10QSB 1 imt2004qtr110qsb.txt QUARTERLY REPORT ON FORM 10-QSB UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 Form 10-QSB --------------- [X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended December 27, 2003. [ ] Transition Report Under Section 13 or 15(d) of the Exchange Act 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 (I. R. S. Employer incorporation or organization) Identification No.) 75 Robin Hill Road, Goleta, California 93117 -------------------------------------------- (Address of principal executive offices) Registrant's telephone number: (805) 681-2800 Check whether the issuer: (1) 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 X No __ 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 X No ___ APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 6,937,444 shares of $.0001 par value common stock as of February 2, 2004. 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 September 27, 2003. 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. 2 INNOVATIVE MICRO TECHNOLOGY Statements of Operations - Unaudited (In thousands except per share data)
Three Months Three Months Ended Ended December 27, December 28, ------------ ------------ 2003 2002 ---- ---- Net revenue MEMS and Other $ 2,548 $ 1,433 Rental Income 131 127 ------------ ------------ 2,679 1,560 Cost of revenues MEMS and Other (including stock-based compensation of $47 and $95 for the periods ended December 27, 2003 and December 28, 2002, respectively) 3,091 1,834 Expenses applicable to rental income 30 35 ------------ ------------ 3,121 1,869 ------------ ------------ Gross loss (442) (309) Research and development expenses (including stock-based compensation of $40 and $79 for the periods ended December 27, 2003 and December 28, 2002, respectively) 201 225 Selling, general and administrative expenses (including stock-based compensation of $70 and $139 for the periods ended December 27, 2003 and December 28, 2002, respectively) 763 698 ------------ ------------ Total operating expenses 964 923 ------------ ------------ Loss from operations (1,406) (1,232) Interest income 1 8 Interest expense (279) (764) Other income, net 84 34 ------------ ------------ Other expense (194) (722) ------------ ------------ Loss before provision for income taxes (1,600) (1,954) Provision for income taxes 10 9 ------------ ------------ Net loss $ (1,610) $ (1,963) ============ ============ Net loss per share: Loss per common share-basic and diluted $ (0.24) $ (0.36) ============ ============ Weighted average number of common shares outstanding: Common shares-basic and diluted 6,737 5,435 ============ ============
The accompanying Selected Notes to Condensed Financial Statements are an integral part of these condensed statements. 3 INNOVATIVE MICRO TECHNOLOGY, INC. Balance Sheet - Unaudited (In thousands except share and par value data)
ASSETS Dec 27, Sept 27, ------------ ---------- 2003 2003 ---- ---- Current Assets: Cash $ 300 $ 2,463 Accounts receivable, net 402 634 Accounts receivable, related party 152 436 Costs in excess of billings for development projects 14 - Prepaid expenses and other 232 272 ------------ ---------- Total current assets 1,100 3,805 ------------ ---------- Property, plant and equipment, at cost 20,328 20,328 Less-accumulated depreciation (2,297) (2,008) ------------ ---------- Total property, plant and equipment 18,031 18,320 ------------ ---------- Other assets 425 448 ------------ ---------- Total assets $ 19,556 $ 22,573 ============ ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt $ 188 $ 1,568 Accounts payable and accrued expenses 604 681 Accrued payroll and benefits 486 386 Billings in excess of costs for development projects 161 306 Billings in excess of costs for development projects-related party 481 536 Other current liabilities 120 1,130 ------------ ---------- Total current liabilities 2,040 4,607 ------------ ---------- Long-term debt, net 9,206 12,057 ------------ ---------- Other liabilities 132 132 ------------ ---------- Stockholders' Equity: Preferred stock, $.0001 par value, authorized 2,500,000 shares, none issued and outstanding - - Common stock , $.0001 par value, 25,000,000 shares authorized, 6,937,444 shares issued at December 27, 2003 and 5,435,000 1 1 shares issuable at December 28, 2002 Paid-in capital 23,056 19,202 Accumulated deficit (14,879) (13,269) ------------ ---------- 8,178 5,934 Unearned restricted stock compensation - (157) ------------ ---------- Total stockholder's equity 8,178 5,777 ------------ ---------- Total liabilities and stockholder's equity $ 19,556 $ 22,573 ============ ==========
The accompanying Selected Notes to Condensed Financial Statements are an integral part of these condensed balance sheets. 4 INNOVATIVE MICRO TECHNOLOGY, INC. Statements of Cash Flows - Unaudited (In thousands)
Three Months One Month Ended Ended December 27, December 28, ------------ ------------ 2003 2002 ---- ---- Cash Flows from Operating Activities: Net loss $ (1,610) $ (1,963) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 289 289 Employee restricted stock amortization 157 312 Amortization of loan costs - 31 Induced conversion of professional notes 203 - Changes in assets and liabilities: Accounts receivable, net 516 259 Costs in excess of billings on development projects (14) (68) Costs in excess of billings on development projects-related party - 25 Prepaid expenses and other 40 46 Other assets 23 24 Accounts payable and accrued expenses (77) 50 Accrued payroll and benefits 100 80 Billings in excess of costs on development projects (145) (41) Billings in excess of costs on development projects-related party (55) 25 Other current liabilities (2) 25 ------------ ------------ Net cash flows used in operating activities (575) (906) ------------ ------------ Cash Flows from Investing Activities: Purchases of property, plant and equipment - (28) ------------ ------------ Net cash flows used in investing activities - (28) ------------ ------------ Cash Flows from Financing Activities: Proceeds from sale of common stock 894 - Repayment of debt (2,482) (94) ------------ ------------ Net cash flows used in financing activities (1,588) (94) ------------ ------------ Net (decrease) increase in cash (2,163) (1,028) ------------ ------------ Cash at beginning of period 2,463 2,890 ------------ ------------ Cash at end of period $ 300 $ 1,862 ============ ============ Supplemental Cash Flow Data: Interest paid $ 293 $ 470 ============ ============ Income taxes paid $ 1 $ - ============ ============ Supplemental disclosure on non-cash financing activity: 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. 