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 December 31, 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

Indicate by check mark whether the registrant is a shell company, as defined in Rule 12b-2 of the Exchange Act

Yes o No ý

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 August 12, 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.

INNOVATIVE MICRO TECHNOLOGY, INC.

Consolidated Statements of Operations - Unaudited

(In thousands, except per share data)

	Three Months Ended December 31, 2005			Three Months Ended January 1, 2005

Net revenue
MEMS and Other	$	5,620		$	3,902
Rental Income	141			132
	5,761			4,034

Cost of revenues
MEMS and Other	5,479			3,542
Expenses applicable to rental income	24			35
	5,503			3,577
Gross profit	258			457

Research and development expenses	124			78
Selling, general and administrative expenses	504			442

Total operating expenses	628			520

Loss from operations	(370		)	(63		)

Interest income	79			1
Interest expense	(147		)	(300		)
Other income, net	8			8

Other expense	(60		)	(291		)
Loss before provision for income taxes	(430		)	(354		)
Provision for income taxes	7			6

Net loss	(437		)	(360		)
Preferred stock dividends	(234		)	—
Net loss available to common stockholders	$	(671	)	$	(360	)

Net loss per share:
Loss per common share- basic and diluted	$	(0.05	)	$	(0.05	)
Weighted average number of common shares outstanding:
Common shares- basic and diluted	12,621			6,937

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

INNOVATIVE MICRO TECHNOLOGY, INC.

Consolidated Balance Sheets - Unaudited

(In thousands, except share and par value data)

	Dec 31, 2005			Oct 1, 2005
ASSETS
Current Assets:
Cash	$	7,564		$	9,321
Accounts receivable, net	2,687			2,106
Accounts receivable, related party	11			—
Inventories	735			—
Costs in excess of billings for development projects	123			45
Costs in excess of billings for development projects- related party	—			24
Prepaid expenses and other	482			525
Total current assets	11,602			12,021
Property, plant and equipment, at cost	21,792			21,281
Less-accumulated depreciation	(4,615		)	(4,376		)
Total property, plant and equipment	17,177			16,905

Other assets	483			411
Total assets	$	29,262		$	29,337

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities:
Current portion of long-term debt	$	223		$	221
Accounts payable and accrued expenses	992			627
Accrued payroll and benefits	922			1,004
Billings in excess of costs for development projects	983			852
Other current liabilities	235			235
Total current liabilities	3,355			2,939
Long-term debt, net	9,568			9,622
Other liabilities	48			48

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 $14,786, including accrued and unpaid dividends of $619)	13,945			13,711

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)	2,614			2,614
Common stock, $.0001 par value, 25,000,000 shares authorized, 6,953,880 shares issued at December 31, 2005 and October 1, 2005	1			1
Paid-in capital	23,141			23,141
Accumulated deficit	(23,410		)	(22,739		)
Total stockholders’ equity	2,346			3,017
Total liabilities and stockholders’ equity	$	29,262		$	29,337

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

INNOVATIVE MICRO TECHNOLOGY, INC.

Consolidated Statements of Cash Flows - Unaudited

(In thousands)

	Three Months Ended December 31, 2005			Three Months Ended January 1, 2005
Cash Flows from Operating Activities:
Net loss	$	(437	)	$	(360	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization	239			290
Changes in assets and liabilities:
Accounts receivable, net	(592		)	(175		)
Inventories	(735		)	—
Costs in excess of billings on development projects	(54		)	20
Prepaid expenses and other	43			(73		)
Other assets	(72		)	22
Accounts payable and accrued expenses	365			200
Accrued payroll and benefits	(82		)	(49		)
Billings in excess of costs on development projects	131			970
Billings in excess of costs on development projects- related party	—			(693		)
Other current liabilities	—			(98		)
Net cash flows (used in) provided by operating activities	(1,194		)	54

Cash Flows from Investing Activities:
Purchases of property, plant and equipment	(511		)	(28		)
Net cash flows used in investing activities	(511		)	(28		)

Cash Flows from Financing Activities:
Repayment of debt	(52		)	(94		)
Net cash flows used in financing activities	(52		)	(94		)

Net decrease in cash	(1,757		)	(68		)
Cash at beginning of period	9,321			429
Cash at end of period	$	7,564		$	361

Supplemental Cash Flow Data:
Interest paid	$	142		$	266
Income taxes paid	$	2		$	11

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

Selected Notes to Condensed Consolidated Financial Statements

(Unaudited)

December 31, 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 $0.4 million for the three months ended December 31, 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.

