** **

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**ý**** ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**For the year endedDecember 31, 2005**

** **

**OR**

 

**o**** TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**Commission file number 0-22384**

 

**MICRO COMPONENT TECHNOLOGY, INC.**

(Exact name of registrant as specified in its charter)

 

| **Minnesota**                   | ** ** | **41-0985960**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer    |
| incorporation or organization)  |       | Identification No.) |

 

**2340 West County Road C, St. Paul, Minnesota 55113**

(Address of principal executive offices)

Registrant’s telephone number, including area code**(651)697-4000**

 

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

 

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

**COMMON STOCK, $.01 PAR VALUE**

(Title of Class)

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act. Yes  o  No  ý

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act. Yes  o  No  ý

 

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months, and (2) has been subject to suchfiling requirements for the past 90 days. Yes  ý No  o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§229.405 of this chapter) is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. ý

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large  Accelerated Filer o |   | Accelerated Filer o |   | Non-Accelerated Filer ý |
|----------------------------|--------|---------------------|--------|------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes  o  No  ý

 

The aggregate marketvalue of the common stock held by non-affiliates of the Registrant as of June 25,2005 (the business day of the Registrant’s most recently completed secondfiscal quarter), was $6.1 million based upon the closing price of $0.24 on thatdate for the shares.

 

Numberof shares outstanding of the Registrant’s Common stock, as of****March 15, 2006,****is 27,215,361.

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Definitive Proxy Statement forthe annual meeting of stockholders (the “Proxy Statement”) to be filed within120 days after the Registrant’s fiscal year ended December 31, 2005, areincorporated by reference into Part III.

 

 

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**MICRO COMPONENT TECHNOLOGY, INC. ANDSUBSIDIARIES**

 

**TABLE OFCONTENTS**

 
| **PART I**                                 |   |   |                                                                                                               |   |
|-------------------------------------------------|--------|--------|--------------------------------------------------------------------------------------------------------------------|--------|
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 1.     | Business                                                                                                           |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 1A.    | Risk Factors                                                                                                       |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 2.     | Properties                                                                                                         |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 3.     | Legal Proceedings                                                                                                  |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 4.     | Submission  of Matters to a Vote of Security Holders                                                               |   |
|                                            |   |   |                                                                                                               |   |
| **PART II**                                |   |   |                                                                                                               |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 5.     | Market  for Registrant’s Common Stock, Related Stockholder Matters and Issuer  Purchases of Equity Securities |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 6.     | Selected  Consolidated Financial Data                                                                              |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 7.     | Management’s  Discussion and Analysis of Results of Operations and Financial Condition                        |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 7A.    | Quantitative  and Qualitative Disclosures About Market Risk                                                        |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 8.     | Consolidated  Financial Statements and Supplementary Data                                                          |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 9.     | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure                              |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 9A.    | Controls and  Procedures                                                                                           |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 9B.    | Other Information                                                                                                  |   |
|                                            |   |   |                                                                                                               |   |
| **PART III**                               |   |   |                                                                                                               |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 10.    | Directors  and Executive Officers of the Registrant                                                                |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 11.    | Executive  Compensation                                                                                            |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 12.    | Security  Ownership of Certain Beneficial Owners and Management  and Related Stockholders Matters                  |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 13.    | Certain  Relationships and Related Transactions                                                                    |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 14.    | Principal  Accountant Fees and Services                                                                            |   |
|                                            |   |   |                                                                                                               |   |
| ITEM                                            |   | 15.    | Exhibits and  Financial Statement Schedules                                                                        |   |
|                                            |   |   |                                                                                                               |   |
| **Index to  Consolidated Financial Statements** |   |
|                                            |   |   |                                                                                                               |   |
| Signatures and  Certifications                  |   |
|                                                 |        |        |                                                                                                                    |        |  |  |

 

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**PART I**

 

This Form 10-Kcontains certain forward-looking statements. For this purpose, any statementscontained in this Form 10-K that are not statements of historical fact may bedeemed to be forward-looking statements. Without limiting the foregoing, wordssuch as “may,” “will,” “expect,” “believe,” “anticipate,” “estimate” or “continue”or comparable terminology are intended to identify forward-looking statements. Thesestatements by their nature involve substantial risks and uncertainties, andactual results may differ materially depending on a variety of factors,including those set forth in the section below entitled “Risk Factors.”****

 

**ITEM 1. Business**

 

**General**

 

Unlessthe context otherwise requires, references in this Report on Form 10-K to “MCT”,“ We”, “Us”, “Registrant” and the “Company” refer to Micro ComponentTechnology, Inc. and its consolidated subsidiaries. MCT was incorporatedin Minnesota on June 20, 1972, was reorganized as a Delaware corporationon June 28, 1983 and reorganized as a Minnesota corporation on November 6,1996. MCT has three wholly owned active operating subsidiaries, Micro ComponentTechnology Asia Pte. Ltd., (“MCT Asia”), MCT Asia (Penang) Sdn. Bhd., (“Penang”),and MCT Philippines, Inc (“Philippines”). Our principal executive offices arelocated at 2340 West County Road C, St. Paul, Minnesota 55113 and our telephonenumber at that location is (651) 697-4000.

 

Our trademarksused in this Form 10-K are: ****MCT****, ****Infinity Systems****,****Aseco****,***Tapestr*y*®***, ****SmartSolutions****, ****SmartMark*******®*, **SmartSort***®*, **SmartTrak***®***, ****Isocut****,****MCT5100****, ****MCT 7632****, ****S-170****and ****S-130****.All other trademarks or trade names referred to in this Form 10-K are theproperty of their respective owners.

 

**Background**

 

On January 31,2000, we completed our acquisition of Aseco Corporation, a Massachusetts basedmanufacturer of handling equipment. The acquisition was structured as astock-for-stock purchase and was accounted for using the purchase method ofaccounting. The purchase price totaled $24.0 million, consisting of 2.6 millionshares of MCT common stock valued at $22.5 million issued to former Asecoshareholders and $1.5 million of acquisition-related costs.

 

On April 11,2000, our Board of Directors elected to change our fiscal year end to a yearending on December 31, effective December 31, 1999. Our interimthirteen-week quarters each end on a Saturday.

 

On August 16,2000, we issued 3,000,000 shares of common stock, and on September 18,2000, we issued 290,000 shares of common stock, in a public stock offering. Proceedsfrom the offering totaled $19.7 million.

 

On December 24,2001, we issued $10.0 million of 10% Senior Subordinated Convertible Notes duein 2006 to a group of accredited investors. These Notes are convertible intoMCT common stock. The conversion price was initially $2.60 per share. The Notesare redeemable by MCT at any time after January 3, 2004 as long as themarket price of our common stock equals or exceeds 150% of the conversion price.Proceeds of the Notes, net of debt issuance costs, totaled $9.2 million. Holdersof the Notes have standard registration rights if they convert the Notes tocommon stock.

 

On March 7,2003 and March 26, 2003, pursuant to a private equity placement with a groupof accredited investors, we issued a total of 3,166,869 shares of common stock,which resulted in net proceeds to us of approximately $1.1 million. Stockissuance costs associated with this offering totaled approximately $241,000. Aspart of this offering, we also issued warrants to purchase 253,350 sharesof common stock that have a term of five years with an exercise price of $0.43per share.

 

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On June 30,2003, we completed the restructuring of $9.29 million, or 92.9%, of our 10%Senior Subordinated Convertible Notes, wherein the participating noteholdersagreed to accept stock in lieu of cash for the next four semi-annual interestpayment dates beginning June 30, 2003 through December 31, 2004, andwe agreed to reduce the conversion price to $1.00 per share. On February 25,2005, we completed a second amendment to the agreement with the holders of our10% Senior Subordinated Convertible Notes, wherein holders of 80% of theremaining Notes, representing $2.9 million, agreed to continue to accept stockin payment of interest for the remaining four interest payments through December 24,2006. The conversion price was then reduced to $0.85 per share. On April 29,2005, we completed another financing transaction with Laurus. As a result ofthe new financing with Laurus, the conversion price for all of the Noteholderswho accepted the prior restructuring agreements was at that time reduced to$0.61 per share.

 

On March 9,2004, we completed a $5.0 million financing transaction with an institutionallender, Laurus Master Fund, Ltd. (“Laurus”), secured by all of the assets ofthe Company. The financing included a $3.0 million working capital line ofcredit and a $2.0 million long-term note. The notes were partially convertibleinto shares of our common stock. In connection with the transaction, we issuedto Laurus a seven-year warrant to purchase 400,000 shares of common stock atexercise prices ranging from $2.30 to $2.88 per share. The secured loan inexistence at that time with a prior lender was terminated.

 

OnJanuary 28, 2005, we completed an amendment to the financing agreementwith Laurus to defer payments on the long-term convertible note. As part ofthis amendment, the conversion prices for both notes were reduced. We alsoissued Laurus at that time a seven-year warrant to purchase 150,000 shares ofcommon stock at $.67 per share.

 

On April 29,2005, we completed another financing transaction with Laurus in which weborrowed an additional $2.5 million, and which was convertible into shares ofcommon stock. We also issued Laurus at that time an option to purchase2,556,651 shares of common stock at an exercise price of $.01 per share. Wereceived net proceeds of approximately $2.4 million at the closing.

 

OnFebruary 17, 2006, we again restructured the financing with Laurus, andincreased the total maximum secured indebtedness with Laurus to $9.25 million. Therestructured financing now includes a $5.25 million term note. Interest ispayable monthly on the term note at the prime rate plus 2.5%. Beginning 360days after closing, we are required to make monthly payments equal to 1/60th ofthe principal amount until three years after the closing, at which time theentire remaining principal and accrued interest is due and payable in full. Thenote is non-convertible. In addition to the $5.25 million note, the workingcapital line of credit was increased from $3.0 million to $4.0 million, andmade non-convertible. The note is payable in full on March 8, 2008. Interestis payable monthly on the note at the prime rate plus 2.5%. The existing $1.2million over-advance in excess of the borrowing base on the working capitalline of credit was extended until April 30, 2007. However, commencing on December 1,2006, the over-advance is to be reduced by $200,000 each month. The Companyalso issued Laurus a 10-year option to purchase 2,500,000 shares at an exerciseprice of $.01 per share. The shares issuable upon exercise of the option havestandard registration rights. As a result of the new financing with Laurus, theconversion price for all of the Noteholders who accepted the priorrestructuring agreements has been reduced to $0.56 per share.

 

**Introduction**

 

We are a leading supplier of integrated automation solutionsfor the global semiconductor test and assembly industry. We offer complete andcomprehensive equipment automation solutions for the test, laser mark and markinspect processes for the back-end of the semiconductor manufacturing processthat significantly improve our customers’ productivity, yield and throughput. Oursolutions include our series of integrated Smart Solutions, automated testhandlers, factory automation software and equipment integration services. Ourcustomers include many leading semiconductor companies such as MicrochipTechnologies, Analog Devices, National Semiconductor, Phillips Semiconductor,Cypress Semiconductor and ST Microelectronics and many of the leading back-endcontract test and assembly companies including Amkor and NS Electronics Bangkok.We believe we have one of the world’s largest installed bases of handlers usedto test semiconductor devices.

 

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Semiconductordevices are becoming more complex and are characterized by shrinking semiconductordevice sizes, miniaturized packaging, increased circuitry and larger wafersizes. These trends have led manufacturers to seek new tools and new solutionsto meet their demanding requirements. We believe that our complete offering ofequipment automation products and services allows manufacturers to effectivelyaddress evolving process technologies and packaging formats, such as QFN (quadflat packages with no external leads) and miniaturized packaging.

 

Beginningin 1999, we broadened our strategy from that of a test handler manufacturer toalso a provider of comprehensive equipment automation solutions for theback-end of the semiconductor manufacturing process. Consistent with this newstrategy, we completed two acquisitions. Our acquisition of Infinity Systems inJune 1999, a company involved in the development of factory automationsoftware, was integral to the development of our integrated equipment SmartSolutions product suite. In January 2000, we completed our acquisition ofAseco, which provided us with increased machine vision and robotics engineeringtechnology critical to the handling of strips and wafers.

 

**IndustryOverview**

 

The semiconductor device industry had grown tremendously overthe ten-year period ending in the year 2000. This growth had been driven bytraditional semiconductor markets like personal computers and data processing,and more recently by the proliferation of semiconductor devices intelecommunications, wireless communications, and consumer electronics, as wellas Internet infrastructure equipment. However, the semiconductor capitalequipment market, in which we compete, has historically been subject tocyclical periods of high growth and contraction. In the fourth quarter of 2000,the semiconductor industry went into a sharp downturn, which intensified andcontinued through the majority of 2003, resulting in a significant adverseimpact on our business. In late 2003, worldwide semiconductor bookings beganshowing signs of stabilization and demand for our products increased duringthis period and continued through the first half of 2004. However, in the thirdquarter of 2004 the markets again retracted, impacting our financial resultsthrough the end of 2004 and continuing through 2005. At this juncture, thereturn to sustained market growth cannot be predicted in the short term.

 

Theprocess of semiconductor manufacturing is one of the most complicated andlogistically challenging manufacturing processes in the world. An advancedsemiconductor device can travel thousands of miles and undergo as many as 500production steps before completion. The semiconductor device manufacturingprocess is traditionally divided into two parts: the front-end, which includeswafer fabrication from raw materials to a finished wafer; and the back-end,which includes semiconductor device assembly, test, and packaging. Front-endand back-end manufacturing facilities are expected to run 24 hours a day, 7days a week to provide the productivity needed to meet the requirements of themarket.

 

Initially,semiconductor manufacturers concentrated their efforts on improving the moreexpensive front-end wafer fabrication process. They improved the front-end byfirst automating the individual production tools and more recently byintegrating the various production tools through factory automation software. Toolautomation was significant because it replaced most human handling of thewafers with robotics, resulting in dramatically increased yields. Factoryautomation software is significantly improving productivity, yield andthroughput in the front-end by utilizing powerful production scheduling,materials handling and process tool control software.

 

Automationand process improvement of back-end tools and facilities has severely laggedthe front-end. Over the last several years, manufacturers began to seekautomation and process solutions for the back-end production process. This isbecause, historically, the cost of back-end assembly and test processes wasonly a small portion of the total semiconductor device cost and traditionalprocesses were able to provide adequate throughput. Today the cost of back-endassembly and test per semiconductor device often equals or exceeds the waferfabrication cost per semiconductor device. We believe that as manufacturersseek to raise the standards of yield, productivity, throughput and costreduction in the back-end, the growth rate of the newly developing back-endautomation market could increase rapidly.

 

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**TraditionalSemiconductor Manufacturing Process**

 

Semiconductordevices arrive for test in strip or wafer format, with each strip or wafercontaining multiple individual devices. Until recently, most semiconductormanufacturers believed it was necessary to test individual semiconductordevices after they were singulated, or cut from the strip or wafer. However, assemiconductor device and package sizes have shrunk, they have become extremelydifficult to handle individually. For example, manufacturers’ chip scale packages,or CSPs, are nearly the same size as the die they package. Traditional handlingtools do not have the precision to adequately address the various semiconductordevice size and chip-scale packaging technologies demanded by manufacturers. Asa result, handling tools designed for singulated processes have become a bottleneckto throughput.

 

Manufacturersnow acknowledge that post-test singulation can be done, in certain packageformats, without damage to the device. This understanding permits manufacturersto process, handle, and test multiple devices while still in strip or waferformat. Strip handling increases process flexibility by permitting the handlingand testing of a variety of packages, substrates and semiconductor devicesizes. In addition, strip handling significantly increases throughput byreducing the number of process steps and by allowing the tester to easily testmultiple semiconductor devices in parallel. We believe that as manufacturersseek to increase productivity, yield and throughput, they will increasinglyadopt strip test processing. Consequently, we believe strip test processingtechnology will be critical to any back-end automation strategy and willfacilitate re-tooling of many back end processes.

 

Inimplementing broader automation strategies in the back-end, manufacturers faceother significant challenges besides the development of strip processing tools.For example, production tools in the back-end historically have notcommunicated well with one another, if at all, and the transitions betweenproduction steps have not been integrated. This lack of communication andintegration has prevented back-end manufacturers from realizing many of thebenefits of factory automation and has prevented the collection of criticalprocess data.

 

**OurSolution**

 

Weseek to provide our customers comprehensive equipment automation solutions fortheir test and assembly processes. By deploying our products and services, ourcustomers are able to improve their production yields, factory throughput, toolproductivity and utilization while reducing product cost. The key components ofour solution are:

 

•Tapestry series automated strip handler,

•Smart Solutions integrated equipment product series,

•Infinity Systems factory automation software and equipment integrationservices, and

•Line of traditional test handlers for singulated processes.

 

Our solution provides thefollowing benefits to our customers:

 

***Flexibility to address new form factors, including wafers andstrips.***We believe that our Tapestry series ofhandlers are among the first handlers capable of processing semiconductordevices in strip or wafer formats. Tapestry provides increased flexibility,permitting the handling and testing of a variety of packages, substrates andsemiconductor device types. Depending on the application, we believe that ourTapestry handler’s throughput capability is three to ten times greater thanexisting singulated handling options available today.

 

***Ability to collect critical process data.***OurSmart Solutions equipment products utilize our factory automation software toprovide both the hardware and software necessary to accurately track importantyield events in the test and assembly portion of the back-end process. We usestate-of-the-art technology including machine vision to accurately track allsemiconductor devices as they travel through the test and assembly processes. Thismachine vision technology is not only critical to the precise positioning ofstrips, but also enables our software to generate critical process data. Thisinformation, together with yield information obtained in the assembly process 

 

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and the front-endfacility, can provide real-time data on the entire semiconductor manufacturingprocess for each wafer, giving manufacturers the information they need toimprove their processes and increase their yields.

 

***Deployment of integrated, comprehensive solutions.***Oursuite of equipment automation tools, software products and servicesaddresses the varied automation needs of individual back-end manufacturingfacilities. Our factory automation software has the ability to integrateproduction tools from various manufacturers into one total solution. Thisallows our customers to fulfill a significant portion of their test andassembly automation needs through a single supplier, thereby simplifyingtraining, maintenance, capacity expansion and supplier accountability.

 

***Worldwide service and support engineering.***Weprovide worldwide service and support engineering to our customers as part ofthe purchase of all of our products, which includes comprehensive installationsupport. As our products have expanded to offer greater functionality, we haveprovided application engineering support so that our customers can takeadvantage of these advances to improve their processes.

 

**Strategy**

 

Ourobjective is to be the leading supplier for the newly developing market ofautomated solutions for the semiconductor test and assembly market. Keyelements of our strategy include:

 

***Providing comprehensive automated solutions.***Today,we provide equipment automation solutions for the test and assembly portion ofthe semiconductor manufacturing process, including test, laser mark, markinspect, and other processes. In addition, we are expanding our automationsolutions to include equipment integration solutions compatible with productsfrom a greater number of other equipment manufacturers such as trim, form andsingulation system providers. We have enhanced the software component of ourautomation solutions by adding data analysis and report generating capabilitiesto increase our customer’s ability to improve their manufacturing process. Inthe future we plan to expand the Smart Solution suite of products tohandle other processes within the semiconductor test and assembly area.

 

***Capitalizing on emerging chip scale packaging, or CSP, processdevelopment.***Our Smart Solutions and Tapestry productsalready meet initial chip scale package process requirements through striphandling. However, the vast numbers of new chip scale packages, recentlyintroduced, have imposed additional requirements on semiconductor test andassembly processes, including the ability to perform multi-pass testingand stacked die testing. As a leader in providing equipment automationsolutions that address chip scale packaging technologies, we are continuingdevelopment of next-generation handling and equipment automation solutions foradvanced semiconductor device packaging.

 

***Strengthening key customer relationships.***Ourcustomers include many of the world’s leading providers of semiconductordevices as well as major third-party test and assembly companies. We expectthat our customers will look to us to help resolve their process as well asautomation problems throughout the back-end. As we solve our customers’ diverseneeds, we will deepen our present customer relationships and also build ourknowledge base so that we can develop similar relationships with others in thesemiconductor manufacturing industry.

 

***Leveraging our strong sales and service capability.***Wepredominantly sell our products through our direct sales force and haveestablished sales and service offices in the world’s major centers ofsemiconductor manufacturing including Penang, Malaysia, Singapore and in thePhilippines. In addition to our sales and service engineers, we have severalapplications engineers in key customer support locations. We have placedsoftware engineers in several Asian locations to directly support InfinitySystems’ pursuit of factory automation software sales.

 

***Continuing to develop and support existing singulated test handlingsolutions and products.***We believe that we have one ofthe largest installed bases of traditional test handlers in the world. Weintend to support our customers who use singulated test handling with newproduct introductions for specialty applications.

