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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-KSB



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ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934



For the fiscal year ended May 31, 2005



Commission file number 0-16250



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DYNATEM, INC.

(Name of small business issuer in its charter)



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|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|California                                                     |  | 95-3627099                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)



23263 Madero, Suite
C

Mission Viejo, California

(949) 855-3235

(Address and telephone number of principal executive offices)



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Securities registered pursuant to Section 12(b) of the Act: None



Securities registered pursuant to Section 12(g) of the Act:

Common Stock

(Title of class)



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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 ̈



Check if there is no disclosure of delinquent filers in
response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.  x



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  x    No ̈



The issuers revenues for its most recent fiscal year were $2,486,516



The aggregate market value of voting and non-voting Common Stock held by nonaffiliates of the registrant was approximately $1 million on
August 1, 2005.



On August 1, 2005, there were 1,469,564 shares of the
issuers Common Stock outstanding.



DOCUMENTS
INCORPORATED BY REFERENCE



Portions of the issuers
Definitive Proxy Statement to be filed for its Annual Meeting of Shareholders to be held on October 27, 2005, are incorporated herein by reference into Part III hereof, to the extent indicated herein.



Transitional Small Business Disclosure
Format    Yes ̈No  x



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PART I



This report contains forward-looking statement within the meaning of Section 27A of the Securities Act of 1933 as amended
(the Securities Act) and Section 21E of the Securities Exchange Act of 1934 (the Exchange Act) that relate to future events or future financial performance. These statements, which may be identified by terms such as
may, will, should, expects, plans, anticipates, believes, estimates, forecasts, potential, or continue, or the
negative of such terms and other comparable technology, only reflect managements expectations. Actual events or results may differ materially, as a result of competitive products and pricing, new product introductions, developing technologies
and general economic conditions affecting the Company and its customers, as more fully discussed below and in Managements Discussion and Analysis or Plan of Operation.



Item 1. Description of Business.



History



Dynatem, Inc. (the Company or Dynatem) was incorporated on May 15, 1981, under the laws of the State of California.
It was organized to design, manufacture and market microcomputers and microcomputer-based systems and software for industrial applications such as factory automation, sensor monitoring, process control, robots, data acquisition, networking and
displays. The Company commenced manufacturing and marketing operations in May 1981 and has conducted such operations continuously from such date. As part of such operations, the Company was, until October 1984, an authorized dealer of certain
modular board level computer products manufactured by Rockwell International Corporation. In October 1984, the Company entered into an agreement with Rockwell pursuant to which the Company was licensed to manufacture these products.



The Company currently designs, manufactures, distributes and markets more than 250 products
or product variations including microcomputers, microcomputer systems, microcomputer modules, software and peripherals, and markets such products and other licensed products individually or as components of a system.



In 1987, the Company began concentrating its design efforts to develop a range of products
compatible with the VMEbus (see below). In order to further expand the product offering, Dynatem entered into agreements to resell the VMEbus products of other vendors that were complimentary to the Companys products. This allowed the Company
to easily integrate complete embedded systems. In 1996, the Company began concentrating most of its design effort in the development of VMEbus systems based on the x86 family of processors. The Company was able to combine the broad range of
relatively inexpensive components and software found in desktop PC- compatible systems with the high performance, flexibility and stability of the VMEbus. To accompany the new x86 hardware, it has been equally important for the Company to develop
software drivers that could enable popular desktop operating systems to operate across the VMEbus. In fact, the ability to run Windows NT in VMEbus systems has been one of the major appeals of this product. In this way, embedded system designers can
combine user-friendly Windows NT or Windows XP, with their huge range of software applications, on the same backplane with dedicated high-speed real-time operating systems. More recently, the interest in Linux systems has also added to the market
appeal of these products.



One area of design effort continues to be the
integration of expansion cards compatible with the PMC (PCI Mezzanine Card) standard. This enables adding functionality to VMEbus x86 processor boards by expansion via the local PCI bus.



Another area of design activity has been based upon the Compact PCI Bus. These products have a similar form factor to the VMEbus but use the
PCI bus as the basis for the interface between modules. This is a simpler and less expensive design than the VMEbus-based products, and from a design and support point of view is a subset of the Pentium-based VMEbus products. The CompactPCI
Bus popularity is based upon its simplicity, high bandwidth and reliability and relatively low cost. Its simplicity and low cost are due to its reliance on architectures and components found in the desktop world. Recent changes to the
CompactPCI specification incorporate switched Ethernet backplane support. This specification is the beginning of the evolution of the backplane technology toward high-speed serial interfaces.



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Market



The Company markets its products on a worldwide basis. Included among the export markets are the United Kingdom, Germany, Japan and Mexico.



For the last two fiscal years the export net sales and the percentage to total net sales
were:



|     |  |        |         |                      |    |  
|---- |  | ------ | ------- | -------------------- | -- | -
|Year |  | Amount |         | % of Total Net Sales |   
|2004 |  | $      | 348,613 |                      | 8  | %
|2005 |  | $      | 264,889 |                      | 11 | %



Products



The Companys products generally consist of modular single board microcomputers known
as Central Processing Unit (CPU) boards, peripheral systems and software drivers. The products are intended for use by manufacturing companies seeking to increase efficiency and productivity through factory automation, sensor monitoring, process
control and other electronic implementations. The military services use Dynatem products for a number of applications including navigation, control of systems and rapid handling of data. The Company provides warranties ranging from 90 days to one
year on all products sold.



VME. The
Companys principal product group is based on the VMEbus specification. These products are used as embedded controllers for telecommunications, industrial controls, robotics, aerospace, and a wide variety of military applications.



In 1996, the Company established a distributor relationship with a German
VMEbus manufacturer, Microsys Electronics GmbH (Microsys). The products manufactured by Microsys are consistently compatible with the Companys product line because, like the Companys VMEbus products, the Microsys products are
relatively low in power consumption and well suited to extended temperature range systems.



The addition of the Microsys line to the Dynatem line has augmented the Dynatem range of products. It has also increased the range of hardware to meet virtually every customers system requirements in connection
with the products designed and manufactured by the Company. This is extremely important because customers prefer buying all of the modules in their system from one vendor who takes responsibility for guaranteeing that all modules function well
together.



New offerings from Microsys include VMEbus and
CompactPCI designs based upon Freescales Power PC family of processors. Microsys has also introduced Computers on Modules (COM) which put CPUs and memory on a module about the size of a credit card. By greatly simplifying the
design, this enables embedded board level designers to develop hardware and software faster and at a lower cost than designing from scratch. COMs recently introduced by Microsys are based upon Motorola embedded PowerPC, PowerQUICC, and Intel Xscale
processors.



Among new products offered, the Company has
recently introduced both VME and CompactPCI processor boards based upon the Pentium M processor from Intel. The embedded PC is excellent for situations where original equipment manufacturers need full PC functionality with the complexity of the
VMEbus or even the CompactPCI bus. A new ruggedized VMEbus processor board based upon the Pentium M processor was introduced in the spring of 2005. This product will feature conduction-cooled versions and is targeted for military
applications.



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With the recent increase in design engineering capability, the Company is also able to offer custom
design capabilities based upon the standard product offering.



Software Drivers. The main focus of the Companys business (excluding Microsys) is the design, manufacture and sale of single-board computers. Most of the end-users use these single-board computers in racks with
backplanes compatible with VMEbus. These customers typically use one of the following operating systems; VxWorks, Linux, Solaris, OS9, Linux, QNX, WindowsNT, WindowsXP, Windows2000. It is necessary for the company to create software drivers that
enable each of its board designs to run with these operating systems. This is especially critical because X86 (Intel) architecture is normally not compatible with the VMEbus backplane architecture developed in the early 1980s by Motorola. Since the
Company only develops these Board Support Packages (BSP) to enable hardware to operate, they are only sold for installation with Dynatem computer boards. The customer is normally charged a one-time fee for each program, regardless of the size of the
program. The Company charges enough to cover the cost of design and support for the BSPs, from $500 (Linux) to $2,500 (Solaris).



Normally, the Company does not resell the actual operating systems. In some cases, customers, ask for pre-installation of BSPs prior to shipment. In the
case of WindowsXP, WindowsNT, or Windows2000, the BSP needs to be installed on top of the OS installation. In these cases the Company purchases the operating system from a Microsoft distributor, install it on computers and then install the BSP. This
situation normally occurs only in the product evaluation or prototyping stage, where the customer wants to quickly begin testing the product or developing application code. OEM customers typically do their own software installation once they are in
production. Any software licensing is done directly between the customers and the operating system vendors.



Operations



The Companys
products are manufactured either at the Companys facility in Mission Viejo, California, or by outside assembly contractors. They are produced from the Companys designs using standard, semi-custom and custom components such as multi-layer
circuit boards. Most of the devices and components used in the Companys products are available from several sources. Although no assurance can be given as to the future, the Company believes that the loss of one or more of its current
suppliers would not have a material adverse effect upon its business.



Marketing



The Companys marketing and sales
department consists of marketing, sales, customer service, engineering and engineering application support. The Company has in recent years continued the use of advertising in major trade publications, coupling it with wide distribution of marketing
brochures. In addition, the Company participates in regional trade shows during the year throughout the United States and Canada. There are over 200 VMEbus and CompactPCI vendors worldwide. Depending on the application, at least one or more of these
companies are in direct competition with Dynatem. Details of unique characteristics of the Companys offerings are more fully described in Products above.