5 Selected Notes to Financial Statements Unaudited December 27, 2003 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 $1.6 million for the three months ended December 27, 2003 and has a working capital deficit of $0.9 million as of December 27, 2003. 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. The above items raise substantial doubt about the Company's ability to continue as a going concern. The Company's independent auditors qualified their opinion on the Company's September 27, 2003 financial statements by including an explanatory paragraph, in which they expressed substantial doubt about the Company's ability to continue as a going concern. Operating results for the three months ended December 27, 2003 are not necessarily indicative of the results that may be expected for the year ending October 2, 2004. 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 September 27, 2003. Note B: Chapter 11 Reorganization --------------------------------- The Company has reorganized itself from a manufacturer of magnetic recording heads for the disk drive industry to a manufacturer of micro electro mechanical systems ("MEMS"), operating in a number of industry sectors. The Company's Reorganization Plan (the "Plan") became effective on November 16, 2001 ("Effective Date"). The Company adopted the fresh- start reporting requirements of American Institute of Certified Public Accountants Statement of Position 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code" during the first quarter of fiscal 2002. In accordance with the fresh-start reporting requirements, the reorganization value of the Company was allocated to the Company's assets in conformity with the procedures specified by SFAS No. 142, "Goodwill and Other Intangible Assets." As provided for under the Plan, the Company converted approximately $12 million of its secured liabilities to debt and $304 million of unsecured liabilities to common stock and warrants in the reorganized entity. The Company issued the common stock and warrants pursuant to the Plan in fiscal 2003. 6 Note C: Related Party Transaction ---------------------------------- On October 31, 2003, L-3 Communications Corporation ("L-3") exercised 167,000 warrants for the purchase of Common Stock at a price of $5.35 per share for a total of $0.9 million. L-3 received these warrants, as well as a thirty-six month warrant for the purchase of 700,000 shares of Common Stock at $7.29 per share, as part of its $5.0 million August 2002 investment in the Company. The Company plans to use the funds for working capital requirements. 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 billings in excess of costs for development projects of $0.5 million and accounts receivable of $0.2 million related to L-3, as of December 27, 2003. Note D: 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 the holder to take a reduced amount of cash for their final agreement with the Company. The Company 7 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 (in thousands): December 27, 2003 --------------- Property Mortgage $ 8,830 Property Taxes 564 --------------- 9,394 Less - Current portion (188) --------------- Total $ 9,206 =============== Note E: 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 months ended December 27, 2003 and December 28, 2002, 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 Three Months Ended Ended December 27, December 28, ------------ ------------ 2003 2002 ---- ---- $ (1,610) $ (1,963) Net loss -- as reported Less -- fair value of stock-based employee compensation expense (293) (265) -------- --------- Net loss -- pro forma $ (1,903) $ (2,228) Net loss per share (basic and diluted) -- as reported $ (0.24) $ (0.36) Net loss per share (basic and diluted) -- pro forma $ (0.28) $ (0.41) 8 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 Three Months Ended Ended December 27, December 28, ------------ ------------ 2003 2002 ---- ---- Risk free interest rate 3.70% 3.82% Expected life 4 years 4 years Expected volatility 70% 70% 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 27, 2003 and December 28, 2002 are as follows: (in thousands, except per share amounts) Three Months Three Months Ended Ended December 27, December 28, ------------ ------------ 2003 2002 ---- ---- BASIC AND DILUTED EPS Net loss $ (1,610) $ (1,963) Denominator: weighted average common shares outstanding 6,737 5,435 Net loss per share - basic and diluted (0.24) (0.36) The following potentially dilutive securities were outstanding at December 27, 2003 and were not included above because to do so would be anti-dilutive: options to purchase 1,679,897 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 9 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. The following potentially dilutive securities were outstanding at December 28, 2002 and were not included above because to do so would be anti-dilutive: 500,000 shares of restricted common stock issuable under the Plan, options to purchase 1,523,397 shares of common stock at prices ranging from $5.00 to $5.35, warrants to purchase 167,000 shares of common stock at a price of $5.35 per share with a term of eighteen months ending February 1, 2004, 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 and approximately 504,500 common shares from the potential conversion of the Professional Persons convertible notes which were due November 16, 2003 (see Note D - Debt). Note G: Significant Accounting Policies and New Accounting Pronouncements -------------------------------------------------------------------------- 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. 