 

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**Products**

 

***AutomationProducts***

 

***Smart Solutions****.*Our Smart Solutions equipment suite of products, onceintegrated with a tester, are designed to automate the entire test process fromthe point where the semiconductor devices have been packaged, through test,laser mark, inspection, singulation and sort, to the point of shipment to thecustomer. Our Smart Solutions product family offers semiconductor manufacturersgreater flexibility, yield and throughput. These products are designed to meetthe back-end semiconductor manufacturer’s demand for greater productionefficiency, lower cost of test and manufacturing flexibility. The followingtable sets forth our key automation product offerings by category, dateintroduced and application.

 
| **Automation  Product Category** | ** ** | **Product Name**                     | ** ** | **Introduced**             | ** ** | **Applications**                                                                                                                                                                            |
|----------------------------------|------------|--------------------------------------|------------|----------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                       | ** ** | ** **                           | ** ** | ** **                 | ** ** | ** **                                                                                                                                                                                  |
| Smart Solutions                  |       | Tapestry SC                          |       | July 2003             |       | A next  generation handling system for semiconductor devices that are in strip or  wafer package formats.                                                                                   |
|                             |       | Tapestry PH1                         |       | February 1999         |       | A next  generation handling system for semiconductor devices that are in strip or  wafer package formats.                                                                                   |
|                             |       | SmartMark SC                         |       | September 2004        |       | A next  generation high-speed laser marker for integration with strip handling or for  marking strips with 2D codes.                                                                        |
|                             |       | SmartTrak                            |       | May 2000              |       | Software  management system providing a map with information about each semiconductor  device in the strip.                                                                                 |
| Automation Software              |       | Infinity Systems  Software Solutions |       | Acquired in June 1999 |       | Manufacturing  software control systems for semiconductor assembly and test plants including  equipment integration through overall factory and corporate information  systems integration. |

 

OurSmart Solutions equipment product family was introduced to meet the anticipatedevolution of back-end manufacturing from singulated handling to stripprocessing through the final stages of assembly and electrical test. Additionally,our Smart Solutions products are designed with electronic strip mappingcapability as a cornerstone. As high-density semiconductor strips with tinychip scale packages become the standard, electronic strip mapping addresses theproblem of manually tracking individual semiconductor devices within the strip.The new Smart Solutions systems provide customers enhanced performance ineither stand-alone or integrated assembly lines. The current average sellingprice for Smart Solutions products vary from $300,000 for a single module andcan approach approximately $1.0 million for a fully configured system thatincludes all of the components.

 

TapestrySC, introduced in July 2003, is our next generation system forsemiconductor devices that are in strip format. The system is targeted to meetthe growing need for lower cost of ownership, greater flexibility, easier use,increased process control, faster set-up and changeover times. The Tapestry SChas several optional features and can be targeted at several different applicationswith the potential to add additional options and / or capability at a latertime. The Tapestry SC is compatible and complementary to the Tapestry PH-1.

 

Tapestry,our strip handling system introduced in February 1999, is the flagship ofthe Smart Solution product family. Tapestry is a versatile, high volume,parallel test handling and thermal conditioning system for semiconductordevices that are in strip format. Thermal conditioning is required to ensurethat a semiconductor device can operate normally in a wide range oftemperatures. Tapestry can condition devices at temperatures ranging from –40degrees centigrade to +130 degrees centigrade. The system is capable ofhandling fine pitch chip scale packages as well as traditional leadedsemiconductor devices in strip format. Using standard industry interfaces, thesystem is designed to function as a stand-alone system, or can be integratedinto an in-line process with our other Smart Solution products or equipment ofother manufacturers.

 

SmartMarkSC, introduced in September 2004, is our next generation high-speed lasermarker for integration with strip handling or for marking strips with 2D codes.This system takes advantage of the same base system that is used with ourTapestry SC, allowing for lower costs of production and a common platform ofspare parts for our customers, thus lowering overall customer costs.

 

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Our suite ofSmart Solution equipment products includes additional modules to assist companiesin automating the back-end of the semiconductor manufacturing process using thenew strip format. These include the input/output devices for both slotted andstacked magazines used with strips.

 

***Automation Software.***Infinity Systems SoftwareSolutions provide highly sophisticated systems integration services to thesemiconductor test and assembly industry. Infinity Systems’ solutions assistcustomers in creating either new manufacturing environments or implementing newmethods and control systems in existing ones. These installations allowpreviously isolated stand-alone equipment to exchange information with otherequipment and provide for remote monitoring and control of these systems. Ourengineering experience, efficient software development process, strong projectmanagement and our understanding of semiconductor handling systems allow us toassist customers in specifying equipment behavior and software interfaces as aproactive component of the design and procurement process.

 

***SingulatedHandling Products***

 

Wealso provide more traditional singulated handling products utilizinggravity-feed technology. As a result of our shift in product strategy tostrip-based solutions, we will build our singulated products only when a salesorder exists and if technology permits. We continue to support these productsfor our installed base of systems for consumable and spare parts.

 

***OtherProducts and Services***

 

We provide service and spare parts for all of our current andmany of our discontinued products. We have also done significant business insupport services for a semiconductor device tester that is still widely usedbut that was last manufactured by us in 1993.

 

**Research and Development**

 

As animportant element of our business strategy, we work closely with our customersto develop new products and enhancements of existing products to meet theevolving needs of the test and assembly market, particularly with respect toemerging semiconductor devices, while striving to provide the lowest cost oftest. These efforts, historically focused on test handler products, haveresulted in the successful introduction of several new product platforms,including our Tapestry family of products including the PH1, SC (ambient andelevated temperature versions) strip testing and associated handling modules,and our SmartMark and SmartMark SC products.

 

Althoughwe rely primarily on our internal engineering capabilities to develop newproducts and enhance existing products, we also utilize contract services toenhance our technical capabilities or temporarily expand our resources. Inaddition, we work closely with several manufacturers of products that areincorporated into our products or are complementary to our products when webelieve a higher quality, lower cost product would result.

 

Anongoing goal of our research and development activities is to reduce the timerequired to develop new products and bring them to market. As the back-endprocess becomes increasingly automated and complex, the development of improvedsoftware for our products becomes increasingly important.

 

Our research and development expenses were $2.0 million,$2.8 million, and $2.4 million in the years ended December 31, 2005, 2004and 2003, respectively. Our combined resources totaled 21 employees and contractorsin research and development, or approximately 26% of our entire workforce, at December 31,2005. We expect research and development expenses to remain fairly flat in 2006relative to 2005 levels, subject to mandated increases due to customer requirementsfor system related products.

 

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**Customers**

 

Our customers include many of the leading manufacturers ofsemiconductor devices, as well as test and assembly companies, in the UnitedStates, Europe and Asia. In recent years, our significant customers haveshifted from the major semiconductor manufacturers to test and assemblycompanies, corresponding to the increased utilization of test and assemblycompanies by the major semiconductor manufacturers. Microchip Technologies,Maxim Tech, and Kestronics accounted for 33%, 11% and 10% of our net sales,respectively, in the year ended December 31, 2005. Analog Devices,Microchip Technologies and Amkor Technology, Inc. accounted for 28%, 20%and 19% of our net sales, respectively, in the year ended December 31,2004. Microchip Technologies and Analog Devices accounted for 32% and 9% of ournet sales, respectively, in the year ended December 31, 2003.

 

Ourcustomers tend to limit the number of qualified equipment vendors they purchasefrom in order to gain the efficiencies of standardization across theirproduction process. We therefore expend substantial efforts to maintain ourrelationships with our existing major customers to increase the likelihood thatthey will continue to select our products for their future generations ofsemiconductor devices.

 

**Marketing,Sales and Worldwide Support**

 

Wemarket our products primarily to semiconductor manufacturers and third partytest and assembly companies through our own sales force and in selected marketsthrough independent sales representatives and distributors. Our automationsolutions, however, are marketed directly by our employees to the key personnelat customers and potential customers who are in charge of capital equipment forthe entire back-end. These sales frequently involve major decisions by thecustomer as to the configuration and operation of its entire back-end operation.Consequently, the sales cycle for Smart Solutions products may be longerthan for our traditional handler products as the average order amount isgenerally larger.

 

Weaugment our sales efforts with direct customer support/service engineers andapplication engineers based in the field. These engineers are specialists inour product portfolio and partner with our customers to help determine productrequirements. Our service engineers install our equipment and train thecustomers’ operators and maintenance technicians on the proper use and care ofour equipment. Our application engineers help identify emerging markets for newproducts.

 

Weestablished a presence in Asia more than 20 years ago, where we operate throughour subsidiaries with offices in Singapore and Penang, Malaysia. To supplementthe region’s sales and service coverage, we use sales representative companiesand distributors in Korea, Taiwan and China. We also established an office inthe Philippines to provide better sales and service support and theestablishment of a software development group. We have stationed service engineersin Singapore, Malaysia, Thailand and the Philippines for rapid response tocustomer needs in Asia.

 

**Manufacturingand Suppliers**

 

In2002, we began the transition of our manufacturing operations from our St.Paul, Minnesota facility to Penang, Malaysia. This was completed in early 2003.It is our belief that our new Malaysian operations will provide cost savings aswell as an increased presence in our prime sales geographical area. We combineproprietary software and components developed in our facilities with componentsand subassemblies obtained from outside suppliers. We have establishedrelationships with suppliers in Malaysia which allow us to out-sourcemanufacturing of our components to a number of different suppliers. We do notmaintain any long-term supply agreements with any of our key suppliers.

 

**Competition**

 

Thesemiconductor device testing and assembly equipment industry is highlycompetitive, and the market for our automation products and services isexpected to become more competitive. We face substantial competition 

 

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throughout the worldprimarily from manufacturers in Asia, the United States, Europe and Japan. Thecompanies that we are aware of that currently offer a production grade striphandling solution comparable to our Tapestry products are Fico BV, ASMInternational, Electroglas, Tesec, Rasco, Multitest and Cohu, Inc., whoseproducts were introduced between 1995 and 2005.

 

Theprincipal elements of competition in our markets include throughput capability,quality, reliability, price, product performance, customer service and support,financial strength, versatility and the ability to deliver on schedule. Althoughwe believe that we compete favorably with respect to each of these factors, newproduct introductions by our competitors could cause a decline in sales or lossof market acceptance of our existing products. If competitors introduce moretechnologically advanced products, the demand for our similar products wouldlikely be reduced.

 

**IntellectualProperty Rights**

 

We attempt toprotect the proprietary aspects of our products with patents, trademarks andcopyrights, as well as contractual and other trade secret protectionstrategies.

 

We frequentlyreview our inventions and discoveries to attempt to determine which inventionswill provide substantial differentiation between our products and those of ourcompetitors. We currently have four U.S. patents issued and active. In certaincases, we may also choose to keep an invention or process confidential astrade secrets, in lieu of making public disclosure through the patentingprocess. Key employees are required to enter into nondisclosure and inventionassignment agreements, and customers, vendors and other third parties also mustagree to nondisclosure restrictions prior to disclosure of our trade secrets orother confidential or proprietary information.

 

We have developedand are using trademarks, slogans and other commercial symbols to advertise andsell our products, a number of which have been registered with the U.S. Patentand Trademark Office. Our proprietary computer programs are protected underfederal copyright law as unpublished original works. We also maintain thesecrecy of our software source codes through licensing and other restrictions.

 

The intellectualproperty position of any manufacturer, including us, is subject touncertainties and may involve complex legal and factual issues. Allowedclaims for our existing or future patents issued may be challenged,invalidated or circumvented, and any rights granted by those patents may notprovide us with adequate protection. Additionally, it may be possible forcompetitors or customers to copy aspects of our products or to obtaininformation that we may regard as a trade secret. Litigation may benecessary in the future to enforce our patents and other intellectual propertyrights or to defend us against claims of infringement.

 

**Backlog**

 

At December 31, 2005, our backlog of unfilled orders forwhich a purchase order number has been assigned by the customer and for which adelivery schedule has been specified was $ 1.9 million. At December 31,2004, our backlog was $1.3 million. A significant portion of the backlog at December 31,2005, is expected to be shipped in the next two quarters. Since a largemajority of the shipments made in a given quarter are usually made during thelatter part of the quarter, and since a significant portion of shipmentsin a given quarter are booked during that same quarter, backlog as of a date inthe middle of the quarter will typically be greater than backlog at quarter end.All orders are subject to cancellation by the customer with limited charges. Ourbacklog at a particular date is not necessarily indicative of actual sales forthat or any succeeding period and does not reflect the effects of the SEC’sStaff Accounting Bulletin No. 101, amended by Staff Accounting Bulletin104 (SAB 104) discussed in our revenue recognition policy in Note 1 of Notes toConsolidated Financial Statements included elsewhere herein.

 

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**Employees**

 

At December 31,2005, we had a total of 80 employees in the following areas: 25 inmanufacturing, 21 in engineering and research and development, 16 in sales,marketing, application engineering and service, and 18 in administration. Ourworkforce remained relatively stable during 2005. Many of our employees arehighly skilled, and we believe our future success will depend in large part onour ability to attract and retain similar employees. None of our employees arecovered by a collective bargaining agreement, and we have experienced no workstoppages. We consider our relationship with our employees to be good.

 

**Seasonalityin Quarterly Operating Results**

 

Duringeach quarter, we customarily sell a relatively small number of systems thatcarry a high average selling price. Although we believe our sales are notseasonal in nature, a small change in the number of products ordered and/orshipped and accepted in a quarter can have a significant impact on results ofoperations for that particular quarter. Moreover, production difficulties coulddelay shipments. Accordingly, our operating results may vary significantlyfrom quarter to quarter and could be adversely affected for a particularquarter if shipments and customer acceptances for that quarter were lower thananticipated. Our quarterly operating results may also be affected by,among other factors, the timing of new product introductions, fluctuations inthe semiconductor market and the actions of competitors.

 

**FinancialInformation about Foreign and Domestic Operations and Export Sales**

 

Weoperate in three geographic areas. Summarized data for our operations areincluded in Note 12 of Notes to Consolidated Financial Statements, includedelsewhere herein.

 

**ITEM 1A. Risk Factors**

 

Setforth below is a discussion of the significant risk factors applicable to theCompany. Additional risk factors may develop in the future.

 

**Ourability to continue as a “going concern” is uncertain.**

 

Ourconsolidated financial statements have been prepared on the assumption that wewill continue as a going concern, which contemplates the realization of assetsand liquidation of liabilities in the normal course of business. The Report ofthe Independent Registered Public Accounting Firm included herein contains anexplanatory paragraph that raises substantial doubt about our ability tocontinue as a going concern.

 

Asof December 31, 2005, we had cash and cash equivalents of $77,000, assetstotaling $4.5 million, liabilities totaling $11.6 million, and incurred lossesfrom continuing operations of $5.1 million for the year then ended. We expectto continue to expend cash and incur operating losses at the current net saleslevels, but to a lesser extent than the twelve months ended December 31,2005 as certain operating expenses are expected to decline from 2005 levels.Our ability to generate cash and operating income is dependent on increasingour customer base to expand the penetration of our product technology and therealization of our lower operating expense targets. It is uncertain whether wewill be able to obtain a sufficient amount of additional capital, if needed, onacceptable terms, or at all. Further, if future financing requirements aresatisfied through the issuance of equity or debt instruments, shareholders may experienceadditional dilution in terms of their percentage of ownership of our securities.In the event that we are unable to obtain additional capital, our operationswill be materially negatively impacted and we will be required to take actionsthat will harm our business, including potentially ceasing certain or all ofour operations.

 

**Thesuccess of our new products depends upon customer acceptance of both thetesting of semiconductor devices in strip form and the automation of theback-end of the semiconductor manufacturing process.**

 

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Severalof our new products, including our Tapestry strip handler and other SmartSolutions products, are used to test and process semiconductor devices in stripform. Assembly of semiconductor devices in strip form is the standardindustry practice. However, we cannot assure you that testing of semiconductordevices in strip form will become widely accepted by the industry. Untilrecently, most semiconductor manufacturers believed it was necessary to testsemiconductors after they were cut from the strips because they believed theact of cutting the strips containing the semiconductor devices, referred to assingulation, could result in damage or contamination to the semiconductordevices and, as a consequence, make the prior test results unreliable.

 

Weintroduced our Tapestry handling system in February 1999. In May 2000,we introduced other Smart Solutions products, which provide additional processcapability for handling and testing semiconductor devices in strip form. In July of2003, we introduced our Tapestry SC, a second-generation system. In July of2004, we introduced our Tapestry SC SmartMark, a second-generation system. Ournew products are attractive to customers only if the customers can see thevalue of automating the test and assembly portions of their semiconductor manufacturingoperations. Although semiconductor manufacturers have automated the waferfabrication portion of their operation, or the front-end of the semiconductormanufacturing process, very few semiconductor manufacturers have invested asignificant amount of capital to automate the test and assembly portions oftheir operations. We are introducing new products for technologies, which may notbe accepted on a wide-scale basis by the industry. If either the testing ofsemiconductor devices in strip form or wide-scale automation of theback-end is not accepted by the industry, our net sales likely will suffer.

 

**Downturnsin semiconductor industry business cycles could have a negative impact on ouroperating results.**

 

Our business depends heavily upon capital expendituresby semiconductor manufacturers. The semiconductor industry is highly cyclical,with periods of capacity shortage and periods of excess capacity. In periods ofexcess capacity, the industry sharply cuts purchases of capital equipment, suchas our products. Thus, a semiconductor industry downturn or slowdown substantiallyreduces our revenues and operating results and could hurt our financialcondition. In the fourth quarter of 2000, the semiconductor capital equipmentindustry went into a severe downturn. This downturn continued through 2005, andhas negatively affected our operations and financial condition.

 

**We haveoffered automation solutions and, unless we effectively market our company as aprovider of automation solutions, our expected financial results will suffer.**

 

We offer equipment automation solutions and softwaredevelopment services. These solutions and services require different marketingtechniques and involve a more extensive decision-making process by customersthan for our traditional handler products. We need to successfully market ourautomation products using different sales methods than we have previously used.

 

Weacquired an automation software business in June 1999 and introduced ourfirst suite of products to provide an automation solution for the testingportion of semiconductor manufacturing in May 2000. The sales from theseoperations make up less than 1%, 3% and 6% of net sales for the years ended December 31,2005, 2004 and 2003, respectively. Our future success is dependent upon beingable to successfully market our automation products. If we are not successfulin effectively marketing ourselves as an equipment automation solutionsprovider to the semiconductor industry, our results of operations and financialcondition will suffer.

 

**We investheavily in research and development efforts and our financial results dependupon the success of these efforts.**

 

Wehave spent, and expect to continue to spend, a significant amount of time andresources developing new products and refining existing products and systems. Inlight of the long product development cycles inherent in our industry, theseexpenditures will be made well in advance of the prospect of deriving revenuefrom the sale of new systems.

 

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Ourability to introduce and market new products successfully is subject to a widevariety of challenges during this development cycle, such as design defects orchanging market requirements that could delay introduction of these systems. Inaddition, since our customers are not obligated by long-term contracts topurchase our products, our anticipated product orders may not materialize,or orders that do materialize may be canceled. As a result, if we do notachieve market acceptance of new products, we may not be able to realizesufficient sales needed to recoup our research and development expenditures.

 

**Ouroperating results often have large changes from period to period, which may resultin a decrease in our stock price.**

 

Our quarterly and annualoperating results are affected by a wide variety of factors that couldadversely affect sales or operating results or lead to significant variabilityin our operating results. A variety of factors could cause this variability,including the following:

 

• the cyclical nature of the semiconductorindustry; 

• delays in, or cancellation of,significant system purchases by customers; 

• delays in the development, introductionand production of our products; 

• changes in the mix of our products andtheir gross margins; 

• new product introductions by competitorsand competitive pricing pressures; 

• the time required for us to adjust ouroperating expenses to respond to changes in sales and market conditions; 

• the timing of any future acquisitionsand their effect on our financial results;

• component shortages resulting inmanufacturing delays; and 

• pressure by customers to reduce prices,shorten delivery times and extend payment terms.

 

Wecannot predict the impact of these and other factors on our sales or operatingresults in any future period. Results of operations in any period, therefore,should not be considered indicative of the results to be expected for anyfuture period. Because of this difficulty in predicting future performance, ouroperating results may fall below expectations of security analysts orinvestors in some future periods. Our failure to meet these expectations wouldlikely adversely affect the market price of our common stock.

 

**Our stockprice is volatile and it may drop unexpectedly.**

 

Stockprices of companies in the semiconductor equipment industry, including ours,can swing dramatically with little relationship to operating performance. Factors,which could cause our stock price to change, include:

 

• changes in the market’s view of thesemiconductor industry in general;

• changes inour quarterly operating results for the reasons set out in the previous riskfactors for other reasons;

• changes inour reported financial results based on accounting pronouncements;

• changes inresearch analysts’ expectations for us or our industry or failure to meetresearch analysts’ estimates; 

• changes inthe general economic conditions or developments in the semiconductor industrywhich affect investors confidence;

• announcements by us or ourcompetitors of technological innovations or new or enhanced products and;

 

Additionalfactors, which may impact our results, include:

 

• we depend upon a few customers forthe majority of our revenues and a reduction in their orders could adverselyaffect us;

• our operating results would beharmed if one of our key suppliers fails to deliver components for our products;

• the loss of any of our key personnelcould harm our business;

• our markets are very competitive anddemand for our products may decrease if additional competitors enter

 

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ourmarkets;

• our dependence upon internationalsales involves significant risk;

• the possible adverse impact ofeconomic or political changes in the market we serve;

• our inability to obtain financing tofund continuing or expanding operations;

 

Fluctuationsor decreases in the trading price of our common stock may adversely affectthe ability to trade our shares. In addition, these fluctuations couldadversely affect our ability to raise capital through future equity financing.

