal quarter of 2004, the MEMS portion of the business had a gross loss of $0.5 million, the combination of Santa Barbara Tool and Die and IMT Analytical generated a $0.1 million gross profit and leasing of excess space to tenants provided a $0.1 million gross profit. The gross loss in the second quarter of fiscal 2005 increased compared to the same period of fiscal 2004 due to the decline in revenue resulting in the under-absorption of the factory fixed costs (eg, depreciation, utilities). As the Company migrates toward high volume production it expects to be able to increase the absorption of its fixed costs. The Company had 96 production employees at the end of the second fiscal quarter of 2005 compared to 54 at the end of the same period of fiscal 2004.

Research and Development. Research and development (“R&D”) expense, as a percentage of net sales, was 2.3% for the second fiscal quarter of 2005 compared to 7.3% for the second quarter of fiscal 2004. R&D expense decreased as a percentage of sales in the second quarter of fiscal 2004 due to the decrease in R&D activities. R&D expenditures were approximately $0.1 million in the second fiscal quarter of 2005 compared to $0.2 million in the second quarter of fiscal 2004. The Company had four employees focused on the development of new products and manufacturing processes as of the end of both periods.

Selling, General and Administrative Expenses. Selling, general and administrative expense (“SG&A”) as a percentage of net sales was 21.8% for the second fiscal quarter of 2005 and 17.5% for the second quarter of fiscal 2004. SG&A expenses increased as a percentage of sales in the second quarter of fiscal 2005 due to the decrease in net sales; measured in dollars, S,G&A expenditures were approximately $0.4 million for both the second fiscal quarter of 2004 and 2005. The Company has seven employees providing the services reported as SG&A as of the end of both periods. These services include sales and marketing, accounting, information systems, human resources and administration.

Interest Expense. Interest expense was $0.3 million for the second fiscal quarter of both 2005 and 2004. The interest expense is primarily associated with the Company’s property mortgage. This debt requires interest-only monthly payments based upon a 12% annual interest rate. The fiscal 2005 expense also includes the accrual of interest for the L-3 Note (see Note B – Related Party Transaction in footnotes to the unaudited interim financial statements).

Preferred Stock Dividends. Preferred stock dividends of $0.2 million were accrued in the second fiscal quarter of 2005 related to the Private Equity Transaction. A total of $3.6 million in dividends will be incurred over the period beginning on January 25, 2005 and ending on January 24, 2009.

Six Months Ended April 2, 2005 Compared to Six Months Ended March 27, 2004

Net Revenue. Net revenue was $5.9 million for the first six months of fiscal 2005 compared to $4.9 million for the six months of fiscal 2004. The fiscal 2005 period sales were made up of $4.8 million of MEMS-related business, $0.8 million from the combination of Santa Barbara Tool and Die and IMT Analytical and $0.3 million from leasing of space to tenants. The MEMS-related business generated sales of $4.0 million, the combination of Santa Barbara Tool and Die and IMT Analytical generated sales of $0.6 million and $0.3 million came from leasing of space to tenants for the first six months of fiscal 2004. The main reason for the increase in sales in fiscal 2005 compared to 2004 is related to the MEMS portion of the business which completed one major contract in the first half of the year. The Company completed a contract with L-3 Communications for $1.6 million in the first six months of 2005.

Gross Loss. Gross loss was $0.3 million or cost exceeded revenue by 4.6% for the first six months of fiscal 2004 compared to a gross loss of $0.8 million or costs in excess of revenue of 16.1% for the first six months of fiscal 2004. The MEMS related business had a gross loss for the fiscal 2005 period of $0.7 million. Santa Barbara Tool and Die and IMT Analytical combined for a gross profit of $0.2 million and leasing of space to tenants had a gross profit of $0.2 million for the first six months of fiscal 2005. The MEMS related business had a gross loss of $1.1 million for the first six months of fiscal 2004. The combination of Santa Barbara Tool and Die and IMT Analytical combined for a $0.1 million gross profit for the fiscal 2004 period. Leasing of space to tenants provided a $0.2 million gross profit for this same period. The MEMS business gross loss included $0.1 million in amortization of employee stock incentives for the first six months of fiscal 2004. The improvement in gross loss in the first six months of fiscal 2005 as compared to the first six months of fiscal 2004 is due to the increase in revenue resulting in absorption of the factory fixed costs (eg, depreciation, utilities). As the Company migrates toward high volume production it expects to be able to increase the absorption of its fixed costs.

