**U.S. Securities and Exchange Commission**

**Washington, D.C. 20549**

** **

**Form 10-KSB**

(Mark One)

**x**                              ANNUALREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**For thefiscal year ended October 1, 2005**

**o**                                 TRANSITIONREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**For thetransition period from                to**

**CommissionFile No. 1-6635**

**Innovative MicroTechnology, Inc.**(Name of small business issuer in its charter)

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

 

**75 RobinHill Road, Goleta, California  93117**(Address of principal executive offices) (Zip Code)

Issuer’s telephonenumber: **(805) 681-2800**

Securities registered under Section 12(b) ofthe Exchange Act: **None**

Securities registered under Section 12(g) ofthe Exchange Act:

**CommonStock, $.0001 par value**(Title of Class)

Check whether the issuer is not required to filereports pursuant to Section 13 or 15(d) of the Exchange Act. o

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Actduring the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes o   No x

Check if there is no disclosure of delinquent filerspursuant to Item 405 of Regulation S-B contained in this form, and nodisclosure will be contained, to the best of the registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-KSB or in any amendment to this Form 10-KSB. o

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

The issuer’s revenues for its most recently completedfiscal year were $10,298,000

There is no public market for the registrant’s CommonStock. As of October 29, 2005, the aggregate book value of the registrant’sCommon Stock held by non-affiliates was $2,599,000.

(ISSUERS INVOLVEDIN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Check whether the issuer has filed all documents andreports required to be filed by Sections 12, 13 or 15(d) of the ExchangeAct after the distribution of securities under a plan confirmed by a court. Yes x   No o

Asof December 22, 2005, there were 6,953,880 shares of the Company's common stockoutstanding.

 

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**DOCUMENTS INCORPORATED BY REFERENCE**

Portions of the registrant’s definitive proxystatement relating to its 2005 Annual Meeting of Stockholders, which will befiled with the Securities and Exchange Commission pursuant to Regulation 14Awithin 120 days of the close of the registrant’s last fiscal year, areincorporated by reference into Part III of this report.

*In this Annual Report on Form 10-KSB,the words “believe,” “estimate,” “anticipate,” “expect,” “intend,” “plan” andsimilar expressions identify forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. These forward-looking statementsspeak only as of the date hereof. All of the forward-looking statements arebased on estimates and assumptions made by management of the Company, which,although believed to be reasonable, are inherently uncertain and difficult topredict. Therefore, undue reliance should not be placed upon such estimates. Suchstatements are subject to certain risks and uncertainties inherent in theCompany’s business that could cause actual results to differ materially fromthose projected. These risks and uncertainties include, but are not limited to,those discussed under the caption “Risk Factors Affecting the Company’sBusiness” and elsewhere in this report and our other documents filed with theSEC, and, the following: the Company’s ability to make the transition to volumeproduction of MEMS products; the Company’s history of losses and bankruptcy;changing technology; competition; the company’s ability to protect intellectualproperty; fluctuations in the Company’s quarterly and annual operating results;lack of an active trading market; risks related to international transactions;environmental laws and regulations; supplies of raw materials; anti-takeoverprovisions of the Company’s charter and Delaware law; and general economic andpolitical uncertainty. The Company does not assume any obligation to update orcorrect forward-looking statements to reflect subsequent events or actualresults.*

 

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**PART I**

**ITEM 1. DESCRIPTION OF BUSINESS**

Innovative MicroTechnology, Inc (“the Company”) designs and manufactures MEMS devices. MEMS isan acronym for micro-electro-mechanical system. The Company’s headquarters arelocated in Goleta, California.

**History**

The Company wasincorporated in California in 1957 and was reincorporated in Delaware in 1987under the name “Applied Magnetics Corporation.” The Company was an independentmanufacturer of head gimbal assemblies (“HGAs”) and head stack assemblies(which consist of multiple HGAs assembled together with other components) tothe disk drive industry. The Company filed for protection under Chapter 11 ofthe U.S. Bankruptcy Code on January 7, 2000. The Company exited Chapter 11on November 16, 2001 under a court approved plan of reorganization (the “ReorganizationPlan”) and changed its name to Innovative Micro Technology, Inc.

**The Company’s MEMS Business**

The Company used the Chapter 11 reorganization processto reposition its operations in the MEMS business. MEMS devices were firstdeveloped in the late 1970s and early 1980s. MEMS devices are made using modernwafer-processing technology, similar to that used in making silicon electronicdevices or thin-film recording heads for magnetic storage devices. Whatdistinguishes MEMS devices is that they include moving components, hence the “mechanical”part of the name. By using wafer techniques, the performance of mechanicalsystems can be enhanced due to their smaller size and/or complexity. MEMSdevices can be manufactured at a lower cost due to the large number of devicesthat can be made on a single wafer.

Common uses for MEMSdevices are automotive air-bag sensors (accelerometers), pressure and airflowsensors, and ink­jet printer heads. Future uses for MEMS devices are expectedto be numerous, in that many small-scale mechanical systems such aselectromagnetic relays, which today are built using assembly techniques, couldbe made using MEMS. In addition, many electrical systems may be replaced byMEMS. An example of this is optical fiber switching, used in telecommunications.MEMS versions of these switches are now beginning to find their way into themarketplace. Another example is components for wireless communicationtechnology. High performance inductors, variable capacitors andtransmit/receive switches could be replaced by MEMS devices at lower cost,using less space and providing higher performance. The Company’s businessactivity is at the product development phase for most of its customers. TheCompany has one customer’s product that is in low-volume production. TheCompany fabricates MEMS products on a six-inch silicon wafer which, dependingupon the size of the individual part, is cut into multiple finished partsreferred to as dies.

**Other Lines of Business**

The Company’s three additional lines of businessare:  “Santa Barbara Tool & Die,”“IMT Analytical” and leasing of excess space in its owned facility underlong-term lease contracts.

Santa Barbara Tool & Die is a precisionmachining and tooling service that provides customers with prototyping,development and production tool and die manufacturing. Santa Barbara Tool &Die’s technology permits high precision manufacturing of tooling, featuringelectron-discharge machining (EDM), which includes metals and ceramicscapabilities.

IMT Analytical is a precision semiconductor and MEMSanalysis service provider. IMT Analytical’s laboratory technology includeselectron microscopy in a variety of forms and a focused ion beam tool 

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which can precisely makethree-dimensional cuts in samples to reveal detailed information as todimension, material makeup, and material crystal properties.

Santa Barbara Tool &Die and IMT Analytical are both strategic parts of the core company in thattheir services are used to make the core business more competitive, and bothalso provide service to outside customers using the portion of their capacitythat is in excess of that required by the Company. In addition, the Company hasapproximately 51,000 square feet of building space available to lease. As of October 1,2005, approximately 31,000 square feet were under long term lease arrangementswith annual rental income of approximately $0.5 million. An existing tenantusing a 3,000 square foot portion of the facility transitioned to a month to monthrental basis as of November 3, 2005.

**Employees**

Highly trainedengineers and technicians maintain and operate the sophisticated equipment usedin the fabrication of MEMS devices. Most of these individuals play a dual rolein operations as well as in process development. The employees cover thefollowing technical areas:

·        photolithography,including resist application, resist development, and patterned exposure;

·        deposition,including sputtering, ion beam deposition, plating;

·        etching,including wet-etching and dry (vacuum) processing;

·        planarization,including chemical-mechanical polishing;

·        waferslicing;

·        assembly,including die bonding, electrical bonding, precision alignment; and

·        testing,including mechanical and electrical testing.

·        TheSanta Barbara Tool & Die employees have extensive tool and dieexperience and the IMT Analytical employees are trained to operatesophisticated analytical tools.

As of October 1,2005, the Company had 136 employees at its headquarters in Goleta, California.

**Technology**

The Company has three main forms of technology:manufacturing, design, and service.

The manufacturing technology encompassesphotolithography, material deposition, and material removal, which are theessential methods of producing integrated wafers. Additional manufacturingtechnology includes wafer bonding, assembly and testing procedures, includingprecision alignment and assembly, ceramic bonding, wire attachment, and testingalgorithms. The Company’s techniques in this area have been developed overseveral years of manufacturing.

Design technology the Company possesses comes fromyears of recording head manufacturing experience, which afforded the Companyspecial skills in the art of making magnetic materials and finding uses forthem. To that end, some of the Company’s intended products surround magneticMEMS devices. Specifically, the Company has skill and experience withgenerating high magnetic fields efficiently using thin-film coils coupled withhigh saturation magnetization materials capable of carrying magnetic flux.Coupled with MEMS concepts, this allows the Company to design and manufacturemagnetic actuators of various types.

The Company’s service technology comes in the form ofthe specialized tool fabrication business offered by Santa Barbara Tool &Die and the specialized test services offered byIMT Analytical (See—Other Lines of Business).

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**Intellectual Property**

The Company regards elements of its manufacturingprocesses, product designs and equipment as proprietary and seeks to protectits proprietary rights through a combination of employee and third partynondisclosure agreements, internal procedures and patent protection. TheCompany has filed 17 patent applications with the United States Patent Officesince January 2000, and more are in preparation related to the MEMSbusiness. Seven of these patents have been issued by the U.S. Patent Office tothe Company.

The Company believes that its success depends on theinnovative skills and technological competence of its employees and upon properprotection of its intellectual properties. The Company has, from time to time,been notified of claims that it may be infringing on patents owned by others.If it appears necessary or desirable, the Company may seek licenses underpatents that it is allegedly infringing. Although patent holders commonly offersuch licenses, no assurance can be given that licenses will be offered or thatthe terms of any offered licenses will be acceptable to the Company. Thefailure to obtain a key patent license from a third party could cause theCompany to incur substantial liabilities or to suspend the manufacture of theproducts using the patented invention.

In the future, the Company may face costly damages orlitigation costs if a third party claims that the Company infringed on itsintellectual property. Advanced technology products such as the Company’s areincreasingly subject to third-party infringement claims. In addition, formeremployers of the Company’s current and future employees may assert that itsemployees have disclosed confidential or proprietary information to theCompany. Any of these claims, even if they are without merit, could beexpensive and time consuming to defend.

In addition, intellectualproperty claims against the Company, with or without merit, could require it toenter into royalty or licensing agreements. These royalty or licensingagreements, if required, may not be available on terms acceptable to theCompany or at all, which could seriously harm its business. A successful claimof infringement against the Company or its failure or inability to license theinfringed or similar technology could adversely affect its business because theCompany would not be able to sell the affected product without redeveloping theproduct or its manufacturing process, incurring significant additionalexpenses.

**Research and Development**

Research and development expenses (“R&D”) were$0.2 million in fiscal 2005 compared to $0.5 million in fiscal 2004. TheR&D expenses represented 2.1% and 5.2% of net revenue in fiscal 2005 and2004, respectively.

R&D expenditures forthe Company focus on development of new MEMS devices and the associatedproduction processes for the telecommunication, inertial navigation, wirelesscommunication, and the biomedical product areas. The reduction in R&Dexpenditures in fiscal 2005 compared to fiscal 2004 was due to the transfer ofa portion of the groups effort in fiscal 2005 to support customer projects.R&D expenditures are expected to grow as the Company continues to diversifyinto new product areas. The Company had two employees focused on thedevelopment of new products and manufacturing processes at the end of fiscal2005 compared to four at the end of fiscal 2004.

**Vendors**

The Company purchasesmaterials from a variety of vendors, including providers of manufacturingsupplies, office supplies, and raw materials. The Company is not solelydependent on any of its vendors, and in the majority of the cases there is ageneral market for the required products.

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**Industry Segments**

TheCompany analyzes its business results based on its four lines of business:  MEMS, Santa Barbara Tool & Die, IMTAnalytical and Rental Income. The following table shows the percentages ofrevenue from each segment during both fiscal 2005 and fiscal 2004. 

**Revenue by Segment**

| ** **                                           | ** ** | ** **          | ** ** | **For the Periods:** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|--------------------------------|------------|
| ** **                                           | ** ** | **Year Ended** | ** ** | **Year Ended**            | ** ** |
| ** **                                           | ** ** | **October 1,** | ** ** | **October 2,**            | ** ** |
| **(As a percentage of revenue)** | ** ** | ** **          | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| MEMS                                                 |       |                | 81         | %                              |       |   | 82 | % |   |
| Santa Barbara  Tool & Die                   |       |                | 13         | %                              |       |   | 12 | % |   |
| IMT Analytical                                       |       |                | 1          | %                              |       |   | 1 | % |   |
| Rental Income                                        |       |                | 5          | %                              |       |   | 5 | % |   |
| Total                                                |       |                | 100        | %                              |       |   | 100 | % |   |
|                                                      |            |                     |            |                                |            |  |  |  |  |  |  |  |  |

 

**Customers**

The Company’s customers are in four categoriesrepresenting its four business segments: MEMS and wafer customers, machine shoptool and die customers, tenants of excess building space and analytical lab servicecustomers.

The MEMS business customers are in the inertialnavigation, telecommunication, RF wireless, and the biomedical industries.Inertial navigation MEMS refers to MEMS gyroscopes and accelerometers. TheCompany has been a subcontractor to L-3 Communications Corporation (“L-3”)to produce gyroscopes and accelerometers for use in inertial navigation. At theend of fiscal 2005, L-3 cancelled its most recent contract with theCompany, because L-3’s contract with the Army for the production ofgyroscopes and accelerometers for use in inertial navigation was cancelled. On March 15,2004, the Company entered into an agreement for a Secured Promissory Note (the “Note”)in the original principal amount of $1.5 million with L-3, a principalstockholder of the Company. On January 25, 2005, the Company usedapproximately $1.6 million of the net proceeds from its $17.0 million privateequity sale to an investor group, consisting of Investor Growth CapitalLimited, BA Venture Partners and Miramar Venture Partners (together the “InvestorGroup”), to repay the Note, including all accrued interest. The Company’srevenue derived from Customer A was for the manufacture of a display used insmall electronic devices, which was completed in the fourth quarter of fiscal 2005.The Company’s revenue derived from Customer B was for the development of atelecommunications switch. The Company leases approximately 34,000 square feetof excess space within its owned facility to tenants under long-term contracts,of which OCCAM Networks, Inc., an unrelated party, leases approximately31,000 square feet. The Company’s revenue derived from Marubeni was for thedevelopment of a telecommunications switch, which was completed in the thirdquarter of fiscal 2005. Biomedical MEMS includes the Company’s assistanceagreement from the U.S. Defense Advanced Research Project Agency (“DARPA”) forprototype development for rapid and efficient isolation of human hematopoieticstem cells for medical and defense applications. The Company finished Phase Iof its DARPA assistance agreement in fiscal 2004 and is currently underagreement for Phase II of the project. The Company’s revenue derived fromGalaxy Scientific Corp. was funded by a contract from the U.S. Army to supportthe development of the inertial navigation device that the Company wasdeveloping for L-3. The Galaxy contract was completed in the firstquarter of fiscal 2004. The Company currently has contracts with customers inthe RF wireless industry, which includes RF switching and phase-shiftingelectronics. The Company’s revenue by significant customer for both fiscal 2005and fiscal 2004 are displayed on the following chart.

 

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| **Revenue by Customer**                    | ** ** | **For the Periods:** | ** ** |
|------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                           | ** ** | **Year Ended**            | ** ** | **Year Ended** | ** ** |
| ** **                                           | ** ** | **October 1,**            | ** ** | **October 2,** | ** ** |
| **(As a percentage of revenue)** | ** ** | ** **                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| L-3                                                  |       |                           | 18         | % |   |   | 40 | % |   |
| Customer A                                           |       |                           | 13         | % |   |   | 0 | % |   |
| Customer B                                           |       |                           | 11         | % |   |   | 3 | % |   |
| OCCAM  Networks, Inc.                           |       |                           | 5          | % |   |   | 5 | % |   |
| Marubeni  Solutions                                  |       |                           | 3          | % |   |   | 4 | % |   |
| DARPA assistance  agreement                          |       |                           | 0          | % |   |   | 11 | % |   |
| Galaxy Scientific                                    |       |                           | 0          | % |   |   | 1 | % |   |
| Spectra                                              |       |                           | 0          | % |   |   | 1 | % |   |
| All Others                                           |       |                           | 50         | % |   |   | 35 | % |   |
| Total                                                |       |                           | 100        | % |   |   | 100 | % |   |
|                                                      |            |                                |            |  |  |  |  |  |  |  |  |

 

The Company’s products andservices are sold in the United States, Canada and Japan by its direct salespersonnel.

**Government Approval**

The Company is asubcontractor to DARPA and L-3 in certain long-term contracts. At the endof fiscal 2005, L-3 cancelled its most recent contract with the Company,because L-3’s contract with the Army for the production of gyroscopes andaccelerometers for use in inertial navigation was cancelled.  However, the Company has a long-term contractdirectly with the Army for the production of gyroscopes and accelerometers foruse in inertial navigation. The Company’s status as a subcontractor, and theproducts it produces in that capacity, are subject to substantial governmentregulation and continuing agency approval.

**Competition**

The Company competes with other independent MEMSmanufacturers. They are generally private entities, and information about theirfinancial status is unavailable to the Company. The names of some of thesefirms are Micralyne, Colibrys, Applied MEMS, Tronics, XFab and Issys. Onepublicly held company that directly competes is MEMScap. Some of thesecompanies operate wafer fabrication (“wafer fab”) facilities using a four-inchdiameter wafer compared to the six-inch format used by the Company. The largerwafer used by the Company has approximately twice the physical useable area, whichprovides approximately twice as many die per wafer compared to the smallerfour-inch wafer. This feature provides the Company with certain costadvantages.