 

# **ITEM2. Properties**

# ** **

We occupy approximately 22,000 square feet of leased space inSt. Paul, Minnesota, for our principal executive offices and research andproduct development activities. This lease expires in 2007. We occupyapproximately 54,000 square feet of leased space in Penang, Malaysia, which isutilized as a manufacturing center. This lease expires in 2007. We occupyapproximately 1,300 square feet of leased space in the Philippines in supportof our applications engineering and software development activities. This leaseexpires in 2008. We believe that our current and committed facilities areadequate to support our activities for at least the next twelve months.

 

**ITEM 3. Legal Proceedings**

 

On April 11, 2005,judgment was entered against the Company in Superior Court of California in theamount of $379,000 plus legal and court costs for a total amount of $547,000 inthe lawsuit brought by a prior landlord. The Company has reached an agreementwith the landlord that will allow the Company to pay the judgment over a30-month period for a total amount of $443,000 plus interest at 10% per annum.

 

**ITEM 4. Submissionof Matters to a Vote of Security Holders**

 

There were no matters submitted to a vote of the securityholders during the quarter ended December 31, 2005.

 

**PART II**

 

**ITEM5. Market for Registrant’s Common Stock, Related Stockholder Matters and IssuerPurchases of Equity Securities**

 

Ourcommon stock is traded on the OTC Bulletin Board under the symbol MCTI. Thefollowing table sets forth, for the periods indicated, the high and low closingsale prices per share of our common stock, as reported by the OTC BulletinBoard. The share prices represent prices established between broker – dealersand therefore do not reflect prices of actual transactions.

 
| ** **                         | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------|------------|----------|------------|---------|------------|
|                               |       |     |       |    |       |
| Year ended December 31, 2005: |       |     |       |    |       |
| First Quarter                      |       | $        | 0.75       |    | $          | 0.33 |   |
| Second Quarter                     |       | 0.39     |       | 0.17    |       |
| Third Quarter                      |       | 0.24     |       | 0.15    |       |
| Fourth Quarter                     |       | 0.19     |       | 0.09    |       |
|                               |       |     |       |    |       |
| Year ended December 31, 2004: |       |     |       |    |       |
| First Quarter                      |       | $        | 2.07       |    | $          | 1.27 |   |
| Second Quarter                     |       | 1.70     |       | 1.08    |       |
| Third Quarter                      |       | 1.26     |       | 0.63    |       |
| Fourth Quarter                     |       | 0.72     |       | 0.33    |       |

 

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The approximate number of holders of record of our commonstock as of December 31, 2005 was 314.

 

Wehave never declared or paid any cash dividends on our common stock and do notanticipate paying any cash dividends in the foreseeable future. We currentlyintend to retain future earnings to fund the development and growth of ourbusiness.

 

Underthe Note Purchase Agreement associated with the issuance of the 10% SeniorSubordinated Convertible Notes and the Security Agreement associated with ourRevolving Line of Credit and Term Note (each discussed in Note 7 in Notes toConsolidated Financial Statements contained elsewhere herein) we are prohibitedfrom paying dividends.

 

**ITEM6. Selected Consolidated Financial Data**

 

**SELECTED CONSOLIDATED FINANCIAL DATA**

 
| ** **                                     | ** ** | **Years Ended**                                               | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Dec. 31,**                                                  | ** ** | **Dec. 31,** | ** ** | **Dec. 31,** | ** ** | **Dec. 31,** | ** ** | **Dec. 31,** | ** ** |
| ** **                                     | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                     | ** ** | **(in thousands, except per share data)** | ** ** |
| **Consolidated Statement of Operations Data:** |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net sales                                      |       | $                                                                  | 7,069      |   | $ | 14,602 |   | $ | 11,123 |   | $ | 12,211 |   | $ | 25,406 |   |
| Cost of sales:                                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Product                                        |       | 4,012                                                              |       | 7,286 |   | 6,295 |   | 7,604 |   | 15,832 |   |
| Inventory revaluation                          |       | 525                                                                |       | — |   | — |   | 913 |   | 8,092 |   |
| Total cost of sales                            |       | 4,537                                                              |       | 7,286 |   | 6,295 |   | 8,517 |   | 23,924 |   |
| Gross Profit                                   |       | 2,532                                                              |       | 7,316 |   | 4,828 |   | 3,694 |   | 1,482 |   |
| Operating expenses:                            |       |                                                               |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative            |       | 4,213                                                              |       | 5,596 |   | 4,872 |   | 8,556 |   | 10,864 |   |
| Research and development                       |       | 1,980                                                              |       | 2,841 |   | 2,351 |   | 4,214 |   | 7,859 |   |
| Amortization of intangible assets              |       | —                                                             |       | — |   | — |   | — |   | 2,632 |   |
| Write-down of impaired intangible assets       |       | —                                                             |       | — |   | — |   | — |   | 9,298 |   |
| Restructuring charges                          |       | 107                                                                |       | 35 |   | 266 |   | 207 |   | 2,444 |   |
| Loss from operations                           |       | (3,768                                                             | )          | (1,156 | ) | (2,661 | ) | (9,283 | ) | (31,615 | ) |
| Other income                                   |       | (1,335                                                             | )          | (892 | ) | (1,007 | ) | (1,047 | ) | 196 |   |
| Loss before income taxes                       |       | (5,103                                                             | )          | (2,048 | ) | (3,668 | ) | (10,330 | ) | (31,419 | ) |
| Income tax provision                           |       | —                                                             |       | — |   | — |   | — |   | — |   |
| Net income (loss)                              |       | $                                                                  | (5,103     | ) | $ | (2,048 | ) | $ | (3,668 | ) | $ | (10,330 | ) | $ | (31,419 | ) |
| Basic earnings (loss) per share                |       | $                                                                  | (0.20      | ) | $ | (0.08 | ) | $ | (0.21 | ) | $ | (0.73 | ) | $ | (2.24 | ) |
| Diluted earnings (loss) per share              |       | $                                                                  | (0.20      | ) | $ | (0.08 | ) | $ | (0.21 | ) | $ | (0.73 | ) | $ | (2.24 | ) |
| Weighted average shares outstanding:           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                          |       | 25,894                                                             |       | 25,013 |   | 17,606 |   | 14,125 |   | 14,027 |   |
| Diluted                                        |       | 25,894                                                             |       | 25,013 |   | 17,606 |   | 14,125 |   | 14,027 |   |
| **Selected Balance Sheet Data:**               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                      |       | $                                                                  | 77         |   | $ | 166 |   | $ | 1,078 |   | $ | 1,560 |   | $ | 11,086 |   |
| Working capital                                |       | (188                                                               | )          | 1,737 |   | 1,618 |   | 2,861 |   | 12,907 |   |
| Total assets                                   |       | 4,546                                                              |       | 6,122 |   | 7,194 |   | 7,753 |   | 21,341 |   |
| Long-term debt                                 |       | 3,683                                                              |       | 1,458 |   | 195 |   | — |   | 33 |   |
| Convertible notes                              |       | 3,630                                                              |       | 3,630 |   | 7,340 |   | 10,000 |   | 10,000 |   |
| Total stockholders equity (deficit)            |       | $                                                                  | (7,056     | ) | $ | (2,676 | ) | $ | (5,026 | ) | $ | (5,794 | ) | $ | 4,377 |   |

 

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**ITEM 7. Management’s Discussion and Analysis ofResults of Operations and Financial Condition**

 

*ThisReport on Form 10-K contains forward-looking statements that have beenmade pursuant to the provisions of the Private Securities Litigation Reform Actof 1995. These forward-looking statements are not historical facts, but ratherare based on our current expectations, estimates and projections about thesemiconductor capital equipment industry, and our beliefs and assumptions. Weintend words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,”“estimates” and similar expressions to identify forward-looking statements. Thesestatements are not guarantees of future performance and are subject to certainrisks, uncertainties and other factors, some of which are beyond our controland are difficult to predict. These factors could cause actual results todiffer materially from those expressed or forecasted in the forward-lookingstatements. These risks and uncertainties are described in Item 1A andelsewhere in this report on Form 10-K. We caution you not to place unduereliance on these forward-looking statements, which reflect our management’sview only as of the date of this Report on Form 10-K. We are not obligatedto update these statements or publicly release the result of any revisions tothem to reflect events or circumstances after the date of this Report on Form 10-Kor to reflect the occurrence of unanticipated events.*

 

**Overview**

 

We supply equipment automation solutions for the globalsemiconductor test and assembly manufacturing market. Our solutions includeautomated test handlers, factory automation software and our new integratedSmart Solutions equipment product line. We believe that our products cansignificantly improve the productivity, yield and throughput of the back-end,or to the post-wafer manufacturing process, including assembling, packaging,testing and singulating semiconductor devices.

 

Beginning in 1999 and continuing into 2000, webroadened our strategy from that of a test handler manufacturer to becoming aprovider of comprehensive equipment automation solutions for the back-end ofthe semiconductor manufacturing process. First, we developed and introduced in February 1999our Tapestry strip handler. Tapestry combines strip handling capability withrobotics, machine vision technology and critical software, enabling the testingand tracking of semiconductor devices in strip form and the generation ofcritical process data throughout the test process. Second, in June 1999 weacquired the Infinity Systems division of Fico. Infinity Systems has beeninvolved in the development of factory automation software for thesemiconductor manufacturing industry. Infinity Systems’ software expertise wasintegral to the development of our integrated Smart Solutions equipment productline, introduced in May 2000. Together with a third party tester, ourSmart Solutions equipment products including our Tapestry handler enablecomplete automation of the test, laser mark, mark inspect and other processesof the back end.

 

The demand for our products and services is dependent upongrowth in the semiconductor industry and the increasing automation needs ofsemiconductor manufacturers and independent test and assembly facilities. Inthe fourth quarter of 2000, the semiconductor industry went into a sharpdownturn, which continued through 2005. At this juncture, the return tosustained market growth cannot be predicted in the short term. As we havedisclosed in our Form 10-K for the year ended December 31, 2004 and2003 and each of our Forms 10-Q for the first three quarters of 2005 and 2004,a continued or renewed market downturn might result in significant losses,charges for inventory revaluation, or asset impairment or restructuring charges.Consequently, in response to these changing market conditions, in addition tothe actions taken in 2003, we took the following additional steps in 2004 and2005.

 

*Workforce and Facility Cost Reductions*

 

During the second quarter of 2005, in responseto the continuing downturn in the semiconductor capital equipment market, wereduced our workforce across all functional areas by approximately 7% resultingin a restructuring charge of $66,000. This charge reflected severance and otherbenefit costs associated with this reduction. This workforce reduction affecteda total of seven employees across all functional areas.

 

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During the third quarter of 2005, in connectionwith our restructuring activities, we reduced our workforce withinmanufacturing and sales by approximately 2% resulting in a restructuring chargeof $40,000. This charge reflected severance and other benefit costs associatedwith this reduction. This workforce reduction affected a total of twoemployees.

 

During the fourth quarterof 2004, we reduced our manufacturing workforce by 11% at the time, resultingin a restructuring charge of $35,000. This charge reflected severance and otherbenefit costs associated with the reduction. This workforce reduction affecteda total of 12 employees all within the manufacturing area.

 

Duringthe first quarter of 2003, in response to the continued and prolonged downturnin the semiconductor capital equipment industry, we reduced our workforceacross all functional areas by approximately 24% at the time, resulting in arestructuring charge of $19,000. This charge reflected severance and otherbenefit costs associated with this reduction. This workforce reduction affecteda total of 26 employees across all functional areas.

 

During the second quarter of 2003, we completed therestructuring of our master lease for our St. Paul, MN facility, resulting in arestructuring charge of $227,000, which included write-offs of $41,000 relatedto leasehold improvements in the vacated space which provided no futureeconomic benefit to us. Additionally, we further reduced our workforce acrossall functional areas by approximately 4% at the time, resulting in a restructuringcharge of $20,000. This charge reflected severance and other benefit costsassociated with this reduction. This workforce reduction affected a total offour employees across all functional areas.

 

*Financing transactions*

 

On March 7, 2003 and March 26, 2003, pursuant to aprivate equity placement with a group of accredited investors, we issued atotal of 3,166,869 shares of common stock, which resulted in net proceeds to usof approximately $1.1 million. Stock issuance costs associated with thisoffering totaled approximately $241,000. As part of this offering, we alsoissued warrants to purchase 253,350 shares of common stock that have a term offive years with an exercise price of $0.43 per share.

 

On June 30, 2003, we completed therestructuring of $9.29 million, or 92.9%, of our 10% Senior SubordinatedConvertible Notes, wherein the participating noteholders agreed to accept stockin lieu of cash for the next four semi-annual interest payment dates beginning June 30,2003 through December 31, 2004, and the conversion price was lowered to$1.00 per share. On February 25, 2005, we completed a secondamendment to the agreement with the holders of our 10% Senior SubordinatedConvertible Notes, wherein holders of 80% of the remaining Notes, representing$2.9 million, agreed to continue to accept stock in payment of interest for theremaining four interest payments through December 24, 2006. The conversionprice was then reduced to $0.85 per share. On April 29, 2005, we completedanother financing transaction with Laurus. As a result of the new financingwith Laurus, the conversion price for all of the Noteholders who accepted theprior restructuring agreements was at that time reduced to $0.61 per share.

 

In July of 2003, wecompleted negotiations with the majority of our vendors to extend the paymentterms of the total amounts owed to them at the time. This resulted in $1.2million of our payables, or 67% of our total accounts payable at the time,being restructured with a total of 281 vendors. Under the terms of the extendedpayment plan, we have agreed to make four to eight equal payments beginning on July 30,2003 until the balances are satisfied. The number of vendors agreeing to thisplan represented approximately 61% of our active vendors. As of December 31,2003, all scheduled payments have been made in accordance with the terms of theextended payment plan.

 

On March 9,2004, we completed a $5.0 million financing transaction with an institutionallender, Laurus Master Fund, Ltd. (“Laurus”), secured by all of the assets ofthe Company. The financing included a $3.0 million working capital line ofcredit and a $2.0 million long-term note. The notes were partially convertibleinto shares of our common stock. In connection with the transaction, we issuedto Laurus a seven-year warrant to purchase 400,000 shares of common stock atexercise prices ranging from $2.30 to $2.88 per share. The secured loan inexistence at that time with a prior lender was terminated.

 

18

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On January 28,2005, we completed an amendment to the financing agreement with Laurus to deferpayments on the long-term convertible note. As part of this amendment, theconversion prices on both notes were reduced. We also issued Laurus at thattime a seven-year warrant to purchase 150,000 shares of common stock at $.67per share.

 

On April 29,2005, we completed another financing transaction with Laurus in which we borrowedan additional $2.5 million, and which was convertible into shares of commonstock. We also issued Laurus at that time an option to purchase 2,556,651shares of common stock at an exercise price of $.01 per share. We received netproceeds of approximately $2.4 million at the closing.

 

OnFebruary 17, 2006, we again restructured the financing with Laurus, andincreased the total maximum secured indebtedness with Laurus to $9.25 million. Therestructured financing now includes a $5.25 million term note. Interest ispayable monthly on the term note at the prime rate plus 2.5%. Beginning 360days after closing, we are required to make monthly payments equal to 1/60th ofthe principal amount until three years after the closing, at which time theentire remaining principal and accrued interest is due and payable in full. Thenote is non-convertible. In addition to the $5.25 million note, the workingcapital line of credit was increased from $3.0 million to $4.0 million, andmade non-convertible. The note is payable in full on March 8, 2008. Interestis payable monthly on the note at the prime rate plus 2.5%. The existing $1.2million over-advance in excess of the borrowing base on the working capitalline of credit was extended until April 30, 2007. However, commencing on December 1,2006, the over-advance is to be reduced by $200,000 each month. The Companyalso issued Laurus a 10-year option to purchase 2,500,000 shares at an exerciseprice of $.01 per share. The shares issuable upon exercise of the option havestandard registration rights. As a result of the new financing with Laurus, theconversion price for all of the Noteholders who accepted the priorrestructuring agreements has been reduced to $0.56 per share.

 

Most industry forecastsare presently predicting that capacity-driven purchases of capital equipmentare expected to improve in 2006. However, the level of improvement and theability for the market to sustain an improvement continues to be uncertain. Therefore,we will continue to monitor the market and if required, examine opportunitiesto further reduce our costs through further consolidation of operations,limiting capital expenditures, monitoring inventory purchases and additionalstrategic restructuring initiatives. Certain of these types of actions have thepotential for further charges in future periods. The impact of a continuingcontraction of the semiconductor capital equipment market has the potential tohave a material adverse effect on our financial condition, results ofoperations, and cash flows.

 

**CriticalAccounting Policies**

 

*Revenue Recognition*

 

Under SAB 104, we recognize revenueupon shipment, as our terms are FOB shipping point, for established equipmentproducts that have previously satisfied existing customer performance specificationsand that provide for full payment tied to shipment. Revenue for products thathave not previously satisfied customer performance specifications or from saleswhere all or a portion of customer payment is based upon acceptance are onlyrecognized upon customer acceptance. As such, in periods of increasingshipments, revenues will be deferred if the shipments are for new customers,new products or the payment terms are tied to acceptance criteria. Consequently,if these conditions exist, we may report revenue levels that are notreflective of actual shipment growth rates. Conversely, in periods ofdecreasing shipments, we potentially could recognize revenues related toshipments made in prior periods. Consequently, if these conditions exist, we may reportrevenue levels that are greater than actual shipments. During the year ended December 31,2005, revenue recorded approximated shipments.

 

19

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*Allowance for Doubtful Accounts*

 

We record a provision fordoubtful accounts based on specific identification of our accounts receivable.This involves a degree of judgment based on discussion with our internal salesand marketing groups, our customer base and the examination of the financialstability of our customers. There can be no assurance that our estimates willmatch actual amounts ultimately written off. During periods of downturn in themarket for semiconductor capital equipment or economic recession, a greaterdegree of risk exists concerning the ultimate collectability of our accountsreceivable due to the impact that these conditions might have on our customerbase. For the year ended December 31, 2005, we recorded a provision of$46,000 and charged approximately $113,000 against the allowance for accountsreceivable write-offs that we deemed to be uncollectible.

 

*Valuation of Inventories*

 

Ourinventories are stated at the lower of cost or market. Cost is determined bythe first-in, first-out (“FIFO”) method. We maintain a standard costing systemfor our inventories. Assumptions with respect to direct labor utilization,standard direct and indirect cost rates, vendor pricing and utilization offactory capacities are formulated in the development of our standard costingsystem. Sudden or continuing changes in the semiconductor capital equipmentmarket affecting our shipments can result in significant production variancesfrom our standard rates. These variances directly impact our gross profit performanceand may cause variability in gross profits results from reportingperiod-to-reporting period. Our labor and overhead rates are set for productionrates that match typical market conditions. Production variances are charged tocost of sales each quarter as incurred. Material standards are based upon normalpurchase volumes. Purchase price variances are charged to costs of sales eachquarter as incurred.

 

Provisions to reduceinventories to the lower of cost or market are made based on a review of excessand obsolete inventories through an examination of historical componentconsumption, current market demands and shifting product technology. Significantassumptions with respect to market trends and customer product acceptance areutilized to formulate our provision methods. Sudden or continuing downwardchanges in the semiconductor capital equipment market may cause us torecord additional inventory revaluation charges in future periods. For the yearended December 31, 2005, we recorded an additional inventory reserve of$525,000. No write-down of our inventories occurred for the year ended December 31,2004 or 2003.

 

*Accrued Warranty*

 

Weprovide a standard thirteen month warranty program for our equipment products.We record provisions for warranty claims for these products based uponhistorical claim performance. This approach has been applied since theinception of the warranty program and involves a degree of subjectivity in thathistorical performance is used to estimate future warranty claims. There can beno assurance that our estimates will match the actual amount of future warrantyclaims.