10 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 December 27, 2003 were minimal related to capitalized costs under 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 27, 2003 were $0.6 million related to capitalized costs under completed contract method of accounting, as described below. Contracts with L-3 (a related party) account for $0.5 million of this billings in excess of costs on development projects balance. 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 first fiscal quarter of 2004 or 2003. The Company's warranty policy provides for the replacement of defective parts when the customers return request is approved within thirty days of the original shipment date. To date, warranty costs have not been significant. 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 the short maturity of these financial instruments. The carrying amount of approximately $8.8 million of the Company's debt at December 27, 2003 approximates fair market value as the debt is with multiple lenders and it had been negotiated at the same rate which appears to represent a market rate of interest. The 8% interest rate on $0.6 million of 11 debt due on delinquent property taxes is at rates below market. The fair value of the debt would be $0.4 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, including potentially dilutive securities outstanding would have been antidilutive 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 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an Amendment to SFAS No. 123." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method on accounting for stock-based employee compensation, as well as additional disclosure requirements for both quarterly and annual reporting. The Company has elected to continue to account for stock-based employee compensation by the intrinsic value method under APB 25, as permitted by SFAS No. 123, while disclosing on a pro forma basis the effect on the Company's financial statements had the fair value method been used. Accordingly, the implementation of SFAS No. 148 has not had a material effect on the Company's consolidated financial position or results of operations. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others," which requires guarantees to be recognized at fair value. Interpretation 45 also requires additional disclosures, which disclosures are effective for financial statements for periods ending after December 15, 2002. While the Company has various guarantees included in contracts in the normal course of business, in the form of product 12 warranties and indemnification of the officers and directors, these guarantees would only result in immaterial increases in future costs, but do not represent significant commitments or contingent liabilities of the indebtedness of others. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46) which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements issued by the Company after 2002; however, disclosures are required currently if the Company expects to consolidate any variable interest entities. No material entities were consolidated as a result of FIN 46. In May 2003 the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires certain instruments, including mandatorily redeemable shares, to be classified as liabilities, not as part of stockholders' equity or redeemable equity. For instruments that are entered into or modified after May 31, 2003, Statement 150 is effective immediately upon entering the transaction or modifying the terms. For other instruments covered by Statement 150 that were entered into before June 1, 2003, Statement 150 is effective for the first interim period beginning after June 15, 2003. The Company does not have any outstanding financial instruments of the type addressed by SFAS No. 150 and accordingly, SFAS No. 150 has not had a material impact on the Company's financial position. In November 2002, the EITF reached a consensus on EITF 00-21, "Revenue Arrangements with Multiple Deliverables," related to the separation and allocation of consideration for arrangements that include multiple deliverables. The EITF requires that when the deliverables included in this type of arrangement meet certain criteria they should be accounted for separately as separate units of accounting. This may result in a difference in the timing of revenue recognition but will not result in a change in the total amount of revenues recognized in a bundled sales arrangement. The allocation of revenues to the separate deliverables is based on the relative fair value of each item. If the fair value is not available for the delivered items then the residual method must be used. This method requires that the amount allocated to the undelivered items in the arrangement is their full fair value. This would result in the discount, if any, being allocated to the delivered items. This consensus is effective prospectively for arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 has not had a material impact on the Company's financial statements. 13 Note H: 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 December 27, 2003, approximately 34,000 square feet were under long-term lease arrangements and 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. 