Research and Development. R&D expense, as a percentage of net sales, was 2.0% for the first six months of fiscal 2005 compared to 7.4% for the first six months of fiscal 2004. R&D expense decreased as a percentage of sales in the second quarter of fiscal 2004 due to the increase in net sales and the decrease in R&D expenditures of approximately $0.3 million. The 2005 fiscal period incurred expenditures of approximately $0.1 million compared to $0.4 million for the same period of fiscal 2004. R&D expense included $0.1 million in amortization of employee stock incentives for the fiscal 2004 period. R&D expenditures reduced in fiscal 2005 as the efforts of the R&D employees were re-directed to support customer development projects.

Selling, General and Administrative Expenses. Selling, general and administrative expense as a percentage of net sales was 14.3% for the first six months of fiscal 2005 compared to 23.5% for the first six months of fiscal 2004. Expenses in dollars were $0.8 million for the first six months of fiscal 2005 compared to $1.1 million for the same period of fiscal 2004. The first six months of fiscal 2004 included $0.2 million in expenses related to the settlement of the Company’s Professional Notes (see Note C - Debt). The fiscal 2004 period expense also included $0.1 million in amortization of employee stock incentives. The Company has seven employees providing the services reported as SG&A as of the end of both periods. These services include sales and marketing, accounting, information systems, human resources and administration.

Interest Expense. Interest expense was $0.7 million for the first six months of fiscal 2005 and $0.6 million for the first six months of fiscal 2004. The increase in interest expense compared to the first six months of fiscal 2004 is primarily due to the increase in debt balances due to the L-3 Note (see Note B – Related Party Transaction). The interest expense for both periods is primarily associated with the Company’s property mortgage. This debt requires interest-only monthly payments based upon a 12% annual interest rate.

Liquidity and Capital Resources

On January 25, 2005, the Company privately sold equity securities to the Investor Group. The Investor Group invested a total of $17.0 million in the Company in exchange for 1,000,000 shares of redeemable preferred stock, Series A, 1,000,000 shares of convertible preferred stock, Series A-1 and warrants for the purchase of up to 500,000 shares of common stock, exercisable only if the Company fails to meet certain performance targets, at a purchase price of $0.30 per share. In connection with the transaction, the Company paid a fee of approximately $1.1 million to its financial advisors, WRH, and issued to WRH a warrant to purchase up to 113,333 shares of common stock at a price of $3.00 per share. The net proceeds to the Company were approximately $15.7 million. On January 25, 2005, the Company used approximately $1.6 million of the net proceeds to repay the Note due to L-3. The remainder of the net proceeds will be used for general working capital needs and other corporate purposes.

The Company’s cash balance was $13.0 million at April 2, 2005 compared to $0.4 million at October 2, 2004. The increase in cash is primarily related to the Company’s $17.0 million private sale of equity completed on January 25, 2005, which resulted in net cash proceeds of $15.7 million after associated expenses. Stockholders exercised warrants for the purchase of 16,437 common shares at $5.35 per share raising a total of $0.1 million. The Company used approximately $1.6 million of the net proceeds to repay the Note due to L-3. The Company used $1.3 million cash from operations in the first fiscal quarter of 2005. The Company had $0.3 million in expenditures for capital equipment in the first six months of fiscal 2005.