The Company also competes with large integratedcircuit manufacturers with six-inch wafer fab facilities. These firms includeHoneywell, Dalsa, Analog Devices, Texas Instruments and Motorola. Thesecompetitors are all significantly larger than the Company with greaterfinancial, technical and marketing resources than the Company. In some cases,these firms operate wafer fabs based on Complimentary Metal Oxide Semiconductor(“CMOS”) technology which limits their use compared to the Company’s equipmentcapabilities.

The principal competitivefactors in the Company’s markets are price, product performance, quality,product availability and responsiveness to customers and technologicalsophistication. See “Customers.”

**Environmental Compliance**

The Company uses hazardous chemicals in itsmanufacturing and is subject to a variety of environmental and land useregulations related to their use, storage and disposal. If the Company fails to

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comply with present orfuture regulations, liability for the cost of remediation, damages orpenalties, and production suspension or delay could result. In addition,environmental or land use regulations could restrict the Company’s ability toexpand its current production facilities or establish additional facilities inother locations, or could require the Company to acquire costly equipment, orto incur other significant expenses for compliance with environmentalregulations or to clean up prior discharges.

The Company has been subject to regulatory and legalproceedings related to past environmental contamination, and other similarproceedings could arise in the future. In fiscal 2002, the Company was advisedby the U.S. Environmental Protection Agency that it may be required to pay forpart of the remediation of a solvent and refrigerant recycling and treatmentfacility formerly operated by the Omega Chemical Company in Whittier,California. The EPA alleges that the Company, along with a number of othercompanies, provided solvent and refrigerant waste to this facility forrecycling and disposal. The Company is still exploring legal defenses,including defenses arising out of the bankruptcy proceedings. At this time, theCompany intends to defend this matter vigorously. If these legal defenses areunsuccessful, the Company could be required to pay an amount of less than $0.1million. The Company is also remediating and monitoring ground watercontaminated with volatile organic compounds (“VOCs”) at a former site leasedby the Company in Goleta, California under an order of the California RegionalWater Quality Control Board (“CRWQCB”). VOC contamination at the site has beenreduced and the Company does not expect future expenditures related to the siteto be material.

In fiscal 2003, the Company sold its Hollisterfacility. The environmental testing performed by the Company in support of thissale determined that the soil at that site showed no metal or VOCcontamination. However, ground water samples showed low levels of VOCcontamination. The CRWQCB required the Company to install one monitoring well,and test results confirmed the low level VOC concentration. The Company has beenasked by the CRWQCB to submit semi-annual sample results from its well. Oneproperty adjacent to the site is conducting a remediation project on its sitefor this same VOC and the CRWQCB required this property to place monitoringwells between the two properties. Their testing detected the presence ofbreakdown products of the same VOC. The owners of the adjacent property havebeen asked to conduct semi-annual sampling of the wells. A second propertyadjacent to the site is conducting site characterization under the guidance ofthe CRWQCB related to the same VOC found on the Company’s site. In the fourthfiscal quarter of 2004, the CRWQCB issued a letter to the Company indicatingthat their investigation of the adjacent properties led them to the conclusionthat the VOC present on the site was the Company’s responsibility. The CRWQCBhas requested that the Company continue to submit results from the semi-annualmonitoring of its well. The Company is unable to make a determination ofpotential future costs for this situation. The Company has a $5.0 millionenvironmental insurance policy covering potential liability relating to thisproperty. The Company’s accumulated cost to date for these matters related tothe Hollister facility has been less than $0.1 million.

The Company believes itconducts its business in a manner that complies with environmental laws andregulations. While the Company’s known environmental liabilities have largelybeen resolved and are not, either individually or taken together, material toits business and financial condition, there can be no assurance that materialenvironmental claims will not arise in the future. If such claims arise, theycould be extremely expensive to contest or to resolve if the Company is foundresponsible and does not have applicable insurance coverage, which would resultin material harm to its business.

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**Executive Officersof the Registrant**

Thefollowing table sets forth information as to the name, age, andoffice(s) held by each executive officer of the Company as ofDecember 16, 2005:

| **Name**                | ** ** | ** ** | ** ** | **Age**                                                        | ** ** | **Position or Office** |
|-------------------------|------------|------------|------------|----------------------------------------------------------------|------------|------------------------|
| Dr. John S. Foster |       | 47         |       | Chief Executive Officer and Chairman   of the Board            |
| Peter T. Altavilla      |       | 52         |       | Chief Financial  Officer, Corporate Controller   and Secretary |

 

Dr. Foster hasover 18 years of experience in technology and operations management. He joinedthe Company in 1993. He has held a variety of senior management positionsincluding two years as the Company’s Managing Director of its former operationin Penang, Malaysia and as the Vice President of Worldwide Operations.Dr. Foster holds a doctorate in Applied Physics from Stanford University.He was elected to the position of Chief Executive Officer of the Company onNovember 16, 2001 and to the position of Chairman of the Board onNovember 19, 2001.

Mr. Altavilla has been employed by the Company since1987. He served as Assistant Controller until August 1, 1994, when he waselected to the position of Corporate Controller. Mr. Altavilla was electedSecretary on February 9, 1996. He was elected to the position of ChiefFinancial Officer of the Company on November 16, 2001.

**ITEM 2.**                DESCRIPTION OFPROPERTY

The Company owns its headquarters, office, plant andwarehouse located in Goleta, California. The facility, used for marketing,manufacturing and engineering, is 130,000 square feet, and includes a 30,000square foot wafer fabrication plant.

At the end of the third fiscal quarter, the Companysecured a new mortgage of $9.9 million with an annual interest rate of 5.65%associated with this property. The loan is due on July 1, 2015 and themonthly payment of $64.8 thousand includes principal amortization computedusing a 22.5 year life. Related to this transaction, the Company created RobinHill Business Park LLC (“RHBP”) as a wholly owned subsidiary. The Companytransferred the mortgaged property to RHBP and this same entity entered intothe loan agreement with the lender. The lender required this structure in orderfor the Company to secure the loan.

As of October 1, 2005, approximately 31,000square feet of this facility were under long term lease arrangements withannual rental income of approximately $0.5 million. An existing tenant using a3,000 square foot portion of the facility transitioned to a month to monthrental basis as of November 3, 2005.

The Company believes itsexisting manufacturing facilities are in good repair and adequate to supportcustomer requirements during fiscal 2006.

**ITEM 3.**                LEGALPROCEEDINGS

The Company is involved in ongoing complianceactivities with local environmental agencies. See “Item 1—Description ofBusiness—Environmental Compliance.”

Neal Feay Company (“NealFeay”), a neighbor of the Company’s former 6300 Hollister facility, filed anenvironmental related complaint against the Company and several otherneighboring properties in August 2004, in the Superior Court of the Stateof California, County of Santa Barbara, Anacapa Division, The claim stems fromenvironmental monitoring activity that the claimant was caused to perform bythe California Regional Water Quality Control Board (RWQCB). The Companybelieves that the Neal Feay complaint is an attempt to avoid or minimize itsalleged liability associated with responding to soil and 

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groundwatercontamination orders from the California Regional Water Quality Control Board.The Company, along with other defendants, has filed a cross-complaint againstNeal Feay. The Company’s cross-complaint alleges that Neal Feay’s criminaldischarge of hazardous wastes into the city sewer system led to thecontamination of the site formerly owned by the Company. The Company seeksdamages for lost property value as a result of Neal Feay’s criminal conduct.The Company has a $5.0 million environmental insurance policy coveringpotential liability relating to this property, including legal defense, and theinsurer has accepted the claim. The current status of the case is that it hasbeen stayed by the Court and the Court has found that the RWQCB has primaryjurisdiction in this matter. The Company continues to attend Case ManagementConferences, as required by the Court. The next Case Management Conference isschedule for February 2006.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

**PART II**

**ITEM 5.**                MARKETFOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUERPURCHASES OF EQUITY SECURITIES.

The Company’sCommon Stock is not traded on any exchange or quoted on NASDAQ.

As of December 16, 2005, there were approximately972 holders of record of the Company’s Common Stock.

The Company has not paiddividends at any time since its emergence from Chapter 11. Because the Companyis not yet profitable and because it intends to reinvest any earnings in theexpansion of its business, the Company does not expect to pay dividends on itsCommon Stock for the foreseeable future.

**RecentSales of Unregistered Securities**

None.

For information related to securities authorized forissuance under the Company’s equity compensation plans, refer to item 11 below.

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**ITEM 6.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

**Selected Financial Data**

Thefollowing selected financial data should be read in conjunction with theConsolidated Financial Statements provided in this report and with Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

| ** **                                                                   | ** ** | **Year Ended  October 1, 2005**                                             | ** ** | **Year Ended  October 2, 2004** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                   | ** ** | **(In thousands, except per share  and employment amounts)** | ** ** |
| **OPERATIONS**                                                               |       |                                                                                       |       |                                           |       |   |   |   |   |
| Net revenue                                                                  |       |                                                                                       | $          | 10,298                                         |       |   |   | $ | 10,114 |   |   |
| Gross Loss                                                                   |       |                                                                                       | (1,809     | )                                              |       |   | (879 | ) |   |
| Research and  development                                                    |       |                                                                                       | 217        |                                           |       |   | 530 |   |   |
| Selling, general  and administrative                                         |       |                                                                                       | 1,753      |                                           |       |   | 1,790 |   |   |
| Interest expense                                                             |       |                                                                                       | (1,005     | )                                              |       |   | (1,159 | ) |   |
| Other income, net                                                            |       |                                                                                       | 31         |                                           |       |   | 103 |   |   |
| Net loss  available to common stockholders                                   |       |                                                                                       | $          | (5,206                                         | )          |   |   | $ | (4,264 | ) |   |
| Loss per common  share—basic and diluted                                |       |                                                                                       | $          | (.48                                           | )          |   |   | $ | (.62 | ) |   |
| Weighted average  number of common shares outstanding—basic and diluted |       |                                                                                       | 10,838     |                                           |       |   | 6,888 |   |   |
| **BALANCE  SHEET**                                                           |       |                                                                                       |       |                                           |       |   |   |   |   |
| Working capital  (deficit)                                                   |       |                                                                                       | $          | 9,082                                          |       |   |   | $ | (2,746 | ) |   |
| Total assets                                                                 |       |                                                                                       | 29,337     |                                           |       |   | 19,499 |   |   |
| Long term debt,  net of current portion                                      |       |                                                                                       | 9,622      |                                           |       |   | 9,112 |   |   |
| Shareholders’  equity                                                   |       |                                                                                       | 3,017      |                                           |       |   | 5,524 |   |   |
| **OTHER  DATA**                                                              |       |                                                                                       |       |                                           |       |   |   |   |   |
| Period-end employment                                                        |       |                                                                                       | 136        |                                           |       |   | 72 |   |   |

 

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The following discussionshould be read together with the consolidated financial statements and relatednotes included elsewhere in this Annual Report on Form 10-KSB. Thisdiscussion contains forward-looking statements that involve risks anduncertainties. Actual results could differ materially from those anticipated inthese forward-looking statements as a result of various factors, includingthose described under “Risk Factors Affecting Our Business” and elsewhere inthis report.

**Overview**

The Company has incurred net losses and losses fromoperations for each quarter since 1999. The Company filed for protection underChapter 11 of the U.S. Bankruptcy Code in January 2000 and, upon emergencefrom bankruptcy, all of the previously issued and outstanding common stock wascanceled without consideration to the holders. The Company has incurredsubstantial cumulative losses since its emergence from bankruptcy, including anet loss of $4.6 million for the fiscal year ended October 1, 2005. TheCompany expects to incur increasing sales and marketing, research anddevelopment and general and administrative expenses. As a result, it will needto significantly increase its revenues to achieve and sustain profitability. Inorder to fund that growth, on January 25, 2005, the Investor Groupinvested a total of $17.0 million in the Company in a private placement ofequity securities. The net proceeds to the Company were approximately $16.0million. In exchange for the investment, the Investor Group received 1,000,000shares of Series A redeemable preferred stock (“Series A”), 1,000,000shares of Series A-1 convertible preferred stock (“Series A-1”)and a warrant for the purchase of up to 500,000 shares of common stock. TheCompany used approximately $1.6 million of the net proceeds to pay off the Notedue to L-3. The remainder of the net proceeds are being used for generalworking capital needs and other corporate purposes.

The Company has reorganized itself from a manufacturerof magnetic recording heads for the disk drive industry to a manufacturer ofmicro-electro-mechanical systems (“MEMS”) operating in a number of industrysegments. MEMS deviceswere first developed in the late 1970s and early 1980s. Generally speaking,MEMS devices are made using modern wafer-processing technology, similar to thatused in making silicon electronic devices or thin-film recording heads formagnetic storage devices. However, what distinguishes MEMS devices is that theyare designed to include moving parts, hence the “mechanical” part of the name.By using modern wafer techniques, device complexity and performance isenhanced, and cost is lowered owing to the large number of devices that can bemade on a single wafer.

Common uses for MEMS devices are automotive air-bagsensors (accelerometers), pressure and airflow sensors, and ink­jet printerheads. Future uses for MEMS devices are expected to be numerous, in that manymechanical systems currently built using conventional techniques could bereplaced and improved with MEMS. Examples of this include electromagneticrelays. In addition, many electrical systems may be replaced by MEMS. Anexample of this is optical fiber switching, used in telecommunications. In thefuture, it is possible that it can be done mechanically using MEMS. Anotherexample is components for wireless communication technology. High-Qinductors, variable capacitors and transmit/receive switches could be replacedby MEMS devices at lower cost, using less space and providing higherperformance. The Company fabricates MEMS products on a six-inch silicon wafer,which, depending upon the size of the individual part, is cut into multiplefinished parts referred to as dies.

The Company’s threeadditional lines of business are:  “SantaBarbara Tool & Die,” “IMT Analytical” and leasing of excess space inits owned facility under long-term lease contracts (see Item 1—Description ofBusiness—Other Lines of Business).

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**Annual Results ofOperations**

Thefollowing table sets forth certain consolidated financial data for the Companyfor the last two fiscal years and provides a presentation of this informationas a percentage of net revenue.

| ** **                                 | ** ** | **Year Ended:  October 1, 2005**            | ** ** | **Year Ended:  October 2, 2004** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                 | ** ** | ** **                                                 | ** ** | **% of Revenue**                      | ** ** | ** ** | ** ** | **% of Revenue** | ** ** |
| ** **                                 | ** ** | **(in thousands except % of revenue)** | ** ** |
| Net revenue                                |       |                                                       |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| MEMS and other                             |       | $                                                          | 9,745      |                                            |       | 94.6 | % |   |   | $ | 9,579 |   |   |   | 94.7 | % |   |
| Rental income                              |       | 553                                                        |       |                                            | 5.4        | % |   |   | 535 |   |   |   | 5.3 | % |   |
| Total                                      |       | 10,298                                                     |       |                                            | 100.0      | % |   |   | 10,114 |   |   |   | 100.0 | % |   |
| Cost of revenue                            |       |                                                       |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| MEMS and other                             |       | 11,967                                                     |       |                                            | 116.2      | % |   |   | 10,858 |   |   |   | 107.4 | % |   |
| Rental income                              |       | 140                                                        |       |                                            | 1.4        | % |   |   | 135 |   |   |   | 1.3 | % |   |
| Total                                      |       | 12,107                                                     |       |                                            | 117.6      | % |   |   | 10,993 |   |   |   | 108.7 | % |   |
| Gross loss                                 |       | (1,809                                                     | )          |                                            | (17.6      | )% |   |   | (879 | ) |   |   | (8.7 | )% |   |
| Research and  development                  |       | 217                                                        |       |                                            | 2.         | % |   |   | 530 |   |   |   | 5.2 | % |   |
| Selling, general  andadministrative        |       | 1,753                                                      |       |                                            | 17.0       | % |   |   | 1,790 |   |   |   | 17.7 | % |   |
| Loss from  operations                      |       | (3,779                                                     | )          |                                            | (36.7      | )% |   |   | (3,199 | ) |   |   | (31.6 | )% |   |
| Interest income                            |       | 211                                                        |       |                                            | 2.0        | % |   |   | 4 |   |   |   | 0.0 | % |   |
| Interest expense                           |       | (1,005                                                     | )          |                                            | (9.8       | )% |   |   | (1,159 | ) |   |   | (11.5 | )% |   |
| Other income, net                          |       | 31                                                         |       |                                            | 0.3        | % |   |   | 103 |   |   |   | 1.0 | % |   |
| Other expense                              |       | (763                                                       | )          |                                            | (7.5       | )% |   |   | (1,052 | ) |   |   | (10.4 | )% |   |
| Loss before  income taxes                  |       | (4,542                                                     | )          |                                            | (44.2      | )% |   |   | (4,251 | ) |   |   | (42.0 | )% |   |
| Provision for  income taxes                |       | 21                                                         |       |                                            | 0.2        | % |   |   | 13 |   |   |   | 0.2 | % |   |
| Net loss                                   |       | $                                                          | (4,563     | )                                               |       | (44.4 | % |   |   | $ | (4,264 | ) |   |   | (42.2 | )% |   |
| Preferred stock  dividends                 |       | (643                                                       | )          |                                            | (6.2       | )% |   |   | — |   |   |   | 0 | % |   |
| Net loss  available to common stockholders |       | $                                                          | (5,206     | )                                               |       | (50.6 | )% |   |   | $ | (4,264 | ) |   |   | (42.2 | )% |   |

 

**NetRevenue:****  **Netrevenue increased slightly to $10.3 million in fiscal 2005 compared to netrevenue of $10.1 million in fiscal 2004. The revenue increase was due to growthin revenue for the Santa Barbara Tool & Die, and Rental Income portions ofthe business, while the MEMS portion of the business was basically flat year toyear with revenue of $8.3 million for both fiscal 2005 and fiscal 2004. TheCompany has added new MEMS customers through its marketing efforts and believesit will see a resulting growth in future revenue. Santa Barbara Tool & Dierevenue increased to $1.3 million in fiscal 2005, compared to $1.2 million infiscal 2004. The increase in net revenue for Santa Barbara Tool & Die isdue to a combination of unit shipments increase and addition of customers. IMTAnalytical had revenue of $0.1 million for both fiscal 2005 and fiscal 2004.Rental Income generated $0.6 million of revenue in fiscal 2005 compared to $0.5million in fiscal 2004. The increase in Rental Income is from an increase inunit price for the square footage occupied by the tenants due to the cost ofliving adjustments provided for in the contracts. The Company expects itsrevenue to grow, but it is uncertain of the future growth rate.