14 The following table represents net sales, gross profit (loss) and long-lived assets by segment (in thousands): Santa Barbara IMT Rental United States MEMS Tool and Die Analytical Income Total -------------------------------------------------------- Three Months Ended: December 27, 2003 Net sales $ 2,287 $ 236 $ 25 $ 131 $ 2,679 ======================================================== Intercompany Sales $ 2 $ 17 $ 67 $ - $ - ======================================================== Gross profit (loss) $ (541) $ 15 $ (17) $ 101 $ (442) ======================================================== Long Lived Assets $ 15,377 $ 111 $ 41 $ 2,502 $ 18,031 ======================================================== Three Months Ended: December 27, 2002 Net sales $ 1,319 $ 79 $ 35 $ 127 $ 1,560 ======================================================== Intercompany Sales $ 2 $ 34 $ 79 $ - $ - ======================================================== Gross profit (loss) $ (374) $ (43) $ 16 $ 92 $ (309) ======================================================== Long Lived Assets $ 16,328 $ 145 $ 64 $ 2,628 $ 19,165 ======================================================== The Company had no purchases of property, plant and equipment in the first three months of fiscal 2004 compared to minimal purchases in the first three months of fiscal 2003. The Company's foreign sales for the first three months of both fiscal 2004 and 2003 were all to a customer in Japan. The following table displays domestic and foreign revenue (in thousands): Three Months Three Months Ended Ended December 27, December 28, ($000's) 2003 2002 ------------------------- Revenue ------- Domestic $ 2,314 $ 1,303 Foreign 365 257 ------------------------- Total $ 2,679 $ 1,560 ========================= The Company had two customers with sales greater than 10% of its total sales for the first three months of fiscal 2004. They individually accounted for 61% and 14% of the Company's total sales for the period. 15 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 independent auditors have expressed doubt as to its ability to continue as a going concern; the Company's ability to make the transition to volume production of MEMS products; the Company's history of losses and bankruptcy; the Company's need for additional capital; 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; anti-takeover provisions of the Company's charter and Delaware law; and general economic and political uncertainty. General ------- The Company designs and manufactures micro-electro-mechanical systems ("MEMS") for the personal security, 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 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 of 2001. During the reorganization period the Company re-organized 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. 16 The Company believes that it will begin the transition to limited volume production of some MEMs products in the third quarter of fiscal 2004. The Company expects the shift to begin to remedy the problems of overcapacity and high fixed costs. The Company is currently seeking additional capital to enable it to make this transition. However, while making the shift to limited volume production will ameliorate the Company's cash flow problems, the Company does not expect to achieve positive net income in the near term. 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 are predominantly orders for delivery of prototypes and new product development. The revenue for the first fiscal quarter of 2004 was predominantly related to the Company's customer development projects. These include an accelerometer for use in inertial navigation and a telecommunications optical switch. Additional revenue was contributed by Santa Barbara Tool & Die, IMT Analytical and leasing of excess space in our owned facility under long-term lease contracts. The current level of sales cannot absorb the fixed costs of operating the Company's 30,000 square foot wafer fabrication facility. The Company plans to transition 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 customer's product and the Company's 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 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. 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. Going Concern Assumption: The Company has incurred net losses and losses from operations for each quarter since 1999. The Company incurred a net loss of $1.6 million for the fiscal quarter ended December 27, 2003 and has a working capital deficit of $0.9 million as of December 27, 2003. It expects to continue 17 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. The Company has not secured additional capital for these expenses or for working capital in future periods. It will also 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 financial statements included in this report have been prepared assuming that the Company will continue as a going concern. The recurring losses from operations and uncertainty regarding future sources of capital discussed above raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include adjustments that might result from the outcome of this uncertainty. Statement of Position 90-7 and Fresh-Start Accounting: The Company exited the Chapter 11 Reorganization on November 16, 2001 ("Effective Date"). The Company adopted the fresh-start reporting requirements of Statement of Position 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code" during the first quarter of fiscal 2002. In accordance with the fresh-start reporting requirements, the reorganization value of the Company was allocated to the Company's assets in conformity with the procedures specified by SFAS No. 142, "Goodwill and Other Intangible Assets." As provided for under the Company's reorganization plan (the "Plan"), the Company converted approximately $12 million of its secured liabilities to debt and $304 million of unsecured liabilities to common stock and warrants in the reorganized entity. The Company issued the common stock certificates and warrants in fiscal 2003. 