 

**Resultsof Operations**

 

Thefollowing table sets forth, for the periods indicated, certain items in ourstatements of operations as a percentage of net sales:

 
| ** **                         | ** ** | **Years Ended** | ** ** |
|------------------------------------|------------|----------------------|------------|
| ** **                         | ** ** | **Dec. 31,**    | ** ** | **Dec. 31,** | ** ** | **Dec. 31,** | ** ** |
| ** **                         | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                          |       | 100.0                | %          | 100.0 | % | 100.0 | % |
| Cost of sales                      |       | 64.2                 |       | 49.9 |   | 56.6 |   |
| Gross profit                       |       | 35.8                 |       | 50.1 |   | 43.4 |   |
| Operating expenses:                |       |                 |       |   |   |   |   |
| Selling, general and adminstrative |       | 59.6                 |       | 38.3 |   | 43.8 |   |
| Research and development           |       | 28.0                 |       | 19.5 |   | 21.1 |   |

 

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| Restructuring charge     |   | 1.5   |   | 0.2   |   | 2.4   |   |
|--------------------------|--------|-------|--------|-------|--------|-------|--------|
| Total operating expenses |   | 89.1  |   | 58.0  |   | 67.3  |   |
| Loss from operations     |   | (53.3 | )      | (7.9  | )      | (23.9 | )      |
| Other expense            |   | (18.9 | )      | (6.1  | )      | (9.1  | )      |
| Net loss                 |   | (72.2 | )%     | (14.0 | )%     | (33.0 | )%     |

 

***Year Ended December 31, 2005 versus Year Ended December 31,2004***

 

*Net Sales.*Net sales for the year ended December 31,2005 decreased $7.5 million or 51.6% to $7.1 million, compared to net sales of$14.6 million for the prior year. Current year product sales continued to beseverely impacted by the continued downturn in the semiconductor capitalequipment market. Sales of our Tapestry and Smart Solutions strip-basedproducts decreased $4.9 million or 60.0% over the prior year period, whilesales of singulated device handler products also decreased $2.4 million or53.5% from the prior year period. Sales of our Tapestry and Smart Solutionsstrip-based product made up 46.0% of our net sales for the year ended December 31,2005 compared to 54.6% in the prior year period. If the market continues to bein this downturn, net sales would be adversely impacted in future periods.

 

Net sales to Asia comprised approximately 78.5% of our netsales for the year ended December 31, 2005. Net sales to customers in theUnited States represented approximately 17.1% and net sales to customers inEurope represented approximately 4.4% for year ended December 31, 2005. Comparatively,net sales to customers in Asia comprised approximately 72.8% of our net salesfor the year ended December 31, 2004. Net sales to customers in the UnitedStates represented approximately 19.0% and net sales to customers in Europerepresented approximately 8.2% for year ended December 31, 2004.

 

*GrossProfit.*Gross profit decreased $4.8 million to $2.5 millionor 35.8% of net sales from $7.3 million or 50.1% of net sales, for thecomparable period in the prior year. The decrease in gross margin is directlyrelated to the $525,000 additional inventory reserve recorded at the end of theyear along with the decline in sales, resulting in fixed costs being spreadover smaller sales volumes. Additionally, for the year ended December 31,2004, we benefited from approximately $1.5 million in gross margin dollarsresulting from sales of products that had been previously written down to lowerof cost or market. However, a continued contraction of the market forsemiconductor capital equipment as well as changes in sales mix wouldnegatively impact our gross margin contribution in future periods.

 

*Selling,General and Administrative Expense.*Selling, general andadministrative expense in 2005 was $4.2 million, or 59.6% of net sales comparedto $5.6 million, or 38.2% of net sales in the prior year. The decrease inexpense for the current year is a result of restructuring efforts that havebeen completed during 2003, 2004, and 2005. Although the expenses have beenreduced, the percentage to net sales is higher than the prior year due toexpenses being spread over lower net sales. Selling, general and administrativeexpense is expected to remain fairly flat in 2006 from 2005 due to expensecutting measures and the continuing retraction in the semiconductor capitalequipment market.

 

*Researchand Development Expense*. Research and development expense in2005 was $2.0 million, or 28.0% of net sales compared to $2.4 million, or 19.5%of net sales in 2004. The decrease in expense for the current year is a directresult of certain development activities that have been completed during theyear. The increase in percent of sales over prior year is directly related tothe spread of expenses over a lower net sales amount. We expect research anddevelopment expenses to be slightly higher in 2006 due to the anticipation ofnew product development projects, subject to impacts resulting from market requirements.

 

*RestructuringCharge.*Due to the continuing retraction of the semiconductorcapital equipment market in 2005, we reduced our workforce across allfunctional areas by approximately 7% in the second quarter and 2% in the thirdquarter. The restructuring charge totaled $107,000 or 1.5% of net sales for thecurrent year period. This charge reflected severance and other benefit costsassociated with the reduction. This workforce reduction affected a total of 9employees.

 

21

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*OtherIncome (Expense).*Interest income for the year ended December 31,2005 was $13,000 compared to $6,000 for the comparable period in the prior year.This increase resulted from a slight rate increase in investment in interest-bearingcash and cash equivalents. Interest expense and other totaled $1.3 million or18.9% of net sales in the current year, compared to $0.9 million or 5.9% of netsales for the comparable period in the prior year. The increase in interestexpense and other relates to the write-off of cumulative translation adjustmentof $69,000 and higher average debt levels due to additional financing with aninstitutional lender.

 

*IncomeTax Provision.*During both 2005 and 2004, we incurred minimaltax liabilities. We have recorded valuation allowances against all benefitsassociated with net operating loss carry forwards due to uncertainty regardingtheir ultimate utilization.

 

*Net Loss.*Net loss for the year ended December 31, 2005 was $5.1million, or $0.20 per basic and diluted share, as compared to net loss of $2.0million, or $ 0.08 per basic and diluted share for the comparable prior yearperiod.

 

***Year Ended December 31, 2004 versus Year Ended December 31,2003***

 

*Net Sales.*Net sales for the year ended December 31,2004 increased $3.5 million or 31.3% to $14.6 million, compared to net sales of$11.1 million for the prior year. Product acceptance requirements related toproduct and customer mix resulted in a net increase to revenues of less than$0.1 million over shipments for the year ended December 31, 2004, whilethese same factors caused a net increase to revenues of $.01 million overshipments in 2003. Sales of our Tapestry and Smart Solutions strip-basedproducts increased $2.5 million or 44.6% over the prior year period, whilesales of singulated device handler products also increased $0.9 million or86.9% from the prior year period. Sales of our Tapestry and Smart Solutionsstrip-based product made up 54.6% of our net sales for the year ended December 31,2004 compared to 49.6% in the prior year period.

 

Net sales to Asia comprised approximately 72.8% of our netsales for the year ended December 31, 2004. Net sales to customers in theUnited States represented approximately 19.0% and net sales to customers inEurope represented approximately 8.2% for year ended December 31, 2004. Comparatively,net sales to customers in Asia comprised approximately 62.8% of our net salesfor the year ended December 31, 2003. Net sales to customers in the UnitedStates represented approximately 33.5% and net sales to customers in Europerepresented approximately 3.7% for year ended December 31, 2003.

 

*GrossProfit.*Gross profit increased $2.5 million to $7.3 millionor 50.1% of net sales from $4.8 million or 43.4% of net sales, for thecomparable period in the prior year. The increase in gross margin in 2004period primarily resulted from the many restructuring efforts that we havecompleted during 2003 coupled with our lower cost of operations associated withour Penang, Malaysia facility and higher net sales levels. This has resulted inlower fixed costs being spread over a larger number of products contributing tothe overall improvement in gross profit performance. Additionally, for the yearended December 31, 2004, we benefited from approximately $1.5 million ingross margin dollars resulting from sales of products that had been previouslywritten down to lower of cost or market. However, the recent contraction of themarket for semiconductor capital equipment has the potential to negativelyimpact our gross margin contribution in future periods as well as changes insales mix.

 

*Selling,General and Administrative Expense.*Selling, general and administrativeexpense in 2004 was $5.6 million, or 38.3% of net sales compared to $4.9million, or 43.8% of net sales in the prior year. The increase in expense for2004 was a result of the costs required in connection with the higher net saleslevels. However, the expense increases were at a lower rate than the increasein net sales, resulting in a decline in the percentage to sales. Selling,general and administrative expense is expected to decline in 2005 from 2004 levelsdue the recent retraction in the semiconductor capital equipment market.

 

*Researchand Development Expense*. Research and development expense in2004 was $2.8 million, or 19.5% of net sales compared to $2.4 million, or 21.1%of net sales in 2003. The increase in expense for 2004 was a direct result ofcertain development activities that resulted in the introduction of new productand existing product 

 

22

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enhancements during theyear. However, the expense increases were at a lower rate than the increase innet sales, resulting in a decline in the percentage to sales.

 

*RestructuringCharge.*Due to the retraction of the semiconductor capitalequipment market in the second half of 2004, we reduced out workforce by 11%. Therestructuring charge totaled $35,000 or 0.2% of net sales for the 2004 year. Thischarge reflected severance and other benefit costs associated with the reduction.This workforce reduction affected a total of 12 employees all within themanufacturing area.

 

*OtherIncome (Expense).*Interest income for the year ended December 31,2004 was $6,000 compared to $5,000 for the comparable period in the prior year.This decrease resulted from the decrease in investment in interest-bearing cashand cash equivalents. Interest expense and other totaled $0.9 million or 6.2%of net sales in 2004 year, compared to $1.2 million or 11.0% of net sales forthe comparable period in the prior year. The decline in interest expense andother resulted from lower average debt levels due to conversions of our 10%senior convertible debt. In connection with the transfer of our manufacturingoperations to Penang, we sold certain fixed and other assets from our St. Paul,Minnesota facility resulting in a gain on sale of $209,000 or 1.9% of net salesfor the year ended December 31, 2003. For the year ended December 31,2004, certain assets were disposed of resulting in a loss on sale of $12,000.

 

*IncomeTax Provision.*During both 2004 and 2003, we incurred minimaltax liabilities. We have recorded valuation allowances against all benefitsassociated with net operating loss carry forwards due to uncertainty regardingtheir ultimate utilization.

 

*Net Loss.*Net loss for the year ended December 31, 2004 was $ 2.0million, or $0.08 per basic and diluted share, as compared to net loss of $3.7million, or $ 0.21 per basic and diluted share for the comparable prior yearperiod.

 

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***QuarterlyResults***

 

Thefollowing tables present selected unaudited quarterly operating results for theeight fiscal quarters ended December 31, 2005, as well as the dataexpressed as a percentage of net sales. We believe that all necessaryadjustments have been included to present fairly the quarterly information whenread in conjunction with our consolidated financial statements. The operatingresults for any quarter are not necessarily indicative of the results for anysubsequent period.

 
| ** **                                                         | ** ** | **(in thousands, except per share data)** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **Quarter Ended**                                             | ** ** |
| ** **                                                         | ** ** | **Dec. 31**                                                   | ** ** | **Sept. 24** | ** ** | **June 25** | ** ** | **Mar.26** | ** ** | **Dec. 31** | ** ** | **Sept. 25** | ** ** | **June 26** | ** ** | **Mar. 27** | ** ** |
| ** **                                                         | ** ** | **2005**                                                           | ** ** | **2005** | ** ** | **2005** | ** ** | **2005** | ** ** | **2004** | ** ** | **2004** | ** ** | **2004** | ** ** | **2004** | ** ** |
| Net sales                                                          |       | $                                                                  | 2,029      |   | 1,758 |   | $ | 1,322 |   | $ | 1,960 |   | $ | 2,252 |   | $ | 3,859 |   | $ | 4,223 |   | $ | 4,268 |   |
| Cost of sales                                                      |       | 1,627                                                              |       | 984 |   | 869 |   | 1,057 |   | 1,394 |   | 1,902 |   | 2,015 |   | 1,975 |   |
| Gross profit loss                                                  |       | 402                                                                |       | 774 |   | 453 |   | 903 |   | 858 |   | 1,957 |   | 2,208 |   | 2,293 |   |
|                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating expenses:                                                |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative                                |       | 992                                                                |       | 945 |   | 1,145 |   | 1,131 |   | 1,544 |   | 1,442 |   | 1,337 |   | 1,273 |   |
| Research and development                                           |       | 466                                                                |       | 435 |   | 491 |   | 588 |   | 731 |   | 788 |   | 673 |   | 649 |   |
| Restructuring charge                                               |       | 1                                                                  |       | 40 |   | 66 |   | — |   | 35 |   | — |   | — |   | — |   |
|                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from operations                                      |       | (1,057                                                             | )          | (646 | ) | (1,249 | ) | (816 | ) | (1,452 | ) | (273 | ) | 198 |   | 371 |   |
|                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other expense                                                      |       | (445                                                               | )          | (346 | ) | (307 | ) | (237 | ) | (305 | ) | (203 | ) | (189 | ) | (195 | ) |
|                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                                  |       | $                                                                  | (1,502     | ) | $ | (992 | ) | $ | (1,556 | ) | $ | (1,053 | ) | $ | (1,757 | ) | $ | (476 | ) | $ | 9 |   | $ | 176 |   |
|                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss) per share: (1)                                   |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                              |       | $                                                                  | (0.06      | ) | $ | (0.04 | ) | $ | (0.06 | ) | $ | (0.04 | ) | $ | (0.07 | ) | $ | (0.02 | ) | $ | 0.00 |   | $ | 0.01 |   |
| Diluted                                                            |       | $                                                                  | (0.06      | ) | $ | (0.04 | ) | $ | (0.06 | ) | $ | (0.04 | ) | $ | (0.07 | ) | $ | (0.02 | ) | $ | 0.00 |   | $ | 0.01 |   |
|                                                               |       |
| Weighted average common and common equivalent shares  outstanding: |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                              |       | 26,215                                                             |       | 26,187 |   | 25,567 |   | 25,567 |   | 25,269 |   | 25,237 |   | 25,120 |   | 24,336 |   |
| Diluted                                                            |       | 26,215                                                             |       | 26,187 |   | 25,567 |   | 25,567 |   | 25,269 |   | 25,237 |   | 28,585 |   | 27,985 |   |

 
| ** **                          | ** ** | **Quarter Ended** | ** ** |
|-------------------------------------|------------|-------------------|------------|
| ** **                          | ** ** | **Dec. 31**  | ** ** | **Sept. 24** | ** ** | **June 25** | ** ** | **Mar. 26** | ** ** | **Dec. 31** | ** ** | **Sept. 25** | ** ** | **June 26** | ** ** | **Mar. 27** | ** ** |
| ** **                          | ** ** | **2005**          | ** ** | **2005** | ** ** | **2005** | ** ** | **2005** | ** ** | **2004** | ** ** | **2004** | ** ** | **2004** | ** ** | **2004** | ** ** |
| **Percentage of Net Sales:**        |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net sales                           |       | 100.0             | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
| Cost of sales                       |       | 80.2              |       | 56.0 |   | 65.7 |   | 53.9 |   | 61.9 |   | 49.3 |   | 47.7 |   | 46.3 |   |
| Gross profit                        |       | 19.8              |       | 44.0 |   | 34.3 |   | 46.1 |   | 38.1 |   | 50.7 |   | 52.3 |   | 53.7 |   |
| Operating expenses:                 |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative |       | 48.9              |       | 53.8 |   | 86.6 |   | 57.7 |   | 68.6 |   | 37.4 |   | 31.7 |   | 29.8 |   |
| Research and development            |       | 22.9              |       | 24.7 |   | 37.1 |   | 30.0 |   | 32.5 |   | 20.4 |   | 15.9 |   | 15.2 |   |
| Restructuring charge                |       | 0.1               |       | 2.3 |   | 5.0 |   | — |   | 1.6 |   | — |   | — |   | — |   |
| Income (loss) from operations       |       | (52.1             | )          | (36.8 | ) | (94.4 | ) | (41.6 | ) | (64.6 | ) | (7.1 | ) | 4.7 |   | 8.7 |   |
| Other expense                       |       | (22.0             | )          | (19.7 | ) | (23.2 | ) | (12.1 | ) | (13.5 | ) | (5.2 | ) | (4.4 | ) | (4.6 | ) |
| Net income (loss)                   |       | (74.1             | )%         | (56.5 | )% | (117.6 | )% | (53.7 | )% | (78.1 | )% | (12.3 | )% | 0.3 | % | 4.1 | % |

 

24

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(1)   The sum of income(loss) per share for the fiscal quarters may differ from annual loss pershare due to the required method of computing weighted average number of sharesin the respective periods.

 

***Liquidity and Capital Resources***

 

The net loss and decreases in accounts payable were theprimary uses of cash in 2005. The net loss and decreases in accounts payableand other accrued liabilities were the primary uses of cash in 2004. The netloss and increase in accounts receivable were the primary uses of cash in 2003.Cash used in operations was $3.2 million, $3.4 million and $2.2 million in2005, 2004 and 2003, respectively.

 

Werecord provisions for doubtful accounts based on specific identification of ouraccounts receivable. As a result of this examination, no provisions wererecorded for the year ended December 31, 2005; however, we wrote offapproximately $113,000, which we deemed uncollectible. We recorded noprovisions for doubtful accounts for the years ended December 31, 2004 andDecember 31, 2003, respectively.

 

Capitalexpenditures totaled $35,000, $149,000 and $111,000 for the years ended December 31,2005, 2004 and 2003, respectively. Capital purchases for all periods have beenprimarily for production and computer equipment and for leasehold improvements.As of December 31, 2005, we had approximately $0.45 million in committedpurchase orders outstanding with our vendors and budgeted capital expendituresfor 2006 is approximately $0.1 million.

 

On March 7,2003 and March 26, 2003, pursuant to a private equity placement with agroup of accredited investors, we issued a total of 3,166,869 shares of commonstock, which resulted in net proceeds to us of approximately $1.1 million. Stockissuance costs associated with this offering totaled approximately $241,000. Aspart of this offering, we also issued warrants to purchase 253,350 sharesof common stock that have a term of five years with an exercise price of $0.43per share.

 

OnJune 30, 2003, we completed the restructuring of $9.29 million, or 92.9%,of our 10% Senior Subordinated Convertible Notes, wherein the participating noteholdersagreed to accept stock in lieu of cash for the next four semi-annual interestpayment dates beginning June 30, 2003 through December 31, 2004. $10.0million of the Notes were originally issued in December 2001, resulting inproceeds to us of $9.2 million. As part of this restructuring, the Companyamended the Notes of the participating noteholders to reduce the conversionprice from $2.60 per share to $1.00 per share for the remainder of the termthrough December 2006. The agreement also included standard anti-dilutionprovisions, and required the Company to register the shares with the Securitiesand Exchange Commission. On February 25,2005, we completed a second amendment to the agreement with the holders of our10% Senior Subordinated Convertible Notes, wherein holders of 80% of theremaining Notes, representing $2.9 million, agreed to continue to accept stockin payment of interest for the remaining four interest payments through December 24,2006. The conversion price was then reduced to $0.85 per share. OnApril 29, 2005, we completed another financing transaction with Laurus. Asa result of the new financing with Laurus, the conversion price for all of theNoteholders who accepted the prior restructuring agreements was at that timereduced to $0.61 per share. As of December 31, 2005, $6.4 million of theNotes have been converted to equity under this agreement, resulting in theissuance of 6,370,081 shares of our common stock to the noteholders.

 

In July of 2003, wecompleted negotiations with the majority of our vendors to extend the paymentterms of the total amounts owed to them at the time. This resulted in $1.2million of our payables, or 67% of our total accounts payable at the time,being restructured with a total of 281 vendors. Under the terms of the extendedpayment plan, we have agreed to make four to eight equal payments beginning on July 30,2003 until the balances are satisfied. The number of vendors agreeing to thisplan represented approximately 61% of our active vendors. As of December 31,2005, allscheduled contractual payments have been made under this plan.

 

On March 9,2004 we completed a $5.0 million secured financing transaction with aninstitutional lender. Under the terms of the three-year agreement, we put inplace a $3.0 million secured working capital line of credit and a $2.0long-term convertible note. In connection with the execution of this creditfacility, we issued to the lender a seven-year warrant to purchase 400,000shares of our common stock at exercise prices ranging from 

 

25

----

 

$2.30 to $2.88. Ourexisting secured lending relationship was terminated as a result of thistransaction. This credit facility is secured by all the assets of the Company.

 

On January 28,2005, we completed an amendment to the financing agreement with Laurus to deferpayments on the long-term convertible note. As part of this amendment, theconversion prices on both notes were reduced. We also issued Laurus at thattime a seven-year warrant to purchase 150,000 shares of common stock at $.67per share.

 

On April 29,2005, we completed another financing transaction with Laurus in which weborrowed an additional $2.5 million, and which was convertible into shares ofcommon stock. We also issued Laurus at that time an option to purchase2,556,651 shares of common stock at an exercise price of $.01 per share. Wereceived net proceeds of approximately $2.4 million at the closing.

 

OnFebruary 17, 2006, we again restructured the financing with Laurus, andincreased the total maximum secured indebtedness with Laurus to $9.25 million. Therestructured financing now includes a $5.25 million term note. Interest ispayable monthly on the term note at the prime rate plus 2.5%. Beginning 360days after closing, we are required to make monthly payments equal to 1/60th ofthe principal amount until three years after the closing, at which time theentire remaining principal and accrued interest is due and payable in full. Thenote is non-convertible. In addition to the $5.25 million note, the workingcapital line of credit was increased from $3.0 million to $4.0 million, andmade non-convertible. The note is payable in full on March 8, 2008. Interestis payable monthly on the note at the prime rate plus 2.5%. The existing $1.2million over-advance in excess of the borrowing base on the working capitalline of credit was extended until April 30, 2007. However, commencing on December 1,2006, the over-advance is to be reduced by $200,000 each month. The Company alsoissued Laurus a 10-year option to purchase 2,500,000 shares at an exerciseprice of $.01 per share. The shares issuable upon exercise of the option havestandard registration rights. As a result of the new financing with Laurus, theconversion price for all of the Noteholders who accepted the priorrestructuring agreements has been reduced to $0.56 per share.