The MEMS industry is capital intensive and requires expenditures for research and development in order to develop and take advantage of technological improvements and new technologies. In fiscal 2005, the Company plans to have approximately $0.7 million in capital expenditures. The Company’s profitability is heavily dependent upon its ability to transition from development to volume production of its MEMS products on a timely basis. Although the Company is devoting substantial engineering and manufacturing resources to these efforts, there can be no assurances that the Company will achieve this transition on a timely basis.

The Company had no purchase commitments associated with capital expenditures at January 1, 2005.

The Company owns its premises and has no leases for which it is the lessee.

The Company is required to comply with the requirements of Sarbanes Oxley Section 404 during its fiscal year ending September 30, 2006. This process will involve the design, documentation and testing of the Company’s internal financial reporting controls. The ultimate cost of this process cannot be determined at this time.

The Company’s liquidity depends, in part, on customers paying according to the Company’s terms. The Company is also subject to market price changes. Any changes in credit terms given to major customers would have an impact on the Company’s cash flow. Credit extended to the Company by suppliers’ is another source of short-term financing and any adverse changes in their terms will have a negative impact on the Company’s cash flow.

The following summarizes the Company’s significant contractual obligations at April 2, 2005 and the effects such obligations are expected to have on liquidity and cash flow in future periods.

Payments Due by Period

(in thousands)

Contractual Obligations	Total		Less than 1 Year		1-3 Years		4-5 Years		After 5 Years

Property Mortgage	$	8,830	$	8,830	$	—	$	—	$	—
Property Taxes	376		188		188				—

Long-Term Debt	$	9,206	$	9,018	$	188	$	—	$	—

Off balance Sheet Arrangements

None

Risk Factors Affecting Our Business

In addition to the factors discussed elsewhere in this report, the following are important factors that could have a material adverse effect on the Company’s financial condition, competitive position and earnings, and that could cause actual results or events to differ materially from those contained in any forward-looking statements made by or on behalf of the Company.

The Company has incurred losses since 1999; it emerged from bankruptcy in 2001, and expects to incur losses for the foreseeable future.

losses of $1.4 million and $1.8 million for the three and six month periods ended April 2, 2005, respectively. The Company expects to incur increasing sales and marketing, research and development and general and administrative expenses. As a result, it will need to significantly increase its revenues to achieve profitability. Although the Company’s revenues have increased, the growth may not continue at the current rate or at all.

The Company cannot satisfy its liquidity requirements without the infusion of capital, which may not be available on acceptable terms or at all.

Since emerging from bankruptcy, the Company’s principal sources of liquidity have been sales of equity securities and borrowing. On January 25, 2005, the Company sold equity securities in the Private Equity Transaction that yielded $17.0 million in gross proceeds and $15.7 million in net proceeds. The net proceeds to the Company were approximately $15.7 million. In exchange for the investment, the Investor Group received 1,000,000 shares of redeemable preferred stock, Series A, 1,000,000 shares of convertible preferred stock, Series A-1 and warrants for the purchase of up to 500,000 shares of common stock. The Company also issued a warrant for the purchase of up to 113,333 shares of common stock to its financial advisor in the transaction. After applying approximately $1.6 million of the net proceeds to repay indebtedness to L-3, the Company intends to use the remainder of the net proceeds for general working capital needs and other corporate purposes. While the proceeds of the private placement along with funds from operations will satisfy the Company’s need for liquidity in the near future, unless the Company can achieve increased sales, it may need to seek additional equity or debt financing. These sources of financing may not be available on acceptable terms or at all.

The Company is continuing its efforts to refinance its existing 12% interest mortgage with current lower rates. The Company cannot give assurance that refinancing of this mortgage will be available or, if available, that its terms will be favorable to the Company.

The Company operates in the MEMS industry, which is capital intensive.