On June 30, 2005, the Company secured a new mortgage of $9.9 million (see Note E — Debt of financial statements). Related to this transaction, the Company created a wholly owned subsidiary entitled Robin Hill Business Park, LLC (“RHBP”). The new entity is consolidated within the accompanying financial statements.

In order to fund revenue growth, on January 25, 2005, the Company sold equity securities in a private transaction to an investor group consisting of Investor Growth Capital Limited, BA Venture Partners and Miramar Venture Partners (together 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 (“Series A”), 1,000,000 shares of convertible preferred stock, Series A-1 (“Series A-1”) and warrants for the purchase of up to 500,000 shares of common stock, which were earned by the Investor Group when the Company failed to meet certain performance targets for 2005, 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 advisor, 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, assuming no exercise of the warrants referenced above.

The Series A shares may be redeemed at the option of the Series A holders at any time after December 31, 2008, by an affirmative vote of the Series A Holders holding at least a majority of the then-outstanding Series A Shares. The Series A-1 shares do not have a redemption feature.

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. Until applied to specific purposes, the Company is investing 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.

Operating results for the three months ended December 31, 2005 are not necessarily indicative of the results that may be expected for the year ending September 30, 2006. For further information, refer to the consolidated financial statements and footnotes thereto, included in the Company’s Annual Report on Form 10-KSB for the year ended October 1, 2005.

Note B: 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.

Inventories: The Company inventories are stated at the lower of cost (first-in, first-out method) or market. Inventories consist of purchased materials and services, direct production labor and manufacturing overhead. Inventories at December 31, 2005 were approximately $0.7 million.

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 December 31, 2005 were approximately $0.1 million and 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 December 31, 2005 were approximately $1.0 million related to capitalized costs and related billings 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 micro-electro mechanical systems (“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 met, reviewed and accepted by the customer. The Company’s MEMS production contracts require delivery of finished product in the form of dies and revenue is recognized after both the product is shipped and title passes. 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. The Company’s MEMS production contracts started in its first fiscal quarter of 2006 and did not have any sales returns in the three months ended December 31, 2005. Santa Barbara Tool & Die and IMT Analytical did not have any sales returns in the three months ended December 31, 2005. The Company’s warranty policy provides for the replacement of defective parts when the customer’s return request is 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.

A portion of the Company’s facilities is leased to a tenant under a long-term contract. The terms of the lease expires within the next year with renewal options. Rental income is recorded on a straight-line basis.

Note C: 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 month period ended December 31, 2005 and January 1, 2005, 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 common share amounts)

	Three Months Ended December 31, 2005			Three Months Ended January 1, 2005
Net loss available to common stockholders— as reported	$	(671	)	$	(360	)
Less — fair value of stock-based employee compensation expense	(15		)	(284		)
Net loss available to common stockholders— pro forma	$	(686	)	$	(644	)
Net loss per share (basic and diluted) — as reported	$	(0.05	)	$	(0.05	)
Net loss available to common stockholders per share (basic and diluted) — pro forma	$	(0.05	)	$	(0.09	)

In the second fiscal quarter of 2005, the Company offered its employees the opportunity to exchange outstanding stock options issued under the Innovative Micro Technology, Inc. 2001 Stock Incentive Plan (the “Plan”) and having an exercise price in excess of $0.30 for new options with an exercise price determined on the grant date, which was the close of the first business day six months and one day following the date the exchange offer closed of April 27, 2005. Pursuant to the offer, the Company accepted for exchange and cancelled options to purchase 1,609,648 shares of its common stock. On October 31, 2005, the first business day six months and one day following the date the exchange offer closed, the Company granted options to purchase 1,609,252 shares of its common stock, to the employees continuing to be employed by the Company, to purchase its common stock at an exercise price of $0.30 per share.

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 December 31, 2005		Three Months Ended January 1, 2005

Risk free interest rate	4.19	%	3.70	%
Expected life	2.9 years		4 years
Expected volatility	60	%	64	%

Note D: 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, 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 has two contracts with L-3.