 

Our contractual obligations are as follows (in thousands):

 
| ** **                                        | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Future rental payments under noncancelable leases |       | $        | 571.0      |     | $          | 259.0    |       | $        | 13.0       |     | —     |           | —     |   | — |   |
|                                              |       |     |       |     |       |     |       |     |       |     |       |           |       |
| Payments due under long term debt agreements      |       | $        | 3,762.9    |     | $          | 1,103.0  |       | $        | 1,050.0    |     | $          | 3,325.0        |       | — |   | — |   |
|                                                   |            |          |            |          |            |          |            |          |            |          |            |                |            |  |  |  |  |

 

Forthe year ended December 31, 2005, no common shares were exercised through employeestock options, warrants and our stock purchase plan. For the year ended December 31,2004, we issued approximately 0.1 million shares of common stock through theexercise of employee stock options and our stock purchase plan, which providedapproximately $21,000 in cash to us. For the year ended December 31, 2003,we issued approximately 0.2 million shares of common stock through the exerciseof employee stock options and our stock purchase plan, which provided approximately$0.2 million in cash to us.

 

We believe that thesetransactions in combination with our existing line of credit will provide thecash necessary to meet our operating, working capital and capital resourceobligations through all of 2006.

 

In thefuture, we estimate that we may need to raise additional capital throughdebt or equity offerings to support the continuing requirements of the businessdue to the retraction of the semiconductor capital equipment market and thepotential impacts on our cash flows and results of operations that couldresult. There is no assurance 

 

26

----

 

that additionalfinancing, if needed, will be available on terms and conditions acceptable orfavorable to us, if at all.

 

**FederalTax Matters**

 

Wepaid only nominal federal and state income taxes in the years ended December 31,2005, 2004 and 2003. At December 31, 2005, we had federal net operatingloss carryforwards for tax reporting purposes of approximately $36.3 millionafter considering annual limitations under Section 382 of the InternalRevenue Code.

 

**ITEM7A . Quantitative And Qualitative Disclosures About Market Risk**

 

The vast majority of our transactions are denominated in U.S.dollars; as such, fluctuations in foreign currency exchange rates have historicallyhad little impact on us. Inflation has not been a significant factor in ouroperations in any of the periods presented, and it is not expected to affectoperations in the future. A 1% increase in interest rates would increase ourinterest expense by $92,500 per year. At December 31, 2005, our 10% SeniorConvertible Notes carried interest at a fixed rate of 10%. Our short termrevolving line of credit and long-term convertible debt carried interest at theprime rate plus 1.75%. The refinancing with Laurus on February 17, 2006changed this rate to prime plus 2.5%. There is no material market risk relatingto our long-term debt.

 

**Impact ofNew Accounting Standards**

 

***SFAS No. 154, Accounting Changes and Error Corrections.***In June 2005,FASB issued SFAS No. 154, “*AccountingChanges and Error Corrections*”, a replacement of APB Opinion No. 20and FASB Statement No. 3. The statement applies to all voluntary changesin accounting principle, and changes the requirements for accounting for andreporting of a change in accounting principle. SFAS No. 154 requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is impracticable. SFAS No. 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. Earlier application is permitted foraccounting changes and corrections of errors made occurring in fiscal yearsbeginning after June 1, 2005. The statement does not change the transitionprovisions of any existing accounting pronouncements, including those that arein a transition phase as of the effective date of this statement. The Companydoes not expect the adoption of SFAS No. 154 to have a material effect onits financial statements.

 

***SFAS No. 123 (revised 2004),Share-Based Payment***. In December 2004, FASB issuedSFAS No. 123 (revised 2004), *Share-BasedPayment*, that focuses primarily on accounting for transactions inwhich an entity obtains employee services in share-based payment transactions. Thisstatement replaces SFAS No. 123, *Accountingfor Stock-Based**Compensation*,and supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees*. Beginning with our quarterly periodthat begins January 1, 2006, we will be required to expense the fair valueof employee stock options and similar awards. As a public company, we areallowed to select from two alternative transition methods, each havingdifferent reporting implications. We do not expect the adoption of SFAS No. 123Rto have a material effect on our financial statements.

 

**ITEM 8. ConsolidatedFinancial Statements and Supplementary Data**

 

SeeConsolidated Financial Statements included elsewhere in this Annual Report on Form 10-Kfor the year ended December 31, 2005. The financial information by quarteris included in Item 7 of this Annual Report on Form 10-K.

 

**ITEM 9. Changesin and Disagreements with Accountants on Accounting and Financial Disclosure**

 

On December 8, 2005, the Registrant’sindependent public accountants, Virchow, Krause & Company, LLP (“VirchowKrause”), formally notified the Registrant that it will resign, effective withthe completion of the audit for the fiscal year ending December 31, 2005.

 

27

----

 

Also on December 8, 2005, the Board ofDirectors, pursuant to the recommendation of the Audit Committee, approved theretention of Olsen, Thielen & Co. Ltd. (“Olsen Thielen”), as theRegistrant’s independent public accountants for the fiscal year ending December 31,2006.

 

The audit report of Virchow Krause on the financial statements of theCompany for the year ended December 31, 2004 contains an explanatoryparagraph that raises substantial doubt about the Registrant’s ability tocontinue as a going concern. The audit reports of Virchow Krause on thefinancial statements of the Registrant for the last two fiscal years ended December 31,2004, did not contain any other adverse opinion or disclaimer of opinion, norwere those opinions otherwise qualified or modified as to audit scope oraccounting principles. During the Registrant’s two most recent fiscal yearsended December 31, 2004, and during the subsequent interim periodpreceding the resignation of Virchow Krause, there was no disagreement betweenthe Registrant and Virchow Krause on any matter of accounting principles orpractices, financial statement disclosure, or auditing scope or procedurewhich, if not resolved to Virchow Krause’s satisfaction, would have causedVirchow Krause to make reference to the subject matter of the disagreement inconnection with its reports. During the Registrant’s two most recent fiscalyears and the subsequent interim period through December 8, 2005, therewere no reportable events, as that term is defined by Item 304 of RegulationS-K.

 

No consultations occurred between the Registrant andOlsen Thielen during the two most recent fiscal years ended December 31,2004, and during the subsequent interim period preceding the resignation ofVirchow Krause, regarding either (1) the application of accountingprinciples to a specified transaction, either completed or proposed, or thetype of audit opinion that might be rendered on the Registrant’s financialstatements, or (2) any matter that was the subject of a disagreement or areportable event.

 

**ITEM9A. Controls and Procedures**

 

(a)     Evaluation ofdisclosure controls and procedures.

 

Underthe supervision and with the participation of our management, including theCompany’s Chief Executive Officer and Chief Financial Officer, we evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rule 13a-15(e) under the Exchange Act) asof the end of the period covered by this report. Based upon that evaluation,the Chief Executive Officer and Chief Financial Officer concluded that, as ofthe evaluation date, our disclosure controls and procedures were not operatingeffectively with respect to the matters referred to in paragraph (b) below, butwere otherwise effective to ensure that the information required to bedisclosed by us in our periodic SEC filings is recorded, processed, summarized,and reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

(b)   Changes ininternal controls over financial reporting.

 

Duringthe course of their audit of our consolidated financial statements for 2005,our independent registered public accounting firm, Virchow, Krause &Company, LLP (Virchow Krause), advised management and the Audit Committee thatour internal controls had allowed an error in the inventory reserve calculationdue to inconsistent treatment of work in process items from 2004 to 2005. Basedon Virchow Krause’s recommendation, management decided that an increase in theinventory reserve of approximately $525,000 was required as of December 31,2005, to reflect a revaluation of excess inventory and adjustments to inventoryconsumption rates. The inventory reserve error had no effect on reportedresults for any of the individual quarters in 2005. As a result of thisexperience, we revised and expanded our procedures for valuations of excessinventory and estimates of inventory consumption rates, and the relatedinternal controls, to involve greater analysis of historical and projectedusage of inventory as well as other data.

 

During the course of their audit, Virchow Krauserecommended changes to certain other of the Company’s controls and procedures,none of which had any impact on the audited financials statements for 2005 orprior years. As of the date of this report, management is in the process ofimplementing changes to these controls and procedures.

 

Therewere no additional changes in our internal control over financial reportingduring the fourth quarter of 2005 that has materially affected, or is reasonablylikely to affect, our internal control over financial reporting.

 

**ITEM 9B. Other Information**

 

This item is not applicable.

 

28

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**PART III**

 

**ITEM 10. Directorsand Executive Officers of the Registrant**

 

The information required by this item concerning directors andexecutive officers is incorporated by reference from the Proxy Statement to befiled no later than 120 days following our December 31, 2005 year-end.

 

**ITEM 11. Executive Compensation**

 

Theinformation required under this item is hereby incorporated by reference fromthe Proxy Statement.

 

**ITEM12. Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters**

 

The information requiredunder this item is hereby incorporated by reference from the Proxy Statement.

 

**ITEM 13. CertainRelationships and Related Transactions**

 

The information required under this item is herebyincorporated by reference from the Proxy Statement.

 

**ITEM14. Principal Accountant Fee and Services**

 

Theinformation required under this item is hereby incorporated by reference fromthe Proxy Statement.

 

**ITEM15. Exhibits, Financial Statement Schedules and Reports on Form 8-K**

 

**(a)1. ConsolidatedFinancial Statements**

 
| Index to  Consolidated Financial Statements                                                                                                                       | F-1  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------|
| Reports of  Independent Registered Public Accounting Firm                                                                                                         | F-2  |
| Consolidated Balance Sheets as of December 31, 2005,  and December 31, 2004                                                                             | F-3  |
| Consolidated  Statements of Operations for the Years Ended December 31, 2005,December 31, 2004,  and December 31, 2003                             | F-4  |
| Consolidated Statements of Changes in Stockholders’ Deficit  for the Years Ended  December 31, 2005, December 31, 2004, and December 31, 2003 | F-5  |
| Consolidated Statements of Cash Flows for the Years Ended December 31,  2005,  December 31, 2004, and December 31, 2003                            | F-6  |
| Notes to Consolidated Financial Statements                                                                                                                        | F-7  |
| Signatures and Certificates                                                                                                                                       | F-23 |

 

**(a)3.Exhibits**

 
| 3A.  | Bylaws of MCT.  (7)                                                                                                             |
|------|---------------------------------------------------------------------------------------------------------------------------------|
| 3B.  | Articles of  Incorporation of MCT. (7)                                                                                          |
| 3C.  | Articles of  Amendment dated March 14, 2002 (11).                                                                          |
| 4.   | Specimen  Certificate of Common stock. (1)                                                                                      |
| 10A. | Form of  Non-Competition Agreement between MCT and certain senior executive officers.  (1)                                 |
| 10B. | Stock Purchase  Agreement and Commission Agreement between MCT and Cardine & Levy,  dated September 25, 1995. (3) |
| 10C. | Employment  Agreement with Roger E. Gower dated March 28, 1995. (2)                                                        |
| 10D. | Employment  Agreement with Dennis L. Nelson dated May 30, 1996. (5)                                                        |
| 10E. | Stock Option  Plan for Outside Directors as amended through April 10, 2001. (10)                                           |
| 10F. | Incentive Stock  Option Plan as amended through April 10, 2001. (10)                                                       |
| 10G. | 2004 Incentive  Stock Plan. (16)                                                                                                |

 

29

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| 10H. | Former Aseco  Corp. 1986 Incentive Stock Option Plan. (9)                                                                                                                                                                                                                                                         |
|------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10I. | Former Aseco  Corp. 1993 Omnibus Stock Plan. (9)                                                                                                                                                                                                                                                                  |
| 10J. | Former Aseco  Corp. 1993 Non-Employee Director Stock Option Plan. (9)                                                                                                                                                                                                                                             |
| 10K. | Lease for MCT’s  corporate headquarters dated October 16, 1996. (6)                                                                                                                                                                                                                                     |
| 10L. | Lease for space  in Marlborough, Massachusetts dated April 13, 1993. (8)                                                                                                                                                                                                                                     |
| 10M. | Employee Stock  Purchase Plan. (4)                                                                                                                                                                                                                                                                                |
| 10U. | Warrant Purchase  Agreement dated July 11, 1992. (1)                                                                                                                                                                                                                                                         |
| 10V. | Second Common  Stock Warrant Purchase Agreement dated August 10, 1993. (1)                                                                                                                                                                                                                                   |
| 10W. | Form of 10%  Senior Subordinated Convertible Note. (11)                                                                                                                                                                                                                                                      |
| 10X. | Agreement for  Payment of Interest with Stock, effective June 30, 2003. (12)                                                                                                                                                                                                                                 |
| 10Y  | Accounts  Receivable Financing Agreement with Silicon Valley Bank (13)                                                                                                                                                                                                                                            |
| 10Z  | Security  Agreement with Laurus Master Fund, Ltd. dated March 9, 2004. (15)                                                                                                                                                                                                                                  |
| 10AA | Securities  Purchase Agreement with Laurus Master Fund, Ltd. dated March 9, 2004.  (15)                                                                                                                                                                                                                      |
| 10BB | Secured  Convertible Minimum Borrowing Note with Laurus Master Fund, Ltd. dated March 9,  2004. (15)                                                                                                                                                                                                         |
| 10CC | Secured  Revolving Note with Laurus Master Fund, Ltd dated March 9, 2004. (15)                                                                                                                                                                                                                               |
| 10DD | Secured  Convertible Term Note with Laurus Master Fund, Ltd dated March 9, 2004.  (15)                                                                                                                                                                                                                       |
| 10EE | Minimum  Borrowing Note Registration Rights Agreement with Laurus Master Fund, Ltd.  dated March 9, 2004. (15)                                                                                                                                                                                               |
| 10FF | Registration  Rights Agreement with Laurus Master Fund, Ltd. dated March 9, 2004. (15)                                                                                                                                                                                                                       |
| 10GG | Common Stock  Purchase Warrant with Laurus Master Fund, Ltd. dated March 9, 2004. (15)                                                                                                                                                                                                                       |
| 10HH | Amendment No. 1 by and between Micro Component  Technology, Inc. and Laurus Master Fund, Ltd. dated January 28,  2005 to Secured Convertible Term Note, Secured Revolving Note, Registration  Rights Agreement and Minimum Borrowing Note Registration Rights Agreement.  (Schedules omitted) (17) |
| 10II | Common  Stock Purchase Warrant with Laurus Master Fund, Ltd. dated January 28,  2005. (17)                                                                                                                                                                                                                   |
| 10JJ | Second  Agreement for Payment of Interest with Stock, effective January 31, 2005  (18).                                                                                                                                                                                                                      |
| 10KK | Security  and Purchase Agreement with Laurus Master Fund, Ltd. effective February 17,  2006 (19).                                                                                                                                                                                                            |
| 10LL | Secured  Non-Convertible Revolving Note with Laurus Master Fund, Ltd effective February 17,  2006 (19).                                                                                                                                                                                                      |
| 10MM | Secured  Non-Convertible Term Note with Laurus Master Fund, Ltd effective February 17,  2006 (19).                                                                                                                                                                                                           |
| 21.  | Revised Listing  of Subsidiaries of Micro Component Technology, Inc. (11).                                                                                                                                                                                                                                   |
| 23.1 | Consent of  Virchow, Krause & Company, LLP (filed herewith).                                                                                                                                                                                                                                             |
| 31.1 | Certification of  Chief Executive Officer (filed herewith).                                                                                                                                                                                                                                                       |
| 31.2 | Certification of  Chief Financial Officer (filed herewith).                                                                                                                                                                                                                                                       |
| 32.0 | Section 1350  Certification (filed herewith).                                                                                                                                                                                                                                                                |

 

----

| (1)    | Incorporated by  reference to the exhibits to the registration statement on Form S-1  filed by MCT on August 24, 1993, as amended, SEC File Number 33-67846.                                     |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                       |
| (2)    | Incorporated by  reference to the report on Form 10-Q filed by MCT for the quarter ended March 25,  1995, SEC File No. 0-22384.                                                             |
|   |                                                                                                                                                                                                       |
| (3)    | Incorporated by  reference to the report on Form 10-Q filed by MCT for the quarter ended September 30,  1995, SEC File No. 0-22384.                                                         |
|   |                                                                                                                                                                                                       |
| (4)    | Incorporated by  reference to the exhibits to the Post-Effective Amendment to Registration  Statement on Form S-8 filed by MCT on July 15, 1996, as amended,  SEC File No. 33-85766.        |
|   |                                                                                                                                                                                                       |
| (5)    | Incorporated by  reference to the exhibits to the report on Form 10-K filed by MCT for  the fiscal year ended June 29, 1996, SEC File No. 0-22384.                                          |
|   |                                                                                                                                                                                                       |
| (6)    | Incorporated by  reference to the report on Form 10-Q filed by MCT for the quarter ended September 28,  1996, SEC File No. 0-22384.                                                         |
|   |                                                                                                                                                                                                       |
| (7)    | Incorporated by  reference to the exhibits to the Post-Effective Amendment No. 1 to the  Registration Statement on Form S-1 filed by MCT on November 18,  1996, SEC File No. 33-98940. |

 

30

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| (8)    | Incorporated by  reference to the Registration Statement on Form S-1, as amended, filed  by Aseco Corporation on January 29, 1993, SEC File No. 33-57644. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                     |
| (9)    | Incorporated by  reference to the exhibits to the Registration Statement on Form S-8  filed by MCT on January 31, 2000, SEC File No. 333-95765.           |
|   |                                                                                                                                                                     |
| (10)   | Incorporated by reference to the definitive proxy  materials for the 2001 Annual Stockholders Meeting, filed April 30,  2001.                                       |
|   |                                                                                                                                                                     |
| (11)   | Incorporated by reference to the report on Form 10-K  filed by MCT for the period ended December 31, 2001, SEC File No. 0-22384.                          |
|   |                                                                                                                                                                     |
| (12)   | Incorporated by reference to the report on Form 10-Q  filed by MCT for the quarterly period ended June 28, 2003, SEC File No. 0-22384.                    |
|   |                                                                                                                                                                     |
| (13)   | Incorporated by reference to the report on Form 10-Q  filed by MCT for the quarterly period ended September 27, 2003, SEC File  No. 0-22384.              |
|   |                                                                                                                                                                     |
| (14)   | Incorporated by reference to the report on Form 10-K  filed by MCT for the period ended December 31, 2002, SEC File No. 0-22384.                          |
|   |                                                                                                                                                                     |
| (15)   | Incorporated by reference to the report on Form 10-K  filed by MCT for the period ended December 31, 2003, SEC File No. 0-22384.                          |
|   |                                                                                                                                                                     |
| (16)   | Incorporated by  reference to the exhibits to the Registration Statement on Form S-8  filed by MCT on July 16, 2004, SEC File No. 333-117407.             |
|   |                                                                                                                                                                     |
| (17)   | Incorporated by  reference to the report on Form 8-K filed by MCT on February 3,  2005.                                                                        |
|   |                                                                                                                                                                     |
| (18)   | Incorporated by  reference to the report on Form 8-K filed by MCT on February 24,  2005.                                                                       |
|   |                                                                                                                                                                     |
| (19)   | Incorporated by  reference to the report on Form 8-K filed by MCT on February 25,  2006.                                                                       |

 

31

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**MICRO COMPONENT TECHNOLOGY, INC. ANDSUBSIDIARIES**

 

**Index to Consolidated FinancialStatements**

 
| Index to Consolidated  Financial Statements                                                                                                                            |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Report of Independent  Registered Public Accounting Firm                                                                                                               |   |
| Consolidated  Balance Sheets as of December 31, 2005, and December 31, 2004                                                                                  |   |
| Consolidated  Statements of Operations for the Years Ended December 31, 2005, December 31, 2004, and December 31,  2003                            |   |
| Consolidated  Statements of Changes in Stockholders’ Deficit for the Years Ended December 31, 2005, December 31,  2004, and December 31, 2003 |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2005, December 31, 2004, and  December 31, 2003                            |   |
| Notes to  Consolidated Financial Statements                                                                                                                            |   |
| Signatures and  Certifications                                                                                                                                         |   |

 

F-1

----

 

##### **REPORT OF INDEPENDENT REGSITERED PUBLICACCOUNTING FIRM**

##### ** **

To the Audit Committee,Stockholders and Board of Directors of

Micro ComponentTechnology, Inc. and Subsidiaries

St. Paul, MN

 

We have audited theaccompanying consolidated balance sheets of Micro Component Technology, Inc.and Subsidiaries as of December 31, 2005 and 2004, and the relatedconsolidated statements of operations, stockholders’ deficit and cash flows forthe years ended December 31, 2005, 2004 and 2003. These consolidatedfinancial statements are the responsibility of the company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the consolidated financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management as well asevaluating the overall consolidated financial statement presentation. Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Micro Component Technology, Inc.and Subsidiaries as of December 31, 2005 and 2004 and the results of theiroperations and their cash flows for the years ended December 31, 2005,2004 and 2003 in conformity with U.S. generally accepted accounting principles.