The MEMS industry is capital intensive and requires expenditures for facilities, equipment and research and development to develop and keep pace with technological improvements. The Company believes that to achieve its objectives, it will need additional resources over the next several years for capital expenditures, working capital and research and development. The Company had $0.3 million in purchases of property, plant and equipment in the first six months of 2005. During fiscal 2005, the Company plans to make approximately $0.7 million in purchases of property, plant and equipment. The Company believes that it will be able to fund future expenditures from a combination of new capital infusion, existing cash balances, including the $15.7 million net proceeds of the Private Equity Transaction, and cash flow from operations. The Company may need additional sources of capital to meet requirements in future years. There is no assurance that additional funds will be available to the Company or, if available, that the terms and conditions will be acceptable to the Company. If the Company cannot obtain sufficient capital, it would need to curtail its operating and capital expenditures, which would adversely affect the Company’s future operating results and could prevent the Company from competing successfully in the MEMS industry.

The Company has high fixed costs and excess capacity due to its current low production volumes.

The fixed costs of operating and maintaining the Company’s 30,000 square foot wafer fabrication facility and other elements of its production capacity are high. Most of its current production consists of prototypes and new product development. These are low-volume projects, which leave the Company’s facilities underutilized and unable to absorb the fixed costs. As a result the Company experiences operating losses. The Company plans to shift from low-volume prototype and development orders to high-volume production for its customers as their development programs mature into production contracts, which will make fuller use of the Company’s excess capacity. However, making this shift depends on the success of the Company’s engineers in developing efficient high-volume production technology, the success of its customers in developing marketable uses for MEMS technology, and the general growth and acceptance of MEMS technology. If the Company cannot successfully make the transition to high-volume production, it will continue to experience losses and suffer material harm to its operating results and liquidity.

If the Company fails to respond to technological changes in the MEMS business, its future operating results may be adversely affected.

The MEMS business has been characterized by rapidly changing technology. The demand for greater capability will cause competitors to continue to build greater performance into their respective products. There can be no assurance that the Company’s products will achieve such performance. There can be no assurance that the Company will not experience manufacturing and product quality problems in the future. The Company’s future success depends in large part on its ability to develop and qualify new products on a timely basis and to manufacture them in sufficient quantities to compete effectively on the basis of price and performance.

Because certain competitors have significantly greater resources, it may be difficult for the Company to compete.

The Company competes with other independent MEMS manufacturers, with large integrated circuit manufacturers, and with captive wafer fabs owned by vertically integrated MEMS users. Many of these competitors are larger than the Company and have greater financial resources. If the Company is unable to equal or surpass its competitors in the area of price, performance, quality or customer responsiveness, then the business will be unsuccessful.

The Company’s success depends in part upon the ability to protect its intellectual property.

The Company’s success depends in large part upon its proprietary technology. The Company relies on a combination of patents, trade secret protection, confidentiality and nondisclosure agreements and licensing arrangements to establish and protect its intellectual property rights. The Company’s patents may be successfully challenged or may not provide it with the intended competitive advantages. Important technology developed by the Company may not be patentable. Despite the Company’s efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of its products or to obtain and use information that is regarded as proprietary. Policing unauthorized use of the Company’s proprietary technology is

difficult and costly. In addition, the laws of some foreign countries do not protect these proprietary rights to as great an extent as do the laws of the United States. The Company’s means of protecting its proprietary rights may not be adequate and its competitors may independently develop similar technology, duplicate its products, or design around its proprietary intellectual property.

The Company may face costly damages or litigation costs if a third party claims that the Company infringed on its intellectual property. Advanced technology products such as the Company’s are increasingly subject to third-party infringement claims. In addition, former employers of the Company’s current and future employees may assert that its employees have disclosed confidential or proprietary information to the Company. Any of these claims even if they are without merit, could be expensive and time consuming to defend.

In addition, intellectual property claims against the Company, with or without merit, could require it to enter into royalty or licensing agreements. These royalty or licensing agreements, if required, may not be available on terms acceptable to the Company or at all, which could seriously harm its business. A successful claim of infringement against the Company or its failure or inability to license the infringed or similar technology could adversely affect its business because the Company would not be able to sell the affected product without redeveloping the product or its manufacturing process, incurring significant additional expenses.