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 first fiscal quarter of 2004 or 2003. The Company's warranty policy provides for the replacement of defective parts when the customers return request is approved within thirty days of the original shipment date. To date, warranty costs have not been significant. 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 18 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. 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 the short maturity of these financial instruments. The carrying amount of approximately $8.8 million of the Company's debt at December 27, 2003 approximates fair market value as the debt is with multiple lenders and it had been negotiated at the same rate which appears to represent a market rate of interest. The 8% interest rate on $0.6 million of debt due on delinquent property taxes is at rates below market. The fair value of the debt would be $0.4 million based on the Company's cost of capital of 12%. Recent Accounting Pronouncements -------------------------------- In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an Amendment to SFAS No. 123." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method on accounting for stock-based employee compensation, as well as additional disclosure requirements for both quarterly and annual reporting. The Company has elected to continue to account for stock-based employee compensation by the intrinsic value method under APB 25, as permitted by SFAS No. 123, while disclosing on a pro forma basis the effect on the Company's financial statements had the fair value method been used., Accordingly, the implementation of SFAS No. 148 has not had a material effect on the Company's consolidated financial position or results of operations. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others," which requires guarantees to be recognized at fair value. Interpretation 45 also requires additional disclosures, which disclosures are effective for financial statements for periods ending after December 15, 2002. While the Company has various guarantees included in contracts in the normal course of business, in the form of product warranties and indemnification of the officers and directors, these guarantees would only result in immaterial increases in future costs, but do not represent significant commitments or contingent liabilities of the indebtedness of others. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46) which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements issued by the Company after 2002; however, disclosures are required currently if the Company expects to consolidate any variable interest entities. No material entities were consolidated as a result of FIN 46. In May 2003 the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires certain instruments, including mandatorily redeemable shares, to be classified as liabilities, not as part of stockholders' equity or 19 redeemable equity. For instruments that are entered into or modified after May 31, 2003, Statement 150 is effective immediately upon entering the transaction or modifying the terms. For other instruments covered by Statement 150 that were entered into before June 1, 2003, Statement 150 is effective for the first interim period beginning after June 15, 2003. The Company does not have any outstanding financial instruments of the type addressed by SFAS No. 150 and accordingly, SFAS No. 150 has not had a material impact on the Company's financial position. In November 2002, the EITF reached a consensus on EITF 00-21, "Revenue Arrangements with Multiple Deliverables," related to the separation and allocation of consideration for arrangements that include multiple deliverables. The EITF requires that when the deliverables included in this type of arrangement meet certain criteria they should be accounted for separately as separate units of accounting. This may result in a difference in the timing of revenue recognition but will not result in a change in the total amount of revenues recognized in a bundled sales arrangement. The allocation of revenues to the separate deliverables is based on the relative fair value of each item. If the fair value is not available for the delivered items then the residual method must be used. This method requires that the amount allocated to the undelivered items in the arrangement is their full fair value. This would result in the discount, if any, being allocated to the delivered items. This consensus is effective prospectively for arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 has not had 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 September 27, 2003. Three Months Ended December 27, 2003 ------------------------------------ Net Revenue. Net revenue was $2.7 million for the first quarter of fiscal 2004 compared to $1.6 million for the same period of fiscal 2003. The sales for the first fiscal quarter of 2004 consisted of $2.3 million of MEMS-related business, $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 sales improvement, as compared to the same quarter of fiscal 2003, was due to an increase in the level of completed contracts in the MEMS-related portion of the business. The Company completed one of its two long-term contracts with L-3 Communications for $1.6 million in the first fiscal quarter of 2004. The sales for the fiscal 2003 period consisted of $1.4 million of MEMS, $0.1 million from the combination of Santa Barbara Tool and Die and IMT Analytical and $0.1 million from leasing of space to tenants. Gross Loss. Gross loss was $0.4 million or cost exceeded revenue by 16.5% for the first fiscal quarter of 2004 compared to a gross loss of $0.3 million or costs in excess