 

The accompanyingconsolidated financial statements have been prepared assuming that the companywill continue as a going concern. As discussed in Note 1 to the consolidatedfinancial statements, the company has suffered recurring losses from operationsand has a stockholders’ deficit. These factors raise substantial doubt aboutits ability to continue as a going concern. Management’s plans in regard tothese matters are also described in Note 1. The consolidated financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

 
|   | /s/ Virchow,  Krause & Company, LLP |
|--------|----------------------------------------------|

 

Minneapolis, Minnesota

February 3, 2006

(Except for Note 12, asto which the date is February 17, 2006)

 

F-2

----

 

**MICRO COMPONENT TECHNOLOGY, INC. ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

(in thousands, except share and per share amounts)

 
| ** **                                                                                          | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                          | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| **Assets**                                                                                          |       |                  |       |                  |       |
| Current assets:                                                                                     |       |                  |       |                  |       |
| Cash and cash equivalents                                                                           |       | $                     | 77         |                  | $          | 166 |   |
| Accounts receivable, less allowance for doubtful  accounts of $148 and $215, respectively           |       | 1,661                 |       | 2,035                 |       |
| Inventories                                                                                         |       | 2,194                 |       | 3,057                 |       |
| Other                                                                                               |       | 169                   |       | 189                   |       |
| Total current assets                                                                                |       | 4,101                 |       | 5,447                 |       |
|                                                                                                |       |                  |       |                  |       |
| Property, plant and equipment, net                                                                  |       | 148                   |       | 270                   |       |
| Debt issuance costs, net of accumulated amortization  of $1,005 and $807, respectively              |       | 276                   |       | 371                   |       |
| Other assets                                                                                        |       | 21                    |       | 34                    |       |
| Total assets                                                                                        |       | $                     | 4,546      |                  | $          | 6,122 |   |
|                                                                                                |       |                  |       |                  |       |
| **Liabilities and Stockholders’ Deficit**                                                      |       |                  |       |                  |       |
| Current liabilities:                                                                                |       |                  |       |                  |       |
| Current portion of long-term debt                                                                   |       | $                     | 133        |                  | $          | 67 |   |
| Bank line of credit, net of discounts of $42 and  $78, respectively                                 |       | 2,630                 |       | 1,583                 |       |
| Accounts payable                                                                                    |       | 425                   |       | 967                   |       |
| Accrued compensation                                                                                |       | 382                   |       | 430                   |       |
| Accrued interest                                                                                    |       | 234                   |       | 56                    |       |
| Accrued warranty                                                                                    |       | 153                   |       | 162                   |       |
| Customer prepayments and unearned service revenue                                                   |       | 152                   |       | 237                   |       |
| Other accrued liabilities                                                                           |       | 180                   |       | 208                   |       |
| Total current liabilities                                                                           |       | 4,289                 |       | 3,710                 |       |
|                                                                                                |       |                  |       |                  |       |
| Long-term debt, net of discounts of $545 and $208,  respectively                                    |       | 3,683                 |       | 1,458                 |       |
| 10% senior subordinated convertible debt                                                            |       | 3,630                 |       | 3,630                 |       |
| Total liabilities                                                                                   |       | 11,602                |       | 8,798                 |       |
|                                                                                                |       |                  |       |                  |       |
| Commitments and contingencies (Note 9)                                                              |       |                  |       |                  |       |
|                                                                                                |       |                  |       |                  |       |
| Stockholders’ deficit:                                                                         |       |                  |       |                  |       |
| Preferred stock, $.01 par value, 1,000,000  authorized, none issued and outstanding                 |       |                  |       |                  |       |
| Common stock, $.01 par value, 55,000,000 authorized  26,215,388 and 25,566,511 issued, respectively |       | 262                   |       | 256                   |       |
| Additional paid-in capital                                                                          |       | 97,670                |       | 97,022                |       |
| Cumulative other comprehensive loss                                                                 |       | —                |       | (69                   | )          |
| Accumulated deficit                                                                                 |       | (104,988              | )          | (99,885               | )          |
| Total stockholders’ deficit                                                                    |       | (7,056                | )          | (2,676                | )          |
| Total liabilities and stockholders’ deficit                                                    |       | $                     | 4,546      |                  | $          | 6,122 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

F-3

----

 

**MICRO COMPONENT TECHNOLOGY, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFOPERATIONS**

(in thousands, except per share data)

 
| ** **                                                         | ** ** | **Years Ended**  | ** ** |
|--------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                         | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                         | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                               |       |                  |       |   |   |   |   |
| Net sales                                                          |       | $                     | 7,069      |   | $ | 14,602 |   | $ | 11,123 |   |
| Cost of sales:                                                     |       |                  |       |   |   |   |   |
| Product                                                            |       | 4,012                 |       | 8,830 |   | 7,336 |   |
| Inventory reserve adjustments                                      |       | 525                   |       | (1,544 | ) | (1,041 | ) |
| Total cost of sales                                                |       | 4,537                 |       | 7,286 |   | 6,295 |   |
| Gross profit                                                       |       | 2,532                 |       | 7,316 |   | 4,828 |   |
|                                                               |       |                  |       |   |   |   |   |
| Operating expenses:                                                |       |                  |       |   |   |   |   |
| Selling, general, and administrative                               |       | 4,213                 |       | 5,596 |   | 4,872 |   |
| Research and development                                           |       | 1,980                 |       | 2,841 |   | 2,351 |   |
| Restructuring charge                                               |       | 107                   |       | 35 |   | 266 |   |
| Total operating expenses                                           |       | 6,300                 |       | 8,472 |   | 7,489 |   |
|                                                               |       |                  |       |   |   |   |   |
| Loss from operations                                               |       | (3,768                | )          | (1,156 | ) | (2,661 | ) |
|                                                               |       |                  |       |   |   |   |   |
| Other income (expense):                                            |       |                  |       |   |   |   |   |
| Interest income                                                    |       | 13                    |       | 6 |   | 5 |   |
| Interest expense                                                   |       | (1,247                | )          | (868 | ) | (1,195 | ) |
| Gain (loss) on sale of property and equipment                      |       | —                |       | 14 |   | 209 |   |
| Other income (expense)                                             |       | (101                  | )          | (44 | ) | (26 | ) |
|                                                               |       |                  |       |   |   |   |   |
| Loss before income taxes                                           |       | (5,103                | )          | (2,048 | ) | (3,668 | ) |
| Income tax provision                                               |       | —                |       | — |   | — |   |
|                                                               |       |                  |       |   |   |   |   |
| Net loss                                                           |       | $                     | (5,103     | ) | $ | (2,048 | ) | $ | (3,668 | ) |
|                                                               |       |                  |       |   |   |   |   |
| Net loss per common share:                                         |       |                  |       |   |   |   |   |
| Basic and diluted                                                  |       | $                     | (0.20      | ) | $ | (0.08 | ) | $ | (0.21 | ) |
|                                                               |       |                  |       |   |   |   |   |
| Weighted average common and common equivalent shares  outstanding: |       |                  |       |   |   |   |   |
| Basic                                                              |       | 25,894                |       | 25,013 |   | 17,606 |   |
| Diluted                                                            |       | 25,894                |       | 25,013 |   | 17,606 |   |

 

See Notes to Consolidated Financial Statements.

 

F-4

----

 

**MICRO COMPONENT TECHNOLOGY, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT**

(in thousands, except share data)

 
| ** **                                                                    | ** ** | **Common Stock** | ** ** | ** ** | ** ** | ** **     | ** ** | **Cumulative**    | ** **   |
|-------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|----------------|------------|-------------------|--------------|
| ** **                                                                    | ** ** | ** **            | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **        | ** **   | ** ** | ** ** | **Other** | ** ** |
| ** **                                                                    | ** ** | ** **            | ** ** | **Par**    | ** ** | **Paid-in**    | ** ** | **Comprehensive** | ** **   | **Accumulated** | ** ** | **Comprehesive** | ** ** |
| ** **                                                                    | ** ** | **Shares**            | ** ** | **Value**  | ** ** | **Capital**    | ** ** | **Loss**          | ** **   | **Deficit** | ** ** | **Loss** | ** ** |
|                                                                          |       |                  |       |       |       |           |       |              |         |   |   |   |   |
| Balance at December 31, 2002                              |       | 14,152,520            |       | $          |  142  |           | $          |  88,302      |         |   |   | $ | (94,169 | ) | $ |  (69) |   |
|                                                                          |       |                  |       |       |       |           |       |              |         |   |   |   |   |
| Net loss                                                                      |       |                  |       |       |       |           |       | $                 | (3,668       | ) | (3,668 | ) |   |   |
| Shares issued in private placement, net of offering  costs                    |       | 3,166,869             |       | 32         |       | 1,005          |       |              |         |   |   |   |   |
| Shares issued on conversion of 10% senior  subordinated convertible debt, net |       | 2,660,081             |       | 27         |       | 2,634          |       |              |         |   |   |   |   |
| Shares issued in lieu of interest                                             |       | 1,007,830             |       | 10         |       | 543            |       |              |         |   |   |   |   |
| Shares issued on exercise of options, net                                     |       | 150,000               |       | 1          |       | 181            |       |              |         |   |   |   |   |
| Shares issued through employee stock purchase plan                            |       | 8,000                 |       | —     |       | 3              |       |              |         |   |   |   |   |
| Comprehensive loss                                                            |       |                  |       |       |       |           |       | $                 |  (3,668 | ) |   |   |   |   |
|                                                                          |       |                  |       |       |       |           |       |              |         |   |   |   |   |
| Balance at December 31, 2003                                             |       | 21,145,300            |       | $          | 212        |           | $          | 92,668            |         |   |   | $ | (97,837 | ) | $ | (69 | ) |
| Net loss                                                                      |       |                  |       |       |       |           |       | $                 | (2,048       | ) | (2,048 | ) |   |   |
| Shares issued on conversion of 10% senior  subordinated convertible debt, net |       | 3,710,000             |       | 37         |       | 3,673          |       |              |         |   |   |   |   |
| Shares issued in lieu of interest                                             |       | 654,260               |       | 7          |       | 659            |       |              |         |   |   |   |   |
| Shares issued on exercise of options / warrants, net                          |       | 56,951                |       | —     |       | 22             |       |              |         |   |   |   |   |
| Comprehensive loss                                                            |       |                  |       |       |       |           |       | $                 |  (2,048 | ) |   |   |   |   |
|                                                                          |       |                  |       |       |       |           |       |              |         |   |   |   |   |
| Balance at December 31, 2004                                             |       | 25,566,511            |       | $          | 256        |           | $          | 97,022            |         |   |   | $ | (99,885 | ) | $ | (69 | ) |
|                                                                          |       |                  |       |       |       |           |       |              |         |   |   |   |   |
| Net loss                                                                      |       |                  |       |       |       |           |       | $                 | (5,103       | ) | (5,103 | ) |   |   |
| Cumulative translation adj                                                    |       |                  |       |       |       |           |       | 69                |         |   |   | 69 |   |
| Shares issued in lieu of interest                                             |       | 648,874               |       | 6          |       | 124            |       |              |         |   |   |   |   |
| Discounts on long-term debt                                                   |       | —                |       | —     |       | 524            |       |              |         |   |   |   |   |
| Shares issued on exercise of options / warrants, net                          |       | —                |       | —     |       | —         |       |              |         |   |   |   |   |
| Comprehensive loss                                                            |       |                  |       |       |       |           |       | $                 |  (5,034 | ) |   |   |   |   |
|                                                                          |       |                  |       |       |       |           |       |              |         |   |   |   |   |
| Balance at December 31, 2005                                             |       | 26,215,385            |       | $          | 262        |           | $          | 97,670            |         |   |   | $ | (104,988 | ) | $ | — |   |
|                                                                               |            |                       |            |            |            |                |            |                   |              |  |  |  |  |  |  |  |  |  |  |

 

See Notes to Consolidated Financial Statements.

 

F-5

----

 

**MICRO COMPONENT TECHNOLOGY, INC. ANDSUBSIDIARIES**

###### **CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(in thousands)

 
| ** **                                                                   | ** ** | **Years Ended**        | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                   | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
| Cash flows from operating activities:                                        |       |                        |       |   |   |   |   |
| Net loss                                                                     |       | $                           | (5,103     | ) | $ | (2,048 | ) | $ | (3,668 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                        |       |   |   |   |   |
| Depreciation                                                                 |       | 191                         |       | 450 |   | 482 |   |
| Amortization                                                                 |       | 420                         |       | 267 |   | 180 |   |
| Inventory reserve adjustments                                                |       | 525                         |       | (1,544 | ) | (1,041 | ) |
| (Gain) loss on disposal of property and equipment                            |       | —                      |       | 14 |   | (209 | ) |
| Changes in operating assets and liabilities:                                 |       |                        |       |   |   |   |   |
| Accounts receivable                                                          |       | 374                         |       | (496 | ) | (753 | ) |
| Inventories                                                                  |       | 275                         |       | 1,651 |   | 1,291 |   |
| Other assets                                                                 |       | 33                          |       | 106 |   | (56 | ) |
| Accounts payable                                                             |       | (99                         | )          | (746 | ) | 703 |   |
| Accrued restructuring costs                                                  |       | —                      |       | — |   | (153 | ) |
| Other accrued liabilities                                                    |       | 138                         |       | (1,084 | ) | 1,058 |   |
| Net cash used in operating activities                                        |       | (3,246                      | )          | (3,430 | ) | (2,166 | ) |
|                                                                         |       |                        |       |   |   |   |   |
| Cash flows from investing activities:                                        |       |                        |       |   |   |   |   |
| Additions to property, plant and equipment                                   |       | (33                         | )          | (149 | ) | (111 | ) |
| Proceeds from disposition of property                                        |       | 28                          |       | — |   | 253 |   |
| Net cash provided (used) in investing activities                             |       | (5                          | )          | (149 | ) | 142 |   |
|                                                                         |       |                        |       |   |   |   |   |
| Cash flows from financing activities:                                        |       |                        |       |   |   |   |   |
| Payments on long-term debt                                                   |       | (315                        | )          | (267 | ) | (29 | ) |
| Proceeds (Payments) on bank line of credit                                   |       | 1,011                       |       | (348 | ) | 348 |   |
| Proceeds from institutional line of credit, net of  discount                 |       | —                      |       | 1,661 |   | — |   |
| Issuance of long-term convertible note, net of debt  issue costs             |       | 2,397                       |       | 1,657 |   | — |   |
| Proceeds from issuance of stock, net of stock  issuance costs                |       | —                      |       | (36 | ) | 1,223 |   |
| Net cash provided by financing activities                                    |       | 3,093                       |       | 2,667 |   | 1,542 |   |
|                                                                         |       |                        |       |   |   |   |   |
| Effects of exchange rate changes                                             |       | 69                          |       | — |   | — |   |
|                                                                         |       |                        |       |   |   |   |   |
| Net decrease in cash and cash equivalents                                    |       | (89                         | )          | (912 | ) | (482 | ) |
|                                                                         |       |                        |       |   |   |   |   |
| Cash and cash equivalents at beginning of period                             |       | 166                         |       | 1,078 |   | 1,560 |   |
|                                                                         |       |                        |       |   |   |   |   |
| Cash and cash equivalents at end of period                                   |       | $                           | 77         |   | $ | 166 |   | $ | 1,078 |   |
|                                                                         |       |                        |       |   |   |   |   |
| Supplemental disclosure:                                                     |       |                        |       |   |   |   |   |
| Non-cash investing and financing activities:                                 |       |                        |       |   |   |   |   |
| Stock issued in lieu of interest                                             |       | $                           | 130        |   | $ | 642 |   | $ | 553 |   |
| Discount on issuance of long-term debt                                       |       | 524                         |       | — |   | — |   |
| Stock issued in conversion of 10% senior  subordinated debt                  |       | —                      |       | 3,710 |   | 2,661 |   |
| Conversion of accounts payable into long term debt                           |       | 450                         |       | — |   | — |   |
|                                                                         |       |                        |       |   |   |   |   |
| Cash paid for interest                                                       |       | $                           | 503        |   | $ | 228 |   | $ | 591 |   |

 

See Notes toConsolidated Financial Statements.

 

F-6

----

 

**MICRO COMPONENT TECHNOLOGY, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 1- DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES**

 

*Business*

 

We design, manufacture,market and service automated test handling equipment for the semiconductorindustry. Our handlers are designed to handle most semiconductor or integratedcircuit device packages currently in production. We operate in one businesssegment in three geographic locations.

 

Anetwork of offices and representatives supports our customers across NorthAmerica, Europe and Asia. Our company was formed in 1972 and is headquarteredin St. Paul, Minnesota.

 

*Basis ofPresentation*

 

Theconsolidated financial statements include the accounts of the parent companyand our subsidiaries after elimination of all significant intercompany balancesand transactions. All significant subsidiaries are 100% owned.

 

Ourconsolidated financial statements have been prepared on the assumption that wewill continue as a going concern, which contemplates the realization of assetsand liquidation of liabilities in the normal course of business. Theindependent registered public accounting firm report included herein containsan explanatory paragraph that raises substantial doubt about our ability tocontinue as a going concern. The financial statements do not include anyadjustments to reflect the possible future effects on the recoverability andclassification of assets or the amounts and classification of liabilities that may resultfrom the outcome of this uncertainty.

 

Asof December 31, 2005, we had cash and cash equivalents of $77,000, workingcapital of negative $188,000, assets totaling $4.5 million, liabilitiestotaling $11.6 million and an accumulated deficit of $105.0 million for theyear then ended. We expect to continue to expend cash and incur operatinglosses at the current net sales levels, but to a lesser extent than the twelvemonths ended December 31, 2005 as certain operating expenses are expectedto decline from 2005 levels. Our ability to generate cash and operating incomeis dependent on increasing our customer base to expand the penetration of ourproduct technology and the realization of our lower operating expense targets.

 

OnFebruary 17, 2006, we restructured the financing with Laurus, andincreased the total maximum secured indebtedness with Laurus to $9.25 millionfrom $7.0 million. The restructured financing now includes a $5.25 million termnote. Interest is payable monthly on the term note at the prime rate plus 2.5%.Beginning 360 days after closing, we are required to make monthly paymentsequal to 1/60th of the principal amount until three years after the closing, atwhich time the entire remaining principal and accrued interest is due andpayable in full. The note is non-convertible. In addition to the $5.25 millionnote, the working capital line of credit was increased from $3.0 million to$4.0 million, and made non-convertible. The note is payable in full on March 8,2008. Interest is payable monthly on the note at the prime rate plus 2.5%. Theexisting $1.2 million over-advance in excess of the borrowing base on theworking capital line of credit was extended until April 30, 2007. However,commencing on December 1, 2006, the over-advance is to be reduced by$200,000 each month. The Company also issued Laurus a 10-year option topurchase 2,500,000 shares at an exercise price of $.01 per share. The sharesissuable upon exercise of the option have standard registration rights.

 

TheCompany believes that the combination of reduced spending, increasing ourcustomer base to further enable the penetration of our product technology, theamendment of our existing credit facility and the amendment of our agreementwith the holders of our 10% Senior Convertible Notes, each discussed in Note13, contained 

 

F-7

----

 

elsewhere herein, willprovide the cash necessary to meet our operating, working capital and capital resourceobligations through all of 2006.

 

*Use ofEstimates*

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires that we make estimates andassumptions that affect amounts reported therein. Due to the inherentuncertainty involved in making estimates, actual results reported in futureperiods might differ from those estimates.

 

*RevenueRecognition*

 

Under SAB 104, our revenue is recognized uponshipment, as our terms are FOB shipping point, for established products thathave previously satisfied existing customer performance specifications and thatprovide for full payment tied to shipment. Revenue for products that have notpreviously satisfied customer performance specifications or from sales whereall or a portion of customer payment is based upon acceptance are onlyrecognized upon customer acceptance. The related inventory costs are offsetagainst the deferred revenue and reported as “deferred revenue in excess ofcosts incurred” in the consolidated balance sheet. Product warranty and installationcosts are accrued in the period sales are recognized. Installation services areconsidered to be perfunctory as defined under SAB 104 and average less than 5%of the contract price. Revenue related to spare parts is recognized uponshipment. Revenue related to maintenance and service contracts are deferred andamortized to earnings on a straight-line basis over the life of the servicecontract. Custom integration software revenue is recognized on a project basiswith milestone acceptance provisions. Shipping and handling costs are billed tothe customer and included in the net revenue with the cost of shipment andhandling charged to cost of goods sold.

 

*Researchand Development Expenses*

 

Researchand development expenses for new product development are charged to expense asincurred.

 

*FinancialInstruments*

 

Thecarrying amounts for all financial instruments approximates fair value. Thecarrying amounts for cash and cash equivalents, accounts receivable, accountspayable and accrued liabilities approximates fair value because of the shortmaturity of these instruments. The fair value of capital lease obligations,note payable and long-term debt approximates the carrying amounts based uponthe Company’s expected borrowing rate for debt with similar remainingmaturities and comparable risk.