Fluctuations in quarterly and annual operating results may adversely affect the Company’s business.

The Company’s operating results have fluctuated and may continue to fluctuate from quarter to quarter and year to year. The Company’s sales are generally made pursuant to individual purchase orders and production is scheduled on the basis of such purchase orders. Because the market for MEMS products is new, and the Company is constantly introducing new designs ordered by customers, the sales cycles are long and unpredictable. The sales cycle for the Company’s products typically ranges from three to six months. Moreover, as customer programs mature, the Company may have to write down the value of inventory and equipment. In addition, the Company must qualify on future programs to sell its products. The Company has an assistance agreement with an agency of the U.S. Government and is a subcontractor for a defense-related Government contract. Changes in U.S. Government spending could have an adverse affect on the Company. Cancellation, rescheduling and reductions of orders in the future could result in inventory losses, under-utilization of production capacity and write-downs of tooling and equipment which would have a material adverse effect on the Company’s future operating results. In particular, in the past the Company’s operating results have been adversely affected when production capacity was underutilized, and they will likely be so affected in the future.

The Company’s common stock may be illiquid and suffer from price volatility because it has not been publicly traded.

There has not been a public market for the Company’s common stock since January, 2000. The Company’s outstanding common stock, which was issued after the emergence of the Company from bankruptcy, is not listed for trading on any stock market or quotation on the Nasdaq. The Company intends to apply for listing of its common stock, but believes it cannot

successfully do so until its financial performance improves. Even if listed, it is likely that the stock will initially be thinly traded and the Company cannot predict when or if investor interest in the Company will lead to the development of an active, liquid trading market. Active trading markets generally result in lower price volatility and more efficient execution of buy and sell orders for investors. A thin trading market in the Company’s stock will likely depress the trading price, make it more difficult for investors to buy or sell its common stock, and result in price volatility.

International sales expose the Company to risk.

The Company sells its products to foreign customers and expects this to be an important part of its ongoing business. Accordingly, the Company faces risks inherent in conducting business internationally, such as:

• difficulties in collecting accounts receivable and longer collection periods;

• seasonal business activity in certain parts of the world;

• potentially adverse tax consequences;

• fluctuations in revenue expressed in dollars due to changes in currency exchange rates;

• political and economic instability; and

• trade barriers.

Any of these factors could seriously harm the Company’s international sales.

The Company is subject to certain environmental laws and regulations and if it fails to comply, its future operating results may be adversely affected.

The Company’s manufacturing processes employ hazardous substances and are subject to regulation pursuant to various federal and state laws governing the environment. In the past, the Company has been subject to claims by government agencies and individuals related to disposal of hazardous materials and it has an outstanding environmental claim pending. The Company believes it conducts its business in a manner that complies with environmental laws and regulations. Nevertheless, material environmental claims could arise in the future, which could have a material adverse effect on the Company.

Interruptions in the Company’s supply of raw materials could adversely affect its business.

The Company’s operations require raw materials that meet exacting standards. The Company generally has multiple sources of supply for its raw materials; however, only a limited number of suppliers are capable of delivering certain raw materials that meet its standards. Various factors could reduce the availability of raw materials such as silicon wafers, photomasks, chemicals, and gases. In addition, any transportation problems could delay the Company’s receipt of raw materials. Although raw materials shortages or transportation problems have not

interrupted its operations in the past, shortages may occur from time to time in the future. Also, lead times for the supply of raw materials have been extended in the past. If the Company’s supply of raw materials is interrupted or its lead times extended, then its cash flow would be reduced, orders may be cancelled or diverted to competitors, and its business would suffer significant harm.

A small group of stockholders can exercise control over the Company.