The Company had minimal accounts receivable from L-3 as of December 31, 2005.

Note E: Debt

On June 30 2005, the Company secured a new mortgage of $9.9 million with an annual interest rate of 5.65%. The loan is due on July 1, 2015 and the monthly payment of $64,800 includes principal amortization computed using a 22.5 year life. The mortgage provided net proceeds to the Company of approximately $9.7 million. The Company used $8.8 million of the net proceeds to retire its previous mortgage, $0.3 million to retire its delinquent property taxes, $0.2 million was placed into escrow to be used for building improvements required by the agreement with the lender and the balance of $0.4 million was used for general working capital needs and other corporate purposes. Related to this transaction, the Company created RHBP as a wholly owned subsidiary. The Company transferred the mortgaged property to RHBP and this same entity entered into the loan agreement with the lender. The lender required this structure in order for the Company to secure the loan.

The Company settled two claims during the Chapter 11 Reorganization that were secured by its owned real properties. One of these claims was a property mortgage of $9.6 million due on November 24, 2005. The mortgage required interest-only payments at a 12% annual interest rate. The other claim was for delinquent property taxes of $0.9 million. The settlement required semi-annual principal and interest payments on November 1 and May 1 of each year with an 8% annual interest rate. The property mortgage and the delinquent property taxes were retired with the proceeds of the new mortgage, which was completed on June 30, 2005.

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 was collateralized by both of its properties, from $9.6 million to $8.8 million. The remaining $8.8 million mortgage was secured by the Company’s Robin Hill property. The $8.8 million mortgage was retired with the proceeds of the new mortgage, which was completed on June 30, 2005.

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

	December 31, 2005
Property mortgage	$	9,791
Less - Current portion	(223		)
Total	$	9,568

Note F: 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 months ended December 31, 2005 and January 1, 2005 are as follows:

(in thousands, except per share amounts)

	Three Months Ended December 31, 2005			Three Months Ended January 1, 2005

BASIC AND DILUTED EPS
Net loss available to common stockholders	$	(671	)	$	(360	)
Denominator: weighted average common shares outstanding	12,621			6,937
Net loss available to common stockholders per share – basic and diluted	$	(0.05	)	$	(0.05	)

The following potentially dilutive securities were outstanding at December 31, 2005 and were not included above because to do so would be anti-dilutive: options to purchase 2,404,448 shares of common stock at prices ranging from $0.30 to $5.35, warrants to purchase 350,000 shares of common stock at a price of $7.29 per share with a term of 36 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 36 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, which were earned by the Investor Group when the Company failed to meet certain performance targets for 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 value of these warrants provided to WRH were determined to be $2,000 using the Black-Scholes option pricing model with the following assumptions: a risk-free interest rate of 3.55%, an expected volatility of 63%, a warrant term of 3 years, and no expected dividends. The warrants were determined to have de minimus value, but were recorded within common stock. 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 January 1, 2005 and were not included above because to do so would be anti-dilutive: options to purchase 1,723,652 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 $5.3 5 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 warrants provided to the subordinated note claimants pursuant to the Plan (the “Plan Warrants”) expired on December 16, 2004.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123(R), “Share-Based Payment,” which addresses the accounting for employee stock options. SFAS 123(R) revises the disclosure provisions of SFAS 123 and supersedes APB 25. SFAS 123(R) requires that the cost of all employee stock options, as well as other equity-based compensation arrangements, be reflected in the financial statements based on the estimated fair value of the awards. In March 2005, the Securities & Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107, “Share-Based Payment”, which summarizes the views of the SEC staff regarding the interaction between SFAS 123(R) and certain SEC rules and regulations, and is intended to assist in the initial implementation. SFAS 123(R) is effective for all small business issuers that file as of the beginning of the fiscal year that begins after December 15, 2005. The effect of adopting this statement will be to increase the Company’s compensation expense in the future.

In December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets, an amendment of APB 29, Accounting for Nonmonetary Transactions.” This Statement’s amendments are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, SFAS 153 eliminates the narrow exception for nonmonetary exchanges of similar productive assets and replaces it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance.