of revenue of 19.8% for the first fiscal quarter of 2003. The fiscal 2003 period saw the MEMS portion of the business generate a gross loss of 20 $0.5 million and leasing of space to tenants provided a $0.1 million gross profit. The combination of IMT Analytical and Santa Barbara Tool and Die produce a minimal gross loss for this same period. In the first fiscal quarter of 2003, the MEMS portion of the business had a gross loss of $0.4 million, leasing of excess space to tenants provided a $0.1 million gross profit and the combination of IMT Analytical and Santa Barbara Tool and Die produced a minimal gross loss. The first fiscal quarter of 2003 included $0.1 million in amortization of employee stock incentives. The Company completed one of its two long-term contracts with L-3 Communications, which started in November 2001, for $1.6 million in the first fiscal quarter of 2004. The Company recognized no margin on a substantial portion of this revenue because losses on the project were recognized in prior periods, as they were determined, in accordance with the Company's revenue recognition policy. Therefore, the revenue for the first fiscal quarter of 2004 excluding this project was approximately $1.1 million or a reduction from the $1.6 million in the first fiscal quarter of 2003. The gross loss in the first quarter of fiscal 2004 was due to 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 fifty-four production employees at the end of the first fiscal quarter of 2004 compared to thirty-eight at the end of the same period of fiscal 2003. Research and Development. Research and development ("R&D") expense, as a percentage of net sales, was 7.5 % for the first fiscal quarter of 2004 compared to 14.4% for the first quarter of fiscal 2003. R&D expense decreased as a percentage of sales in the first quarter of fiscal 2004 due to the increase in net sales; however, measured in dollars, R&D expenditures were approximately the same for the two periods at $0.2 million. R&D expense for the first fiscal quarter of 2003 included $0.1 million in amortization of employee stock incentives. 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 28.5% for the first fiscal quarter of 2004 and 44.7% for the first quarter of fiscal 2003. SG&A expenses decreased as a percentage of sales in the first quarter of fiscal 2004 due to the increase in net sales; however, measured in dollars, S,G&A expenditures were $0.8 million and $0.7 million for the first fiscal quarter of 2004 and 2003, respectively. The first fiscal quarter of 2004 included $0.2 million in expenses related to the settlement of the Company's Professional Notes (see Note D - Debt). The first fiscal quarter of both 2004 and 2003 SG&A expense included $0.1 million in amortization of employee stock incentives. The Company has seven employees providing the services reported as SG&A as of December 27, 2003 compared to eight at December 28, 2002. Interest Expense. Interest expense was $0.3 million for the first fiscal quarter of 2004 compared to $0.8 million for the first fiscal quarter of 2003. The fiscal 2004 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 decrease in interest expense compared to the first fiscal quarter of 2003 is primarily due to the decrease in debt balances due to the sale of the Company's Hollister property and the payoff of its associated mortgage, which occurred in the second fiscal quarter of 2003 and the settlement of the Company's Professional Notes in the first fiscal quarter of 2004 (see 21 Note D - Debt). The sale of the Hollister property and the settlement of the Professional Notes combined for an annual reduction of the Company's interest expense of approximately $1.2 million. Liquidity and Capital Resources ------------------------------- The Company's cash balance was $0.3 million at December 27, 2003 vs. $2.5 million at September 27, 2003. The decrease in cash was primarily due to the use of $2.4 million for the cash portion of the Company's settlement of its Professional Notes (see Note D - Debt) and $0.6 million for operating activities for the first three months of fiscal 2004. The Company had minimal expenditures for capital equipment in the first three months of fiscal 2003. On October 31, 2003, L-3 exercised 167,000 warrants for the purchase of Common Stock at a price of $5.35 per share for a total of $0.9 million. L-3 received these warrants, as well as a thirty-six month warrant for the purchase of 700,000 shares of Common Stock at $7.29 per share, as part of its $5.0 million August 2002 investment in the Company. 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 2004, the Company plans to have minimal capital expenditures. The Company's liquidity and ability to fund operating and capital expenditure requirements during fiscal 2004 are heavily dependent on 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. If the Company is unable to achieve any of its targeted revenue sources on which the fiscal 2004 liquidity depends on a timely basis, and is unable to obtain adequate alternative financing or capital infusion, the Company will have difficulty maintaining its competitive position. If the Company cannot secure the funds to support its high fixed costs, it could be forced to cease operations. Because of the Company's recurring losses from operations and negative cash flow, the Company's accountants have expressed substantial doubt about its ability to continue as a going concern. The Company completed an equity financing transaction with L-3, a strategic investor, on August 2, 2002 for $5 million in cash. The Company issued to L-3 935,000 shares of common stock along with two warrants. The first warrant for the purchase of 167,000 shares of common stock at $5.35 per share was exercised on October 31, 2003 for $0.9 million. The second warrant has a term of thirty-six months, is