A small group of stockholders holds most of the Company’s voting power. Several of these holders are parties to a voting agreement giving them, as of January 25, 2005, control over approximately 60% of the Company’s voting stock. The Company’s outstanding voting stock consists of 6,453,880 shares of common stock and 1,000,000 shares of Series A-1 Convertible Preferred Stock (the “Series A-1 Shares”). The three beneficial holders of the Series A-1 Shares are entitled to an aggregate of 5,666,700 votes on all matters presented to the stockholders other than the election of directors, and are entitled, voting as a separate class, to elect three of the Company’s eight directors. Accordingly, in matters other than the election of directors, the holders of Series A-1 Shares hold approximately 46.8% of the outstanding voting power. L-3 holds common stock representing 13.0% of the Company’s outstanding voting power. Under a Voting Agreement dated January 25, 2005, L-3 and certain members of management agreed to vote their shares with the Series A-1 shares in certain matters. Because this group currently holds approximately 60% of the Company’s voting power it could determine the outcome in any matter presented to the stockholders.

The Company’s certificate of incorporation and bylaws could delay or prevent an acquisition or sale of the Company.

The Company’s Certificate of Incorporation empowers the Board of Directors to establish and issue a class of preferred stock, and to determine the rights, preferences and privileges of the preferred stock. This gives the Board of Directors the ability to deter, discourage or make more difficult a change in control of the Company, even if such a change in control would be in the interest of a significant number of the Company’s stockholders or if such a change in control would provide stockholders with a substantial premium for their shares over the then prevailing market price for the common stock.

Anti-takeover provisions of Delaware law could delay or prevent an acquisition of the Company.

The Company is subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which regulates corporate acquisitions. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control transaction. They could also have the effect of discouraging others from making tender offers for the Company’s common stock or preventing changes in its management.

Current economic and political uncertainties may harm the Company’s business.

Deteriorating global economic conditions and the effects of ongoing military actions against terrorists may cause significant disruptions to commerce throughout the world. To the extent that such disruptions result in delays or cancellations of customer orders, a general decrease in corporate spending on advanced technology, or the Company’s inability to effectively market, manufacture or ship its products, its business, results of operations and financial conditions could suffer harm. In addition, the Company’s ability to raise capital for purposes of research and development, capital expenditures and ongoing operations depends on access to financing. During times of adverse global economic and political conditions, general investor confidence could decrease and make it more difficult for the Company to find potential investors. If the Company does not have access to financing, it could be unable to fund operations, invest in capital expenditures and fully carry out its research and development efforts, which could adversely affect the business, results of operations and financial conditions.

Standards for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 are uncertain, and if the Company fails to comply in a timely manner, investor confidence could be harmed.

Rules adopted by the Securities and Exchange Commission pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of the Company’s internal control over financial reporting, and attestation of the assessment by our independent registered public accountants. This requirement will first apply to the Company’s annual report for the period ending October 1, 2006. The standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing, and possible remediation to meet the detailed standards. The Company may encounter problems or delays in completing activities necessary to make an assessment of its internal control over financial reporting. In addition, the attestation process by the Company’s independent registered public accountants is new and the Company may encounter problems or delays in completing the implementation and requested improvements and receiving an attestation of the assessment by its independent registered public accountants. If the Company cannot assess its internal control over financial reporting as effective, or the Company’s independent registered public accountants are unable to provide an unqualified attestation report on such assessment, investor confidence may be negatively impacted.

Item 3. Controls And Procedures

Evaluation of the disclosure controls and procedures. The Chief Executive Officer and the Chief Financial Officer of the Company, with the participation of the Company’s management, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Limitations on the effectiveness of disclosure controls and procedures. Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such as simple errors or mistakes or intentional circumvention of the established process. Notwithstanding these limitations, the Company’s disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives. The Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are, in fact, effective at the “reasonable assurance” level.