 

*Cash andCash Equivalents*

 

Weconsider all highly liquid investments purchased with original maturities of 90days or less to be cash equivalents. We place our temporary cash investmentswith high credit quality financial institutions. At times such investments may bein excess of the Federal Deposit Insurance Corporation (FDIC) insurance limit.

 

*AccountsReceivable*

 

We review customers’ credit history beforeextending unsecured credit and establish an allowance for doubtful accountsbased upon factors surrounding the credit risk of specific customers and otherinformation. Invoice terms can vary from net 30 days, to percentage amounts ofthe total customer purchase order tied to acceptance criteria. The Company doesnot accrue interest on past due accounts receivable. The Company writes offreceivables when they are deemed uncollectible after all collection attemptshave failed. Accounts receivable are

 

F-8

----

 

shownnet of an allowance for doubtful accounts of $148,000 and $215,000 at December 31,2005 and 2004, respectively.

 

*Inventories*

 

Inventoriesare stated at the lower of cost or market. Cost is determined by the first-in,first-out (“FIFO”) method. Provisions to reduce inventories to the lower ofcost or market is made based on a review of excess and obsolete inventories,estimates of future sales, examination of historical consumption rates and therelated value of component parts.

 

*Property,Plant and Equipment*

 

Property,plant and equipment are stated at cost. Depreciation is provided by thestraight-line method over the estimated useful lives of the assets forfinancial reporting and accelerated methods for tax purposes. Leaseholdimprovements are amortized over the shorter of the estimated useful life or thelease term for financial reporting purposes. Estimated lives used in computingbook depreciation are as follows:

 

| Leasehold  improvements  |   | 3 to 10 years |
|--------------------------|--------|---------------|
| Machinery and  equipment |   | 2 to 7        |
| Furniture and  fixtures  |   | 3 to 5        |

 

*Impairmentof Long-Lived Assets*

 

Weperiodically evaluate the carrying value of long-lived assets for potentialimpairment. We consider projected future operating results, cash flows, trends,and other circumstances in making such estimates and evaluations. When thecarrying value of any long-lived asset exceeds its projected undiscounted cashflows, impairment is recognized to reduce the carrying value to its fair marketvalue.

 

*ProductWarranty*

 

At thetime the product is sold, estimated costs of warranty obligations to customersare charged to expense and a related accrual is established.

 

*IncomeTaxes*

 

Weaccount for income taxes in accordance with the provisions of Statement ofFinancial Accounting Standards (SFAS) No. 109*, Accountingfor Income Taxes*. Deferred income taxes are recorded based on differencesin the bases of assets and liabilities between the financial statements and thetax returns as well as from loss carryforwards. The valuation allowance fordeferred income tax benefits is determined by us based upon the expectation ofwhether the benefits are more likely than not to be realized.

 

*Stock-BasedCompensation*

 

Weaccount for stock-based transactions under SFAS No. 123*, Accounting for Stock-Based Compensation*. As permitted bySFAS No. 123, we have elected to continue following the guidance of APBOpinion No. 25 (as interpreted by FIN 44) for measurement and recognitionof stock-based transactions with employees and non-employee directors. Becausestock options have been granted at exercise prices at least equal to the fairmarket value of the stock at the grant date, no compensation cost has beenrecognized for stock options issued to employees and non-employee directorsunder the stock option plans. Stock-based transactions with non-employees areaccounted for in accordance with SFAS No. 123 and related interpretations.

 

F-9

----

 

If compensation cost for our stock option and employee stockpurchase plans had been determined based on the fair value at the grant dates,consistent with the method provided in SFAS No. 148 and SFAS No. 123,our net loss and net loss per share would have been as follows:

 

| ** **                         | ** ** | **Years Ended**   | ** ** |
|------------------------------------|------------|------------------------|------------|
| ** **                         | ** ** | **Dec. 31  2005** | ** ** | **Dec 31  2004** | ** ** | **Dec. 31  2003** | ** ** |
| Net loss, in thousands:            |       |                   |       |   |   |   |   |
| As reported                        |       | $                      | (5,103     | ) | $ | (2,048 | ) | $ | (3,668 | ) |
| Fair value compensation expense    |       | (184                   | )          | (1,581 | ) | (985 | ) |
| Pro forma                          |       | $                      | (5,287     | ) | $ | (3,629 | ) | $ | (4,653 | ) |
|                               |       |                   |       |   |   |   |   |
| Net loss per share – basic:   |       |                   |       |   |   |   |   |
| As reported                        |       | $                      | (0.20      | ) | $ | (0.08 | ) | $ | (0.21 | ) |
| Fair value compensation expense    |       | (0.01                  | )          | (0.06 | ) | (0.06 | ) |
| Pro forma                          |       | $                      | (0.21      | ) | $ | (0.14 | ) | $ | (0.27 | ) |
|                               |       |                   |       |   |   |   |   |
| Net loss per share – diluted: |       |                   |       |   |   |   |   |
| As reported                        |       | $                      | (0.20      | ) | $ | (0.08 | ) | $ | (0.21 | ) |
| Fair value compensation expense    |       | (0.01                  | )          | (0.06 | ) | (0.06 | ) |
| Pro forma                          |       | $                      | (0.21      | ) | $ | (0.14 | ) | $ | (0.27 | ) |
|                               |       |                   |       |   |   |   |   |
| Stock Based Compensation:          |       |                   |       |   |   |   |   |
| As reported                        |       | $                      | —     |   | $ | — |   | $ | — |   |
| Fair value compensation expense    |       | (184                   | )          | (1,581 | ) | (985 | ) |
| Pro forma                          |       | $                      | (184       | ) | $ | (1,581 | ) | $ | (985 | ) |

 

In December of 2004, theCompensation Committee of the Board of Directors approved the acceleration ofthe vesting of all of the then outstanding options under all plans. At the timeof this approval all option exercise prices exceeded the public market price ofthe underlying common shares. This action resulted in 1,029,500 shares beingaccelerated with respect to their original vesting dates. This accelerationresulted in an additional $737,000 of net compensation expense being includedin the above tables for the year ended December 31, 2004.

 

The fair value of options granted under the stock option andemployee stock purchase plans for the years ended December 31, 2005, 2004,and 2003 was estimated on the date of grant using the Black-Scholes optionpricing model with the following weighted average assumptions and results:

 
| ** **                              | ** ** | **Years Ended**    | ** ** |
|-----------------------------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** | **Dec. 31,  2003** | ** ** |
|                                    |       |                    |       |   |   |   |   |
| Dividend yield                          |       | 0.00                    | %          | 0.00 | % | 0.00 | % |
| Expected volatility                     |       | 94.31                   | %          | 93.53 | % | 139.76 | % |
| Risk-free interest rate                 |       | 3.89                    | %          | 3.41 | % | 2.52 | % |
| Expected life of options                |       | 3.5 years               |       | 3.5 years |   | 3.5 years |   |
| Fair value per share of options granted |       | $                       | 0.21       |   | $ | 0.87 |   | $ | 0.70 |   |
|                                         |            |                         |            |  |  |  |  |  |  |  |

 

F-10

----

 

*ForeignCurrency Translation*

 

Assets and liabilities of the foreign subsidiary aretranslated to U.S. dollars at year-end rates, and the statements of operationsare translated at average exchange rates during the year. Translation adjustmentsarising from the translation of the foreign affiliates’ net assets into U.S.dollars were recorded in cumulative other comprehensive income until 1999. During1999, the foreign subsidiary’s functional currency changed to the U.S. dollardue principally to a significant shift in the amount of activity denominated inU.S. dollars versus the local currency. All translation adjustments are nowrecorded in the consolidated statements of operations. For the year ended December 31,2005, we expensed the cumulative translation adjustment of $69,000.

 

*Reclassifications*

 

Certain amounts previously reported in the 2003 consolidatedfinancial statements have been reclassified to conform to the 2005 and2004 presentations. These reclassifications had no effect in previouslyreported net loss or stockholders’ deficit.

 

*NewAccounting Standards*

 

In December 2004,FASB issued SFAS No. 123 (revised 2004), *Share-BasedPayment*, that focuses primarily on accounting for transactions inwhich an entity obtains employee services in share-based payment transactions. Thisstatement replaces SFAS No. 123, *Accountingfor Stock-Based Compensation*, and supersedes APB Opinion No. 25,*Accounting for Stock Issued to Employees*.Beginning with our quarterly period that begins June 26, 2006, we will berequired to expense the fair value of employee stock options and similar awards.As a public company, we are allowed to select from two alternative transitionmethods, each having different reporting implications. The impact of SFAS No. 123Rhas not been determined at this time.

 

In June 2005,FASB issued SFAS No. 154, “*AccountingChanges and Error Corrections*”, a replacement of APB Opinion No. 20and FASB Statement No. 3. The statement applies to all voluntary changesin accounting principle, and changes the requirements for accounting for andreporting of a change in accounting principle. SFAS No. 154 requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is impracticable. SFAS No. 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. Earlier application is permitted foraccounting changes and corrections of errors made occurring in fiscal yearsbeginning after June 1, 2005. The statement does not change the transitionprovisions of any existing accounting pronouncements, including those that arein a transition phase as of the effective date of this statement. The Companydoes not expect the adoption of SFAS No. 154 to have a material effect onits financial statements.

 

F-11

----

 

**NOTE 2 -LOSS PER COMMON SHARE**

 

Loss per common share is computed in accordance withSFAS No. 128, *Earnings Per Share*.Basic loss per share is computed using the weighted average number of commonshares outstanding during each period. Diluted earnings per share include thedilutive effect of common shares potentially issuable upon the exercise ofstock options, warrants outstanding and the conversion of convertible debt. Thefollowing table reconciles the denominators used in computing basic and dilutedloss per share for the periods reported (in thousands):

 
| ** **                                    | ** ** | **Years Ended**           | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **December 31,  2005(1)** | ** ** | **December 31,  2004(1)** | ** ** | **December 31,  2003(1)** | ** ** |
|                                          |       |                           |       |   |   |   |   |
| Weighted average common shares outstanding    |       | 25,894                         |       | 25,013 |   | 17,125 |   |
| Effect of dilutive stock options and warrants |       | —                         |       | — |   | — |   |
| Effect of convertible debt                    |       | —                         |       | — |   | — |   |
|                                          |       | 25,894                         |       | 25,013 |   | 17,125 |   |

 

----

(1)   We reported a loss for the period. Noadjustment was made for the effect of stock options, warrants or convertibledebt as the effect was anti-dilutive. Stock options and warrants outstandingtotaled 5,013,398 shares at December 31, 2005, 3,358,058 shares at December 31,2004 and 2,882,468 shares at December 31, 2003. We also have potentiallyissuable common shares of 5,950,687 related to our 10% Senior SubordinatedConvertible Notes described in Note 7 contained elsewhere herein.

 

**NOTE 3 -RESTRUCTURING CHARGES**

 

The restructuring chargesdescribed below were incurred and paid within the years as set forth below.

 

**2005 Restructuring Charges**

 

During the second quarter of 2005, in responseto the continuing downturn in the semiconductor capital equipment market, wereduced our workforce across all functional areas by approximately 7% resultingin a restructuring charge of $66,000. This charge reflected severance and otherbenefit costs associated with this reduction. This workforce reduction affecteda total of seven employees across all functional areas.

 

During the third quarter of 2005, in connectionwith our restructuring activities, we reduced our workforce withinmanufacturing and sales by approximately 2% resulting in a restructuring chargeof $40,000. This charge reflected severance and other benefit costs associatedwith this reduction. This workforce reduction affected a total of twoemployees.

 

**2004 Restructuring Charges**

 

Duringthe fourth quarter, in response to a second half 2004 market contraction, wereduced our workforce by approximately 11% at the time, resulting in arestructuring charge of $35,000. This charge reflected severance and benefitcosts associated with this reduction. This work force reduction affected atotal of 12 employees principally with the manufacturing function.

 

**2003Restructuring Charges**

 

Duringthe first quarter, in response to the continued and prolonged downturn in thesemiconductor capital equipment industry, we reduced our workforce across allfunctional areas by approximately 24% at the time, resulting in a restructuringcharge of $19,000. This charge reflected severance and other benefit costs

 

F-12

----

 

associated with this reduction. This workforcereduction affected a total of 26 employees across all functional areas.

 

Duringthe second quarter, we completed the restructuring of our master lease for ourSt. Paul, MN facility, resulting in a restructuring charge of $227,000, whichincluded write-offs of $41,000 related to leasehold improvements in the vacatedspace which provided no future economic benefit to us. Additionally, we furtherreduced our workforce across all functional areas by approximately 4% at thetime, resulting in a restructuring charge of $20,000. This charge reflectedseverance and other benefit costs associated with this reduction. Thisworkforce reduction affected a total of 4 employees across all functionalareas.

 

**NOTE 4 –FINANCING TRANSACTIONS**

 

OnMarch 7, 2003 and March 26, 2003, pursuant to a private equityplacement with a group of accredited investors, we issued a total of 3,166,869shares of common stock, which resulted in net proceeds to us of approximately$1.1 million. Stock issuance costs associated with this offering totaledapproximately $241,000. As part of this offering, we also issued warrantsto purchase 253,350 shares of common stock that have a term of five years withan exercise price of $0.43 per share.

 

On June 9,2003, the Company completed a one-year, $2.5 million secured working capitalline of credit agreement with a bank. The advances bear interest at prime plus2.0% (6% at December 31, 2003). As of December 31, 2003, $348,000 wasoutstanding under this agreement. This loan was terminated in 2004.

 

On March 9,2004, we completed a $5.0 million financing transaction with an institutionallender, Laurus Master Fund, Ltd. (“Laurus”), secured by all of the assets ofthe Company. The financing included a $3.0 million working capital line ofcredit and a $2.0 million long-term note. The notes were partially convertible intoshares of our common stock. In connection with the transaction, we issued toLaurus a seven-year warrant to purchase 400,000 shares of common stock atexercise prices ranging from $2.30 to $2.88 per share. The secured loan inexistence at that time with a prior lender was terminated.

 

On January 28,2005, we completed an amendment to the financing agreement with Laurus to deferpayments on the long-term convertible note. As part of this amendment, theconversion prices on both notes were reduced. We also issued Laurus at thattime a seven-year warrant to purchase 150,000 shares of common stock at $.67per share.

 

On April 29,2005, we completed another financing transaction with Laurus in which weborrowed an additional $2.5 million, and which was convertible into shares ofcommon stock. We also issued Laurus at that time an option to purchase2,556,651 shares of common stock at an exercise price of $.01 per share. Wereceived net proceeds of approximately $2.4 million at the closing.

 

OnFebruary 17, 2006, we again restructured the financing with Laurus, andincreased the total maximum secured indebtedness with Laurus to $9.25 million. Therestructured financing now includes a $5.25 million term note. Interest ispayable monthly on the term note at the prime rate plus 2.5%. Beginning 360days after closing, we are required to make monthly payments equal to 1/60th ofthe principal amount until three years after the closing, at which time theentire remaining principal and accrued interest is due and payable in full. Thenote is non-convertible. In addition to the $5.25 million note, the workingcapital line of credit was increased from $3.0 million to $4.0 million, andmade non-convertible. The note is payable in full on March 8, 2008. Interestis payable monthly on the note at the prime rate plus 2.5%. The existing $1.2million over-advance in excess of the borrowing base on the working capitalline of credit was extended until April 30, 2007. However, commencing on December 1,2006, the over-advance is to be reduced by $200,000 each month. The Companyalso issued Laurus a 10-year option to purchase 2,500,000 shares at an exerciseprice of $.01 per share. The shares issuable upon exercise of the option havestandard registration rights.

 

F-13

----

 

**NOTE 5 –BALANCE SHEET INFORMATION**

 

The allowance fordoubtful accounts receivable was as follows (in thousands):

 
| ** **        | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------|------------|-----------------------------|------------|-----------------------------|------------|
|              |       |                        |       |                        |       |
| Beginning balance |       | $                           | 215        |                        | $          | 303 |   |
| Provisions        |       | 46                          |       | —                      |       |
| Write offs        |       | (113                        | )          | (88                         | )          |
| Ending balance    |       | $                           | 148        |                        | $          | 215 |   |

 

Provisions are charged to selling,general and administrative expense.

 

Major components ofinventories were as follows (in thousands):

 
| ** **      | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------|------------|-----------------------------|------------|-----------------------------|------------|
|            |       |                        |       |                        |       |
| Raw materials   |       | $                           | 1,783      |                        | $          | 2,078 |   |
| Work-in-process |       | 394                         |       | 765                         |       |
| Finished goods  |       | 17                          |       | 214                         |       |
|            |       | $                           | 2,194      |                        | $          | 3,057 |   |

 

In accordance withaccounting principles generally accepted in the United States of America, wevalue our inventories at the lower of cost or market.

 

The following tableprovides the inventory reserves for the years ended December 31, 2005 and2004.

 
| ** **                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
|                                           |       |     |       |     |       |
| Inventory reserve balance - beginning          |       | $        | 7,149      |     | $          | 8,996 |   |
| Release of inventory reserve on sale of goods  |       | (61      | )          | (1,544   | )          |
| Release of inventory reserve on scrap of goods |       | (212     | )          | (303     | )          |
| Additional inventory reserve                   |       | 525      |       | —   |       |
| Inventory reserve balance- ending              |       | $        | 7,401      |     | $          | 7,149 |   |

 

We provide a standardthirteen month warranty program for our equipment products. We record provisionsfor warranty claims for these products based upon historical claim performance.The following table provides the expense recorded and charges against ourreserves for the years ended December 31, 2005 and 2004.

 
| ** **                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Accrued warranty balance - beginning |       | $        | 162        |     | $          | 181 |   |
| Provision                            |       | 62       |       | 107      |       |
| Warranty claims                      |       | (71      | )          | (126     | )          |
| Accrued warranty balance- ending     |       | $        | 153        |     | $          | 162 |   |

 

F-14

----

 

Property, plant andequipment were as follows (in thousands):

 
| ** **                    | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                          |       |                        |       |                        |       |
| Leasehold improvements        |       | $                           | 188        |                        | $          | 284 |   |
| Machinery and equipment       |       | 2,070                       |       | 2,264                       |       |
| Furniture and fixtures        |       | 208                         |       | 297                         |       |
|                          |       | 2,466                       |       | 2,845                       |       |
| Less accumulated depreciation |       | 2,318                       |       | (2,575                      | )          |
|                          |       | $                           | 148        |                        | $          | 270 |   |

 

#### **NOTE 6 - LONG-TERM DEBT**

#### ** **

Long-term debt and financing obligations were as follows (inthousands):

 
| ** **                                                               | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                                                     |       |                        |       |                        |       |
| Long-term Laurus notes, net of discounts of $545 and  $208, respectively |       | $                           | 3,455      |                        | $          | 1,525 |   |
| Long-term CA lease                                                       |       | 361                         |       | —                      |       |
| Less: current portion                                                    |       | (133                        | )          | (67                         | )          |
| Total long-term debt                                                     |       | $                           | 3,683      |                        | $          | 1,458 |   |
|                                                                     |       |                        |       |                        |       |
| 10% senior subordinated convertible notes                                |       | $                           | 3,630      |                        | $          | 3,630 |   |

 

On March 9,2004, we completed a $5.0 million financing transaction with an institutionallender, Laurus Master Fund, Ltd. (“Laurus”), secured by all of the assets ofthe Company. The financing included a $3.0 million working capital line ofcredit and a $2.0 million long-term note. The notes were partially convertibleinto shares of our common stock. In connection with the transaction, we issuedto Laurus a seven-year warrant to purchase 400,000 shares of common stock atexercise prices ranging from $2.30 to $2.88 per share. The secured loan inexistence at that time with a prior lender was terminated.

 

On January 28,2005, we completed an amendment to the financing agreement with Laurus to deferpayments on the long-term convertible note. As part of this amendment, theconversion prices on both notes were reduced. We also issued Laurus at thattime a seven-year warrant to purchase 150,000 shares of common stock at $.67per share.

 

On April 29,2005, we completed another financing transaction with Laurus in which weborrowed an additional $2.5 million, and which was convertible into shares ofcommon stock. We also issued Laurus at that time an option to purchase2,556,651 shares of common stock at an exercise price of $.01 per share. Wereceived net proceeds of approximately $2.4 million at the closing.

 

OnFebruary 17, 2006, we again restructured the financing with Laurus, andincreased the total maximum secured indebtedness with Laurus to $9.25 million. Therestructured financing now includes a $5.25 million term note. Interest ispayable monthly on the term note at the prime rate plus 2.5%. Beginning 360days after closing, we are required to make monthly payments equal to 1/60th ofthe principal amount until three years after the closing, at which time theentire remaining principal and accrued interest is due and payable in full. Thenote is non-convertible. In addition to the $5.25 million note, the workingcapital line of credit was increased from $3.0 million to $4.0 million, andmade non-convertible. The note is payable in full on March 8, 2008. Interestis payable monthly on the note at the prime rate plus 2.5%. The existing $1.2million over-advance in excess of the

 

F-15

----

 

borrowing base on the working capitalline of credit was extended until April 30, 2007. However, commencing on December 1,2006, the over-advance is to be reduced by $200,000 each month. The Companyalso issued Laurus a 10-year option to purchase 2,500,000 shares at an exerciseprice of $.01 per share. The shares issuable upon exercise of the option havestandard registration rights. The term debt has been classified as long-termdue to the refinancing subsequent to year-end (see Note 12) in accordance withSFAS 6, Classification of Short-Term Obligations Expected to Be Refinanced asAmended by ARB No. 43, Chapter 3d.