Marketing of the Companys products is accomplished through direct marketing and telemarketing efforts. Direct marketing efforts
include responding to inquiries generated through press releases, trade publications, advertising, current customer lists and other similar leads. Telemarketing is utilized to inform current and potential customers of new products and technical
product changes, as well as allow the Company to evaluate the market and customer needs. Implementation of a World Wide Web site (www.dynatem.com) has been accomplished over the past few years. It has become an effective means of attracting
new customers throughout the world. It has also become an excellent product and technical reference for existing and potential customers.



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Research and Development



The Company believes that its future growth greatly depends on its ability to be an innovator in the development and application of new and
existing hardware and software technology. Expenditures for Company-sponsored research and development for the fiscal years ended May 31, 2005 and 2004 were $550,346 and $516,604, respectively. Increases in R&D expenditures reflect the increased
emphasis on new product development and additional engineering staff.



Last
fiscal year Dynatem introduced a new Pentium M based Single Board Computer (SBC) for the VMEbus. This one design is used for two products: the industrial DPM and the rugged RPM. The latter uses the same printed circuit board and components as the
former but is assembled with cooling plates and wedgelocks so that it may be used in conduction-cooled systems, in demand for military applications. The Pentium M is a very low-power CPU that is popular in laptop PCs as it provides powerful
processing while drawing little current from the systems battery. These attributes make it very attractive for the embedded, board level computer market. The RPM and DPM will exploit the cool low-power performance of the Pentium M to operate
in a broad temperature range, also attractive in the embedded world.



The
DPM/RPM also provides a variety of breaking technology like four channels of USB 2.0, two Gigabit Ethernet ports (routed to the backplane in compliance with Vita 31.1 for backplane fabric switching), and Serial ATA in addition to traditional IDE for
mass storage. The DPM/RPM can support up to 1 GByte of DDR DRAM and it supports expansion through one on-board PMC site.



The Company has introduced four support products that take full advantage of the DPM/RPMs capabilities: the XPMPMC3 for three-site PMC expansion; the XPMPTB for I/O
expansion from behind the backplane; the TBR for adjacent slot I/O and mass storage support (hard drives and CD-ROM or floppy drive support); and the TBQ for adjacent slot I/O expansion in special systems that have no rear I/O access.



The Company has already started leveraging the DPM/RPM development into other products like
the custom CompactPCI card the CPM and the off-the-shelf CPM1. The CPM is in pre-production debug presently and the CPM1 is in development.



The Company is also developing a PCI expansion card that uses groundbreaking technology to provide 10 Gigabit Ethernet over copper media. Presently the only available
alternative is to use optical fiber. This is Dynatems first PCI product.



Software development has focused on BIOS support for the DPM/RPM which has been challenging because of the Pentium M and its associated chipsets great expansion and multimedia capability. Support for Serial ATA booting, USB booting,
Ethernet booting (PXE), and digital graphics (DVO) as well as conventional VGA is now available. The Company has also ported Windows 2000 and XP, Linux, VxWorks, and Solaris operating systems to the DPM/RPM.



Employees



At present the Company employs 20 people in sales, engineering, financial and manufacturing departments. Neither the Company nor its
employees are parties to a collective bargaining agreement. The Company believes that its employee relations are good.



Competition



Competition within the industry is based primarily upon product line breadth, product performance, price and customer service. The Company competes with over 200 manufacturers of VMEbus and CompactPCI products in
North America and Europe. The Company believes it has a marketing advantage based upon its ability to quickly



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modify hardware and firmware for the customer application, which provides a level of support not always provided by the
Companys competitors. As part of this approach, the Company provides high quality products, competitive pricing, and technical support, which includes, when needed, special interface hardware and/or writing of special software drivers. In
addition, the Company provides customers with most products required for specific applications including, but not limited to, special power supplies, special enclosures, cables and other requisite hardware. This approach is not customary with larger
competitors who would normally limit themselves to sales of standard products. However, most of these manufacturers have certain other competitive advantages over the Company, including greater financial and technological resources, earlier access
to customers, established client service programs and client loyalty.



Item 2. Description of Property.



The
Companys executive offices and manufacturing plant are located in a 6,357 square foot facility in Mission Viejo, California. The facility is leased from an unaffiliated party for a term expiring in January 2006.



Item 3. Legal Proceedings.



None.



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



None.



PART II



Item 5. Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities.



There is a limited trading market for the Companys common stock (Common
Stock). Set forth below are the high and low closing bid prices per share of the Companys Common Stock for the periods indicated, as reported by The Pink Sheets weekly OTC Market Report. This report lists the firms who make a
market in the Common Stock. The OTC Report presents inter-dealer sales without adjustment for retail mark-up, markdown or commissions, and may not represent actual transactions. Trading in the Companys Common Stock is limited in volume and may
not be a reliable indicator of its market value.



|               |  |                            |  |      |  |      |  |     
|-------------- |  | -------------------------- |  | ---- |  | ---- |  | ----
|               |  | Fiscal Years Ended May 31,
|               |  | 2005                       |  | 2004
|               |  | High                       |  | Low  |  | High |  | Low 
|First Quarter  |  | 1.90                       |  | 1.60 |  | 1.50 |  | 1.20
|Second Quarter |  | 1.90                       |  | 1.56 |  | 2.00 |  | 1.30
|Third Quarter  |  | 1.85                       |  | 1.56 |  | 1.65 |  | 1.45
|Fourth Quarter |  | 1.79                       |  | 1.17 |  | 1.80 |  | 1.50



On August 1, 2005, the closing bid
price of the Companys Common Stock was $1.50 per share.



Rules 15g-1
through 15g-9 promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act), imposes sales practice and disclosure requirements on certain broker-dealers who engage in certain transactions involving a penny
stock. Subject to certain exceptions, a penny stock generally includes any non-NASDAQ equity security that has a market price of less than $5.00 per share. The market price of our Common Stock during the twelve months ended July 31, 2005 has
ranged between a high of $1.90 and a low of $1.15 per share, and our Common Stock is thus deemed to be penny stock for purposes of the Exchange Act. The additional sales practice and disclosure requirements imposed upon broker-dealers may discourage
them from effecting transactions in our Common Stock, which could severely limit the liquidity of the sale of our Common Stock in the secondary market.



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As of August 1, 2005, there were approximately 190 shareholders reported by Continental Stock Transfer and Trust Company,
the Companys Transfer Agent, and ADP Investor Communications Services, the firm that handles communications with shareholders holding stock in street name.



The Company has never paid cash dividends on its Common Stock and the Board of Directors intends to continue this policy for the foreseeable
future. Future dividend policy will depend upon the Companys earnings, capital requirements, financial condition and other factors considered relevant by the Companys Board of Directors.



The following table sets forth as of May 31, 2005, information on the Companys equity
compensation plans in effect as of that date:



|                                                           |  |                                                                                             |  |                                                                             |      |                                                                                                                                           |        
|---------------------------------------------------------- |  | ------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------- | ---- | ----------------------------------------------------------------------------------------------------------------------------------------- | -------
|Plan category                                              |  | Number of securities tobe issued upon exerciseof outstanding options,warrants and rights(1) |  | Weighted-average exercise price of outstanding options, warrants and rights |      | Number of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected incolumn (a)
|Equity compensation plans approved by security holders     |  | 195,000                                                                                     |  | $                                                                           | 0.64 |                                                                                                                                           | 155,000
|Equity compensation plans not approved by security holders |  | N/A                                                                                         |  |                                                                             | N/A  |                                                                                                                                           | N/A    

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|(1) | Net of 10,000 options exercised during fiscal 2005.
|--- | ---------------------------------------------------



Item 6. Managements Discussion and Analysis or Plan of Operation.



Results of Operations



Net sales for the Companys fiscal year ended May 31, 2005 decreased 44.4% to $2,486,515 as compared to net sales of $4,476,685 in fiscal year 2004. The decrease in
sales is due to delays in receipt of orders for ongoing programs. Decreased revenues also reflect lower than anticipated sales in the LV-Xeon based DHC and CHC products. The newer Pentium M based DPM and CPM1 products are expected to sell better,
but it may be several months of customer product development before higher production volumes are realized. Export sales amounted to $264,889 representing 11 % of the total net sales for the fiscal year ended May 31, 2005



Gross profit as a percentage of sales decreased from 43% for fiscal year 2004 to 34% for
fiscal year 2005, reflecting lower revenue and higher expenses associated with production.



Selling, general and administrative expenses were $1,060,731 for fiscal year 2005 compared to $1,002,386 for fiscal year 2004, an increase of 5.8%. The increase in selling, general and administrative expenses was
primarily the result of adding a new director of business development to assist with a more aggressive marketing strategy.



Research and development costs were $550,346 in fiscal year 2005 compared to $516,604 in fiscal year 2004, a 6.5% increase. The increase is attributable to the ongoing
development of new products utilizing advanced microprocessor technology including the DPM (VMEbus Pentium M SBC), RPM (ruggedized version of DPM), CPMI(CompactPCI Pentium M SBC) and CPM-SI (custom design for OEM customer). The Company is
also developing a PCI expansion card that uses groundbreaking technology to provide 10 Gigabit Ethernet over copper media. Presently the only available alternative is to use optical fiber. This is Dynatems first PCI product.