Changes in internal controls over financial reporting. The Chief Executive Officer and Chief Financial Officer with the participation of the Company’s management, also conducted an evaluation of the Company’s internal controls over financial reporting to determine whether any changes occurred during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, there has been no such change during the period covered by this quarterly report.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The Company is not a party, nor are its properties subject to, any material pending legal proceedings other than ordinary routine litigation incidental to the Company’s business and the matters described in the Company’s Annual Report on Form 10-KSB.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On January 25, 2005, the Company completed the Private Equity Transaction, pursuant to which the Company sold, to the Investor Group, 1,000,000 shares of redeemable preferred stock, 1,000,000 shares of convertible preferred stock and conditional warrants to purchase up to 500,000 shares of common stock. In addition, the Company issued to its financial advisor in the transaction a warrant to purchase up to 113,333 shares of common stock. The Private Equity Transaction is described in the Company’s 8-K filed with the SEC on January 31, 2005.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

The Company’s Annual Shareholders meeting was held on March 10, 2005. The following matters were voted on and passed at the meeting:

Dr. John S. Foster and Dr. Calvin Quate were elected to serve on the Company’s Board of Directors for a three year term. BDO Seidman, LLP, independent registered public accountants, was appointed as the Company’s auditors for the fiscal year ending October 1, 2005. The Company’s Certificate of Incorporation was amended to permit removal of directors without cause.

Item 5. Other Information

None.

Item 6. Exhibits

3.1 Amended and Restated Certificate of Incorporation, as amended to date (incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-KSB for the fiscal year ended September 29, 2001).

3.3 Amended and Restated Bylaws of Innovative Micro Technology, Inc., as amended on January 25, 2005 (incorporated by reference to Exhibit 3.3 to the Company’s Current Report on Form 8-K filed on January 31, 2005).

4.1 Form of Warrant Agreement between the Company and Certain Claimants Under the Plan of Reorganization (incorporated by reference to Exhibit 4.1 to the

Company’s Annual Report on Form 10-KSB for the fiscal year ended September 29, 2001).

4.2 Warrant Agreement between the Company and L-3 Communications Corporation, dated August 1, 2003 (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed August 13, 2003).

4.3 Warrant Agreement between the Company and L-3 Communications Corporation, dated September 3, 2003 (incorporated by reference to Exhibit 4.3 to the Company’s Quarterly Report on Form 10-Q for the period ended June 26, 2004).

4.4 Warrant Agreement between the Company and Stutman Treister & Glatt, Professional Corporation, dated September 30, 2003 (incorporated by reference to Exhibit 4.4 to the Company’s Quarterly Report on Form 10-Q for the period ended June 26, 2004).

4.5 Certificate of Designation of Series A Redeemable Preferred Stock and Series A-1 Convertible Preferred Stock, dated January 24, 2005 (incorporated by reference to Exhibit 4.5 to the Company’s Current Report on Form 8 K filed on January 31, 2005).

4.6 Warrants issued by the Company to the Investors listed on Schedule I to the Preferred Stock Purchase Agreement of the Company, dated as of January 25, 2005 (incorporated by reference to Exhibit 4.6 to the Company’s Current Report on Form 8 K filed on January 31, 2005).

4.7 Warrant Agreement between the Company and W.R. Hambrecht + Co., LLC, dated as of January 25, 2005 (incorporated by reference to Exhibit 4.6 to the Company’s Current Report on Form 8 K filed on January 31, 2005).

31.1 Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003.

31.2 Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003.

32.1 Certification Pursuant to 18 U.S.C. Section 1350, Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2003.

SIGNATURE

In accordance with the requirements of the Exchange Act , the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	INNOVATIVE MICRO TECHNOLOGY, INC.


Dated: May 17 , 2005	/s/John S. Foster
	John S. Foster
	On behalf of the Company and as
	Chairman of the Board and Chief Executive Officer
	(Principal Executive Officer)

Dated: May 17 , 2005	/s/Peter T. Altavilla
	Peter T. Altavilla
	Chief Financial Officer and Secretary
	(Principal Accounting Officer)