 

InDecember 2001, we issued $10.0 million of 10% Senior SubordinatedConvertible Notes due in 2006 to a group of accredited investors. These Noteswere initially convertible into our common stock at a conversion price equal to$2.60 per share. The Notes are redeemable by us at any time after January 3,2004 as long as the market price of our common stock equals or exceeds 150% ofthe conversion price. Proceeds from the Notes, net of debt issuance costs,totaled $9.2 million. Holders of the Notes have standard registration rights ifthey convert the Notes to common stock. The Note Purchase Agreement between usand the holders of the Notes contains certain affirmative and negativecovenants. Among other things, these covenants prohibit us from paying dividendsto our shareholders or incurring more than $5.0 million of indebtedness that issenior to, or ranks the same as the Notes. The covenants also require us tocomply with applicable laws and regulations, maintain a market for our commonstock, and provide the Note holders with copies of our SEC reports and certainother information. There are no financial covenants related to these Notes. On June 30, 2003, we completed therestructuring of $9.29 million, or 92.9%, of our 10% Senior SubordinatedConvertible Notes, wherein the participating noteholders agreed to accept stockin lieu of cash for the next four semi-annual interest payment dates beginning June 30,2003 through December 31, 2004, and the conversion price for the Notes wasreduced to $1.00 per share. On February 25, 2005, we completed a second amendment tothe agreement with the holders of our 10% Senior Subordinated ConvertibleNotes, wherein holders of 80% of the remaining Notes, representing $2.9 million,agreed to continue to accept stock in payment of interest for the remainingfour interest payments through December 24, 2006. As part of thisamendment, we agreed to reduce the Note conversion price to $0.85 per share,and use our best efforts to register the shares with the SEC. OnApril 29, 2005, we completed another financing transaction with Laurus. Asa result of the new financing with Laurus, the conversion price for all of theNoteholders who accepted the prior restructuring agreements was at that timereduced to $0.61 per share. During theyear ended December 31, 2004, principal in the amount of $3.71 million andinterest in the amount of $642,000 were converted into 4,364,260 shares ofcommon stock. During the year ended December 31, 2003, principal in theamount of $2.66 million and interest in the amount of $553,000 were convertedinto 3,667,911 shares of common stock. There was no beneficial conversion ofthe Notes payable into common stock as defined in EITF 00-27 of “Application ofIssue No. 98-5 to Certain Convertible Instruments.”

 

On April 11,2005, judgement was entered against the Company in Superior Court of Californiain the amount of $379,000 plus legal and court costs for a total amount of$547,000 in a lawsuit brought by a prior landlord. The Company has reached anagreement with the landlord that will allow the Company to pay the judgementover a 30-month period for a total amount of $443,000 plus interest at 10% perannum.

 

Paymentsdue under debt obligations, including additional amounts borrowed subsequent toyear-end (see Note 12) are as follows: 2006 - $3,763,000, 2007 - $1,103,000;2008 - $1,050,000; and 2009 - $3,325,000.

 

**NOTE 7 - INCOME TAXES**

 

The Company incurredlosses for the years ended December 31, 2005, 2004, and 2003,respectively, and recorded no provision for income taxes.

 

Thereconciliation of income tax computed at the U.S. federal statutory rate toincome tax expense recorded in the consolidated financial statements was asfollows:

 

F-16

----

 
| ** **                         | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                               |       |                                        |       |   |   |   |   |
| Tax (benefit) at statutory rate    |       | (35.0                                       | )%         | (35.0 | )% | (35.0 | )% |
| Effect of graduated tax rates      |       | 1.0                                         |       | 1.0 |   | 1.0 |   |
| State taxes                        |       | (3.0                                        | )          | (3.0 | ) | (3.0 | ) |
| Adjustment for valuation allowance |       | 37.0                                        |       | 37.0 |   | 37.0 |   |
|                               |       | 0.0                                         | %          | 0.0 | % | 0.0 | % |

 

As of December 31,2005, we had federal net operating loss (NOL) carryforwards totalingapproximately $36.3 million and tax credit carryforwards of approximately$122,000 which can be used to reduce future taxable income. Such tax loss andtax credit carryforwards begin to expire in 2012. Changes in the ownership ofthe Company have placed limitations on the annual usage of these NOLs. Futurechanges in ownership may place additional limitations on these losses.

 

Thecomponents of the deferred tax asset is as follows:

 
| ** **                      | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                            |       |                        |       |                        |       |
| Net operating loss carryfowards |       | $                           | 13,431     |                        | $          | 11,100 |   |
| Inventories                     |       | 3,068                       |       | 3,108                       |       |
| Accrued expenses                |       | 235                         |       | 162                         |       |
| Other                           |       | 269                         |       | 352                         |       |
| Valuation allowance             |       | (17,003                     | )          | (14,722                     | )          |
|                            |       | $                           | —     |                        | $          | — |   |

 

TheCompany has recorded a full valuation allowance against the asset because, inthe opinion of management, it is more like than not that some portion or all ofthe deferred tax assets will not be realized.

 

**NOTE 8- ACCOUNTS PAYABLE – LONG TERM**

 

In July of 2003, wecompleted negotiations with the majority of our vendors to extend the paymentterms of the total amounts owed to them at the time. This resulted in $1.2million of our payables, or 67% of our total accounts payable at the time, beingrestructured with a total of 281 vendors. Under the terms of the extendedpayment plan, we agreed to make four to eight equal payments beginning on July 30,2003 until the balances are satisfied. The number of vendors agreeing to thisplan represented approximately 61% of our active vendors. As of December 31,2005, all scheduled contractual payments have been made under this plan. The followingsets forth the amounts due under this plan:

 
| ** **                                          | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                                |       |                        |       |                        |       |
| Total accounts payable due under the plan           |       | $                           | —     |                        | $          | 183,000 |   |
| Less: Current Portion due under the plan            |       | —                      |       | (183,000                    | )          |
|                                                |       |                        |       |                        |       |
| Total long-term accounts payable due under the plan |       | $                           | —     |                        | $          | — |   |

 

F-17

----

 

**NOTE 9 - COMMITMENTSAND CONTINGENCIES**

 

We lease certain facilities and equipment under variousoperating leases. Effective April 1997, we entered into an operating leaseagreement and relocated our headquarters to a new facility in St. Paul,Minnesota, coinciding with the expiration of the operating lease at ourprevious headquarters facility. Under the terms of the new agreement, whichextends through April 2007, we are responsible for base rent and alloperating expenses associated with the portion of the facility that we occupy. Theagreement provides us with a one-time option to cancel the lease after sevenyears, at which time we would only be responsible for certain unamortizedbuild-out costs incurred by the landlord. In May 2000, we notified our landlord of our intentto exercise our one-time option to lease the remaining additional 11,000 squarefeet within the same building at a date to be mutually determined. We occupy approximately 54,000 square feet of leased space inPenang, Malaysia, which is utilized as a manufacturing center for our matureproducts. This lease expires in June 2007.

 

Totalrent expense charged to operations, primarily for facilities and equipment, was$615,000, $814,000 and $847,000 for the years ended December 31, 2005,2004 and 2003, respectively.

 

The future minimum rentalpayments at December 31, 2005, due under noncancelable operating leases,are as follows: 2006 - $571,000; 2007 - $259,000 ; 2008 - $13,000 and zerothereafter.

 

We have an employmentagreement with our Chief Executive Officer that may be terminated upon 60days written notice by either party. If we terminate the agreement, we shallcontinue to pay his salary in effect at date of termination for 12 monthsthereafter. We also have an agreement with another executive officer that providesfor severance pay and other remuneration if his employment is terminated orduties significantly diminished as a result of a change of control.

 

**NOTE 10 -STOCK OPTION AND BONUS PLANS AND WARRANTS TO PURCHASE COMMON STOCK**

 

TheBoard of Directors previously reserved a total of 2,600,000 shares of commonstock under the 1993 Incentive Stock Options Plan for key employees. This planexpired in April 2003 except for outstanding options. In June of2004, the Board of Directors and shareholders approved the 2004 Incentive StockPlan and the reservation of 880,000 shares. Options under the two plans expirefive to ten years from the date of grant and generally vest over a two-year orfour-year period. If an individual ceases employment, he/she has 90 days toexercise vested options. Options granted in excess of the $100,000 annual IRSlimitations become non-qualified. The Compensation Committee of the Board ofDirectors at their discretion can grant non-qualified options and restrictedstock to eligible employees. In 2004 and 2003, the Board of Directors granted155,000 and 1,000,000, respectively, non-qualified options, which are includedin the stock option table below.

 

In fiscal 1996, our Boardof Directors and our shareholders approved the Stock Option Plan for OutsideDirectors. A total of 570,000 shares have been reserved for issuance under theplan. Each person who becomes an outside director will automatically be grantedan option to purchase 10,000 shares. In addition, each outside director willalso automatically be granted an option to purchase 10,000 shares immediatelyupon each reelection as a director, or on the anniversary of the prior year’sgrant in any year in which there is no meeting of the stockholders at whichdirectors are elected. The period within which an option must be exercised willbe the earlier of (1) ten years from the date of the grant, or (2) thedate which is one year after the director ceases to be a director for anyreason, provided that if a director voluntarily declines to stand forre-election after the age of 60, he shall not be required to exercise hisoptions within one year after he ceases to be a director and shall continue tovest in his options after he ceases to be a director. The exercise price foreach option will be the fair market value of the stock on the date of grant,and each option will generally vest over a two-year period at 50 percent peryear.

 

F-18

----

 

As of December 31,2005, we have also reserved a total of 9,563,077 shares of common stock forissuance upon conversion of the Notes described in Note 7. As of December 31,2005, 6,370,081 shares of stock have been issued from this reserve pursuant tothe conversion features of the Notes described in Note 7.

 

Asof December 31, 2005, we have also reserved a total of 2,092,350 shares ofcommon stock for issuance upon conversions in connection with the securedfinancing described in Note 7. As of December 31, 2005, no shares of stockhave been issued from this reserve pursuant to the conversion features of theconvertible debt described in Note 5. Debt subsequently made non-convertibledescribed in Note 13.

 

Wehave also reserved 150,000 shares of common stock for the grant ofnon-qualified stock options for outside directors, consultants, advisors andemployees.

 

F-19

----

 

Shares subject to optionsunder these plans were as follows:

 
| **Options**                           | ** ** | **Shares** | ** ** | **Exercise  Price Range** | ** ** | **Weighted  Average  Exercise  Price Per  Share** | ** ** |
|---------------------------------------|------------|------------|------------|--------------------------------|------------|--------------------------------------------------------|------------|
|                                  |       |       |       |                           |       |                                                   |       |
| Outstanding at December 31, 2001 |       | 2,337,915  |       | $1.00 to $11.25                |       | $                                                      | 3.44       |   |
|                                  |       |       |       |                           |       |                                                   |       |
| Granted                               |       | 633,109    |       | $0.69 to $3.55                 |       | $                                                      | 2.07       |   |
| Exercised                             |       | (49,176    | )          | $1.00 to $2.62                 |       | $                                                      | 1.66       |   |
| Expired                               |       | (245,097   | )          | $1.94 to $11.25                |       | $                                                      | 4.98       |   |
|                                  |       |       |       |                           |       |                                                   |       |
| Outstanding at December 31, 2002 |       | 2,676,751  |       | $0.69 to $11.25                |       | $                                                      | 3.01       |   |
|                                  |       |       |       |                           |       |                                                   |       |
| Granted                               |       | 1,060,000  |       | $0.90 to $1.27                 |       | $                                                      | 0.97       |   |
| Exercised                             |       | (150,000   | )          | $1.22                          |       | $                                                      | 1.22       |   |
| Expired                               |       | (999,633   | )          | $0.69 to $11.25                |       | $                                                      | 3.01       |   |
|                                  |       |       |       |                           |       |                                                   |       |
| Outstanding at December 31, 2003 |       | 2,587,118  |       | $0.69 to 11.25                 |       | $                                                      | 2.27       |   |
|                                  |       |       |       |                           |       |                                                   |       |
| Granted                               |       | 390,000    |       | $0.88 to $2.04                 |       | $                                                      | 1.23       |   |
| Exercised                             |       | (26,750    | )          | $0.69 to $0.90                 |       | $                                                      | 0.79       |   |
| Expired                               |       | (226,822   | )          | $0.69 to $7.75                 |       | $                                                      | 2.52       |   |
|                                  |       |       |       |                           |       |                                                   |       |
| Outstanding at December 31, 2004 |       | 2,723,546  |       | $0.69 to 11.25                 |       | $                                                      | 2.13       |   |
|                                  |       |       |       |                           |       |                                                   |       |
| Granted                               |       | 890,000    |       | $0.16 to $0.36                 |       | $                                                      | 1.23       |   |
| Exercised                             |       | —     |       | —                         |       | —                                                 |       |
| Expired                               |       | (1,941,311 | )          | $0.36 to $9.25                 |       | $                                                      | 1.98       |   |
|                                  |       |       |       |                           |       |                                                   |       |
| Outstanding at December 31, 2005 |       | 1,672,235  |       | $0.16 to 11.25                 |       | $                                                      | 1.33       |   |
|                                  |       |       |       |                           |       |                                                   |       |
| Exercisable at December 31, 2005 |       | 1,632,235  |       | $0.16 to 11.25                 |       | $                                                      | 1.38       |   |

 

Options outstanding at December 31, 2005 had exerciseprices ranging from $0.16 to $11.25 per share as summarized in the followingtable:

 

| **Range of  Exercise  Prices** | ** ** | **Number  Outstanding  at Dec. 31,  2005** | ** ** | **Weighted  Average  Remaining  Life** | ** ** | **Weighted  Average  Exercise  Price Per Share** | ** ** | **Number  Exercisable  at Dec. 31,  2005** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------|------------|
| $0.16 to $1.56                      |       | 1,251,235                                            |       | 2.3 years                              |       | $                                                          | 0.58       |                                                 | 1,211,235  |   |
| $1.84 to $2.95                      |       | 211,500                                              |       | 5.4 years                              |       | $                                                          | 2.50       |                                                 | 211,500    |   |
| $3.19 to $4.00                      |       | 139,500                                              |       | 3.6 years                              |       | $                                                          | 3.29       |                                                 | 139,500    |   |
| $5.44 to $7.75                      |       | 60,000                                               |       | 4.2 years                              |       | $                                                          | 7.13       |                                                 | 60,000     |   |
| $9.25 to $11.25                     |       | 10,000                                               |       | 4.2 years                              |       | $                                                          | 11.25      |                                                 | 10,000     |   |
| $0.16 to $11.25                     |       | 1,672,235                                            |       | 2.9 years                              |       | $                                                          | 1.35       |                                                 | 1,632,235  |   |

 

F-20

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At December 31, 2005and 2004, 765,000 shares were available for future grants under the terms ofthese plans. In December of 2004, the Compensation Committee of the Boardof Directors approved the acceleration of the vesting of all of the thenoutstanding options under all plans. At the time of this approval all optionexercise prices exceeded the public market price of the underlying commonshares. This action resulted in 1,029,500 shares being accelerated with respectto their original vesting dates.

 

In February 1996,the Board of Directors adopted the Employee Stock Purchase Plan and reserved300,000 shares of common stock for issuance under the Plan. Eligible employeescan elect under the Plan to contribute between two percent and ten percent oftheir base pay each plan year (June 1 - May 31) to purchase shares ofcommon stock at a price per share equal to 85 percent of market value on thefirst day of the plan year or the last day of the plan year, whichever is lower.Employee contributions are deducted from their regular salary or wages. Themaximum number of shares that can be purchased by an employee in any plan yearis 1,000 shares. For the years ended December 31, 2005 and 2004, no shareswere issued under the plan. For the year ended December 31, 2003, 8,000shares were issued under the plan at a price of $0.37. For the year ended December 31,2002, 28,551 shares were issued under the plan at prices ranging from $2.59 to$2.68 at a weighted average price of $2.68. Approximately 122,900 shares remainreserved for future issuances.

 

**NOTE 11 - SEGMENT, GEOGRAPHIC, CUSTOMERINFORMATION AND CONCENTRATION OF CREDIT RISK**

 

We operate in one industry segment supplying automatedequipment test handlers to the semiconductor industry. Net sales to customerslocated in the three geographic regions in which we operate are summarized asfollows (in thousands):

 
| ** **    | ** ** | **Years Ended**    | ** ** |
|---------------|------------|-------------------------|------------|
| ** **    | ** ** | **Dec. 31,  2005** | ** ** | **Dec. 31,  2004** | ** ** | **Dec. 31,  2003** | ** ** |
| United States |       | $                       | 1,205      |   | $ | 2,769 |   | $ | 3,725 |   |
| Asia          |       | 5,550                   |       | 10,640 |   | 6,989 |   |
| Europe        |       | 314                     |       | 1,193 |   | 409 |   |
|          |       | $                       | 7,069      |   | $ | 14,602 |   | $ | 11,123 |   |

 

Althoughour primary manufacturing facility is located in Penang, Malaysia, we do nothold a material amount of long-lived assets outside of the United States. Ofour inventory reflected on the Company balance sheet as of December 31,2005, $2.5 million was located in our facility in Penang, Malaysia.

 

During the year ended December 31,2005 our top ten customers accounted for approximately 92% of net sales withthree customers accounting for approximately 53.3% and one customer accountingfor approximately 33% of net sales. During the year ended December 31,2004 our top ten customers accounted for approximately 93% of net sales withthree customers accounting for approximately 65% of net sales and one customeraccounting for approximately 26% of net sales. During the year ended December 31,2003, our top ten customers accounted for approximately 86% of net sales withthree customers accounting for approximately 50% of net sales and one customeraccounting for approximately 32% of net sales. As of December 31, 2005,one customer accounted for 55.6% of our total net accounts receivable.

 

**NOTE 12– SUBSEQUENT EVENT**

 

OnFebruary 17, 2006, we restructured the financing with Laurus, andincreased the total maximum secured indebtedness with Laurus to $9.25 million. Therestructured financing now includes a $5.25 million term note. Interest ispayable monthly on the term note at the prime rate plus 2.5%. Beginning 360days after closing, we are required to make monthly payments equal to 1/60th ofthe principal amount until three years after the

 

F-21

----

 

closing, at which time the entire remainingprincipal and accrued interest is due and payable in full. The note isnon-convertible. In addition to the $5.25 million note, the working capitalline of credit was increased from $3.0 million to $4.0 million, and madenon-convertible. The note is payable in full on March 8, 2008. Interest ispayable monthly on the note at the prime rate plus 2.5%. The existing $1.2million over-advance in excess of the borrowing base on the working capitalline of credit was extended until April 30, 2007. However, commencing on December 1,2006, the over-advance is to be reduced by $200,000 each month. The Companyalso issued Laurus a 10-year option to purchase 2,500,000 shares at an exerciseprice of $.01 per share. The shares issuable upon exercise of the option havestandard registration rights.

 

Asa result of the new financing with Laurus, the conversion price for all of theNoteholders who accepted the prior restructuring agreements has been reduced to$0.56 per share due to the conversion provision in the Note documents.

 

F-22

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned; thereunto duly authorized, inthe City of St. Paul, State of Minnesota, on March 30, 2006.

 
|   | MICRO COMPONENT TECHNOLOGY, INC. |
|--------|---------------------------------------|
|   |                                  |
|   | By:                                   | /s/ Roger E.  Gower |   |
|   |                                  |  Roger E. Gower |   |
|   | President,  Chief Executive Officer,  |
|   | Chairman  of the Board and Director   |

 

Pursuant to the requirements of the Securities Exchange Act of1934, this report has been signed below by the following persons on behalf ofthe registrant in the capacities indicated on March 30, 2006.

 
| **Signature**            | ** ** | **Capacity** |
|--------------------------|------------|--------------|
|                     |       |         |
| /s/Roger E.  Gower       |       |         | President, Chief  Executive Officer, |
| Roger E. Gower           |       |         | Chairman of the  Board and Director |
|                     |       |         |
| /s/BachThuy T.  Vo       |       |         | Interim Chief  Financial Officer |
| BachThuy T. Vo           |       |         |   |
|                     |       |         |
| /s/Donald J.  Kramer     |       |         | Director |
| Donald J. Kramer         |       |         |   |
|                     |       |         |
| /s/David M.  Sugishita   |       |         | Director |
| David M. Sugishita       |       |         |   |
|                     |       |         |
| /s/Donald R.  VanLuvanee |       |         | Director |
| Donald R. VanLuvanee     |       |         |   |
|                     |       |         |
| /s/Patrick  Verderico    |       |         | Director |
| Patrick Verderico        |       |         |   |

 

----