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		Total
Three Months Ended:
December 31, 2005
Net sales	$	5,284	$	309	$	27	$	141	$	5,761
Intercompany sales	$	10	$	37	$	84	$	—	$	—
Gross profit	$	40	$	41	$	60	$	117	$	258
Long lived assets	$	15,454	$	206	$	—	$	1,517	$	17,177

Three Months Ended:
January 1, 2005
Net sales	$	3,526	$	339	$	37	$	132	$	4,034
Intercompany sales	$	5	$	33	$	65	$	—	$	—
Gross profit	$	255	$	60	$	45	$	97	$	457
Long lived assets	$	14,449	$	69	$	17	$	2,382	$	16,917

The Company had approximately $0.5 million in purchases of property, plant and equipment in the first three months of fiscal 2006 compared to minimal purchases in the first three months of fiscal 2005.

The Company’s foreign sales for the first three months of both fiscal 2006 and 2005 were principally to one customer located in Canada. The following table displays domestic and foreign revenue (in thousands):

($000’s)	Three Months Ended December 31, 2005		Three Months Ended January 1, 2005

Revenue
Domestic	$	1,933	$	3,518
Foreign	3,828		516
Total	$	5,761	$	4,034

The Company had one customer with sales greater than 10% of its total sales for the first three months of fiscal 2006. The customer accounted for 66% 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 1, 2005.

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 is currently in volume production on one of its customer’s MEMS products.

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 first fiscal quarter of 2006 was predominantly related to the Company’s MEMS customer development projects. These include a telecommunications switch, and infrared sensors used to detect gases in internal environments. 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 started volume production shipments on one of its customer’s products in the first quarter of fiscal 2006. 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, 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 sold equity securities in a private transaction to an investor group made up of Investor Growth Capital Limited, BA Venture Partners and Miramar Venture Partners (together 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 Series A shares, 1,000,000 Series A-1 shares and warrants for the purchase of up to 500,000 shares of common stock, which were earned by the Investor Group when the Company failed to meet certain performance targets for 2005, 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 advisor, 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, assuming no exercise of the warrants referenced

above. On January 25, 2005, the Company used approximately $1.6 million of the net proceeds to repay all of its indebtedness under a secured promissory note issued to L-3 Communications Corporation (“L-3”). The remainder of the net proceeds were used for general working capital needs and other corporate purposes, as defined in further detail below.

The Company expects to use the remainder of 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.

On June 30 2005, the Company secured a new mortgage of $9.9 million with an annual interest rate of 5.65%. The loan is due on July 1, 2015 and the monthly payment of $64,800 includes principal amortization computed using a 22.5 year life. The mortgage provided net proceeds to the Company of approximately $9.7 million. The Company used $8.8 million of the net proceeds to retire its previous mortgage, $0.3 million to retire its delinquent property taxes, $0.2 million was used for building improvements required by the agreement with the lender and the balance of $0.4 million was used for general working capital needs and other corporate purposes. The reduction in interest rate from 12% on the previous mortgage to 5.65% on the new mortgage provides the Company with an annual interest cost savings of approximately $0.5 million.

Until applied to specific purposes, the Company is investing 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.

determined to be complete after all contract milestones have been met, reviewed and accepted by the customer. The Company’s MEMS production contracts require delivery of finished product in the form of dies and revenue is recognized after both the product is shipped and title passes. 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. The Company’s MEMS production contracts started in its first fiscal quarter of 2006 and did not have any sales returns in the three months ended December 31, 2005. Santa Barbara Tool & Die and IMT Analytical did not have any sales returns in the three months ended December 31, 2005. 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.

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.

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 December 31, 2005 were approximately $1.0 million related to capitalized costs under the completed contract method of accounting, as described below.

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 $9.8 million of the Company’s mortgage indebtedness at December 31, 2005 has an interest rate of 5.65% and is carried at its full value.

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 n ot have a basis to conclude that it is more likely than not that it will realize the deferred tax assets.

Recent Accounting Pronouncements

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”), which is an interpretation of SFAS 143, “Accounting for Asset Retirement Obligations.” FIN47 clarifies terminology within SFAS 143 and requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 is effective for fiscal years ending after December 15, 2005. The adoption of this statement is not expected to have a material impact on the Company’s financial statements.