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At May 31, 2005, the Company does not expect to pay significant income taxes due to its utilization of net operating loss
carry forwards and tax credits.



Net loss for fiscal 2005 was $745,150 as
compared to net income for fiscal 2004 of $403,993. The net loss was the result of lower revenue as mentioned above.



Liquidity and Capital Resources



At May 31, 2005, the Companys working capital, which is current assets less current liabilities, was $1,360,472 and the Companys current ratio which is
current assets divided by current liabilities, was 3.7:1 compared to $2,191,921 and a ratio of 5.00:1 as of May 31, 2004. Management believes that the Companys existing working capital and cash flows from operations will be sufficient to meet
its working capital needs during fiscal year 2006.



The Company has a
revolving line-of-credit agreement (the Line of Credit) that permits borrowings of up to $500,000. This Line of Credit is secured by substantially all of the assets of the Company, expires on September 18, 2005, as amended. The Company
is currently negotiating and extension to the agreement. Interest on the borrowings is paid monthly at varying interest rates based on the Lenders prime rate plus 1.5%. There were no borrowings outstanding as of May 31, 2005, nor were there
any borrowings during the year then ended. At May 31, 2005, the Company was not in compliance with one restrictive financial covenant under the Line of Credit, and we have not received a waiver from the lender. Such default could restrict the
availability of funds to the Company in the future; however, the Company has borrowed and repaid approximately $44,000 subsequent to year-end.



Critical Accounting Policies



Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, the valuation of long-lived and intangible assets, and the amortization of intangible
assets. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may materially differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant
judgments and estimates used in preparation of our consolidated financial statements.



| |  |  | Revenue recognition;
| | - |  | --------------------



| |  |  | Valuation of deferred tax assets; and
| | - |  | -------------------------------------



| |  |  | Estimation of the allowance for doubtful accounts receivable.
| | - |  | -------------------------------------------------------------



Revenue recognition



Revenue is recognized at the time the product is shipped.



In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 101 (SAB 101), Revenue Recognition, as superseded
by SAB 104, which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and for disclosure related to revenue recognition policies in financial statements filed with the Securities and
Exchange Commission. Management believes the Companys revenue recognition policy conforms to SAB 104.



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VME



The VME product group is the Companys principal product group. This product group consists of hardware only. A customer will place an order. The Company then fills
the order and ships the product to the customer FOB shipping point, with a warranty from 90 days to one year depending on the type of hardware sold. Revenue is recognized at the time the product is shipped.



CPU Boards  The Company manufactures boards classified as hardware products and
recognizes revenue upon shipment.



Hardware  The Company
manufactures computer hardware as noted above and recognizes revenue upon shipment of the product.



Support Services  The Company does not provide support services. It provides a hardware warranty. If the product does not work, the Company repairs or replaces the product.



CustomDesigned Products and Software  The Company occasionally provides
custom designed hardware products, but generally builds single board products for sale to its general customer base.



Software



The Company sells software drivers and software it has purchased from other suppliers (operating system software for resale). The volume of resale software is minimal and only involves installing an operating system
in order to pre-install software drivers if the customer requests pre-installation (the drivers cannot be installed unless there is an operating system). The software drivers are sold with the related hardware as an off the shelf
product. Software resale represents off the shelf operating systems designed, maintained, and supported by the original software manufacturer. The Company provides support to its customers under the terms of its warranty and does
not supply software support services billed separately. There are no multiple element software sales as described in SOP 97-2. The Companys software sale activities are incidental to the core hardware products sold and the Company is not in
the business of selling software; rather, it is necessary for the Company to supply integration of the various hardware products it sells. Such integration is done by software drivers, which in effect are part of the hardware.



Systems and Software  The Company does not develop operating system software and
is not in this line of business. The Company sells hardware systems and related software drivers.



Software Drivers  The Company develops and sells software drivers with its hardware products. Revenue is recognized upon shipment of the related hardware products.



Resale of Other ManufacturersSoftware  The Company is not in the
business of selling software and rarely sells an operating system (such as Windows XP) in order for pre-installation of drivers. The Company recognizes the revenue upon shipment of the related hardware products. Software sales of this type are very
minor.



Microsys



The Company is a distributor of Microsys products and purchases such products from Microsys
as needed. The Company reports the related revenue on a gross revenue basis under EITF 99-19 because the Company is (1) the primary obligor in the arrangement, (2) has the general inventory risk, (3) has reasonable latitude to establish
the price with the customer, (4) changes the mix of the products between Microsys and Company products as required, (5) determines the customer needs, (6) has physical loss inventory risk, and finally (7) has the credit risk. Revenue is recognized
upon shipment of the Microsys product as noted herein in accordance with EITF 99-19.



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Valuation of deferred tax assets



The Company records an estimated valuation allowance on its significant deferred tax assets when, based on the weight of available evidence
(including the scheduled reversal of deferred tax liabilities, projected future taxable income or loss, and tax-planning strategies), it is more likely than not that some or all of the tax benefit will not be realized.



Allowance for doubtful accounts receivable



We establish our allowance for doubtful accounts receivable based on our qualitative and
quantitative review of credit profiles of our customers, contractual terms and conditions, current economic trends and historical payment, return and discount experience. We reassess the allowance for doubtful accounts each period. If we made
different judgments or utilized different estimates for any period, material differences in the amount and timing of revenue recognized could result.



Significant Recently Issued Accounting Pronouncements



In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB 51. The primary objectives of FIN
No. 46 are to provide guidance on the identification of entities for which control is achieved through means other than voting rights (variable interest entities, or VIEs) and how to determine when and which business enterprise should
consolidate the VIE. This new model for consolidation applies to an entity for which either: (1) the equity investors do not have a controlling financial interest; or (2) the equity investment at risk is insufficient to finance that entitys
activities without receiving additional subordinated financial support from other parties. In addition, FIN No. 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional
disclosures. As amended in December 2003, the effective dates of FIN No. 46 for public entities that are small business issuers, as defined (SBIs), are as follows: (a) For interests in special-purpose entities (SPEs): periods
ended after December 15, 2003; and (b) For all other VIEs: periods ended after December 15, 2004. The December 2003 amendment of FIN No. 46 also includes transition provisions that govern how an SBI which previously adopted the pronouncement (as it
was originally issued) must account for consolidated VIEs. Management has concluded that the Company does not have an interest in any SPEs, and is evaluating the other effects of FIN No. 46 (as amended) on its future consolidated financial
statements.



In November 2004, the FASB issued SFAS No. 151, Inventory
Costs - an amendment of ARB No. 43, Chapter 4, which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. In Chapter 4 of ARB 43, paragraph 5 previously stated that
under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and re-handling costs may be so abnormal as to require treatment as current period charges.... SFAS No. 151 requires that such items
be recognized as current-period charges, regardless of whether they meet the criterion of so abnormal (an undefined term). This pronouncement also requires that allocation of fixed production overhead to the costs of conversion be based on the
normal capacity of the production facilities. SFAS No. 151 is effective for inventory costs incurred in years beginning after June 15, 2005.



In December 2004, the FASB issued SFAS No. 123-R, Share-Based Payment, which requires that the compensation cost relating to share-based payment
transactions (including the cost of all employee stock options) be recognized in the financial statements. That cost will be measured based on the estimated fair value of the equity or liability instruments issued. SFAS No. 123-R covers a wide range
of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS No.123-R replaces SFAS No. 123, Accounting for
Stock-Based Compensation, and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.



10



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##### Table of Contents

As originally issued, SFAS No. 123 established as preferable a fair-value-based method of accounting for share-based
payment transactions with employees. However, that pronouncement permitted entities to continue applying the intrinsic-value model of APB Opinion 25, provided that the financial statements disclosed the pro forma net income or loss based on the
preferable fair-value method. Small Business Issuers are required to apply SFAS No. 123-R in the first interim or annual reporting period that begins after December 15, 2005. Thus, the Companys consolidated financial statements will reflect an
expense for (a) all share-based compensation arrangements granted after January 1, 2006 and for any such arrangements that are modified, cancelled, or repurchased after that date, and (b) the portion of previous share-based awards for which the
requisite service has not been rendered as of that date, based on the grant-date estimated fair value.



Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed by management to have a material impact on the Companys
present or future consolidated financial statements.



Management is presently
evaluating the potential effect, if any, the above pronouncements might have on its future financial statements. Additionally, recent accounting pronouncements discussed in the notes to the May 31, 2004 and 2003 audited financial statements, filed
previously with the Securities and Exchange Commission on Form 10-KSB, that were required to be adopted during the year ending May 31, 2005 did not have a significant impact on the Companys financial statements for the year then ended.



Future Trends



The Companys PC-compatible VMEbus module has been designed into several fairly large,
long-term programs, and it is being well received by the VMEbus market. New product introductions in fiscal 2005 are expected to enable the Company to win a larger percentage of new programs. CompactPCI versions of these products should enable the
Company to become a larger player in the CompactPCI market. The Company has put great effort into being first to the market with error-free versions of several popular real-time operating systems. As the PC-compatible market changes, the Company
will, in a timely manner, attempt to achieve market leadership by offering new products based upon the latest PC-compatible technology.



The Company will continue to take advantage of local contract manufacturing facilities utilizing the most modern techniques of SMT (Surface Mount Technology) and BGA
(Ball Grid Array).



Item 7. Financial Statements.



The Financial Statements of the company required to be included in this
Item 7 are set forth in a separate section of this report and commence on Page F-1 immediately following page 13.



Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.



None.



Item 8A. Controls and Procedures.



We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the Exchange Act)) that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the
Securities and Exchange Commissions rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving
the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.



11



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##### Table of Contents

We carried out an evaluation under the supervision and with the participation of management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of May 31, 2005, the end of the period covered by this report. Based on that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of May 31, 2005.



There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter
ended May 31, 2005 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



Item 8B. Other Information



None.



PART III



Item 9.
Directors and Executive Officers of the Registrant.



Information
concerning the Companys directors and executive officers in compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the portion of the Companys Definitive Proxy Statement, to be filed on or before October
3, 2005 for its 2005 Annual Meeting of Shareholders to be held on October 27, 2005, set forth under the heading ELECTION OF DIRECTORS



Item 10. Executive Compensation.



Information concerning executive compensation is incorporated herein by reference to the portion of the Companys Definitive Proxy Statement, to be filed on or
before October 3, 2005 for its 2005 Annual Meeting of Shareholders to be held on October 27, 2005, set forth under the heading ELECTION OF DIRECTORS - Compensation of Executive Officers.



Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.



Information concerning security
ownership of certain beneficial owners and management is incorporated herein by reference to the portion of the Companys Definitive Proxy Statement, to be filed on or before October 3, 2005 for its 2005 Annual Meeting of Shareholders to be
held on October 27, 2005, set forth under the heading PRINCIPAL HOLDERS OF VOTING SECURITIES.



Item 12. Certain Relationships and Related Transactions.



Information concerning certain relationships and related transactions is incorporated herein by reference to the portion of the Companys Definitive Proxy Statement, to be filed on or before October 3, 2005 for
its 2005 Annual Meeting of Shareholders to be held on October 27, 2005, set forth under the heading ELECTION OF DIRECTORS - Relationships with Outside Firms.



12



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##### Table of Contents

Item 13. Exhibits.



The following is a list of Exhibits required by Item 601 of Regulation S-B. Except for those exhibits indicated by an asterisk which are
filed herewith, the remaining exhibits listed below are incorporated by reference to the exhibit previously filed by us as indicated.



|              |  |                                                                                                                                                          
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit                                                                                                                                                  
|3(a)          |  | Restated Articles of Incorporation of the Company1                                                                                                       
|              | 
|3(b)          |  | Bylaws of the Company2                                                                                                                                   
|              | 
|31.1*         |  | Certifications Pursuant to Securities Exchange Act Rules 13A  14 and 15D - 14 - Section 302, signed by Michael Horan, Chief Executive Officer           
|              | 
|31.2*         |  | Certifications Pursuant to Securities Exchange Act Rules 13A  14 and 15D - 14 - Section 302, signed by Belen Ramos, Chief Financial Officer             
|              | 
|32*           |  | Certification Pursuant to 18 U.S.C. Section 1350 - Section 906, signed by Michael Horan, Chief Executive Officer and Belen Ramos, Chief Financial Officer



Item 14. Principal
Accountant Fees and Services



Information concerning certain
relationships and related transactions is incorporated herein by reference to the portion of the Companys Definitive Proxy Statement, to be filed on or before October 3, 2005 for its 2005 Annual Meeting of Shareholders to be held on October
27, 2005, set forth under the heading PRINCIPAL ACCOUNTANT FEES AND SERVICES.



---

|1 | Incorporated herein by reference to Exhibit 3(a) to the Companys Annual Report on Form 10-KSB for fiscal year ended May 31, 1997.
|- | ----------------------------------------------------------------------------------------------------------------------------------

|2 | Incorporated herein by reference to Exhibit 3(b) to the Companys Annual Report on Form 10-KSB for fiscal year ended May 31, 1997.
|- | ----------------------------------------------------------------------------------------------------------------------------------



13



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##### Table of Contents

SIGNATURES



In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.



|                       |  |               |  |                              
|---------------------- |  | ------------- |  | -----------------------------
|                       |  | DYNATEM, INC.
|                       |  |              
|Dated: August 26, 2005 |  | By:           |  | /s/ Michael Horan            
|                       |  |               |  | Michael Horan, President and 
|                       |  |               |  | Chief Executive Officer      
|                       |  |               |  | (principal executive officer)
|                       |  |              
|                       |  | By:           |  | /s/ Belen Ramos              
|                       |  |               |  | Belen Ramos                  
|                       |  |               |  | Chief Financial Officer      
|                       |  |               |  | (principal financial officer)



In accordance with the Exchange Act,
this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.



|    |  |                          |  |                                                            |  |                 
|--- |  | ------------------------ |  | ---------------------------------------------------------- |  | ----------------
|    |  | Name                     |  | Position                                                   |  | Date            
|By: |  | /s/ Michael Horan        |  | President, Chief Executive Officer and Director            |  | August 26, 2005 
|    |  | Michael Horan            |  |                                                            | 
|    |  |                          | 
|By: |  | /s/ Eileen Schmalbach    |  | Executive Vice President, Corporate Secretary and Director |  | August 26, 2005 
|    |  | Eileen Schmalbach        |  |                                                            | 
|    |  |                          | 
|By: |  | /s/ Robert Anslow        |  | Director                                                   |  | August 26, 2005 
|    |  | Robert Anslow,           |  |                                                            |  |                 
|    |  |                          | 
|By: |  | /s/ Richard Jackson      |  | Director                                                   |  | August 26, 2005 
|    |  | Richard Jackson          |  |                                                            |  |                 
|    |  |                          | 
|By: |  | /s/ Charles Spear        |  | Director                                                   |  | August 26, 2005 
|    |  | Charles Spear, Director  |  |                                                            |  |                 
|    |  |                          | 
|By: |  | /s/ H. Richard Anderson  |  | Director                                                   |  | August 26, 2005 
|    |  | H. Richard Anderson      |  |                                                            |  |                 
|    |  |                          | 
|By: |  | /s/ Costis Toregas       |  | Director                                                   |  | August 26 , 2005
|    |  | Costis Toregas, Director |  |                                                            |  |                 



14



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##### Table of Contents

DYNATEM, INC.



FINANCIAL STATEMENTS



May 31, 2005 and 2004



---

##### Table of Contents

INDEX TO FINANCIAL STATEMENTS



|                                                        |  |    
|------------------------------------------------------- |  | ---
|Report of Independent Registered Public Accounting Firm |  | F-1
|                                                        | 
|Balance Sheet                                           |  | F-2
|                                                        | 
|Statements of Operations                                |  | F-3
|                                                        | 
|Statements of Stockholders Equity                      |  | F-4
|                                                        | 
|Statements of Cash Flows                                |  | F-5
|                                                        | 
|Notes to Financial Statements                           |  | F-6



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM



To the Board of Directors and Stockholders

Dynatem, Inc.



We have audited the accompanying balance sheet of Dynatem, Inc. (the Company), as of May 31, 2005, and the related statements of operations, stockholders equity and cash flows for each of the years
in the two-year period then ended. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Dynatem, Inc. as of May 31, 2005, and the results of its operations and its cash flows for each of the years in
the two-year period then ended in conformity with accounting principles generally accepted in the United States of America.



/s/ Squar, Milner, Reehl & Williamson, LLP



Newport Beach, California

July 8, 2005



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##### Table of Contents

DYNATEM, INC.

BALANCE SHEET

May 31, 2005



ASSETS



|                                                                      |  |   |          
|--------------------------------------------------------------------- |  | - | ---------
|Current Assets                                                        |  |   |          
|Cash and cash equivalents                                             |  | $ | 720,046  
|Accounts receivable, net of allowance for doubtful accounts of $5,000 |  |   | 280,446  
|Inventories, net                                                      |  |   | 814,675  
|Prepaid expenses and other current assets                             |  |   | 43,506   
|                                                                      |  |   |          
|Total current assets                                                  |  |   | 1,858,673
|                                                                      | 
|Property and Equipment, net                                           |  |   | 53,043   
|                                                                      | 
|Other Assets                                                          |  |   | 12,252   
|                                                                      |  |   |          
|                                                                      |  | $ | 1,923,968
|                                                                      |  |   |          



LIABILITIES AND
STOCKHOLDERS EQUITY



|                                                                                                  |  |   |           |  
|------------------------------------------------------------------------------------------------- |  | - | --------- | -
|Current Liabilities                                                                               |  |   |           |  
|Accounts payable                                                                                  |  | $ | 219,967   |  
|Accrued expenses                                                                                  |  |   | 278,234   |  
|                                                                                                  |  |   |           |  
|Total current liabilities                                                                         |  |   | 498,201   |  
|                                                                                                  | 
|Commitments and Contingencies                                                                     |  |   |           |  
|                                                                                                  | 
|Stockholders Equity                                                                              |  |   |           |  
|Common stock, no par value; 50,000,000 shares authorized; 1,469,564 shares issued and outstanding |  |   | 2,185,408 |  
|Accumulated deficit                                                                               |  |   | (759,641  | )
|                                                                                                  |  |   |           |  
|Total stockholders equity                                                                        |  |   | 1,425,767 |  
|                                                                                                  |  |   |           |  
|                                                                                                  |  | $ | 1,923,968 |  
|                                                                                                  |  |   |           |  



|         |  |                                                                           
|-------- |  | --------------------------------------------------------------------------
|Page F-2 |  | The accompanying notes are an integral part of these financial statements.



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##### Table of Contents

DYNATEM, INC.

STATEMENTS OF OPERATIONS

For the Years Ended May 31, 2005 and 2004



|                                                              |  |      |           |   |      |   |          
|------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | ---------
|                                                              |  | 2005 |           |   | 2004
|NET SALES                                                     |  | $    | 2,486,515 |   |      | $ | 4,476,685
|                                                              |  |     
|COST OF SALES                                                 |  |      | 1,632,594 |   |      |   | 2,565,610
|                                                              |  |      |           |   |      |   |          
|GROSS PROFIT                                                  |  |      | 853,921   |   |      |   | 1,911,075
|                                                              |  |      |           |   |      |   |          
|OPERATING EXPENSES                                            |  |      |           |   |      |   |          
|Selling, general and administrative                           |  |      | 1,060,731 |   |      |   | 1,002,386
|Research and development                                      |  |      | 550,346   |   |      |   | 516,604  
|                                                              |  |      |           |   |      |   |          
|                                                              |  |      | 1,611,077 |   |      |   | 1,518,990
|                                                              |  |      |           |   |      |   |          
|OPERATING (LOSS) INCOME                                       |  |      | (757,156  | ) |      |   | 392,085  
|                                                              |  |     
|OTHER INCOME                                                  |  |      |           |   |      |   |          
|Interest income                                               |  |      | 12,806    |   |      |   | 12,708   
|                                                              |  |      |           |   |      |   |          
|(LOSS) INCOME BEFORE PROVISION FOR INCOME TAXES               |  |      | (744,350  | ) |      |   | 404,793  
|                                                              |  |     
|PROVISION FOR INCOME TAXES                                    |  |      | 800       |   |      |   | 800      
|                                                              |  |      |           |   |      |   |          
|NET (LOSS) INCOME                                             |  | $    | (745,150  | ) |      | $ | 403,993  
|                                                              |  |      |           |   |      |   |          
|Net (loss) income available to common stockholders per share: |  |      |           |   |      |   |          
|Basic                                                         |  | $    | (0.50     | ) |      | $ | 0.26     
|                                                              |  |      |           |   |      |   |          
|Diluted                                                       |  | $    | (0.50     | ) |      | $ | 0.24     
|                                                              |  |      |           |   |      |   |          
|Weighted average number of common shares outstanding:         |  |      |           |   |      |   |          
|Basic                                                         |  |      | 1,479,685 |   |      |   | 1,563,665
|                                                              |  |      |           |   |      |   |          
|Diluted                                                       |  |      | 1,479,685 |   |      |   | 1,686,385
|                                                              |  |      |           |   |      |   |          



|         |  |                                                                           
|-------- |  | --------------------------------------------------------------------------
|Page F-3 |  | The accompanying notes are an integral part of these financial statements.



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##### Table of Contents

DYNATEM, INC.

STATEMENTS OF STOCKHOLDERS EQUITY

For the Years Ended May 31, 2005 and 2004



|                                                                  |  |              |   |  |                    |           |   |                          |   |          |   |  |   |           |  
|----------------------------------------------------------------- |  | ------------ | - |  | ------------------ | --------- | - | ------------------------ | - | -------- | - |  | - | --------- | -
|                                                                  |  | Common Stock |   |  | AccumulatedDeficit |           |   | TotalStockholdersEquity |  
|                                                                  |  | Shares       |   |  | Amount             |           |   |                         
|Balance at May 31, 2003                                           |  | 1,519,042    |   |  | $                  | 2,389,085 |   |                          | $ | (418,484 | ) |  | $ | 1,970,601 |  
|Exercise of stock options                                         |  | 88,850       |   |  |                    | 19,597    |   |                          |   |         |   |  |   | 19,597    |  
|Shares surrendered for cashless exercise of stock options         |  | (3,666       | ) |  |                    | (4,400    | ) |                          |   |         |   |  |   | (4,400    | )
|Shares repurchased and retired                                    |  | (84,662      | ) |  |                    | (140,574  | ) |                          |   |         |   |  |   | (140,574  | )
|Intrinsic value related to the cashless exercise of stock options |  |             |   |  |                    | 19,600    |   |                          |   |         |   |  |   | 19,600    |  
|Net income                                                        |  |             |   |  |                    |          |   |                          |   | 403,993  |   |  |   | 403,993   |  
|                                                                  |  |              |   |  |                    |           |   |                          |   |          |   |  |   |           |  
|Balance at May 31, 2004                                           |  | 1,519,564    |   |  |                    | 2,283,308 |   |                          |   | (14,491  | ) |  |   | 2,268,817 |  
|Exercise of stock options                                         |  | 10,000       |   |  |                    | 3,500     |   |                          |   |         |   |  |   | 3,500     |  
|Shares repurchased and retired                                    |  | (60,000      | ) |  |                    | (101,400  | ) |                          |   |         |   |  |   | (101,400  | )
|Net loss                                                          |  |             |   |  |                    |          |   |                          |   | (745,150 | ) |  |   | (745,150  | )
|                                                                  |  |              |   |  |                    |           |   |                          |   |          |   |  |   |           |  
|Balance at May 31, 2005                                           |  | 1,469,564    |   |  | $                  | 2,185,408 |   |                          | $ | (759,641 | ) |  | $ | 1,425,767 |  
|                                                                  |  |              |   |  |                    |           |   |                          |   |          |   |  |   |           |  



|         |  |                                                                           
|-------- |  | --------------------------------------------------------------------------
|Page F-4 |  | The accompanying notes are an integral part of these financial statements.



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##### Table of Contents

DYNATEM, INC.

STATEMENTS OF CASH FLOWS

For the Years Ended May 31, 2005 and 2004



|                                                                                     |  |      |           |   |      |   |           |  
|------------------------------------------------------------------------------------ |  | ---- | --------- | - | ---- | - | --------- | -
|                                                                                     |  | 2005 |           |   | 2004 |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                                 |  |      |           |   |      |   |           |  
|Net (loss) income                                                                    |  | $    | (745,150  | ) |      | $ | 403,993   |  
|Adjustments to reconcile net (loss) income to net cash used in operating activities: |  |      |           |   |      |   |           |  
|Depreciation and amortization                                                        |  |      | 13,019    |   |      |   | 20,951    |  
|Cashless exercise of options                                                         |  |      |          |   |      |   | 19,600    |  
|Allowance for doubtful accounts                                                      |  |      | (6,500    | ) |      |   | 1,500     |  
|Reserve for obsolete inventory                                                       |  |      | 10,000    |   |      |   | 10,000    |  
|Changes in operating assets and liabilities:                                         |  |      |           |   |      |   |           |  
|Accounts receivable                                                                  |  |      | 720,593   |   |      |   | (758,006  | )
|Inventories                                                                          |  |      | (161,236  | ) |      |   | (100,811  | )
|Prepaid expenses and other current assets                                            |  |      | (4,768    | ) |      |   | 13,679    |  
|Other assets                                                                         |  |      | 11,190    |   |      |   | (13,861   | )
|Accounts payable                                                                     |  |      | (62,932   | ) |      |   | 169,691   |  
|Accrued expenses                                                                     |  |      | 13,738    |   |      |   | (111,638  | )
|                                                                                     |  |      |           |   |      |   |           |  
|Net cash used in operating activities                                                |  |      | (212,046  | ) |      |   | (344,902  | )
|                                                                                     |  |      |           |   |      |   |           |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                |  |      |           |   |      |   |           |  
|Purchases of property and equipment                                                  |  |      | (12,608   | ) |      |   | (18,552   | )
|                                                                                     |  |      |           |   |      |   |           |  
|Net cash used in investing activities                                                |  |      | (12,608   | ) |      |   | (18,552   | )
|                                                                                     |  |      |           |   |      |   |           |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                                 |  |      |           |   |      |   |           |  
|Payments for repurchase and retirement of the Companys common stock                 |  |      | (101,400  | ) |      |   | (140,574  | )
|Proceeds from the exercise of stock options                                          |  |      | 3,500     |   |      |   | 15,197    |  
|                                                                                     |  |      |           |   |      |   |           |  
|Net cash used in financing activities                                                |  |      | (97,900   | ) |      |   | (125,377  | )
|                                                                                     |  |      |           |   |      |   |           |  
|NET DECREASE IN CASH AND CASH EQUIVALENTS                                            |  |      | (322,554  | ) |      |   | (488,831  | )
|                                                                                     |  |     
|CASH AND CASH EQUIVALENTS  beginning of year                                        |  |      | 1,042,600 |   |      |   | 1,531,431 |  
|                                                                                     |  |      |           |   |      |   |           |  
|CASH AND CASH EQUIVALENTS  end of year                                              |  | $    | 720,046   |   |      | $ | 1,042,600 |  
|                                                                                     |  |      |           |   |      |   |           |  
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION                                     |  |      |           |   |      |   |           |  
|                                                                                     |  |     
|Cash paid during the year for income taxes                                           |  | $    | 1,416     |   |      | $ | 800       |  
|                                                                                     |  |      |           |   |      |   |           |  



See accompanying notes to financial
statements for additional disclosure of non-cash investing and financing activities.



|         |  |                                                                           
|-------- |  | --------------------------------------------------------------------------
|Page F-5 |  | The accompanying notes are an integral part of these financial statements.



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Organization and Nature of Operations



Dynatem, Inc. (the Company) was incorporated in the State of California in May 1981. The Company designs, manufactures, distributes and markets modular single board microcomputers and microcomputer-based systems and software.
These systems are used for industrial applications, including factory automation, process control, robotics, data acquisition and networking.



Concentrations of Credit Risks



Cash and cash equivalent balances are maintained at various financial institutions. The Federal Deposit Insurance Corporation (FDIC) insures accounts at each
institution for up to $100,000. From time to time, the Company maintains cash balances at certain institutions in excess of the FDIC limit. At May 31, 2005, the Company had approximately $139,000 in excess of this limit.



The Company sells products to customers throughout the United States and in several foreign
countries. The Company performs periodic credit evaluations of its customers and does not obtain collateral with which to secure its accounts receivable. The Company maintains reserves for potential credit losses based upon the Companys
historical experience related to credit losses which management believes are sufficient. Although the Company expects to collect amounts due, actual collections may differ from the estimated amounts.



During fiscal 2005, the Company had sales to five customers, which represented 61% of net
sales. During fiscal 2004, the Company had sales to three customers, which represented 59% of net sales. At May 31, 2005, one customer accounted for 40% of accounts receivable. If the relationship between the Company and these customers was altered,
the future results of operations and financial condition could be significantly affected. Additionally, during fiscal 2005 and 2004, export sales approximated 11% and 8% of net sales, respectively.



Risks and Uncertainties



The Company operates in a highly competitive industry that is subject to intense
competition, government regulation and rapid technological change. The Companys operations are subject to significant risks and uncertainties including financial, operational, technological, regulatory and other risks associated with a
technology business including the potential risk of business failure.



Use of Estimates in the Preparation of Financial Statements



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 the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Significant estimates made by management are, among others,
provisions for losses on accounts receivable, provisions for slow moving and obsolete inventories and estimates for current and deferred taxes. Actual results could materially differ from those estimates.



Page F-6



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Cash Equivalents



Cash equivalents consist of highly liquid investments (certificates of deposit) with
original maturities of 90 days or less. At May 31, 2005, cash equivalent balances approximated $324,000.



Inventories



Inventories are
stated at the lower of cost or estimated market value. Cost is determined under the average cost method. Market is determined by comparison of current replacement costs with recent sales or net realizable value. The Company operates in an industry
in which its products are subject to design changes and are manufactured based on customer specifications. Accordingly, should design requirements change significantly or customer orders be canceled or decline, the ultimate net realizable value of
such products could be less than the carrying value of such amounts.



Property and Equipment



Property and equipment are
recorded at cost and are depreciated using the straight-line method over the estimated useful lives of the related assets, ranging from three to five years. Leasehold improvements are amortized using the straight-line method over the shorter of the
lease term (including renewals that are reasonably assured at the time leasehold improvements are acquired) or the estimated useful life of the related asset. Maintenance and repairs are charged to expense as incurred. Significant renewals and
betterments are capitalized. At the time of retirement or other disposition of property and equipment, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in operations.



Long-Lived Assets



Statement of Financial Accounting Standards (SFAS) No. 144, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 requires that long-lived assets be reviewed
for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. If the cost basis of a long-lived asset is greater than the projected future undiscounted net cash flows from such asset
(excluding interest), an impairment loss is recognized. Impairment losses are calculated as the difference between the cost basis of an asset and its estimated fair value. SFAS No. 144 also requires companies to separately report discontinued
operations and extends that reporting requirement to a component of an entity that either has been disposed of (by sale, abandonment or in a distribution to owners) or is classified as held for sale. Assets to be disposed of are reported at the
lower of the carrying amount or the estimated fair value less costs to sell. The provisions of this pronouncement relating to assets held for sale or other disposal generally are required to be applied prospectively after the adoption date to newly
initiated commitments to plan to sell or dispose of such assets, as defined, by management. As a result, management cannot determine the potential effects that adoption of SFAS No. 144 will have on the Companys financial statements with
respect to future disposal decisions, if any.



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Long-Lived Assets(continued)



Management believes that no impairment loss is necessary on long-lived assets. There can be
no assurance, however, that market conditions or demand for the Companys products or services will not change which could result in future long-lived asset impairment changes in the future.



Warranties



The Company provides warranties ranging from ninety days to one year on all products sold. Estimated future warranty obligations related to
certain products and services are provided by charges to operations in the period in which the related revenue is recognized. The Company has a warranty reserve of approximately $17,500 at May 31, 2005, which is included in accrued expenses in the
accompanying balance sheet.



Revenue Recognition



Revenue is recognized at the time the product is shipped more specifically as follows:



VME



This product group consists of hardware only. A customer will place an order; the Company
then fills the order and ships the product to the customer FOB shipping point, with a warranty from 90 days to one year depending on the type of hardware sold. Revenue is recognized at the time the product is shipped.



CPU Boards  The Company manufactures boards classified as hardware products and
recognizes revenue upon shipment.



Hardware  The Company
manufactures computer hardware as noted above and recognizes revenue upon shipment of the product.



Support Services  The Company does not provide support services. It provides a hardware warranty. If the product does not work, the Company repairs or replaces the product.



Custom Designed Products and Software  The Company occasionally provides custom
designed hardware products, but generally builds single board products for sale to its general customer base.



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Revenue Recognition(continued)



Software



The Company sells software drivers and software it has purchased from other suppliers (operating system software for resale). The volume of
resale software is minimal and only involves installing an operating system in order to pre-install software drivers if the customer requests pre-installation (the drivers cannot be installed unless there is an operating system). The software
drivers are sold with the related hardware as an off the shelf product. Software resale represents off the shelf operating systems designed, maintained, and supported by the original software manufacturer. The Company
provides support to its customers under the terms of its warranty and does not supply software support services billed separately. There are no multiple element software sales as described in SOP 97-2. The Companys software sale activities are
incidental to the core hardware products sold and the Company is not in the business of selling software; rather, it is necessary for the Company to supply integration of the various hardware products it sells. Such integration is done by software
drivers, which in effect are part of the hardware.



Systems and Software
 The Company does not develop operating system software and is not in this line of business. The Company sells hardware systems and related software drivers.



Software Drivers  The Company develops and sells software drivers with its hardware products. Revenue is recognized upon
shipment of the related hardware products.



Resale of Other
Manufacturers Software  The Company is not in the business of selling software and rarely sells an operating system (such as Windows XP) in order for pre-installation of drivers. The Company recognizes the revenue upon shipment of
the related hardware products. Software sales of this type are very minor.



Microsys



The Company is a distributor of Microsys
products and purchases such products from Microsys as needed. The Company reports the related revenue on a gross revenue basis under EITF 99-19 because the Company is (1) the primary obligor in the arrangement, (2) has the general
inventory risk, (3) has reasonable latitude to establish the price with the customer, (4) changes the mix of the products between Microsys and Company products as required, (5) determines the customer needs, (6) has physical loss inventory risk, and
finally (7) has the credit risk.



Distribution of Microsys Products
 The Company is a distributor of Microsys products and recognizes revenue as noted above in accordance with EITF 99-19.



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Revenue Recognition(continued)



In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin
101 (SAB 101), Revenue Recognition, as amended and superseded by SAB 104 in December 2003, which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and
for disclosure related to revenue recognition policies in financial statements filed with the Securities and Exchange Commission. Management believes the Companys revenue recognition policy conforms to SAB 104.



Research and Development Costs



Research and development costs are expensed as incurred.



Advertising



Advertising costs are expensed as incurred. Advertising costs incurred for the years ended May 31, 2005 and 2004 approximated $41,000 and
$40,000 respectively.



Income Taxes



The Company accounts for income taxes under SFAS No. 109, Accounting for Income
Taxes. Under SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is
provided for significant deferred tax assets when it is more likely than not that such assets will not be recovered.



Accounting for Stock-Based Compensation



The Company accounts for employee stock options in accordance with the Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock
Issued to Employees and related Interpretations and makes the necessary pro forma disclosures mandated by SFAS No. 123, Accounting for Stock-based Compensation, as amended.



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Accounting for Stock-Based Compensation(continued)



In March 2000, the Financial Accounting Standards Board
(FASB) issued Interpretation No. 44, (FIN 44), Accounting for Certain Transactions Involving Stock Compensation - an Interpretation of APB 25. This Interpretation clarifies (a) the definition of employee
for purposes of applying APB 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the
accounting for an exchange of stock compensation awards in a business combination. Management believes that the Company accounts for its employee stock based compensation in accordance with FIN 44.



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123. SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair-value-based method of
accounting for stock-based employee compensation. It also amends the disclosure provisions of that statement to require prominent disclosure about the effects on reported net income and earnings per share and the entitys accounting policy
decisions with respect to stock-based employee compensation. Certain of the disclosure requirements are required for all companies, regardless of whether the fair value method or intrinsic value method is used to account for stock-based employee
compensation arrangements. The Company continues to account for its employee incentive stock option plans using the intrinsic value method in accordance with the recognition and measurement principles of APB 25.



At May 31, 2005, the Company has two stock-based employee compensation plans (the
Plans) (see Note 5). The Company accounts for the Plans under the recognition and measurement principles of APB 25 and related Interpretations. There was no stock-based employee compensation cost reflected in net loss for the year ended
May 31, 2005. The Company recorded stock-based employee compensation cost of $19,600 during the year ended May 31, 2004, in connection with the cashless exercise of employee stock options (see Note 5). The following table illustrates the effect on
net income and earnings per common share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Accounting for Stock-Based Compensation(continued)



|                                                                |  |                    |          |   |      |   |        
|--------------------------------------------------------------- |  | ------------------ | -------- | - | ---- | - | -------
|                                                                |  | Year Ended May 31,
|                                                                |  | 2005               |          |   | 2004
|Net income (loss) available to common stockholders, as reported |  | $                  | (745,150 | ) |      | $ | 403,993
|Pro forma compensation expense                                  |  |                    | (74,250  | ) |      |   |       
|                                                                |  |                    |          |   |      |   |        
|Pro forma net income (loss) available to common stockholders    |  | $                  | (819,400 | ) |      | $ | 403,993
|                                                                |  |                    |          |   |      |   |        
|Income (loss) per share, as reported                            |  |                    |          |   |      |   |        
|Basic                                                           |  | $                  | (0.50    | ) |      | $ | 0.26   
|Diluted                                                         |  | $                  | (0.50    | ) |      | $ | 0.24   
|Income (loss) per share, pro forma                              |  |                    |          |   |      |   |        
|Basic                                                           |  | $                  | (0.55    | ) |      | $ | 0.26   
|Diluted                                                         |  | $                  | (0.55    | ) |      | $ | 0.24   



Basic and Diluted Earnings
(Loss) Per Common Share



Under SFAS No. 128, Earnings per
Share, basic earnings (loss) per common share is computed based on the weighted average number of shares outstanding for the period. Diluted earnings per share is computed by dividing net income by the weighted average shares outstanding
assuming all dilutive potential common shares were issued (using the treasury stock method, total additional dilutive potential shares totaled 118,720 and 122,720 as of May 31, 2005 and 2004, respectively). See Note 8 for more information.



Fair Value of Financial Instruments



SFAS No. 107, Disclosures About Fair Value of Financial Instruments,
requires disclosure of fair value information about financial instruments when it is practicable to estimate that value. The carrying amount of the Companys cash and cash equivalents, accounts receivable, accounts payable and accrued expenses
approximates their estimated fair values due to the short-term maturities of those financial instruments.



Segments of an Enterprise and Related Information



SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, requires public companies to report selected segment information in their quarterly and annual reports issued to
shareholders. It also requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenues and its major customers. Segment reporting is not required as the Company
currently operates in one segment, as discussed above.



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Significant Recent Accounting Pronouncements



In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest
Entities, an Interpretation of ARB 51. The primary objectives of FIN No. 46 are to provide guidance on the identification of entities for which control is achieved through means other than voting rights (variable interest entities, or
VIEs) and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity for which either: (1) the equity investors do not have a controlling financial interest; or
(2) the equity investment at risk is insufficient to finance that entitys activities without receiving additional subordinated financial support from other parties. In addition, FIN No. 46 requires that both the primary beneficiary and all
other enterprises with a significant variable interest in a VIE make additional disclosures. As amended in December 2003, the effective dates of FIN No. 46 for public entities that are small business issuers, as defined (SBIs), are as
follows: (a) For interests in special-purpose entities (SPEs): periods ended after December 15, 2003; and (b) For all other VIEs: periods ended after December 15, 2004. The December 2003 amendment of FIN No. 46 also includes transition
provisions that govern how an SBI which previously adopted the pronouncement (as it was originally issued) must account for consolidated VIEs. Management has concluded that the Company does not have an interest in any SPEs, and is evaluating the
other effects of FIN No. 46 (as amended) on its future consolidated financial statements.



In November 2004, the FASB issued SFAS No. 151, Inventory Costs - an amendment of ARB No. 43, Chapter 4, which clarifies the accounting for abnormal amounts of idle facility expense, freight,
handling costs and wasted material. In Chapter 4 of ARB 43, paragraph 5 previously stated that under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and re-handling costs may be so abnormal as
to require treatment as current period charges.... SFAS No. 151 requires that such items be recognized as current-period charges, regardless of whether they meet the criterion of so abnormal (an undefined term). This pronouncement also
requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for inventory costs incurred in years beginning after June 15, 2005.



In December 2004, the FASB issued SFAS No. 123-R, Share-Based Payment,
which requires that the compensation cost relating to share-based payment transactions (including the cost of all employee stock options) be recognized in the financial statements. That cost will be measured based on the estimated fair value of the
equity or liability instruments issued. SFAS No. 123-R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase
plans. SFAS No.123-R replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.



Page F-13



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Significant Recent Accounting Pronouncements(continued)



As originally issued, SFAS No. 123 established as preferable a
fair-value-based method of accounting for share-based payment transactions with employees. However, that pronouncement permitted entities to continue applying the intrinsic-value model of APB Opinion 25, provided that the financial statements
disclosed the pro forma net income or loss based on the preferable fair-value method. Small Business Issuers are required to apply SFAS No. 123-R in the first interim or annual reporting period that begins after December 15, 2005. Thus, the
Companys consolidated financial statements will reflect an expense for (a) all share-based compensation arrangements granted after January 1, 2006 and for any such arrangements that are modified, cancelled, or repurchased after that date, and
(b) the portion of previous share-based awards for which the requisite service has not been rendered as of that date, based on the grant-date estimated fair value.



Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not or are
not believed by management to have a material impact on the Companys present or future consolidated financial statements.



2. INVENTORIES



Inventories consist of the following at May 31, 2005:



|                                  |  |   |         |  
|--------------------------------- |  | - | ------- | -
|Raw materials and component parts |  | $ | 534,626 |  
|Work-in-process                   |  |   | 253,435 |  
|Finished goods                    |  |   | 86,614  |  
|Reserve for obsolete inventory    |  |   | (60,000 | )
|                                  |  |   |         |  
|                                  |  | $ | 814,675 |  
|                                  |  |   |         |  



3. PROPERTY AND EQUIPMENT



Property and equipment consist of the following at May 31, 2005:



|                                               |  |   |          |  
|---------------------------------------------- |  | - | -------- | -
|Machinery and equipment                        |  | $ | 6,125    |  
|Product tooling                                |  |   | 278,906  |  
|Furniture and fixtures                         |  |   | 131,354  |  
|Leasehold improvements                         |  |   | 1,647    |  
|                                               |  |   |          |  
|                                               |  |   | 418,032  |  
|                                               | 
|Less accumulated depreciation and amortization |  |   | (364,989 | )
|                                               |  |   |          |  
|                                               |  | $ | 53,043   |  
|                                               |  |   |          |  



During fiscal 2005 and 2004,
depreciation and amortization expense totaled $13,019 and $21,023, respectively.





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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



4. LINE OF CREDIT



The Company has a revolving line of credit agreement (the Line of Credit) that permits borrowings of up to $500,000. This Line
of Credit, as amended, is secured by substantially all of the assets of the Company and expires on September 18, 2005. The Company is currently negotiating and extension to the agreement. Interest on the borrowings is paid monthly at varying
interest rates based on the Lenders prime rate (6.00% at May 31, 2005) plus 1.5%. There were no borrowings outstanding as of May 31, 2005, nor were there any borrowings during the year then ended. At May 31, 2005, the Company was not in
compliance with one restrictive financial covenant under the Line of Credit, and they have not received a waiver from the lender. Such default could restrict the availability of funds to the Company in the future; however, the Company has borrowed
and repaid approximately $44,000 subsequent to year-end.



5.
STOCKHOLDERS EQUITY



Common Stock



During fiscal 2004, the Company issued 85,184 shares of common stock (net of 3,666 shares of
common stock redeemed) in connection with the exercise of stock options by employees. Pursuant to the exercise, certain stockholders redeemed 3,666 shares of common stock with a market value of $4,400 (estimated by the Company based on the closing
market price on the date of exercise) for the exercise of options to purchase 20,000 shares of common stock. Additionally, the Company repurchased and retired 84,662 shares of its restricted common stock for $140,574.



As mentioned above, a certain employee redeemed 3,666 shares of common stock to affect a
cashless exercise of stock options for 20,000 shares of the Companys common stock (16,334 net shares issued). As required by SFAS No. 123, and related Interpretations, the Company recorded $19,600 as stock-based employee compensation expense
in connection with this cashless exercise.



During fiscal 2005, the Company
issued 10,000 shares of common stock at $0.35 per share for cash proceeds of $3,500, in connection with the exercise of stock options by employees.



During fiscal 2005, the Company repurchased and retired 60,000 shares of common stock for total cash payments approximating $101,000.



Options



On August 31, 1993, the Companys Board of Directors adopted, and the shareholders approved, the Dynatem, Inc. 1993 Stock Option Plan
(1993 Plan), which provides for the grant of options intended to qualify as incentive stock options under Section 422 of the Internal Revenue Code and for the grant of nonqualified stock options. In connection with the 1993 Plan, 200,000
shares of the Companys common stock have been reserved for issuance upon the exercise of options to be granted.



On October 7, 1998, the Companys Board of Directors adopted and the shareholders approved, the 1998 Stock Option Plan of Dynatem, Inc. (1998 Plan).
200,000 shares of the Companys common stock have been reserved for issuance upon the exercise of options to be granted under the 1998 Plan.



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



5. STOCKHOLDERS EQUITY(continued)



The following represents a summary of the stock options outstanding at May 31, 2005 and 2004
and the changes during the years then ended:



|                                               |  |                    |   |      |                              |      |         |         |   |                              |   |     
|---------------------------------------------- |  | ------------------ | - | ---- | ---------------------------- | ---- | ------- | ------- | - | ---------------------------- | - | ----
|                                               |  | Year Ended May 31,
|                                               |  | 2005               |   | 2004
|                                               |  | Options            |   |      | WeightedAverageExercisePrice |      | Options |         |   | WeightedAverageExercisePrice
|Outstanding, beginning of year                 |  | 160,000            |   |      | $                            | 0.34 |         | 253,850 |   |                              | $ | 0.30
|Granted                                        |  | 45,000             |   |      |                              | 1.65 |         |        |   |                              |   |    
|Exercised                                      |  | (10,000            | ) |      |                              | 0.35 |         | (88,850 | ) |                              |   | 0.22
|Cancelled/Forfeited                            |  |                   |   |      |                              |     |         | (5,000  | ) |                              |   | 0.20
|                                               |  |                    |   |      |                              |      |         |         |   |                              |   |     
|Outstanding, end of year                       |  | 195,000            |   |      | $                            | 0.64 |         | 160,000 |   |                              | $ | 0.34
|                                               |  |                    |   |      |                              |      |         |         |   |                              |   |     
|Exercisable, end of year                       |  | 195,000            |   |      | $                            | 0.64 |         | 160,000 |   |                              | $ | 0.34
|                                               |  |                    |   |      |                              |      |         |         |   |                              |   |     
|Weighted average fair value of options granted |  |                    |   |      | $                            | 1.65 |         |         |   |                              | $ |    
|                                               |  |                    |   |      |                              |      |         |         |   |                              |   |     



All of the options outstanding at May
31, 2005 have exercise prices between $0.22 and $1.65 and a weighted average remaining contractual life of 5.08 years. Additionally, the fair value of options granted during the year ended May 31, 2005 was calculated using the Black-Scholes
option-pricing model using the following assumptions: expected dividend yield of 0.00%; volatility of 362%; risk-free interest rate of 4.10%; and an expected life of 10 years.



The following table summarizes information concerning currently outstanding and exercisable options:



|                     |  |                                           |  |                                           |  |                              |     
|-------------------- |  | ----------------------------------------- |  | ----------------------------------------- |  | ---------------------------- | ----
|Exercise price range |  | Number ofoptionsoutstandingandexercisable |  | Weighted averageremainingcontractual life |  | Weightedaverageexerciseprice
|$0.22- $0.35         |  | 130,000                                   |  | 3.45 years                                |  | $                            | 0.27
|$0.80                |  | 20,000                                    |  | 5.96 years                                |  | $                            | 0.80
|$1.65                |  | 45,000                                    |  | 9.42 years                                |  | $                            | 1.65
|                     |  |                                           |  |                                           |  |                              |     
|                     |  | 195,000                                   |  | 5.08 years                                |  | $                            | 1.58
|                     |  |                                           |  |                                           |  |                              |     



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



5. STOCKHOLDERS EQUITY(continued)



Options (continued)



As of May 31, 2005, 155,000 and 40,000 options (net of 90,000 and 125,000 options exercised) have been granted by the Company and are
outstanding under the 1998 Plan and the 1993 Plan, respectively.



6. INCOME
TAXES



During both fiscal 2005 and 2004, the provision for income taxes
consists of the following:



|              |  |         |   |       |   |       |  |   |    
|------------- |  | ------- | - | ----- | - | ----- |  | - | ---
|              |  | Federal |   | State |   | Total
|Current       |  | $       |  |       | $ | 800   |  | $ | 800
|Deferred      |  |         |  |       |   |      |  |   |   
|              |  |         |   |       |   |       |  |   |    
|Tax provision |  | $       |  |       | $ | 800   |  | $ | 800
|              |  |         |   |       |   |       |  |   |    



During fiscal 2005 and 2004, the
provision for income taxes differs from the amounts computed by applying the U.S. Federal income tax rate of 34% to income before provision for taxes as a result of the following:



|                                                        |  |      |          |   |      |   |          |  
|------------------------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
|                                                        |  | 2005 |          |   | 2004 |  
|Computed expected tax expense                         |  | $    | (253,000 | ) |      | $ | 137,000  |  
|                                                        |  |     
|Addition to (reduction) in income taxes resulting from: |  |      |          |   |      |   |          |  
|State income taxes, net of federal benefit              |  |      | (82,000  | ) |      |   | 800      |  
|Change in valuation allowance                           |  |      | 371,000  |   |      |   | (137,000 | )
|Other                                                   |  |      | (35,200  | ) |      |   |         |  
|                                                        |  |      |          |   |      |   |          |  
|                                                        |  | $    | 800      |   |      | $ | 800      |  
|                                                        |  |      |          |   |      |   |          |  



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



6. INCOME TAXES(continued)



The tax effects of temporary differences that give rise to significant portions of the
deferred tax assets at May 31, 2005 are presented below:



|                                                  |  |   |          |  
|------------------------------------------------- |  | - | -------- | -
|Deferred tax assets:                              |  |   |          |  
|Net operating loss carryforwards                  |  | $ | 250,000  |  
|Research and development credit carryforwards     |  |   | 317,000  |  
|Inventory reserve and uniform cost capitalization |  |   | 90,000   |  
|Other                                             |  |   | 120,000  |  
|                                                  |  |   |          |  
|                                                  |  |   | 777,000  |  
|Less valuation allowance                          |  |   | (777,000 | )
|                                                  |  |   |          |  
|Net deferred tax assets                           |  | $ |         |  
|                                                  |  |   |          |  



At May 31, 2005, the Company had
federal net operating loss carryforwards of approximately $629,000, which, if not utilized to offset future taxable income, will expire in various years through 2020.



At May 31, 2005, the Company had unused federal and California research and development credits of approximately $262,000 and $55,000,
respectively, which, if not used, will expire in various years through 2017.



In the event the Company were to experience a greater than 50% change in ownership, as defined in Section 382 of the Internal Revenue Code, the utilization of the Companys tax net operating loss carryforwards could be severely
restricted.



7. COMMITMENTS AND CONTINGENCIES



Leases



The Company has entered into non-cancelable operating lease agreements for its corporate and manufacturing facilities. In addition to
monthly lease payments for the facilities, the Company is required to pay utilities and certain insurance and maintenance costs. The leases provide for annual rental increases and a renewal option based on certain terms and conditions. The leases
expire through fiscal 2006, and the approximate lease payment for the year ending May 31, 2006 is $49,000.



During fiscal 2005 and 2004, the Company incurred approximately $112,000 and $108,000, respectively, related to these leases, of which approximately $63,000 and $61,000 has been classified as a component of cost of
sales in the accompanying statements of income.



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##### Table of Contents

DYNATEM, INC.

NOTES TO FINANCIAL STATEMENTS

For the Years Ended May 31, 2005 and 2004



7. COMMITMENTS AND CONTINGENCIES(continued)



Royalty and Licensing Agreements



The Company is a party to a royalty agreement that requires it to pay royalties of 25% of
sales of a select hardware product and 50% of sales of a select software product, as defined. The Company is also a party to another royalty agreement that requires it to pay royalties of 50% of the gross profit earned by the Company on sales of
certain hardware products, as defined.



During 1997, the Company entered into
two software licensing agreements. The licensed software will be used with various products that the Company manufactures and distributes. One of the agreements provides for a one-time licensing fee and the other agreement provides for a fixed fee
on each unit of software sold. During fiscal 2005 and 2004, total royalty and licensing expense for the royalty and licensing agreements mentioned herein approximated $0 and $4,000, respectively.



8. BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE



The following is a reconciliation of the numerators and denominators of the basic and
diluted earnings (loss) per common share computations:



|                                                                     |  |      |           |   |      |   |          
|-------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | ---------
|                                                                     |  | 2005 |           |   | 2004
|Numerator for basic and diluted earnings (loss) per share:           |  |      |           |   |      |   |          
|Net (loss) income                                                    |  | $    | (745,150  | ) |      | $ | 403,993  
|                                                                     |  |      |           |   |      |   |          
|Denominator for basic and diluted earnings (loss) per share:         |  |      |           |   |      |   |          
|Weighted average shares (basic)                                      |  |      | 1,479,685 |   |      |   | 1,563,665
|Common stock equivalents                                             |  |      |          |   |      |   | 122,720  
|                                                                     |  |      |           |   |      |   |          
|Weighted average shares (diluted)                                    |  |      | 1,479,685 |   |      |   | 1,686,385
|Net (loss) income available to common shareholders per common share: |  |      |           |   |      |   |          
|Basic                                                                |  | $    | (0.50     | ) |      | $ | 0.26     
|                                                                     |  |      |           |   |      |   |          
|Diluted                                                              |  | $    | (0.50     | ) |      | $ | 0.24     
|                                                                     |  |      |           |   |      |   |          



During the year ended May 31, 2005,
the Company had a loss, so dilutive potential common shares totaling 118,720 were excluded from diluted earnings (loss) per common share as their inclusion would be antidilutive. For the years ended May 31, 2005 and 2004, options to acquire 45,000
shares and zero shares, respectively, were not considered dilutive potential common shares as their exercise prices were greater than the average market price of the Companys common stock during the years then ended.



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