exercisable for up to 700,000 shares at an aggregate price of $5.1 million, or $7.29 per share. The Company completed a second sale of Common Stock and warrants to L-3 Communications Corporation ("L-3") on September 3, 2003 for $2.5 million in cash. In that transaction, the Company issued 467,500 shares of Common Stock to L-3 along with two warrants. The first warrant has a term of eighteen months to purchase 83,500 shares of Common Stock at a price of $5.35 per share or an aggregate value of $0.4 million. The second warrant has a term of thirty-six months to purchase 350,000 shares of Common Stock at a price of $7.29 per share or an aggregate value of $2.6 million. The value of the warrants is not reflected in the accompanying financial statements, as it was recorded within common stock. Funding through the exercise of the warrants, or any part of the warrants, is at the exclusive discretion of L-3. The Company cannot give assurance that any additional financing will be available or, if available, that its terms will be favorable to the Company. 22 In order to obtain additional working capital, the Company is currently pursuing a replacement mortgage on its facility in California. The Company is in negotiation with a lender on a loan application that could provide up to $2.8 million in working capital and replace the existing 12% interest mortgage with current lower rates. The refinancing is expected to be completed in the second fiscal quarter of 2004. The Company will require an additional cash infusion in order to finance itself through the completion of the mortgage refinancing. The Company expects to secure the cash through an advance from L-3 on its existing MEMS development contract or through the exercise of additional warrants by L-3. However, L-3 is not obligated to provide this financing and 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 is currently investigating accounts receivable financing opportunities. The Company has determined that this financing is not available for its development projects; however, it will be available for its products when it achieves volume production. The Company expects to be in limited volume production by its third fiscal quarter of 2004 and will attempt to secure accounts receivable financing at that time. The Company cannot give assurance that accounts receivable financing will be available or, if available, that its terms will be acceptable to the Company. If the Company is unable to achieve its production goals or obtain additional financing on acceptable terms, on a timely basis, there will be a material adverse effect on the Company's financial condition and competitive position. As of December 27, 2003, the Company has a working capital deficit of $0.9 million. Because of the Company's recurring losses from operations and negative cash flow the Company's auditors have expressed substantial doubt about its ability to continue as a going concern. The Company had no purchase commitments associated with capital expenditures at December 27, 2003. The Company owns its premises and has no leases for which it is the lessee. 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' credit 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. 23 The following summarizes the Company's significant contractual obligations at December 27, 2003 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 Less than Total 1 Year 1-3 Years 4-5 Years After 5 Years -------------------------------------------------------------------------------- Property Mortgage $8,830 $ - $ 8,830 $ - $ - -------------------------------------------------------------------------------- Property Taxes 564 188 376 $ - $ - -------------------------------------------------------------------------------- Long-Term Debt 9,394 188 9,206 $ - $ - -------------------------------------------------------------------------------- Risk Factors Affecting Our Business IN ADDITION TO THE FACTORS DISCUSSED ELSEWHERE IN THIS REPORT, THE FOLLOWING ARE IMPORTANT FACTORS THAT COULD CAUSE A MATERIAL ADVERSE EFFECT ON THE COMPANY'S FINANCIAL CONDITION, COMPETITIVE POSITION AND ABILITY TO CONTINUE AS A GOING CONCERN, 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 RECENTLY EMERGED FROM BANKRUPTCY, AND EXPECTS TO INCUR LOSSES FOR THE FORESEEABLE FUTURE. 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 and, on emergence from bankruptcy, all of the previously issued and outstanding common stock was canceled without consideration to the holders. The Company incurred net losses of $1.6 million for the three month periods ended December 27, 2003. 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. 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. The above factors raise substantial doubt about the Company's ability to continue as a going concern. LIQUIDITY The Company is currently pursuing a replacement mortgage on its facility in California. The Company is in negotiation with a lender on a loan application that could provide up to $2.8 million in working capital and replace its existing 12% interest mortgage with current lower rates. The re-financing is expected to be completed in the second fiscal quarter of 2004. The Company will 24 require an additional cash infusion in order to finance itself through the completion of the mortgage re-finance. The Company expects to secure the cash through an advance from L-3 on its existing MEMS development contract or through the exercise of additional warrants by L-3. The Company cannot give assurance that re-financing of this mortgage will be available or, if available, that its terms will be favorable to the Company. The Company is currently investigating accounts receivable financing opportunities. The Company has determined that this financing is not available for its development projects; however, it will be available for its products when it achieves volume production. The Company expects to be in limited volume production by its third fiscal quarter of 2004 and will attempt to secure accounts receivable financing at that time. The Company cannot give assurance that accounts receivable financing will be available or, if available, that its terms will be favorable to the Company. CAPITAL NEEDS. 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 no purchases of property, plant and equipment in the first fiscal quarter of 2004. During fiscal 2004, the Company plans to have minimal purchases of property, plant and equipment. However, the Company has an immediate need to secure additional working capital to fund its operations and the transition from production of primarily prototypes to volume production. The Company may also 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 operations 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 or continuing its business. 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 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 cannot 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 better use of its 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 its 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. 25 TECHNOLOGICAL CHANGES. 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. COMPETITION. 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. 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. 26 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 writedown 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 budget 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. PLANT EXCESS CAPACITY. The Company has a 6-inch wafer fabrication facility, which has 30,000 square feet of fully facilitized manufacturing space. At the current level of customer orders this facility is underutilized and the associated depreciation and utilities expenses are underabsorbed. The Company is working with customers on development programs that are expected to mature into production contracts, which will more fully utilize its plant capacity. However, these contracts may never materialize and the plant underutilization could continue to cause an adverse affect on the Company's operating results. 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 condition 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. 27 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: o difficulties in collecting accounts receivable and longer collection periods; o seasonal business activity in certain parts of the world; o potentially adverse tax consequences; o fluctuations in revenue expressed in dollars due to changes in currency exchange rates; o political and economic instability; and o trade barriers. Any of these factors could seriously harm the Company's international sales. ENVIRONMENTAL LAWS AND REGULATIONS. 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. These matters have largely been resolved and 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. 28 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 our stockholders or if such a change in control would provide its stockholders with a substantial premium for their shares over the then-prevailing market price for the common stock. The Company's Amended and Restated Bylaws contain other provisions that could have an anti-takeover effect, including the following: o only one of the three classes of directors is elected each year; o stockholders have limited ability to remove directors; o stockholders cannot call a special meeting of stockholders; and o stockholders must give advance notice to nominate directors or submit proposals for consideration at stockholder meetings. 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. 29 Item 3. 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 believe that, as of December 27, 2003, the Company's disclosure controls and procedures are effective in making known to them material information relating to the Company (including its consolidated subsidiaries) required to be included in this report. 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. There were no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls, known to the Chief Executive Officer or the Chief Financial Officer, subsequent to the date of the evaluation. 30 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. Changes in Securities --------------------- 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 and Reports on Form 8-K -------------------------------- (a) Exhibits 3.1 Amended and Restated Certificate of Incorporation (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). 3.2 Amended and Restated Bylaws of Innovative Micro Technology, Inc. (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-KSB for the fiscal year ended September 29, 2001). 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, 2002 (incorporated by reference to Exhibit 4.2 to the Company's Current Report on form 8-K filed August 13, 2002). 4.3 Warrant Agreement between the Company and L-3 Communications Corporation, dated September 3, 2003. 4.4 Warrant Agreement between the Company and Stutman Treister & Glatt, Professional Corporation, dated September 30, 2003. 31 31 Certifications Pursuant to Rule 13a-14(a) Under the Exchange Act. 32 Certification Pursuant to 18 U.S.C. 1350 adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K. None 32 SIGNATURE --------- In accordance with the requirements of the Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NNOVATIVE MICRO TECHNOLOGY, INC. Dated: February 10, 2004 /s/ John S. Foster ----------------- John S. Foster On behalf of the Company and as Chairman of the Board and Chief Executive Officer Dated: February 10, 2004 /s/ Peter T. Altavilla ----------------------- Peter T. Altavilla Chief Financial Officer (Principal Accounting Officer) 33