In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections.” SFAS 154 replaces APB 20, “Accounting Changes” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements” and establishes retrospective application as the required method for reporting a change in accounting principle. SFAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of this statement is not expected to have a material impact on the Company’s financial statements.

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 1, 2005 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 December 31, 2005 Compared to Three Months Ended January 1, 2005

Net Revenue. Net revenue was $5.8 million for the first quarter of fiscal 2006 compared to $4.0 million for the same period of fiscal 2005. The sales for the first quarter of fiscal 2006 consisted of $5.3 million of MEMS-related business, $0.3 million from the combination of Santa Barbara Tool and Die and $0.2 million from leasing of space to tenants. The sales increase, as compared to the same quarter of fiscal 2005, was due to the increase in the level of completed contracts in the MEMS-related portion of the business. The Company completed a development contract with one of its customers in the telecommunications market for a value of $2.6 million in the first quarter of fiscal 2006. The Company’s contract activity, measured by the completed contracts plus the change in contract inventory, shows an increase for the first quarter of fiscal 2006 compared to the same quarter of last year. The Company’s contracts generally take more than one quarter to complete, thus the net revenue increase is due to the timing of the contract completions. The net revenue for the fiscal 2005 period consisted of $3.5 million of MEMS, $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.

Gross Profit. Gross profit was $0.3 million or 4.5% of revenue for the first quarter of fiscal 2006 compared to a gross profit of $0.5 million or 11.3% of net revenue for the first quarter of fiscal 2005. The fiscal 2006 period saw the MEMS portion of the business generate a gross profit of $0.1 million, the combination of Santa Barbara Tool and Die and IMT Analytical generated a $0.1 million gross profit and leasing of space to tenants provided a $0.1 million gross profit. The fiscal 2005 period saw the MEMS portion of the business generate a gross profit of $0.3 million, the combination of Santa Barbara Tool and Die and IMT Analytical generated a $0.1 million gross profit and leasing of space to tenants provided a $0.1 million gross profit. The Company experienced a minimal gross profit in the first quarter of fiscal 2006 due to an increase in revenue as compared to the same period of fiscal 2005, which resulted in the absorption of the factory fixed costs (e.g, depreciation, utilities). However, the Company’s fixed cost absorption was offset by cost increases associated with the headcount increase required to enable the Company to transition into production, resulting in a lower gross profit compared to the same period of fiscal 2005. As the Company migrates toward high volume production it anticipates increased absorption of its fixed costs. The Company had 128 production employees at the end of the first fiscal quarter of 2006 compared to 84 at the end of the same period of fiscal 2005.

Research and Development. Research and development (“R&D”) expense, as a percentage of net sales, was 2.2% for the first quarter of fiscal 2006 compared to 1.9% for the first quarter of fiscal 2005. R&D expenditures were approximately $0.1 million for both the first quarter of fiscal 2006 and fiscal 2005. The Company had three employees focused on the development of new products and manufacturing processes as of the end of the first quarter of fiscal 2006 compared to four for the same period of fiscal 2005.

Selling, General and Administrative Expenses. Selling, general and administrative expense (“SG&A”), as a percentage of net sales, was 8.7% for the first quarter of fiscal 2006 and 11.0% for the first quarter of fiscal 2005. SG&A expenses decreased as a percentage of sales in the first quarter of fiscal 2006 due to the increase in net revenue. Measured in dollars, SG&A expenditures were approximately $0.5 million for the first quarter of fiscal 2006 compared to $0.4 million for the same period of fiscal 2005. The Company had nine employees providing the services reported as SG&A as of the end of the first quarter of fiscal 2006 and seven as of the end of the same period of fiscal 2005. These services include sales and marketing, accounting, information systems, human resources and administration.

Interest Expense. Interest expense was $0.1 million for the first quarter of fiscal 2006 compared to $0.3 million for the first quarter of fiscal 2005. The interest expense is primarily associated with the Company’s property mortgage. On June 30 2005, the Company secured a new mortgage of $9.9 million with an annual interest rate of 5.65%. The loan is due on July 1, 2015 and the monthly payment of $64,800 includes principal amortization computed using a 22.5 year life. The reduction in interest rate from 12% on the previous mortgage to 5.65% on the new mortgage provides the Company with an annual interest cost savings of approximately $0.5 million.