**GrossLoss:****  **Grossloss, which is the amount by which costs of revenue exceeded revenue, was $1.8million or 17.6% of revenue for fiscal 2005 compared to $0.9 million or 8.7% ofrevenue for fiscal 2004. The Company has more than doubled its productionemployee headcount in fiscal 2005 compared to fiscal 2004 in order to preparefor volume production on one of its customer’s products, which is anticipatedto occur in fiscal 2006. As the Company migrates toward high volume productionit expects to be able to increase the absorption of its fixed costs (e.g.depreciation and utilities). The MEMS portion of the business had a gross lossof $2.7 million or a negative 32.6% in fiscal 2004 and a $1.6 million grossloss or a 

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negative 18.8% in fiscal2004. Santa Barbara Tool & Die had a $0.3 million gross profit in fiscal2005 compared to $0.2 million in fiscal 2004. IMT Analytical generated a $0.2million gross profit in fiscal 2005 and $0.1 million of gross profit in fiscal2004. Rental Income generated a gross profit of $0.4 million in both fiscal2005 and fiscal 2004. The Company had 125 production employees at the end offiscal 2005, compared to 61 at the end of fiscal 2004.

**Researchand Development:**   Research and developmentexpenses (“R&D”) were $0.2 million in fiscal 2005 compared to $0.5 millionin fiscal 2004. The R&D expenses represented 2.1% and 5.2% of net revenuein fiscal 2005 and 2004, respectively.

R&D expenditures for the Company focus on developmentof new MEMS devices and the associated production processes for thetelecommunication, inertial navigation, wireless communication, and thebiomedical product areas. The reduction in R&D expenditures in fiscal 2005compared to fiscal 2004 was due to the transfer of a portion of the group’seffort in fiscal 2005 to support customer projects. R&D expenditures areexpected to grow as the Company continues to diversify into new product areas.The Company had two employees focused on the development of new products andmanufacturing processes at the end of fiscal 2005 compared to four at the endof fiscal 2004.

**Selling,General and Administrative Expenses:****  **Selling, general and administrative (“SG&A”)expenses were $1.8 million in both fiscal 2005 and fiscal 2004. SG&Aexpenses included $0.1 million in bad debt expenses in fiscal 2005 and $0.1million in amortization of employee stock incentives in fiscal 2004. 

The total SG&A expenses decreased as a percentageof revenue from 17.7% to 17.0%, respectively, for such periods. The Companycurrently has nine employees providing the services reported as SG&Acompared to seven at the end of fiscal 2004. 

**InterestExpense:**   Interest expense was $1.0 million and$1.2 million in fiscal 2005 and 2004, respectively.  At the end of the third fiscal quarter of2005, the Company secured a new mortgage of $9.9 million with an annualinterest rate of 5.65%. The loan is due on July 1, 2015 and the monthly paymentof $64.8 thousand includes principal amortization computed using a 22.5 yearlife. The reduction in interest rate from 12% on the previous mortgage to 5.65%on the new mortgage provides the Company with an annual interest cost savingsof approximately $0.5 million.

**OtherIncome.****  **TheCompany****recognized minimal other income infiscal 2005 compared to $0.1 million in fiscal 2004, which was the result ofthe receipt of a final payment associated with the sale of a minority ownershipposition in Magnetic Data Technologies, LLC, a former subsidiary of theCompany. 

**Provisionfor Income Taxes:****  **The****fiscal 2005 and 2004 provision for income taxes includedminimum state income taxes.

Due to the change in control as a result of thebankruptcy, the Company may not be able to receive the full benefit from netoperating loss carryforwards accumulated prior to the bankruptcy. Portions ofthe Company’s pre-bankruptcy tax losses, however, may be eligible for use infuture periods. The Company is currently evaluating these amounts. Fromthe commencement of the Chapter 11 Reorganization through October 1, 2005,the Company has accumulated net operating loss carryforwards of approximately$40.9 million for federal tax purposes and $20.4 million for state taxpurposes. Once the Company has utilized these remaining net operating losscarry forwards, future U.S. earnings will be taxed at the U.S. statutory ratesless available tax credits, if any. To the extent not used, the net operatingloss carryforwards expire in varying amounts beginning in 2021 for federalpurposes and 2011 for state purposes**.** At October 1,2005, all identified deferred tax assets are offset by a valuation allowancedue to the uncertainty of future realization of those additional operating losscarryforwards; therefore, recognizing any additional operating losscarryforwards would not result in a benefit in the provision for income taxes.

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If future taxable incomeenables the Company to realize its deferred tax assets, the valuation allowancewill be reversed in whole or in part, and the Company will recognize an incometax benefit.

**Off Balance Sheet Arrangements**

None.

**Backlog and Billings**

As of October 1, 2005, the Company had $4.4million in sales order backlog and $6.3 million in billings on uncompletedcontracts. These amounts are substantially related to contracts the Company haswith Customer B and DARPA. The Company’s development project with DARPA had$2.7 million in billings and $2.4 million in capitalized costs resulting in$0.3 million in billings in excess of costs. The Company’s development projectwith Simpler Networks, had $2.6 million in billings and $2.5 million incapitalized costs resulting in $0.1 million in billings in excess of costs. TheCompany expects to complete the Customer B contract for a value of $2.8 millionin its first fiscal quarter of 2006. The Company presents the billings inexcess of costs on uncompleted contracts as a net figure in accordance withARB45.

At October 2, 2004,the Company had $2.9 million in sales order backlog and $4.1 million in billingson uncompleted contracts. These amounts were substantially related to contractsthe Company had with L-3 and DARPA. The Company’s development projectwith DARPA had $0.9 million in billings and $0.8 million in capitalized costsresulting in $0.1 million in billings in excess of costs. The Company’sdevelopment project with L-3 had $1.6 million in billings and $0.9million in capitalized costs resulting in $0.7 million in billings in excess ofcosts. The Company completed the L-3 contract for a value of $1.6 millionin its first fiscal quarter of 2005.

**Liquidity and Capital Resources**

The Company’s principal funding need is for workingcapital to fund continuing operations, research and development and expansionof the business. The Company expects to meet the needs for liquidity duringfiscal 2006 with funds from operations. The Company’s ability to generaterevenue from operations in the future will depend heavily on its ability toachieve volume production of its MEMS products on a timely basis. Although theCompany is devoting substantial engineering and manufacturing resources to itsproduction goals, there can be no assurances that the Company will achieveplanned production levels. Accordingly, in the future, the Company may need toobtain additional funds for operations by the sale of equity securities orborrowing, but it can give no assurance that debt or equity financing will beavailable on terms that are acceptable to the Company, or at all.

The Company’s cash balance was $9.3 million at October 1,2005 compared to $0.4 million at October 2, 2004. The increase in cash wasprimarily due to the private placement of equity securities by the Company withthe Investor Group for a total of $17.0 million, which was completed on January 25,2005. The net proceeds to the Company were approximately $15.7 million. Inexchange for the investment, the Investor Group received 1,000,000 shares of Series A,1,000,000 shares of Series A-1 and a warrant for the purchase of upto 500,000 shares of common stock. The Company used approximately $1.6 millionof the net proceeds to pay off the Note due to L-3. On June 30 2005,the Company secured a new mortgage of $9.9 million with an annual interest rateof 5.65% and used the net proceeds of approximately $9.7 million to pay off itsoriginal mortgage of approximately $8.8 million and delinquent property taxesof approximately $0.3 million, which provided the Company with a net increasein cash of approximately $0.6 million. Investors of the Company exercisedwarrants in the second fiscal quarter of 2005, which resulted in an increase incash for the Company of approximately $0.1 million. The investment and mortgageproceeds were offset by the use of cash by operations of $5.0 million and theuse of $0.9 million for the purchase of capital equipment.

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At the end of the third fiscal quarter, the Companysecured a new mortgage of $9.9 million with an annual interest rate of 5.65%.The loan is due on July 1, 2015 and the monthly payment of $64.8 thousandincludes principal amortization computed using a 22.5 year life. Related tothis transaction, the Company created Robin Hill Business Park LLC (“RHBP”) asa wholly owned subsidiary. The Company transferred the mortgaged property toRHBP and this same entity entered into the loan agreement with the lender. Thelender required this structure in order for the Company to secure the loan.

The MEMS industry is capital intensive and requiresexpenditures for manufacturing equipment and research and development in orderto develop and take advantage of technological improvements and newtechnologies. In fiscal 2006, the Company plans approximately $3.5 million incapital expenditures primarily to continue development and production of newMEMS technologies and products and to increase overall production capacity. TheCompany plans to pursue lease financing in fiscal 2006 to support the purchaseof its capital equipment requirements. Capital equipment purchase commitmentswere approximately $0.4 million at October 1, 2005. If the Company is unableto achieve its production goals or obtain additional financing on acceptableterms, on a timely basis, there will be a material adverse effect on theCompany’s financial condition and competitive position.

The Company has incurred net losses and losses fromoperations for each quarter since 1999. The Company filed for reorganizationunder Chapter 11 of the U.S. Bankruptcy Code in January 2000 and, uponemergence from bankruptcy, all of the previously issued and outstanding commonstock was canceled without consideration to the holders. The Company incurred anet loss of $4.6 million for the fiscal year ended October 1, 2005 and hasincurred substantial cumulative losses since its emergence from bankruptcy. TheCompany expects to incur increasing sales and marketing, research anddevelopment and general and administrative expenses. As a result, it will needto significantly increase its revenues to achieve profitability. The Companyexpects its revenue to grow, but it is uncertain of the future growth rate.

The Company’s principalremaining indebtedness is the mortgage on its headquarters and operatingfacility. The Company has not been in default under this indebtedness.

**Commitments and Contingencies**

The Company’s use of hazardous chemicals in itsmanufacturing subjects it to a variety of environmental and land useregulations related to their use, storage and disposal. The Company iscurrently engaged in efforts to remedy soil and water contamination under thesupervision of government agencies. If the Company fails to comply with presentor future regulations, liability for the cost of remediation, damages andpenalties, and production suspension or delay could result.

The Company believes itconducts its business in a manner that complies with environmental laws andregulations. While the Company’s known environmental liabilities have largelybeen resolved and are not, either individually or taken together, material toits business and financial condition, there can be no assurance that materialenvironmental claims will not arise in the future. If such claims arise, theycould be extremely expensive to contest or to resolve if the Company is foundresponsible and does not have applicable insurance coverage, which would resultin material harm to its business. See “Item 1. Business-EnvironmentalCompliance.”

Purchase commitmentsassociated with capital expenditures were approximately $0.4 million at October 1,2005

The Company has no leases under which it is thelessee.

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The Company is required to comply with therequirements of Section 404 of the Sarbanes-Oxley Act during its fiscalyear ending September 30, 2007. This process will involve the design,documentation and testing of the company’s internal financial reportingcontrols. The ultimate cost of this process cannot be determined at this time.

Thefollowing summarizes the Company’s significant contractual obligations atOctober 1, 2005 and the effects such obligations are expected to have onliquidity and cash flow in future periods.

| ** **                                        | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | **(in thousands)**                   | ** ** |
| **Significant Contractual Obligations** | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less than 1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5 Years** | ** ** |
| Property mortgage  principal                      |       | $                                         | 9,843      |   |   | $ | 221 |   |   |   | $ | 477 |   |   |   | $ | 537 |   |   |   | $ | 8,608 |   |   |
| Property mortgage  interest                       |       | $                                         | 4,897      |   |   | $ | 557 |   |   |   | $ | 1,079 |   |   |   | $ | 1,019 |   |   |   | $ | 2,242 |   |   |
| Purchase  Commitments                             |       | $                                         | 356        |   |   | $ | 356 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Total                                             |       | $                                         | 15,096     |   |   | $ | 1,134 |   |   |   | $ | 1,556 |   |   |   | $ | 1,556 |   |   |   | $ | 10,850 |   |   |
|                                                   |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Critical Accounting Policies**

Application of the Company’s accounting policiesrequires management to make judgments and estimates about the amounts reflectedin the financial statements. Management uses historical experience and allavailable information to make these estimates and judgments, although differingamounts would be reported if the assumptions and estimates changed. Estimatesare used for, but not limited to, the accounting for the allowance for doubtfulaccounts, inventory allowances, impairment costs and other special charges,depreciation and amortization, warranty costs and contingencies. Management hasidentified the following accounting policies as critical to an understanding ofits financial statements and as areas most dependent on management’s judgmentand estimates.

**RevenueRecognition and Warranty Policies:**   The Companyuses the completed contract method of accounting for its product developmentprojects due to the inability to accurately estimate percentage of completionduring performance of the contract. Costs are capitalized during the projectand recorded as cost of revenue at its completion along with the recognition ofrevenue. Losses on projects are recognized as they are determined. The Company’sMEMS development contracts include milestones that require delivery ofengineering reports, wafers and/or dies. The Company’s MEMS developmentcontracts are determined to be complete and the revenue is recognized after allcontract milestones have been completed, reviewed and accepted by the customer.Santa Barbara Tool & Die delivers a finished product to the customerand revenue is recognized after both the product is shipped and title passes.IMT Analytical has service related revenue and this revenue is recognized uponcompletion of the service for the customer. The Company’s MEMS developmentcontracts do not have any rights of return. Santa Barbara Tool & Dieand IMT Analytical did not have any sales returns in fiscal 2005 or 2004. TheCompany’s warranty policy provides for the replacement of defective parts whenthe customer’s return request is approved within 30 days of the originalshipment date. To date, warranty costs have not been significant.

**Long-lived Assets:**   TheCompany reviews long-lived assets for impairment whenever events or changes incircumstances indicate that an asset’s carrying value may exceed theundiscounted expected future cash flows to be derived from that asset. Wheneverundiscounted expected future cash flows are less than the carrying value, theasset will be reduced to an amount equal to the net present value of theexpected future cash flows and an impairment loss will be recognized.

**Recent Accounting Pronouncements**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS 123(R), “Share-Based Payment,” whichaddresses the accounting for employee stock options. SFAS 123(R) revises 

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the disclosure provisionsof SFAS 123 and supersedes APB 25. SFAS 123(R) requires that the cost ofall employee stock options, as well as other equity-based compensationarrangements, be reflected in the financial statements based on the estimatedfair value of the awards. In March 2005, the Securities &Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107, “Share-BasedPayment”, which summarizes the views of the SEC staff regarding the interactionbetween SFAS 123(R) and certain SEC rules and regulations, and isintended to assist in the initial implementation. SFAS 123(R) is effectivefor all public companies that file as of the beginning of the first annualreporting period that begins after June 15, 2005. The Company is currentlyevaluating the provisions of SFAS 123(R) and its effect on its financialstatements. The effect of adopting this statement will be to increase theCompany’s compensation expense in the future.

In December 2004, the FASB issued SFAS 153, “Exchangesof Nonmonetary Assets, an amendment of APB 29, Accounting for NonmonetaryTransactions.” This Statement’s amendments are based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofthe assets exchanged. Further, SFAS 153 eliminates the narrow exception fornonmonetary exchanges of similar productive assets and replaces it with abroader exception for exchanges of nonmonetary assets that do not havecommercial substance. Provisions of this statement are effective for fiscalperiods beginning after June 15, 2005. The adoption of this statement isnot expected to have a material impact on its financial statements.

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

In May 2005, the FASBissued SFAS 154, “Accounting Changes and Error Corrections.”   SFAS 154 replaces APB 20, “AccountingChanges” and SFAS 3, “Reporting Accounting Changes in Interim FinancialStatements” and establishes retrospective application as the required methodfor reporting a change in accounting principle. SFAS 154 provides guidance fordetermining whether retrospective application of a change in accountingprinciple is impracticable and for reporting a change when retrospectiveapplication is impracticable. The reporting of a correction of an error byrestating previously issued financial statements is also addressed. SFAS 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. The Company does not expect theadoption of this statement to have a material impact on its financialstatements.

**RiskFactors Affecting the Company’s Business**

*Inaddition to the factors discussed elsewhere in this report, the following areimportant factors that could have a material adverse effect on the Company’sfinancial condition, competitive position and earnings, and that could causeactual results or events to differ materially from those contained in anyforward-looking statements made by or on behalf of the Company.*

*The Company has incurred losses since 1999; it emergedfrom bankruptcy in 2001, and expects to incur losses for the foreseeablefuture.*

The Company has incurrednet losses and losses from operations for each quarter since 1999. The Companyfiled for reorganization under Chapter 11 of the U.S. Bankruptcy Code in January 2000and, upon emergence from bankruptcy, all of the previously issued andoutstanding common stock was canceled without consideration to the holders. TheCompany incurred a net loss of $4.6 million for the year ended 

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October 1,2005. The Company expects to incur increasing sales and marketing, research anddevelopment and general and administrative expenses. As a result, it will needto significantly increase its revenues to achieve profitability. The Company expects its revenue to grow, butit is uncertain of the future growth rate.

*The Companyoperates in the MEMS industry, which is capital intensive.*

The MEMS industry iscapital intensive and requires expenditures for facilities, equipment andresearch and development to develop and keep pace with technologicalimprovements. The Company believes that to achieve its objectives, it will needadditional resources over the next several years for capital expenditures,working capital and research and development. The Company had $0.9 million inpurchases of property, plant and equipment in fiscal 2005. During fiscal 2006,the Company plans to make approximately $3.5 million in purchases of property,plant and equipment. The Company believes that it will be able to fund futureexpenditures from a combination of new capital infusion, existing cashbalances, including the $15.7 million net proceeds of the Private EquityTransaction, and cash flow from operations. The Company may need additionalsources of capital to meet requirements in future years. There is no assurancethat additional funds will be available to the Company or, if available, thatthe terms and conditions will be acceptable to the Company. If the Companycannot obtain sufficient capital, it would need to curtail its operating andcapital expenditures, which would adversely affect the Company’s futureoperating results and could prevent the Company from competing successfully inthe MEMS industry.

*The Company hashigh fixed costs and excess capacity due to its current low production volumes.*

The fixed costs ofoperating and maintaining the Company’s 30,000 square foot wafer fabricationfacility and other elements of its production capacity are high. Most of itscurrent production consists of prototypes and new product development. Theseare low-volume projects, which leave the Company’s facilities underutilized andunable to absorb all of its fixed costs. As a result the Company experiencesoperating losses. The Company plans to shift from low-volume production anddevelopment orders to high-volume production for its customers as theirdevelopment programs mature into production contracts, which will make fulleruse of the Company’s excess capacity. However, making this shift depends on thesuccess of the Company’s engineers in developing efficient high-volumeproduction technology, the success of its customers in developing marketableuses for MEMS technology, and the general growth and acceptance of MEMStechnology. If the Company cannot successfully make the transition tohigh-volume production, it will continue to experience losses and suffermaterial harm to its operating results and liquidity.

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

The MEMS business has beencharacterized by rapidly changing technology. The demand for greater capabilitywill cause competitors to continue to build greater performance into theirrespective products. There can be no assurance that the Company’s products willachieve such performance. There can be no assurance that the Company will notexperience manufacturing and product quality problems in the future. TheCompany’s future success depends in large part on its ability to develop andqualify new products on a timely basis and to manufacture them in sufficientquantities to compete effectively on the basis of price and performance.

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

The Company competes withother independent MEMS manufacturers, with large integrated circuitmanufacturers, and with captive wafer fabs owned by vertically integrated MEMSusers. Many of these 

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competitorsare larger than the Company and have greater financial resources. If theCompany is unable to equal or surpass its competitors in the area of price,performance, quality or customer responsiveness, then the business will beunsuccessful.

*The Company’ssuccess depends in part upon the ability to protect its intellectual property.*

The Company’s success depends in large part upon itsproprietary technology. The Company relies on a combination of patents, tradesecret protection, confidentiality and nondisclosure agreements and licensingarrangements to establish and protect its intellectual property rights. TheCompany’s patents may be successfully challenged or may not provide it with theintended competitive advantages. Important technology developed by the Companymay not be patentable. Despite the Company’s efforts to protect its proprietaryrights, unauthorized parties may attempt to copy aspects of its products or toobtain and use information that is regarded as proprietary. Policing unauthorizeduse of the Company’s proprietary technology is difficult and costly. Inaddition, the laws of some foreign countries do not protect these proprietaryrights to as great an extent as do the laws of the United States. The Company’smeans of protecting its proprietary rights may not be adequate and itscompetitors may independently develop similar technology, duplicate itsproducts, or design around its proprietary intellectual property.

The Company may face costly damages or litigationcosts if a third party claims that the Company infringed on its intellectualproperty. Advanced technology products such as the Company’s are increasinglysubject to third-party infringement claims. In addition, former employers ofthe Company’s current and future employees may assert that its employees havedisclosed confidential or proprietary information to the Company. Any of theseclaims even if they are without merit, could be expensive and time consuming todefend.

In addition, intellectualproperty claims against the Company, with or without merit, could require it toenter into royalty or licensing agreements. These royalty or licensingagreements, if required, may not be available on terms acceptable to theCompany or at all, which could seriously harm its business. A successful claimof infringement against the Company or its failure or inability to license theinfringed or similar technology could adversely affect its business because theCompany would not be able to sell the affected product without redeveloping theproduct or its manufacturing process, incurring significant additionalexpenses.

*Fluctuations inquarterly and annual operating results may adversely affect the Company’sbusiness.*

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

20

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

There has not been apublic market for the Company’s common stock since January, 2000. The Company’soutstanding common stock, which was issued after the emergence of the Companyfrom bankruptcy, is not listed for trading on any stock market or quotation onthe Nasdaq. The Company believes that an effort to list it’s stock would beunsuccessful until the Company’s financial performance improves. Even ifeventually listed, it is likely that the stock would initially be thinlytraded. The Company cannot predict when or if investor interest in the Companywill lead to the development of an active, liquid trading market. Activetrading markets generally result in lower price volatility and more efficientexecution of buy and sell orders for investors. A thin trading market in theCompany’s stock will likely depress the trading price, make it more difficultfor investors to buy or sell its common stock, and result in price volatility.

*International sales expose the Company to risk.*

The Company sellsits products to foreign customers and expects this to be an important part ofits ongoing business. Accordingly, the Company faces risks inherent inconducting business internationally, such as:

·       difficultiesin collecting accounts receivable and longer collection periods;

·       seasonalbusiness activity in certain parts of the world;

·       potentiallyadverse tax consequences;

·       fluctuationsin revenue expressed in dollars due to changes in currency exchange rates;

·       politicaland economic instability; and

·       tradebarriers.

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

*The Company is subject to certain environmental lawsand regulations and if it fails to comply, its future operating results may beadversely affected.*

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

*Interruptions inthe Company’s supply of raw materials could adversely affect its business.*

The Company’s operationsrequire raw materials that meet exacting standards. The Company generally hasmultiple sources of supply for its raw materials; however, only a limitednumber of suppliers are capable of delivering certain raw materials that meetits standards. Various factors could reduce the availability of raw materialssuch as silicon wafers, photomasks, chemicals, and gases. In addition, anytransportation problems could delay the Company’s receipt of raw materials.Although raw materials shortages or transportation problems have notinterrupted its operations in the past, shortages may occur from time to timein the future. Also, lead times for the supply of raw materials have beenextended in the past. If the Company’s supply of raw materials is interruptedor its lead times extended, then its cash flow 

21

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would bereduced, orders may be cancelled or diverted to competitors, and its businesswould suffer significant harm.

*A small group ofstockholders can exercise control over the Company.*

A small group ofstockholders holds most of the Company’s voting power. Several of these holdersare parties to a voting agreement giving them, as of January 25, 2005,control over approximately 60% of the Company’s voting stock. The Company’soutstanding voting stock consists of 6,453,880 shares of common stock and1,000,000 shares of Series A-1. The three beneficial holders of the Series A-1shares are entitled to an aggregate of 5,666,700 votes on all matters presentedto the stockholders other than the election of directors, and are entitled,voting as a separate class, to elect three of the Company’s eight directors. Accordingly,in matters other than the election of directors, the holders of Series A-1shares hold approximately 46.8% of the outstanding voting power. L-3holds common stock representing 13.0% of the Company’s outstanding voting power.Under a Voting Agreement dated January 25, 2005, L-3 and certainmembers of management agreed to vote their shares with the Series A-1shares on certain matters. Because this group currently holds approximately 60%of the Company’s voting power it could determine the outcome in any matterpresented to the stockholders.

*The Company’s Certificate of Incorporation and Bylawscould delay or prevent an acquisition or sale of the Company.*

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

*Anti-takeover provisions of Delaware law could delayor prevent an acquisition of the Company.*

The Company is subject tothe anti-takeover provisions of Section 203 of the Delaware GeneralCorporation Law, which regulates corporate acquisitions. These provisions coulddiscourage potential acquisition proposals and could delay or prevent a changein control transaction. They could also have the effect of discouraging othersfrom making tender offers for the Company’s common stock or preventing changesin its management.

*Current economicand political uncertainties may harm the Company’s business.*

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

22

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

Rules adopted by theSecurities and Exchange Commission pursuant to Section 404 of theSarbanes-Oxley Act of 2002 require annual assessment of the Company’s internalcontrol over financial reporting, and attestation of the assessment by ourindependent registered public accountants. This requirement will first apply tothe Company’s annual report for the period ending September 30, 2007. Thestandards that must be met for management to assess the internal control overfinancial reporting as effective are new and complex, and require significantdocumentation, testing, and possible remediation to meet the detailedstandards. The Company may encounter problems or delays in completingactivities necessary to make an assessment of its internal control overfinancial reporting. In addition, the attestation process by the Company’s independentregistered public accountants is new and the Company may encounter problems ordelays in completing the implementation and requested improvements andreceiving an attestation of the assessment by its independent registered publicaccountants. If the Company cannot assess its internal control over financialreporting as effective, or the Company’s independent registered publicaccountants are unable to provide an unqualified attestation report on suchassessment, investor confidence may be negatively impacted.

**ITEM 7.**                CONSOLIDATEDFINANCIAL STATEMENTS.

Refer to consolidatedfinancial statements found at pages F-1 through F-26.

**ITEM 8.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

**ITEM 8A.**        CONTROLSAND PROCEDURES

**Evaluationof the disclosure controls and procedures.**   Underthe supervision and with the participation of the Company’s management, theChief Executive Officer and the Chief Financial Officer of the Company, havecarried out an evaluation of the effectiveness of the Company’s disclosurecontrols and procedures, as such term is defined under Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended. Based upon thatevaluation, the Chief Executive Officer and the Chief Financial Officerconcluded that the Company’s disclosure controls and procedures were effectiveas of the end of the period covered by this report.

**Limitationson the effectiveness of disclosure controls and procedures.**   Disclosurecontrols and procedures, no matter how well designed and implemented, canprovide only reasonable assurance of achieving an entity’s disclosureobjectives. The likelihood of achieving such objectives is affected bylimitations inherent in disclosure controls and procedures. These include thefact that human judgment in decision-making can be faulty and that breakdownsin internal control can occur because of human failures such as simple errorsor mistakes or intentional circumvention of the established process.Notwithstanding these limitations, the Company’s disclosure controls andprocedures are designed to provide reasonable assurance of achieving theirobjectives. The Company’s Chief Executive Officer and Chief Financial Officerhave concluded that the Company’s disclosure controls and procedures are, infact, effective at the “reasonable assurance” level.

**Changes in internalcontrols over financial reporting.**   The ChiefExecutive Officer and Chief Financial Officer, with the participation of theCompany’s management, also conducted an evaluation of the Company’s internalcontrols over financial reporting to determine whether any changes occurredduring the fourth quarter of fiscal 2005 that have materially affected, or arereasonably likely to materially 

23

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affect, the Company’sinternal control over financial reporting. Based on that evaluation, there hasbeen no such change during the period covered by this report.

**ITEM 8B.**       OTHERINFORMATION

None.

**PART III**

**ITEM 9.**                DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITHSECTION 16(a) OF THE EXCHANGE ACT

The information requiredin this item is incorporated herein by reference to portions of the ProxyStatement for Annual Meeting of Stockholders to be filed with the Securitiesand Exchange Commission within 120 days of the close of the fiscal year ended October 1,2005.

**ITEM 10.**         EXECUTIVECOMPENSATION

The information requiredin this item is incorporated herein by reference to portions of the ProxyStatement for Annual Meeting of Stockholders to be filed with the Securitiesand Exchange Commission within 120 days of the close of the fiscal year ended October 1,2005.

**ITEM 11.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.

The information requiredin this item is incorporated herein by reference to portions of the ProxyStatement for Annual Meeting of Stockholders to be filed with the Securitiesand Exchange Commission within 120 days of the close of the fiscal year ended October 1,2005.

**ITEM 12.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The information requiredin this item is incorporated herein by reference to portions of the ProxyStatement for Annual Meeting of Stockholders to be filed with the Securitiesand Exchange Commission within 120 days of the close of the fiscal year ended October 1,2005.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

The information required in this item is incorporatedherein by reference to portions of the Proxy Statement for Annual Meeting ofStockholders to be filed with the Securities and Exchange Commission within 120days of the close of the fiscal year ended October 1, 2005.

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**ITEM13. EXHIBITS AND REPORTS ON FORM 8-K**

| Exhibit   Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                 |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              |       | Debtor’s Third  Amended Plan of Reorganization Under Chapter 11 of the Bankruptcy Code Dated  as of September 24, 2001 (incorporated by reference to Exhibit 2.1  to the Company’s Current Report on Form 8-K filed  November 20, 2001).                                          |
| 3.1              |       | Amended and  Restated Certificate of Incorporation, as amended to date (incorporated by  reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-KSB  for the fiscal year ended September 29, 2001).                                                                             |
| 3.2              |       | Amended and  Restated Bylaws of Innovative Micro Technology, Inc. (incorporated by  reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-KSB  for the fiscal year ended September 29, 2001).                                                                             |
| 3.3              |       | Amended and Restated  Bylaws of Innovative Micro Technology, Inc., as amended on  January 25, 2005 (incorporated by reference to Exhibit 3.3 to the  Company’s Current Report on Form 8-K filed on January 31,  2005).                                                            |
| 4.1              |       | Form of  Warrant Agreement between the Company and Certain Claimants Under the Plan of  Reorganization (incorporated by reference to Exhibit 4.1 to the  Company’s Annual Report on Form 10-KSB for the fiscal year ended  September 29, 2001).                                        |
| 4.2              |       | Warrant Agreement  between the Company and L-3 Communications Corporation, dated  August 1, 2003 (incorporated by reference to Exhibit 4.2 to the  Company’s Current Report on Form 8-K filed August 13, 2003).                                                                        |
| 4.3              |       | Warrant Agreement  between the Company and L-3 Communications Corporation, dated  September 3, 2003 (incorporated by reference to Exhibit 4.3 to the  Company’s Quarterly Report on Form 10-Q for the period ended  June 26, 2004).                                                    |
| 4.4              |       | Warrant Agreement  between the Company and Stutman Treister & Glatt, Professional  Corporation, dated September 30, 2003 (incorporated by reference to  Exhibit 4.4 to the Company’s Quarterly Report on Form 10-Q  for the period ended June 26, 2004).                      |
| 4.5              |       | Certificate of  Designation of Series A Redeemable Preferred Stock and Series A-1  Convertible Preferred Stock, dated January 24, 2005 (incorporated by  reference to Exhibit 4.5 to the Company’s Current Report on Form 8  K filed on January 31, 2005).                   |
| 4.6              |       | Warrants issued  by the Company to the Investors listed on Schedule I to the Preferred Stock  Purchase Agreement of the Company, dated as of January 25, 2005  (incorporated by reference to Exhibit 4.6 to the Company’s Current  Report on Form 8 K filed on January 31, 2005). |
| 4.7              |       | Warrant Agreement  between the Company and W.R. Hambrecht + Co., LLC, dated as of  January 25, 2005 (incorporated by reference to Exhibit 4.6 to the  Company’s Current Report on Form 8 K filed on January 31, 2005).                                                                 |
| 10.1             |       | Change in Control  Agreement between the Company and John Foster, dated April 15, 2003  (incorporated by reference to Exhibit 10.1 to the Company’s Annual  Report on Form 10-KSB for the fiscal year ended September 29,  2001).                                                      |
| 10.2             |       | Change in Control  Agreement between the Company and Peter T. Altavilla, dated April 15,  2003 (incorporated by reference to Exhibit 10.2 to the Company’s Annual  Report on Form 10-KSB for the fiscal year ended September 29,  2001).                                               |

25

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| 10.3  |   | Form of  Indemnification Agreement for directors and officers (incorporated by  reference to Exhibit 10.3 to the Company’s Annual Report on Form 10-KSB  for the fiscal year ended September 29, 2001).                                                                                                                          |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.4  |   | Stock Purchase  Agreement between the Company and L-3 Communications Corporation, dated  August 1, 2003 (incorporated by reference to Exhibit 10.4 to the  Company’s Current Report on Form 8-K filed August 13, 2003).                                                                                                          |
| 10.5  |   | 2001 Stock  Incentive Plan, as amended (incorporated by reference to Appendix B to the  Company’s Proxy Statement on Schedule 14A filed on January 28, 2004).                                                                                                                                                                                   |
| 10.6  |   | Form of  Stock Option Agreement under 2001 Stock Incentive Plan (incorporated by  reference to Exhibit 10.6 to the Company’s Annual Report on Form 10-KSB  for the fiscal year ended September 29, 2001).                                                                                                                        |
| 10.7  |   | Form of  Restricted Stock Agreement under 2001 Stock Incentive Plan (incorporated by  reference to Exhibit 10.7 to the Company’s Annual Report on Form 10-KSB  for the fiscal year ended September 29, 2001).                                                                                                                    |
| 10.8  |   | Fixed Rate Note  of the Company, payable to Owens Financial Group, Inc., dated  December 20, 2001 (incorporated by reference to Exhibit 10.8 to the  Company’s Annual Report on Form 10-KSB for the fiscal year ended  September 29, 2001).                                                                                 |
| 10.9  |   | Deed of Trust,  Security Agreement and Assignment of Leases and Rents, between the Company,  Owens Financial Group, Inc. and Investors Yield, Inc., dated  December 20, 2001 (incorporated by reference to Exhibit 10.9 to the  Company’s Annual Report on Form 10-KSB for the fiscal year ended  September 29, 2001). |
| 10.10 |   | Worldwide Cash  Profit Sharing Plan (incorporated by reference to Exhibit 10 to  Amendment No. 1 to the Company’s Report on Form 10-Q filed  March 4, 1996).                                                                                                                                                                     |
| 10.11 |   | Stock Purchase  Agreement between the Company and L-3 Communications Corporation, dated  September 3, 2003 (incorporated by reference to Exhibit 10.12 to the  Company’s Annual Report on Form 10-KSB for the fiscal year ended October 2,  2004).                                                                                    |
| 10.12 |   | Letter Agreement  between Stutman Treister & Glatt, Professional Corporation, Houlihan  Lokey Howard & Zukin, O’Melveny & Myers LLP, Sheppard  Mullin Richter & Hampton LLP and the Company for the settlement of  the Professional Persons Notes, dated as of September 22, 2003.                          |
| 10.13 |   | Promissory Note  dated March 15, 2004 by Innovative Micro Technology in favor of L-3  Communications Corporation (incorporated by reference to Exhibit 10.14  to the Company’s Current Report on Form 8-K filed on  March 30, 2004).                                                                                             |
| 10.14 |   | Security  Agreement dated March 15, 2004 by and between the Company and L-3  Communications Corporation (incorporated by reference to Exhibit 10.15  to the Company’s Current Report on Form 8-K filed on  March 30, 2004).                                                                                                      |
| 10.15 |   | Supplemental  Agreement dated March 15, 2004 by and between the Company and L-3  Communications Corporation (incorporated by reference to Exhibit 10.16  to the Company’s Current Report on Form 8-K filed on  March 30, 2004).                                                                                                  |

26

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| 10.16 |   | Deed of Trust and  Security Agreement between Robin Hill Business Park, LLC, a subsidiary of the  Company, and Morgan Stanley Mortgage Capital, Inc., dated as of  June 30, 2005 (incorporated by reference to Exhibit 10.2 to the  Company’s Report on Form 10-QSB filed on August 16, 2005). |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.17 |   | Promissory Note  between Robin Hill Business Park, LLC, a subsidiary of the Company, and  Morgan Stanley Mortgage Capital, Inc., dated as of June 30, 2005  (incorporated by reference to Exhibit 10.1 to the Company’s Report on  Form 10-QSB filed on August 16, 2005).                      |
| 31.1  |   | Certification  Pursuant to Rule 13a-14(a) of the Securities Exchange Act of  1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003.                                                                                                                                                         |
| 31.2  |   | Certification  Pursuant to Rule 13a-14(a) of the Securities Exchange Act of  1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003.                                                                                                                                                         |
| 32    |   | Certification Pursuant  to 18 U.S.C. Section 1350, Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2003.                                                                                                                                                                                             |

 

 

27

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**SIGNATURES**

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

|            | **INNOVATIVE MICRO TECHNOLOGY, INC.** |
|------------|---------------------------------------|
| ** ** | **By:**                               | **/s/ JOHN S. FOSTER** |
| ** ** | ** **                            | **Dr. John S. Foster** |
| ** ** | ** **                            | ***Chairman and Chief Executive  Officer, Principal Executive Officer*** |
| ** ** | ** **                            | **Date: December 23, 2005** |

 

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

| By:    | /s/ JOHN  S. FOSTER                                                |   | By:    | /s/ PETER  T. ALTAVILLA                                                                   |
|--------|--------------------------------------------------------------------|--------|--------|-------------------------------------------------------------------------------------------|
|   | Dr. John S. Foster                                            |   |   | Peter T. Altavilla                                                                        |
|   | Chairman and  Chief Executive Officer, Principal Executive Officer |   |   | Chief Financial  Officer, Corporate Controller and Secretary, Principal Financial Officer |
|   | Date: December 23,  2005                                      |   |   | Date: December 23,  2005                                                             |
| By:    | /s/ SCOTT  AVILA                                              |   | By:    | /s/ JOSE  SUAREZ                                                                     |
|   | Scott Avila                                                        |   |   | Jose F. Suarez                                                                            |
|   | Director                                                           |   |   | Director                                                                                  |
|   | Date: December 23,  2005                                      |   |   | Date: December 23,  2005                                                             |
| By:    | /s/ MALCOLM  CURRIE                                           |   | By:    | /s/ BARRY  WAITE                                                                     |
|   | Dr. Malcolm Currie                                            |   |   | Barry Waite                                                                               |
|   | Director                                                           |   |   | Director                                                                                  |
|   | Date: December 23,  2005                                      |   |   | Date: December 23,  2005                                                             |
| By:    | /s/ CALVIN  QUATE                                             |   | By:    | /s/ JILL  WITTELS                                                                    |
|   | Dr. Calvin Quate                                              |   |   | Dr. Jill Wittels                                                                     |
|   | Director                                                           |   |   | Director                                                                                  |
|   | Date: December 23,  2005                                      |   |   | Date: December 23,  2005                                                             |
| By:    | /s/ ERIC M. SIGLER                                                 |   |   |                                                                                      |
|   | Eric M. Sigler                                                     |   |   |                                                                                      |
|   | Director                                                           |   |   |                                                                                      |
|   | Date: December 23,  2005                                      |   |   |                                                                                      |

 

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**Innovative Micro Technology, Inc.**

**ITEM 7.**                CONSOLIDATEDFINANCIAL STATEMENTS

**Indexto Consolidated Financial Statements and Related Information**
| **Consolidated Financial Statements:**                                                                                  |   |   |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Report of Independent Registered Public Accounting  Firm                                                                |   | F-2    |   |
| Consolidated  Balance Sheet as of October 1, 2005                                                                  |   | F-3    |   |
| Consolidated Statements of Operations for the years  ended October 1, 2005 and October 2, 2004                |   | F-4    |   |
| Consolidated Statements of Shareholders’ Equity for  the years ended October 1, 2005 and October 2, 2004 |   | F-5    |   |
| Consolidated Statements of Cash Flows for the years  ended October 1, 2005 and October 2, 2004                |   | F-6    |   |
| Notes to Consolidated Financial Statements                                                                              |   | F-7    |   |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

**To the Board of Directors andStockholders ofInnovative Micro Technology, Inc.**

We have audited the accompanying consolidated balancesheet of Innovative Micro Technology, Inc. as of October 1, 2005, andthe related consolidated statements of operations, consolidated shareholders’equity, and consolidated cash flows for the years ended October 1, 2005and October 2, 2004. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditingstandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. The Company is not required to have, nor were we engagedto perform, an audit of its internal control over financial reporting. Ouraudits included consideration of internal controls over financial reporting asa basis for designing audit procedures that are appropriate in thecircumstances, but not for expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Innovative MicroTechnology, Inc. as of October 1, 2005, and the results of itsconsolidated operations and its consolidated cash flows for the years ended October 1,2005 and October 2, 2004 in conformity with accounting principlesgenerally accepted in the United States of America.

/s/BDO Seidman, LLP

LosAngeles, California

November 23, 2005

F-2

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**Innovative Micro Technology, Inc.CONSOLIDATED BALANCE SHEET(In thousands, except share and par value data)**

| ** **                                                                                                                                                                                                                                    | ** ** | **As of**                | ** **   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|--------------|
| ** **                                                                                                                                                                                                                                    | ** ** | **October 1, 2005** | ** **   |
| ASSETS                                                                                                                                                                                                                                        |       |                          |         |   |   |
| Current assets:                                                                                                                                                                                                                               |       |                          |         |   |   |
| Cash                                                                                                                                                                                                                                          |       |                          | $            | 9,321 |   |   |
| Accounts receivable, net of allowance for doubtful  accounts of $34                                                                                                                                                                           |       |                          | 2,106        |   |   |
| Costs in excess of billings on development projects                                                                                                                                                                                           |       |                          | 45           |   |   |
| Costs in excess of billings on development projects-  related party                                                                                                                                                                           |       |                          | 24           |   |   |
| Prepaid expenses and other                                                                                                                                                                                                                    |       |                          | 525          |   |   |
| Total current  assets                                                                                                                                                                                                                         |       |                          | 12,021       |   |   |
| Property, plant  and equipment, at cost:                                                                                                                                                                                                      |       |                          |         |   |   |
| Land                                                                                                                                                                                                                                          |       |                          | 8,750        |   |   |
| Buildings                                                                                                                                                                                                                                     |       |                          | 9,451        |   |   |
| Manufacturing equipment                                                                                                                                                                                                                       |       |                          | 3,080        |   |   |
| Total property,  plant and equipment, at cost                                                                                                                                                                                                 |       |                          | 21,281       |   |   |
| Less-accumulated depreciation and amortization                                                                                                                                                                                                |       |                          | (4,376       | ) |   |
| Total property,  plant and equipment                                                                                                                                                                                                          |       |                          | 16,905       |   |   |
| Other assets                                                                                                                                                                                                                                  |       |                          | 411          |   |   |
| Total assets                                                                                                                                                                                                                                  |       |                          | $            | 29,337 |   |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                                                                                                    |       |                          |         |   |   |
| Current liabilities:                                                                                                                                                                                                                          |       |                          |         |   |   |
| Current portion of long-term debt                                                                                                                                                                                                             |       |                          | $            | 221 |   |   |
| Accounts payable                                                                                                                                                                                                                              |       |                          | 627          |   |   |
| Accrued payroll and benefits                                                                                                                                                                                                                  |       |                          | 1,004        |   |   |
| Accrued audit and legal                                                                                                                                                                                                                       |       |                          | 87           |   |   |
| Billings in excess of costs for development projects                                                                                                                                                                                          |       |                          | 852          |   |   |
| Other current liabilities                                                                                                                                                                                                                     |       |                          | 148          |   |   |
| Total current  liabilities                                                                                                                                                                                                                    |       |                          | 2,939        |   |   |
| Long-term debt                                                                                                                                                                                                                                |       |                          | 9,622        |   |   |
| Other long-term  liabilities                                                                                                                                                                                                                  |       |                          | 48           |   |   |
| Preferred stock,  $.0001 par value, authorized 2,500,000 shares, Series A redeemable  preferred stock, 1,000,000 shares issued and outstanding (aggregate  liquidation value of $14,621, including accrued and unpaid dividends of $454) |       |                          | 13,711  |   |   |
| Shareholders’ equity:                                                                                                                                                                                                                    |       |                          |         |   |   |
| Preferred stock, $.0001 par value, authorized  2,500,000 shares, Series A-1 convertible preferred stock,  1,000,000 shares issued and outstanding (aggregate liquidation value of  $2,833)                                               |       |                          | 2,614        |   |   |
| Common stock, $.0001 par value, 25,000,000 shares  authorized, 6,953,880 shares issued and outstanding at October 1, 2005                                                                                                                |       |                          | 1            |   |   |
| Paid-in capital                                                                                                                                                                                                                               |       |                          | 23,141       |   |   |
| Accumulated deficit                                                                                                                                                                                                                           |       |                          | (22,739      | ) |   |
| Total  shareholders’ equity                                                                                                                                                                                                              |       |                          | 3,017        |   |   |
| Total liabilities and  shareholders’ equity                                                                                                                                                                                              |       |                          | $            | 29,337 |   |   |

** **

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

F-3

----

**Innovative Micro Technology, Inc.CONSOLIDATED STATEMENTSOF OPERATIONS(In thousands, except per share data)**

| ** **                                                                                                                         | ** ** | **Year Ended** | ** ** | **Year Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                                                                                         | ** ** | **October 1,** | ** ** | **October 2,** | ** ** |
| ** **                                                                                                                         | ** ** | **2005**            | ** ** | **2004**            | ** ** |
| Net revenue                                                                                                                        |       |                |       |                |       |   |   |   |   |
| MEMS and Other                                                                                                                     |       |                | $          | 9,745               |       |   |   | $ | 9,579 |   |   |
| Rental income                                                                                                                      |       |                | 553        |                |       |   | 535 |   |   |
| Total                                                                                                                              |       |                | 10,298     |                |       |   | 10,114 |   |   |
| Cost of revenues                                                                                                                   |       |                |       |                |       |   |   |   |   |
| Cost of MEMS and Other revenue (including  stock-based compensation of  $47 for the year ended October 2, 2004)               |       |                | 11,967     |                |       |   | 10,858 |   |   |
| Expenses applicable to rental income                                                                                               |       |                | 140        |                |       |   | 135 |   |   |
| Total                                                                                                                              |       |                | 12,107     |                |       |   | 10,993 |   |   |
| Gross loss                                                                                                                         |       |                | (1,809     | )                   |       |   | (879 | ) |   |
| Research and  development expenses (including stock-based compensation of  $40 for the year ended October 2, 2004)            |       |                | 217        |                |       |   | 530 |   |   |
| Selling, general  and administrative expenses (including stock-based  compensation of $70 for the year ended October 2, 2004) |       |                | 1,753      |                |       |   | 1,790 |   |   |
| Loss from operations                                                                                                               |       |                | (3,779     | )                   |       |   | (3,199 | ) |   |
| Interest income                                                                                                                    |       |                | 211        |                |       |   | 4 |   |   |
| Interest expense                                                                                                                   |       |                | (1,005     | )                   |       |   | (1,159 | ) |   |
| Other income, net                                                                                                                  |       |                | 31         |                |       |   | 103 |   |   |
| Other expense                                                                                                                      |       |                | (763       | )                   |       |   | (1,052 | ) |   |
| Loss before provision for income taxes                                                                                             |       |                | (4,542     | )                   |       |   | (4,251 | ) |   |
| Provision for  income taxes                                                                                                        |       |                | 21         |                |       |   | 13 |   |   |
| Net loss                                                                                                                           |       |                | (4,563     | )                   |       |   | (4,264 | ) |   |
| Preferred stock  dividends                                                                                                         |       |                | (643       | )                   |       |   | — |   |   |
| Net loss  available to common stockholders                                                                                         |       |                | $          | (5,206              | )          |   |   | $ | (4,264 | ) |   |
| Net loss per  share:                                                                                                               |       |                |       |                |       |   |   |   |   |
| Loss per common share—basic and diluted                                                                                       |       |                | $          | (0.48               | )          |   |   | $ | (0.62 | ) |   |
| Weighted average  number of common shares outstanding:                                                                             |       |                |       |                |       |   |   |   |   |
| Common shares—basic  and diluted                                                                                              |       |                | 10,838     |                |       |   | 6,888 |   |   |

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

F-4

----

**Innovative Micro Technology, Inc.CONSOLIDATED STATEMENTSOF SHAREHOLDERS’ EQUITY (In thousands, except share amounts)**

| ** **                                                | ** ** | **Common Stock**           | ** ** | **Preferred Stock** | ** ** | ** **                 | ** ** | ** ** | ** ** | ** **           | ** ** | ** **               | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|---------------------|------------|----------------------------|------------|------------|------------|----------------------|------------|--------------------------|------------|
| ** **                                                | ** ** | **Number of  Shares** | ** ** | **Amount**          | ** ** | **Number of  Shares** | ** ** | **Amount** | ** ** | **Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Restricted  Stock** | ** ** | **Shareholders’  Equity** | ** ** |
| Balance, September 27, 2003                     |       |                       | 6,152,498  |                |       |                       | $          | 1          |       |                 |       |                     |       |   |   | $ | — |   |   | $ | 19,202 |   |   | $ | (13,269 | ) |   |   | $ | (157 | ) |   |   | $ | 5,777 |   |   |
| Private equity sale                                       |       |                       | 167,000    |                |       |                       |       |       |       |                 |       |                     |       |   |   |   |   | 894 |   |   |   |   |   |   |   |   |   |   | 894 |   |   |
| Cancellation of shares                                    |       |                       | (168       | )                   |       |                       |       |       |       |                 |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | — |   |   |
| Conversion of professional notes payable to common  stock |       |                       | 368,113    |                |       |                       |       |       |       |                 |       |                     |       |   |   |   |   | 2,960 |   |   |   |   |   |   |   |   |   |   | 2,960 |   |   |
| Amortization and deemed issuance of restricted stock      |       |                       | 250,000    |                |       |                       |       |       |       |                 |       |                     |       |   |   |   |   |   |   |   |   |   |   |   | 157 |   |   |   | 157 |   |   |
| Net loss                                                  |       |                       |       |                |       |                       |       |       |       |                 |       |                     |       |   |   |   |   |   |   |   | (4,264 | ) |   |   |   |   |   |   | (4,264 | ) |   |
| Balance, October 2, 2004                             |       |                       | 6,937,443  |                |       |                       | 1          |       |       |                 |       |                     |       |   | — |   |   | 23,056 |   |   | (17,533 | ) |   |   | — |   |   |   | 5,524 |   |   |
| Exercise of warrants to purchase common stock             |       |                       | 16,437     |                |       |                       |       |       |       |                 |       |                     |       |   |   |   |   | 85 |   |   |   |   |   |   |   |   |   |   | 85 |   |   |
| Sale of convertible preferred stock                       |       |                       |       |                |       |                       |       |       |       |                 | 1,000,000  |                     |       |   | 2,614 |   |   |   |   |   |   |   |   |   |   |   |   |   | 2,614 |   |   |
| Preferred stock dividends                                 |       |                       |       |                |       |                       |       |       |       |                 |       |                     |       |   |   |   |   |   |   |   | (643 | ) |   |   |   |   |   |   | (643 | ) |   |
| Net loss                                                  |       |                       |       |                |       |                       |       |       |       |                 |       |                     |       |   |   |   |   |   |   |   | (4,563 | ) |   |   |   |   |   |   | (4,563 | ) |   |
| Balance,  October 1, 2005                            |       |                       | 6,953,880  |                |       |                       | $          | 1          |       |                 |       | 1,000,000                |       |   |   | $ | 2,614 |   |   | $ | 23,141 |   |   | $ | (22,739 | ) |   |   | $ | — |   |   |   | $ | 3,017 |   |   |

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

F-5

----

**Innovative Micro Technology, Inc.CONSOLIDATED STATEMENTSOF CASH FLOWS(In thousands)**

| ** **                                                                   | ** ** | **Twelve Months  Ended** | ** ** | **Twelve Months  Ended** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                                   | ** ** | **October 1, 2005** | ** ** | **October 2, 2004** | ** ** |
| Cash Flows from Operating  Activities:                                       |       |                          |       |                          |       |   |   |   |   |
| Net loss                                                                     |       |                          | $          | (4,563                        | )          |   |   | $ | (4,264 | ) |   |
| Adjustments to reconcile  net loss to net cash used in operating activities: |       |                          |       |                          |       |   |   |   |   |
| Depreciation and amortization                                                |       |                          | 1,213      |                          |       |   | 1,155 |   |   |
| Loss on disposal of property, plant and equipment                            |       |                          | 4          |                          |       |   | — |   |   |
| Employee restricted stock amortization                                       |       |                          | —     |                          |       |   | 157 |   |   |
| Induced conversion of professional notes                                     |       |                          | —     |                          |       |   | 203 |   |   |
| Non-cash interest                                                            |       |                          | —     |                          |       |   | 574 |   |   |
| Changes in assets  and liabilities:                                          |       |                          |       |                          |       |   |   |   |   |
| Accounts receivable                                                          |       |                          | (947       | )                             |       |   | (525 | ) |   |
| Accounts receivable—related party                                       |       |                          | 128        |                          |       |   | 308 |   |   |
| Costs in excess of billings on development projects                          |       |                          | (12        | )                             |       |   | (33 | ) |   |
| Costs in excess of billings on development projects—related  party      |       |                          | (24        | )                             |       |   | — |   |   |
| Prepaid expenses and other                                                   |       |                          | (247       | )                             |       |   | (6 | ) |   |
| Other assets                                                                 |       |                          | (118       | )                             |       |   | 155 |   |   |
| Accounts payable                                                             |       |                          | (156       | )                             |       |   | 156 |   |   |
| Accrued payroll and benefits                                                 |       |                          | 428        |                          |       |   | 190 |   |   |
| Accrued property taxes                                                       |       |                          | (34        | )                             |       |   | 1 |   |   |
| Accrued audit and legal                                                      |       |                          | (46        | )                             |       |   | 79 |   |   |
| Billings in excess of costs for development projects                         |       |                          | 257        |                          |       |   | 289 |   |   |
| Billings in excess of costs for development projects—related  party     |       |                          | (693       | )                             |       |   | 157 |   |   |
| Other current liabilities                                                    |       |                          | (123       | )                             |       |   | (392 | ) |   |
| Other long-term liabilities                                                  |       |                          | (42        | )                             |       |   | (42 | ) |   |
| Net cash used in operating activities                                        |       |                          | (4,975     | )                             |       |   | (1,838 | ) |   |
| Cash Flows from Investing  Activities:                                       |       |                          |       |                          |       |   |   |   |   |
| Purchases of property, plant and equipment                                   |       |                          | (943       | )                             |       |   | (14 | ) |   |
| Net cash used in investing activities                                        |       |                          | (943       | )                             |       |   | (14 | ) |   |
| Cash Flows from Financing  Activities:                                       |       |                          |       |                          |       |   |   |   |   |
| Proceeds from sale of redeemable preferred stock                             |       |                          | 17,000     |                          |       |   | — |   |   |
| Proceeds from sale of common stock                                           |       |                          | 88         |                          |       |   | 894 |   |   |
| Equity issuance costs                                                        |       |                          | (1,321     | )                             |       |   | — |   |   |
| Proceeds from loan                                                           |       |                          | 9,895      |                          |       |   | 1,500 |   |   |
| Repayment of debt                                                            |       |                          | (10,852    | )                             |       |   | (2,576 | ) |   |
| Net cash provided by (used in) financing activities                          |       |                          | 14,810     |                          |       |   | (182 | ) |   |
| Net increase  (decrease) in cash                                             |       |                          | 8,892      |                          |       |   | (2,034 | ) |   |
| Cash at beginning of year                                                    |       |                          | 429        |                          |       |   | 2,463 |   |   |
| Cash at end of year                                                          |       |                          | $          | 9,321                         |       |   |   | $ | 429 |   |   |
| Supplemental Cash Flow  Data:                                                |       |                          |       |                          |       |   |   |   |   |
| Interest paid                                                                |       |                          | $          | 1,000                         |       |   |   | $ | 1,113 |   |   |
| Income taxes paid                                                            |       |                          | $          | 27                            |       |   |   | $ | 25 |   |   |
| Supplemental disclosure  on non-cash financing activity:                     |       |                          |       |                          |       |   |   |   |   |
| Conversion of  professional notes payable to common stock                    |       |                          | $          | —                        |       |   |   | $ | 2,757 |   |   |

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

F-6

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**Innovative Micro Technology, Inc**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.   Reorganization, Basis of Presentation**

Innovative Micro Technology, Inc. (the “Company”)was incorporated in California in 1957 and was reincorporated in Delaware in1987. The Company is engaged in the business of the design and manufacture ofMEMS devices. MEMS is anacronym for micro-electro-mechanical system. To date these operations haveconsisted of product development contracts. The Company’s business plan is totransition itself to a high volume manufacturer. MEMS devices were firstdeveloped in the late 1970s and early 1980s. Generally, MEMS devices are madeusing modern wafer-processing technology, similar to that used in makingsilicon electronic devices or thin-film recording heads for magnetic storagedevices. MEMS devices, however, are distinguished in that they are designed toinclude moving parts, hence the “mechanical” part of the name. By using modernwafer techniques, device complexity and performance is enhanced, and cost islowered due to the large number of devices that can be made on a single wafer.Common uses for MEMS devices are automotive air-bag sensors (accelerometers),pressure and airflow sensors, and ink­jet printer heads.

The Company used the Chapter 11 reorganizationdiscussed below to reposition itself in the MEMS business. The core competencyof the Company is wafer manufacturing and assembly. To that end, the Companyhas determined that the MEMS business allows use of the manufacturing facility,many of the manufacturing techniques, and the skills of its employees obtainedwhile manufacturing magnetic recording heads in the past.

The Company’s three additional lines of businessare:  “Santa Barbara Tool & Die,”“IMT Analytical” and leasing of excess space in its owned facility underlong-term lease contracts. Santa Barbara Tool & Die’s technologypermits high precision manufacturing of tooling, and the business featureselectron-discharge machining (EDM) which includes metals and ceramicscapabilities. IMT Analytical’s laboratory technology includes electronmicroscopy in a variety of forms and features operation of a focused ion beamtool which can precisely make three-dimensional cuts in samples and revealdetailed information as to dimension, material makeup, and material crystalproperties. Santa Barbara Tool & Die and IMT Analytical are strategicparts of the core company in that their services are used to make the corebusiness more competitive; and both use the capacity that exceeds internal Companyneeds to provide services to outside customers. In addition, the Company has approximately51,000 square feet of building space available to lease. As of October 1,2005, approximately 31,000 square feet were under long term lease arrangementswith annual rental income of approximately $0.5 million. An existing tenantusing a 3,000 square foot portion of the facility transitioned to a month tomonth rental basis as of November 3, 2005.

The Company has incurred net losses and losses fromoperations for each quarter since 1999. The Company filed for reorganizationunder Chapter 11 of the U.S. Bankruptcy Code in January 2000 and, uponemergence from bankruptcy, all of the previously issued and outstanding commonstock was canceled without consideration to the holders. The Company incurred anet loss of $4.6 million for the year ended October 1, 2005. The Companyexpects to have increasing sales and marketing, research and development andgeneral and administrative expenses. As a result, it will need to significantlyincrease its revenues to achieve profitability. The Company expects its revenue to grow, butit is uncertain of the future growth rate.

On January 25, 2005,the Company privately sold equity securities to an investor group madeup of Investor Growth Capital Limited, BA Venture Partners and Miramar VenturePartners (“Investor Group”). The Investor Group invested a total of $17.0million in the Company in exchange for 1,000,000 shares of Series Aredeemable preferred stock (“Series A”), 1,000,000 shares of Series A-1convertible preferred stock (“Series A-1”) and a warrant for thepurchase of up to 500,000 shares of common stock. 

F-7

----

The net proceeds to theCompany were approximately $15.7 million. The Company used approximately $1.6million of the net proceeds to pay off the Note due to L-3 CommunicationsCorporation (“L-3”). The remainder of the net proceeds are being used forgeneral working capital needs and other corporate purposes. (See Note 8).

On June 30 2005, the Company secured a newmortgage of $9.9 million with an annual interest rate of 5.65%. The loan is dueon July 1, 2015 and the monthly payment of $64.8 thousand includesprincipal amortization computed using a 22.5 year life. The mortgage providednet proceeds to the Company of approximately $9.7 million. The Company used$8.8 million of the proceeds to retire its previous mortgage, $0.3 million toretire its delinquent property taxes and the balance of $0.6 million was beused for general working capital needs and other corporate purposes. Thereduction in interest rate from 12% on the previous mortgage to 5.65% on thenew mortgage provides the Company with an annual interest cost savings ofapproximately $0.5 million.

The Company exited Chapter 11 on November 16,2001 (“Effective Date”). The Company adopted the fresh start reportingrequirements of Statement of Position 90-7, “Financial Reporting byEntities in Reorganization under the Bankruptcy Code” during the first quarterof fiscal 2002. In accordance with the fresh start reporting requirements, thereorganization value of the Company was allocated to the Company’s assets inconformity with the procedures specified by Statement of Financial AccountingStandards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” Asprovided for under the Company’s reorganization plan (the “Reorganization Plan”),the Company converted approximately $12 million of its secured liabilities todebt and $304 million of unsecured liabilities to equity in the reorganizedentity.

A provision of the ReorganizationPlan related to the treatment of subordinated note claims. The Company’s formerMalaysian subsidiary had credit facilities with five Malaysian Banks (“MalaysianBanks”) that were guaranteed by the Company, and that provided them with acredit position that was senior to the Company’s note holders. The Company’s14% Note, 2% Notes and 7% Notes each contained subordination provisions. Pursuantto these provisions the Malaysian Banks, the holder of the 14% Note, theholders of the 2% Notes, and the holders of the 7% Notes have certainsubordinated rights and claims. A Warrant Agreement was included in theReorganization Plan to provide a method for the subordinated claimants toparticipate in the anticipated future growth in value of the Company’s CommonStock that was issued pursuant to the Reorganization Plan (“New Common Stock”).The Company has no remaining guaranties. The Warrant Agreement expired on December 16,2004 and all warrants were cancelled.

**2.   Summary of Significant Accounting Policies**

**Useof Estimates:****  **Thepreparation of financial statements in conformity with  accounting principles generally accepted inthe United States of America requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from these estimates.

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

**Depreciationand Amortization Policies:****  **Inaccordance with the fresh start reporting requirements, property, plant, andequipment are stated at fair value at the Effective Date and are depreciated oramortized over their estimated useful lives using the straight-line method,except for leasehold improvements which are amortized over the shorter of theestimated useful life or the life of the lease.

F-8

----

Estimateduseful lives are as follows:

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

** **

Depreciation and amortization expense amounted to $1.2million for fiscal 2005 and fiscal 2004.

**Long-livedAssets:****  **TheCompany reviews long-lived assets for impairment whenever events or changes incircumstances indicate that an asset’s carrying value may exceed theundiscounted expected future cash flows to be derived from that asset. Wheneverundiscounted expected future cash flows are less than the carrying value, theasset will be reduced to an amount equal to the net present value of theexpected future cash flows and an impairment loss will be recognized.

**Billingsin excess of costs on development projects:**   Theseamounts reflect the excess of billings over the accumulated costs as defined inthe completed contract method of accounting for long-term contracts. Billingsin excess of costs at October 1, 2005 were $0.9 million related tocapitalized costs under the completed contract method of accounting, asdescribed below. Contracts with L-3 (a related party) account for aminimal portion of this billings in excess of costs on development projectsbalance.

**RevenueRecognition and Warranty Policies:**   The Companyuses the completed contract method of accounting for its product developmentprojects due to the inability to accurately estimate percentage of completionduring performance of the contract. Costs are capitalized during the projectand recorded as cost of revenue at its completion along with the recognition ofrevenue. Losses on projects are recognized as they are determined. The Company’sMEMS development contracts include milestones that require delivery ofengineering reports, wafers and/or dies. The Company’s MEMS developmentcontracts are determined to be complete and the revenue is recognized after allcontract milestones have been completed, reviewed and accepted by the customer.Santa Barbara Tool & Die delivers a finished product to the customerand revenue is recognized after both the product is shipped and title passes.IMT Analytical has service related revenue and this revenue is recognized uponcompletion of the service for the customer. The Company’s MEMS developmentcontracts do not have any rights of return. Santa Barbara Tool & Dieand IMT Analytical did not have any sales returns in fiscal 2005 or 2004. TheCompany’s warranty policy provides for the replacement of defective parts whenthe customers return request is approved within thirty days of the originalshipment date. To date, warranty costs have not been significant.

Aportion of the Company’s facilities are leased to tenants under long-termcontracts. The terms of the leases expire within the next year with renewal atthe option of the tenants. Future minimum lease income for these agreements, asof October 1, 2005, are as follows (in thousands):

| **Fiscal Year** | ** ** | ** ** | ** ** | **Rental  Income** | ** ** |
|----------------------|------------|------------|------------|--------------------|------------|
| 2006                 |       |       | $          | 462                |       |   |
| Total minimum income |       |       | $          | 462                |       |   |

 

**FairValue of Financial Instruments:**   The carryingamounts of cash, customer receivables, trade accounts payable and other accruedliabilities approximate their fair value because of the short maturity of thesefinancial instruments. The carrying amount of approximately $9.8 million of theCompany’s mortgage indebtedness at October 1, 2005 has an interest rate of5.65% and is carried at its full value.

F-9

----

**NetLoss per Common Share:**   Basic loss per share iscomputed by dividing net loss by the weighted average number of common sharesoutstanding. Diluted loss per share is computed by dividing net loss by the sumof the weighted average number of common shares outstanding for the period plusthe assumed exercise of all dilutive securities. However, in the case of a lossper share, dilutive securities outstanding would be antidilutive and would,therefore, be excluded from the computation of diluted loss per share.

The following dilutive securities were outstanding at October 2,2004: 500,000 shares of restricted Common Stock issuable in accordance with theReorganization Plan, options to purchase 1,723,652 common shares at pricesranging from $5.00 to $5.35, warrants to purchase 700,000 common shares at aprice of $7.29 per share with a term of thirty-six months ending August 1,2005, warrants to purchase 83,500 common shares at a price of $5.35 per sharewith a term of eighteen months ending March 3, 2005, warrants to purchase350,000 common shares at a price of $7.29 per share with a term of thirty-sixmonths ending September 3, 2006, warrants to purchase 16,437 common sharesat a price of $5.35 with a term of eighteen months ending March 30, 2005and warrants to purchase 68,777 common shares at a price of $7.29 per sharewith a term of thirty-six months ending September 30, 2006. The Warrantsissuable to the subordinated note claimants pursuant to the ReorganizationPlan, which were exercisable for 1,880,564 common shares as of October 1,2005, are not considered dilutive as the Company had an offsetting right torepurchase an equal number of shares at the same prices. The warrants issued tothe subordinated note claimants expired on December 16, 2004, along withall related repurchase rights of the Company.

The following dilutive securities were outstanding at October 1,2005: 500,000 shares of restricted Common Stock issuable in accordance with theReorganization Plan, options to purchase 767,596 common shares at pricesranging from $0.30 to $5.35, warrants to purchase 350,000 common shares at aprice of $7.29 per share with a term of thirty-six months ending September 3,2006 and warrants to purchase 68,777 common shares at a price of $7.29 pershare with a term of thirty-six months ending September 30, 2006.Additionally, in connection with the January 25, 2005 Investor Grouptransaction, the Company issued warrants for the purchase of up to 500,000shares of common stock, exercisable only if the Company fails to meet certainperformance targets in 2005, at a purchase price of $0.30 per share and awarrant to WRH to purchase up to 113,333 shares of common stock at a price of$3.00 per share. The value of these warrants provided to WRH were determined tobe $2.0 thousand using the Black-Scholes option pricing model with thefollowing assumptions: a risk-free interest rate of 3.55%, an expected volatilityof 63%, a warrant term of 3 years, and no expected dividends. The warrantswere determined to have de minimus value, but were recorded within commonstock.

In the second fiscal quarter of 2005, the Companyoffered its employees the opportunity to exchange outstanding stock optionsissued under the Innovative Micro Technology, Inc. 2001 Stock IncentivePlan (the “Plan”) and having an exercise price in excess of $0.30 for newoptions with an exercise price to be determined on the date they are granted,which it expects to be on the first business day that is at least six monthsand one day following the date the exchange offer closed of April 27,2005. Pursuant to the offer, the Company accepted for exchange and cancelled1,623,648 options to purchase its common stock. On October 31, 2005, thefirst business day at least six months and one day following the date of theexchange offer, the Company granted the replacement of the 1,609,252 options topurchase its common stock at a price of $0.30 per share. (See Note 11).

F-10

----

**Stock Based Compensation:**   TheCompany accounts for its equity compensation plans in accordance with Accounting Principles Board Opinion No. 25.As stock options granted in the current period were granted at or above fairmarket value, no compensation expense has been recorded. Had the Companyinstead determined compensation cost on the basis of fair value pursuant toSFAS No. 123, “Accounting for Stock-Based Compensation,” net loss andbasic and diluted EPS would have been as follows (in thousands, except pershare amounts):

| ** **                                                                     | ** ** | **Year Ended**           | ** ** | **Year Ended**           | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                                     | ** ** | **October 1, 2005** | ** ** | **October 2, 2004** | ** ** |
| Net loss—as  reported                                                     |       |                          | $          | (4,563                        | )          |   |   | $ | (4,264 | ) |   |
| Less—fair value  of stock-based employee compensation expense, net of tax |       |                          | (6         | )                             |       |   | (1,135 | ) |   |
| Net loss—pro  forma                                                       |       |                          | $          | (4,569                        | )          |   |   | $ | (5,399 | ) |   |
| Net loss per  share (basic and diluted)—as reported                       |       |                          | $          | (.48                          | )          |   |   | $ | (.62 | ) |   |
| Net loss per share  (basic and diluted)—pro forma                         |       |                          | $          | (.48                          | )          |   |   | $ | (.78 | ) |   |

 

In assessing the effect had the fair value method beenused, the fair value of each option is estimated on the date of grant using theBlack-Scholes option pricing model with the following assumptions for the yearended October 1, 2005: weighted average risk-free interest rate of 3.80%,expected volatility of 61%, an expected option life of 4.7 years, and no expecteddividends. The assumptions for the fiscal 2004 period are as follows: weightedaverage risk-free interest rate of 3.71%, expected volatility of 66%, anexpected option life of 4 years, and no expected dividends. The fair value ofthe option grants was $0.1 million for the year ended October 1, 2005 and$4.7 million for the year ended October 2, 2004.

**Researchand Development Expenses:****  **TheCompany is actively engaged in basic technology and applied research anddevelopment programs, which are designed to develop new products and productapplications and related manufacturing processes. The costs of these programsare classified as research and development expenses and are charged tooperations as incurred.

**IncomeTaxes:**   Income taxes are computed using theliability method. The provision for income taxes includes income taxes payablefor the current period and the deferred income tax consequences of transactionsthat have been recognized in the Company’s financial statements or income taxreturns. The carrying value of deferred income tax assets is determined basedon an evaluation of whether the Company is more likely than not to realize theassets. Temporary differences result primarily from basis differences inproperty, plant and equipment and net operating loss carryforwards. Thevaluation allowance is reviewed periodically to determine the amount ofdeferred tax asset considered realizable.

**Recent AccountingPronouncements:**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS 123(R), “Share-Based Payment,” whichaddresses the accounting for employee stock options. SFAS 123(R) revisesthe disclosure provisions of SFAS 123 and supersedes APB 25. SFAS 123(R) requiresthat the cost of all employee stock options, as well as other equity-basedcompensation arrangements, be reflected in the financial statements based onthe estimated fair value of the awards. In March 2005, the Securities &Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107, “Share-BasedPayment”, which summarizes the views of the SEC staff regarding the interactionbetween SFAS 123(R) and certain SEC rules and regulations, and isintended to assist in the initial implementation. SFAS 123(R) is effectivefor all public companies that file as of the beginning of the first annualreporting period that begins after June 15, 2005. The Company is currentlyevaluating the provisions of SFAS 123(R) and its effect on its financialstatements. The effect of adopting this statement will be to increase theCompany’s compensation expense in the future.

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In December 2004, the FASB issued SFAS 153, “Exchangesof Nonmonetary Assets, an amendment of APB 29, Accounting for NonmonetaryTransactions.” This Statement’s amendments are based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofthe assets exchanged. Further, SFAS 153 eliminates the narrow exception fornonmonetary exchanges of similar productive assets and replaces it with abroader exception for exchanges of nonmonetary assets that do not havecommercial substance. Provisions of this statement are effective for fiscalperiods beginning after June 15, 2005. The adoption of this statement isnot expected to have a material impact on its financial statements.

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

In May 2005, the FASB issued SFAS 154, “AccountingChanges and Error Corrections.”   SFAS154 replaces APB 20, “Accounting Changes” and SFAS 3, “Reporting AccountingChanges in Interim Financial Statements” and establishes retrospectiveapplication as the required method for reporting a change in accountingprinciple. SFAS 154 provides guidance for determining whether retrospectiveapplication of a change in accounting principle is impracticable and forreporting a change when retrospective application is impracticable. The reportingof a correction of an error by restating previously issued financial statementsis also addressed. SFAS 154 is effective for accounting changes and correctionsof errors made in fiscal years beginning after December 15, 2005. TheCompany does not expect the adoption of this statement to have a materialimpact on its financial statements.

**RiskConcentrations:****  **Financialinstruments that potentially subject the Company to concentrations of creditrisk consist primarily of accounts receivable. The Company performs ongoingcredit evaluations of its customers and maintains an allowance for potentialcredit losses.

The table below shows the revenue by customer andindicates that L-3 represented 18% of the Company’s revenue for the yearended October 1, 2005. The Company had no accounts receivable from thiscustomer at October 1, 2005. Customer A represented 13% of the Company’srevenue for the year ended October 1, 2005. The Company had minimaloutstanding accounts receivable from this customer, representing 1% of theCompany’s accounts receivable balance at October 1, 2005. Customer Brepresented 11% of the Company’s revenue for the year ended October 1,2005. The Company had $0.6 million of outstanding accounts receivable from thiscustomer, representing 27% of the Company’s accounts receivable balance at October 1,2005.

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Thetable below shows the revenue by customer and indicates that L-3represented 40% of the Company’s revenue for the year ended October 2,2004. The Company had $0.1 million of accounts receivable from this customer,representing 10% of the Company’s accounts receivable balance atOctober 2, 2004. An assistance agreement from the U.S. Defense AdvancedResearch Projects Agency (“DARPA”) represented 11% of the Company’s revenue forthe year ended October 2, 2004. The Company had $0.2 million of outstandingaccounts receivable from this customer, representing 17% of the Company’saccounts receivable balance at October 2, 2004.

**Revenue by Customer**

| ** **                        | ** ** | **For the Periods:** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|
| **(As a  percentage of revenue)** | ** ** | ** **                     | ** ** | **Year Ended  October 1,  2005** | ** ** | **Year Ended  October 2,  2004** | ** ** |
| ** **                        | ** ** |                           | ** ** | ** ** |   |   | ** ** | ** ** |   |
| L-3                               |       |                           | 18         | % |   |   | 40 | % |   |
| Customer A                        |       |                           | 13         | % |   |   | 0 | % |   |
| Customer B                        |       |                           | 11         | % |   |   | 3 | % |   |
| OCCAM  Networks, Inc.        |       |                           | 5          | % |   |   | 5 | % |   |
| Marubeni  Solutions               |       |                           | 3          | % |   |   | 4 | % |   |
| DARPA assistance  agreement       |       |                           | 0          | % |   |   | 11 | % |   |
| Galaxy Scientific                 |       |                           | 0          | % |   |   | 1 | % |   |
| Spectra                           |       |                           | 0          | % |   |   | 1 | % |   |
| All Others                        |       |                           | 50         | % |   |   | 35 | % |   |
| Total                             |       |                           | 100        | % |   |   | 100 | % |   |
|                                   |            |                                |            |  |  |  |  |  |  |  |  |

 

**CashConcentration:****  **TheCompany places its cash with major financial institutions. At times, cash andcash equivalents balances may be in excess of amounts insured by Federalagencies. At October 1, 2005, uninsured cash balances approximated $9.3million.

**Advertising:****  **The Company expenses advertising costs when incurred.Advertising expense was immaterial for both fiscal 2005 and 2004.

**FiscalYear:****  **TheCompany’s fiscal year ends on the Saturday closest to September 30. Fiscalyears 2005 and 2004 ended on October 1, 2005 and October 2, 2004,respectively. Fiscal 2005 included 52 weeks and fiscal 2004 included 53 weeks.References to years in these financial statements relate to fiscal years ratherthan calendar years.

**3.  Segments ofBusiness**

Indicated below is the information required to complywith SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information.” Under SFAS No. 131,“operating segments” are components of an enterprise about which separatefinancial information is available that is evaluated regularly by the chiefoperating decision maker in deciding how to allocate resources and in assessingperformance. Generally, financial information is required to be reported on thebasis that it is used internally for evaluating segment performance anddeciding how to allocate resources to segments.

The Company operates in four business segments. Itmanufactures MEMS devices for several industries. It also operates a machine,model and die shop, a materials science analytical lab and leases excess spacein its owned facility to tenants under long-term lease contracts. The Company’sassets are all located in the United States.

The Company’s management evaluates performance of eachsegment primarily on net revenue and gross profit (loss), as well as long-livedassets. The information in the following table is derived directly 

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from the segments’internal financial reporting used for corporate management purposes. Researchand development and general and administrative expenses are not allocated toor  among the segments.

Thefollowing table represents net revenue, gross profit (loss), depreciationexpense and long-lived assets by segment (in thousands):

| ** **                                                     | ** ** | ** **        | ** ** | **Santa Barbara**       | ** ** | **IMT**        | ** ** | **Rental** | ** ** | **United States** | ** ** |   |
|----------------------------------------------------------------|------------|-------------------|------------|------------------------------|------------|----------------|------------|------------|------------|------------------------|------------|--------|
| ** **                                                     | ** ** | **MEMS**          | ** ** | **Tool & Die** | ** ** | **Analytical** | ** ** | **Income** | ** ** | **Total**              | ** ** |   |
| ** **                                                     | ** ** | **($000’s)** | ** ** |                         |
| **Year Ended:**                                                |       |              |       |                         |       |           |       |       |       |                   |       |   |   |   |   |   |   |
| **October 1, 2005**                                       |       |              |       |                         |       |           |       |       |       |                   |       |   |   |   |   |   |   |
| Net revenue                                                    |       | $                 | 8,336      |                         |       | $              | 1,299      |       |       |                   | $          | 110    |   |   | $ | 553 |   |   | $ | 10,298 |   |   |
| Intercompany  Revenue                                          |       | $                 | 20         |                         |       | $              | 143        |       |       |                   | $          | 295    |   |   | $ | — |   |   | $ | — |   |   |
| Gross profit  (loss)                                           |       | $                 | (2,714     | )                            |       | $              | 297        |       |       |                   | $          | 195    |   |   | $ | 413 |   |   | $ | (1,809 | ) |   |
| Depreciation and  Amortization Expense                         |       | $                 | 1,006      |                         |       | $              | 63         |       |       |                   | $          | 23     |   |   | $ | 121 |   |   | $ | 1,213 |   |   |
| Long-Lived Assets                                              |       | $                 | 14,480     |                         |       | $              | 134        |       |       |                   | $          | — |   |   | $ | 2,291 |   |   | $ | 16,905 |   |   |
| **Year Ended:**                                                | ** ** |              |       |                         |       |           |       |       |       |                   |       |   |   |   |   |   |   |
| **October 2, 2004**                                       | ** ** |              |       |                         |       |           |       |       |       |                   |       |   |   |   |   |   |   |
| Net revenue                                                    |       | $                 | 8,310      |                         |       | $              | 1,200      |       |       |                   | $          | 69     |   |   | $ | 535 |   |   | $ | 10,114 |   |   |
| Intercompany  Revenue                                          |       | $                 | 12         |                         |       | $              | 68         |       |       |                   | $          | 361    |   |   | $ | — |   |   | $ | — |   |   |
| Gross profit  (loss)                                           |       | $                 | (1,560     | )                            |       | $              | 166        |       |       |                   | $          | 115    |   |   | $ | 400 |   |   | $ | (879 | ) |   |
| Depreciation and  Amortization Expense                         |       | $                 | 956        |                         |       | $              | 55         |       |       |                   | $          | 23     |   |   | $ | 121 |   |   | $ | 1,155 |   |   |
| Cost of Revenues  portion of Non-Cash Stock Based Compensation |       | $                 | 47         |                         |       | $              | —     |       |       |                   | $          | — |   |   | $ | — |   |   | $ | 47 |   |   |
| Long-Lived Assets                                              |       | $                 | 14,661     |                         |       | $              | 83         |       |       |                   | $          | 23     |   |   | $ | 2,412 |   |   | $ | 17,179 |   |   |

 

The MEMS intercompany revenue results from managementservices provided to IMT Analytical and is charged at the cost of suchservices. The Santa Barbara Tool & Die and IMT Analytical intercompanyrevenue provided to the MEMS segment, for the services received, is recorded atmarket prices for their services.

Capital additions for fiscal 2005 were $0.9 millioncompared to minimal expenditures in fiscal 2004. The fiscal 2005 additions were predominantly related to theMEMS portion of the business.

The following tablerepresents the Company’s net revenue for domestic and foreign customers (inthousands):

| ** **   | ** ** | **Year Ended**                | ** ** | **Year Ended**                | ** ** |
|--------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **   | ** ** | **October 1, 2005** | ** ** | **October 2, 2004** | ** ** |
| Net revenue: |       |                          |       |                          |       |   |   |   |   |
| Domestic     |       |                          | $          | 8,886                         |       |   |   | $ | 9,413 |   |   |
| Foreign      |       |                          | 1,412      |                          |       |   | 701 |   |   |
| Total        |       |                          | $          | 10,298                        |       |   |   | $ | 10,114 |   |   |

 

The Company’s products are sold in the United States,Canada and Japan by its direct sales personnel.

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**4.  Income Taxes**

The provision for incometaxes for the following fiscal years consists of (in thousands):

| ** **           | ** ** | **Year Ended**                | ** ** | **Year Ended**                | ** ** |
|----------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **           | ** ** | **October 1, 2005** | ** ** | **October 2, 2004** | ** ** |
| Federal Income Taxes |       |                          |       |                          |       |   |   |   |   |
| Current              |       |                          | $          | —                        |       |   |   | $ | — |   |   |
| Deferred             |       |                          | —     |                          |       |   | — |   |   |
| State Income Taxes   |       |                          |       |                          |       |   |   |   |   |
| Current              |       |                          | 21         |                          |       |   | 13 |   |   |
| Deferred             |       |                          | —     |                          |       |   | — |   |   |
| Total                |       |                          | $          | 21                            |       |   |   | $ | 13 |   |   |

 

Reconciliationof the actual provisions for income taxes to the income tax calculated at theUnited States Federal rates for operations were as follows (in thousands):

| ** **                                                                | ** ** | **Year Ended**                | ** ** | **Year Ended**                | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                                | ** ** | **October 1, 2005** | ** ** | **October 2, 2004** | ** ** |
| Expected income  tax benefit at the United States federal income tax rate |       |                          | $          | (1,544                        | )          |   |   | $ | (1,446 | ) |   |
| State income  taxes, net of federal income tax benefit                    |       |                          | (259       | )                             |       |   | (246 | ) |   |
| Change in valuation  allowance                                            |       |                          | 1,824      |                          |       |   | 1,705 |   |   |
|                                                                      |       |                          | $          | 21                            |       |   |   | $ | 13 |   |   |

 

Thecomponents of deferred income taxes at October 1, 2005 are as follows (inthousands):

| Net operating  loss carryforwards                  |   | $       | 16,353 |   |
|----------------------------------------------------|--------|---------|--------|--------|
| Basis difference  in property, plant and equipment |   | 986     |   |
| Total deferred  tax asset                          |   | 17,339  |   |
| Valuation  allowance                               |   | (17,339 | )      |
| Total net deferred tax  asset                      |   | $       | — |   |

 

SFAS 109 requires that all deferred tax balances bedetermined using the tax rates and limitations expected to be in effect whenthe taxes will actually be paid or recovered. Consequently, the income taxprovision will increase or decrease in the period in which a change in tax rateor limitation is enacted. As of October 1, 2005, the Company had totaldeferred tax assets of $17.3 million. The Company recorded a valuationallowance in the full amount of $17.3 million at October 1, 2005, againstthe amount by which deferred tax assets exceed deferred tax liabilities. Thisrepresents an increase in the valuation allowance of $1.8 million at year-end2005 over year-end 2004. The valuation reserve at October 1, 2005 has beenprovided due to the uncertainty of the amount of future taxable income. TheCompany provides a valuation allowance in the full amount of its deferred taxassets because under the criteria of SFAS No. 109, the Company does nothave a basis to conclude that it is more likely than not that it will realizethe deferred tax assets.

Due to the change incontrol that resulted from the bankruptcy and various subsequent financings,the Company may not be able to receive the full benefit of net operating losscarryforwards accumulated prior to the bankruptcy, which total approximately$283.1 million and $131.1 million for federal and state tax purposes,respectively. Portions of the Company’s pre-bankruptcy tax losses, however, maybe eligible for use in future periods. From the commencement of the Chapter 11reorganization through October 1, 2005, the Company has accumulated netoperating loss carryforwards of approximately $40.9 million for federal 

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taxpurposes and $20.4 million for state tax purposes. Once the Company hasutilized these remaining net operating loss carry forwards, future U.S.earnings will be taxed at the U.S. statutory rates less available tax credits,if any. To the extent not used, the net operating loss carryforwards forfederal and state purposes expire in varying amounts beginning in 2021 and2011, respectively**.** At October 1,2005, all identified deferred tax assets are reduced by a valuation allowance;therefore, any additional operating loss carryforwards not recognized would notresult in a benefit in the provision for income taxes due to the uncertainty offuture realization of those additional operating loss carryforwards.

**5.   Debt**

The Company settled two claims during the Chapter 11reorganization that were secured by its owned properties. One of these claimswas a property mortgage of $9.6 million due on November 24, 2005. Upon thesale of the Company’s Hollister facility, in the second quarter of fiscal 2003,a portion of the proceeds were used to reduce this debt to $8.8 million. Thebalance of the proceeds were used to pay, in full, a separate loan with abalance of $5.4 million. The remaining mortgage required interest-only paymentsat a 12% annual interest rate. The other claim was for delinquent propertytaxes of $0.9 million. On June 30 2005, the Company secured a new mortgageof $9.9 million with an annual interest rate of 5.65% and used the net proceedsof approximately $9.7 million to pay off its original mortgage of approximately$8.8 million and its delinquent property taxes of approximately $0.3 million,which provided the Company with a net increase in cash of approximately $0.6million.

At the end of the third fiscal quarter of 2005, theCompany secured a new mortgage of $9.9 million with an annual interest rate of5.65%. The loan is due on July 1, 2015 and the monthly payment of $64.8thousand includes principal amortization computed using a 22.5 year life.Related to this transaction, the Company created Robin Hill Business Park LLC (“RHBP”)as a wholly owned subsidiary. The Company transferred the mortgaged property toRHBP and this same entity entered into the loan agreement with the lender. Thelender required this structure in order for the Company to secure the loan.

TheCompany’s long-term debt is summarized below (in thousands):

| ** **                 | ** ** | **October 1,  2005** | ** ** |
|----------------------------|------------|---------------------------|------------|
| Property mortgage          |       |                      | 9,843      |   |   |
| Less—Current  portion |       |                      | (221       | ) |   |
| Total                      |       |                      | $          | 9,622 |   |   |
|                            |            |                           |            |  |  |  |

 

Theaggregate maturities of long-term debt are as follows (in thousands):

| **Fiscal Year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------|------------|
| 2006                 |       | $          | 221        |       |
| 2007                 |       | 240        |       |
| 2008                 |       | 255        |       |
| 2009                 |       | 269        |       |
| 2010                 |       | 285        |       |
| thereafter           |       | 8,573      |       |
| Total                |       | $          | 9,843      |       |

 

**6.  Commitmentsand Contingencies**

The Company uses hazardous chemicals in itsmanufacturing and is subject to a variety of environmental and land useregulations related to their use, storage and disposal. If the Company fails tocomply with present or future regulations, liability, production suspension ordelay could result. In 

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addition, environmental orland use regulations could restrict the Company’s ability to expand its currentproduction facilities or establish additional facilities in other locations, orcould require the Company to acquire costly equipment, or to incur othersignificant expenses for compliance with environmental regulations or to cleanup prior discharges. The Company currently maintains a restricted cash accountof $0.1 million in other assets as required by the Department of ToxicSubstance Control.

The Company has been subject to regulatory and legalproceedings related to past environmental contamination, and other similarproceedings could arise in the future. The Company has recently been advised bythe U.S. Environmental Protection Agency that it may be required to pay forpart of the remediation of a solvent and refrigerant recycling and treatmentfacility formerly operated by the Omega Chemical Company in Whittier,California. The EPA alleges that the Company, along with a number of othercompanies, provided solvent and refrigerant waste to this facility forrecycling and disposal. The Company is still exploring legal defenses,including defenses arising out of the bankruptcy proceedings. At this time, theCompany intends to defend this matter vigorously. If these legal defenses areunsuccessful, the Company could be required to pay an amount of less than $0.1million. The Company is also remediating and monitoring ground watercontaminated with volatile organic compounds (“VOCs”) at a former site leasedby the Company in Goleta, California, under an order of the California RegionalWater Quality Control Board (“CRWQCB”). VOC contamination at the site has beenreduced and the Company does not expect future expenditures related to the siteto be material.

In fiscal 2003, the Company sold its Hollister facility.The environmental testing performed by the Company in support of this saledetermined that the soil at that site showed no metal or VOC contamination.However, ground water samples showed low levels of VOC contamination. TheCRWQCB required the Company to install one monitoring well, and test resultsconfirmed the low level VOC concentration. The Company has been asked by theCRWQCB to submit semi-annual sample results from its well. One propertyadjacent to the site is conducting a remediation project on its site for thissame VOC and the CRWQCB required this property to place monitoring wellsbetween the two properties. Their testing detected the presence of breakdownproducts of the same VOC. The owners of the adjacent property have been askedto conduct semi-annual sampling of the wells. A second property adjacent to thesite is conducting site characterization under the guidance of the CRWQCBrelated to the same VOC found on the Company’s site. In the fourth fiscalquarter of 2004, the CRWQCB issued a letter to the Company indicating thattheir investigation of the adjacent properties led them to the conclusion thatthe VOC present on the site was the Company’s responsibility. The CRWQCB hasrequested that the Company continue to submit results from the semi-annualmonitoring of its well. The Company is unable to make a determination ofpotential future costs for this situation. The Company has a $5.0 millionenvironmental insurance policy covering potential liability relating to thisproperty. The Company’s accumulated cost to date for these matters related tothe Hollister facility has been less than $0.1 million.

Purchase commitments associated with capitalexpenditures were approximately $0.4 million at October 1, 2005.

The Company has no leases under which it is thelessee.

The company is required to comply with therequirements of Sarbanes Oxley Section 404 during its fiscal year ending September 30,2007. This process will involve the design, documentation and testing of thecompany’s internal financial reporting controls. The ultimate cost of thisprocess cannot be determined at this time.

Under its bylaws andindemnification agreements, the Company has agreed, subject to certainexceptions, to indemnify its officers and directors for certain events oroccurrences arising as a result of the officer and director’s serving in suchcapacity, to the fullest extent authorized or permitted by the Delaware GeneralCorporation Law. The maximum potential amount of future payments the Companycould be required to make under these indemnification agreements is unlimited.However, the Company has a 

F-17

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directorsand officers liability insurance policy that limits its exposure and enables itto recover a portion of any future amounts paid. As a result of its insurancepolicy coverage, the Company believes the estimated fair value of theseindemnification agreements is minimal and has no liabilities recorded for theseagreements as of October 1, 2005.

**7.  EmployeeBenefit Plans**

The Company has aqualified retirement plan (the “401(k) Plan”) under the provisions ofsection 401(k) of the Internal Revenue Code, in which eligible employeesmay participate. Substantially all participants in this plan are able to defercompensation up to the annual maximum amount allowable under Internal RevenueService regulations. The Company has a 401(k) cash match program whichprovides a match of one half of the first five percent of an employee’scontributions. This matching contribution was less than $0.1 million in bothfiscal 2005 and 2004. The Company’s 401(k) Plan has a provision thatprovides management with an option to make a discretionary contribution to theplan. Additionally, the Company has a profit sharing plan, in which alleligible employees participate. There was less than $0.1 million incompensation expense recorded under the cash profit sharing plan in both fiscal2005 and fiscal 2004. The Company made no discretionary 401(k) contributionsduring either fiscal 2005 or fiscal 2004 under this plan.

**8.  FinancingTransactions**

On January 25, 2005, the Investor Group investeda total of $17.0 million in a private sale of equity securities of the Company.The net proceeds to the Company were approximately $15.7 million. In exchangefor the investment, the Investor Group received 1,000,000 shares of Series A,1,000,000 shares of Series A-1 and a warrant for the purchase of upto 500,000 shares of common stock. The Company used approximately $1.6 millionof the net proceeds to pay off the Note due to L-3. The remainder of thenet proceeds are being used for general working capital needs and othercorporate purposes. The Company recorded $0.5 million in accrued and unpaiddividends related to the Series A shares in fiscal 2005.

On September 30, 2003, the Company reached asettlement with the holders of its Professional Notes, who had providedprofessional services to the Company during its Chapter 11 reorganizationand received convertible promissory notes evidencing the Company’s indebtednessfor those services. As partial consideration for the cancellation of theProfessional Notes, the Company issued 368,113 shares of Common Stock, eighteenmonth warrants for the purchase of a total of 16,437 common shares at a priceof $5.35 per share, which will expire on March 30, 2005, and thirty-sixmonth warrants for the purchase of a total of 68,777 common shares at apurchase price of $7.29 per share, which will expire on September 30,2006. In the second fiscal quarter of 2005, these investors exercised warrantsfor the purchase of 16,437 common shares at a price of $5.35 per share forapproximately $0.1 million.

The Company completed a sale of Common Stock andwarrants to L-3 on September 3, 2003 for $2.5 million in cash. TheCompany is a subcontractor to L-3 for a long-term government contract toproduce gyroscopes and accelerometers for use in inertial navigation. TheCompany issued 467,500 shares of Common Stock to L-3 along with twowarrants. The first warrant for a term of eighteen months to purchase 83,500shares of Common Stock at a price of $5.35 per share expired on March 3,2005. The second warrant has a term of thirty-six months to purchase 350,000shares of Common Stock at a price of $7.29 per share. The value of the warrants is notreflected separately in the accompanying financial statements as it wasrecorded within Common Stock.

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L-3 made a previousinvestment in the Company on August 2, 2002 for $5 million in cash. TheCompany issued 935,000 shares of Common Stock to L-3 along with twowarrants. The first warrant had a term of eighteen months to purchase 167,000shares of Common Stock at a price of $5.35 per share. This warrant wasexercised by L-3 on October 31, 2003 for an aggregate amount of $0.9million. The second warrant for a term of thirty-six months to purchase 700,000shares of Common Stock at a price of $7.29 per share expired on August 2,2005. The valueof the warrants is not reflected separately in the accompanying financialstatements as it was recorded within Common Stock.

**9.  Restricted Stock and Stock Option Program**

The Company’s stock option and long-term incentiveplans were cancelled as part of the Reorganization Plan. The Company hadapproximately 3.8 million options outstanding as of the date of its petitionfor protection under Chapter 11 of the Bankruptcy code. The Reorganization Planprovided for future stock incentives for the employees and directors of theCompany. Pursuant to the Reorganization Plan the Company, as of the effectivedate of the Reorganization Plan on November 16, 2001 (“Effective Date”),adopted the 2001 Stock Incentive Plan, authorizing the grant of restrictedshares of Common Stock and options to purchase shares of Common Stock toemployees. Pursuant to the Reorganization Plan, the Company issued, as of theEffective Date, restricted shares of Common Stock and options allocated andvested as provided for in the 2001 Stock Incentive Plan.

Pursuantto the Reorganization Plan, 2,250,000 shares of New Common Stock were reservedfor the grants of restricted shares of Common Stock and options, as follows:

| **Class**                          | ** ** | ** ** | ** ** | **Number Of Shares Of  New Common Stock** | ** ** |
|------------------------------------|------------|------------|------------|--------------------------------------------------------------------|------------|
| New Employee  Options              |       |       | 1,000,000  |                                                               |       |
| Employee/DirectorReserved  Options |       |       | 750,000    |                                                               |       |
| Restricted stock                   |       |       | 500,000    |                                                               |       |
| Total                              |       |       | 2,250,000  |                                                               |       |

 

Each new employee option provided for an exerciseprice of $5.00 per share. Each employee/director reserved option provides for apurchase price for each share of Common Stock to be determined by the Board ofDirectors as the then fair market value of the new Common Stock. Fifty percentof each grant of employee restricted stock vested one year after the EffectiveDate and the remaining 50% vested two years after the Effective Date. Therestricted stock agreement contains additional vesting provisions, which theCompany does not intend to enforce. Accordingly, the Company measured thecompensation expense associated with the Plan on November 16, 2001 andrecognized the expense over two years. The new employee options vest ratablyover three years. Upon vesting, the new employee options can be exercised ifand only if all of the following conditions have been satisfied: (i) notmore than ten (10) years after the issuance of the option has lapsed; and (ii) therecipient of the New Option is employed by the Company at the time therecipient seeks to exercise the option (or not more than ninety (90) days havepassed since such employee’s employment has been terminated); provided,however, if the recipient is not employed by the Company at the time ofexercise by reason of the recipient’s death, the recipient’s heir (or estate)can exercise the option for a period of eighteen months after the death of arecipient who was employed at the time of his death. The New EmployeeRestricted Stock and Option Agreement related to each grant provides foraccelerated vesting upon certain specified conditions related to a transfer of ownershipor sale of the business.

The 500,000 shares of Common Stock issued under the2001 Incentive Plan, were determined to have a market value of $2.5 million,based on a $5.00 per share price determined by the Board of Directors.****The employees received the common stock at a purchase priceof $0.0001, subject to a two-year vesting period. The Company recorded noamortization expense for the year ended October 1, 2005 and $0.2 millionfor 

F-19

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the year ended October 2,2004. The combination of Cost of revenue and Research and Development werecharged with approximately $0.1 million and Selling, General and Administrativeincurred $0.1 million of the amortization expense in fiscal 2004.

The Shareholders approved an amendment to the Company’s2001 Stock Incentive Plan at its February 27, 2004 Annual ShareholdersMeeting, increasing the number of shares of common stock reserved for issuancethereunder from 2,250,000 to 3,000,000.

Stockoption activity of the Company is as follows:

| ** **                       | ** ** | **Options Outstanding** | ** ** |
|----------------------------------|------------|------------------------------|------------|
| ** **                       | ** ** | **Number  of Shares**   | ** ** | **Exercise Price  Per Option** | ** ** | **Weighted Averag  Exercise Pricee** | ** ** |
| Balance  September 27, 2003 |       | 1,664,897                    |       | $ | 5.00 - $5.35 |   |   | $ | 5.09 |   |   |
| Granted                          |       | 88,100                       |       | $5.35 |   |   | $ | 5.35 |   |   |
| Exercised                        |       | —                       |       |   |   |   |   |   |   |
| Cancelled                        |       | (29,345                      | )          | $ | 5.00 - $5.35 |   |   | $ | 5.17 |   |   |
| Balance October 2,  2004    |       | 1,723,652                    |       | $ | 5.00 - $5.35 |   |   | $ | 5.10 |   |   |
| Granted                          |       | 782,200                      |       | $0.30 |   |   | $ | 0.30 |   |   |
| Exercised                        |       | —                       |       |   |   |   |   |   |   |
| Cancelled                        |       | (1,738,256                   | )          | $ | 5.00 - $5.35 |   |   | $ | 5.05 |   |   |
| Balance October 1,  2005    |       | 767,596                      |       | $ | 0.30 - $5.35 |   |   | $ | 0.32 |   |   |

 

Warrantactivity of the Company is as follows:

| ** **                       | ** ** | **Warrants Outstanding** | ** ** |
|----------------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | **Number  of Shares**    | ** ** | **Exercise Price  Per warrant** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| Balance  September 27, 2003 |       | 1,300,500                     |       | $ | 5.35 - $7.29 |   |   | $ | 6.92 |   |   |
| Granted                          |       | 85,214                        |       | $ | 5.35 - $7.29 |   |   | $ | 6.92 |   |   |
| Exercised                        |       | (167,000                      | )          | $5.35 |   |   | $ | 5.35 |   |   |
| Cancelled                        |       | —                        |       |   |   |   |   |   |   |
| Balance  October 2, 2004    |       | 1,218,714                     |       | $ | 5.35 - $7.29 |   |   | $ | 7.13 |   |   |
| Granted                          |       | —                        |       | $ | 5.35 - $7.29 |   |   | $ | 6.92 |   |   |
| Exercised                        |       | (16,437                       | )          | $5.359 |   |   | $ | 5.35 |   |   |
| Cancelled                        |       | (783,500                      | )          | $ | 5.35 - $7.29 |   |   | $ | 7.08 |   |   |
| Balance October 1,  2005    |       | 418,777                       |       | $7.29 |   |   | $ | 7.29 |   |   |

 

The weighted average fair value of warrants grantedduring the year ended October 2, 2004 totaled $0.09. There were nowarrants issues in fiscal 2005.

Thefollowing table summarizes information regarding options outstanding at October 1,2005:

| ** **                         | ** ** | **Options  Outstanding** | ** ** | **Options  Exercisable** | ** ** |
|------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| **Range of  Exercise Prices** | ** ** | ** **               | ** ** | **Number  Outstanding**  | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $5.00                              |       |                     | 500        |                     |       |   | 6.13 |   |   |   | $ | 5.00 |   |   |   | 500 |   |   |   | $ | 5.00 |   |   |
| $5.35                              |       |                     | 1,896      |                     |       |   | 7.57 |   |   |   | $ | 5.35 |   |   |   | 1,264 |   |   |   | $ | 5.35 |   |   |
| $0.30                              |       |                     | 765,200    |                     |       |   | 9.83 |   |   |   | $ | 0.30 |   |   |   | — |   |   |   | $ | 0.30 |   |   |
|                               |       |                     | 767,596    |                     |       |   |   |   |   |   |   |   |   |   | 1,764 |   |   |   |   |   |   |
|                                    |            |                          |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Theweighted average fair value of options granted during the years ended October 1,2005 and October 2, 2004 totaled $0.16 and $2.83, respectively.

**10.  RelatedParty Transactions.**

The Company hadrevenue of $1.8 million, minimal costs in excess of billings on developmentprojects, which includes capitalized costs of approximately $0.1 million, andno accounts receivable from L-3, a stockholder and customer, for the yearended October 1, 2005. The Company had revenue of $4.0 million, billingsin excess of costs on development projects of $0.7 million, which includescapitalized costs of $0.9 million, and accounts receivable of $0.1 million fromL-3 for the year ended October 2, 2004.

**11.  SubsequentEvents.**

In the second fiscal quarter of 2005, the Companyoffered its employees the opportunity to exchange outstanding stock optionsissued under the Innovative Micro Technology, Inc. 2001 Stock IncentivePlan (the “Plan”) and having an exercise price in excess of $0.30 for newoptions with an exercise price to be determined on the date they are granted,which it expects to be on the first business day that is at least six monthsand one day following the date the exchange offer closed of April 27,2005. Pursuant to the offer, the Company accepted for exchange and cancelled1,623,648 options to purchase its common stock. On October 31, 2005, thefirst business day at least six months and one day following the date of theexchange offer, the Company granted the replacement of 1,609,252 options, tothe employees continuing to be employed by the Company, to purchase its commonstock at a price of $0.30 per share.

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