Preferred Stock Dividends. Preferred stock dividends of $0.2 million were accrued in the first fiscal quarter of 2006 related to the Private Equity Transaction, which was completed on January 25, 2005. 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.

Liquidity and Capital Resources

The Company’s principal funding need is for working capital to fund continuing operations, research and development and expansion of the business. The Company expects to meet its needs for liquidity during fiscal 2006 with funds from operations. The Company’s ability to generate revenue from operations in the future will depend heavily on its ability to achieve volume production of its MEMS products on a timely basis. Although the Company is devoting substantial engineering and manufacturing resources to its production goals, there can be no assurances that the Company will achieve planned production levels. Accordingly, in the future, the Company may need to obtain additional funds for operations by the sale of equity securities or borrowing, but it can give no assurance that debt or equity financing will be available on terms that are acceptable to the Company, or at all.

On January 25, 2005, the Company sold equity securities in a private transaction to the Investor Group. The Investor Group invested a total of $17.0 million in the Company in exchange for 1,000,000 Series A shares, 1,000,000 Series A-1 shares and warrants for the purchase of up to 500,000 shares of common stock, which were earned by the Investor Group when the Company failed to meet certain performance targets for 2005, 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, assuming no exercise of the warrants referenced above. 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 are being used for general working capital needs and other corporate purposes.

The Company’s cash balance was $7.6 million at December 31, 2005 compared to $9.3 million at October 1, 2005. The decrease in cash is primarily related the use of $1.2 million of cash for operations in the first three months of fiscal 2006. The Company had $0.5 million in expenditures for capital equipment in the first three months of fiscal 2006. The Company used $0.1 million for the payment of the principal on its mortgage.

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 2006, the Company plans to have approximately $3.5 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 December 31, 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, 2007. 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.

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.

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 Series A shares, 1,000,000 Series A-1 shares 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 is using 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.

On June 30 2005, the Company secured a new mortgage of $9.9 million with an annual interest rate of 5.65%. The mortgage provided net proceeds to the Company of approximately $9.7 million. The Company used $8.8 million of the proceeds to retire its previous mortgage, $0.3 million to retire its delinquent property taxes, $0.2 million was placed into escrow to be used for building improvements required by the agreement with the lender and the balance of $0.4 million are being used for general working capital needs and other corporate purposes.

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 $0.5 million in purchases of property, plant and equipment in the first three months of 2006. During fiscal 2006, the Company plans to make approximately $3.5 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, lease financing, 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 believes that an effort to list its stock would be unsuccessful until the Company’s financial performance improves. Even if eventually listed, it is likely that the stock would initially be thinly traded. 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 on 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

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

None.

Item 3. Defaults Upon Senior Securities

None.

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

None.

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-QSB 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-QSB 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).

10.1		Deed of Trust and Security Agreement between Robin Hill Business Park, LLC, a subsidiary of the Company, and Morgan Stanley Mortgage Capital, Inc., dated as of June 30, 2005. (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-QSB for the period ended July 2, 2005).

10.2		Promissory Note between Robin Hill Business Park, LLC, a subsidiary of the Company, and Morgan Stanley Mortgage Capital, Inc., dated as of June 30, 2005. (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-QSB for the period ended July 2, 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.

	INNOVATIVE MICRO TECHNOLOGY, INC.


Dated: February 13, 2006	/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: February 13, 2006	/s/Peter T. Altavilla
	Peter T. Altavilla
	Chief Financial Officer and Secretary
	(Principal Financial and Accounting Officer)

Date: February 13, 2006		/s/ John S. Foster
		John S. Foster
		Chairman of the Board and Chief Executive Officer
		(Principal Executive Officer)

Date: February 13, 2006		/s/Peter T. Altavilla
		Peter T. Altavilla
		Chief Financial Officer and Secretary
		(Principal Financial and Accounting Officer)

Dated: February 13, 2006	/s/ John S. Foster
	John S. Foster
	Chief Executive Officer
	(Principal Executive Officer)


Dated: February 13, 2006	/s/ Peter T. Altavilla
	Peter T. Altavilla
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS

APPLICABLE ONLY TO CORPORATE ISSUERS

Recent Accounting Pronouncements

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS