SECURITIES AND EXCHANGE
COMMISSIONWASHINGTON, D.C. 20549

# FORM 10-K

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) of the Securities Exchange
Act of 1934 for the Year Ended December 31, 2003.

[   ]   TRANSITION PURSUANT TO SECTION 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from ___________ to ___________.

COMMISSION FILE NO. (0-16577)

| | CYBEROPTICS CORPORATION                               
| | ------------------------------------------------------
| | (Exact name of registrant as specified in its charter)

|Minnesota                                                      |  | 41-1472057                          
|-------------------------------------------------------------- |  | ------------------------------------
|                                                               |  |                                     
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|5900 Golden Hills DriveMinneapolis, Minnesota                  |  | 55416                               
|                                                               |  |                                     
|(Address of principal executive offices)                       |  | (Zip Code)                          

| | (763) 542-5000                                      
| | ----------------------------------------------------
| |                                                     
| | (Registrants telephone number, including area code)

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

# Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, no par value

Indicate by check mark
whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.   Yes  X   No

Indicate by check mark if
disclosure 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
information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.   [   ]

Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).   Yes     No  X

As of June 30, 2003 (the last
business day of the registrants second fiscal quarter), the aggregate market value
of the registrants Common Stock, no par value, held by non-affiliates of the
registrant was $51,808,878 (based on the closing sale price of common stock as of June 30,
2003 as quoted on the Nasdaq National Market).

As of March 25, 2004, there were
8,419,744 shares of the registrants Common Stock, no par value, issued and
outstanding.

# DOCUMENTS INCORPORATED BY REFERENCE:

The responses to
items 10, 11, 12 and 13 herein are incorporated by reference to
certain information in the Companys Definitive proxy Statement for its
Annual Meeting of Shareholders to be held May 14, 2004.

1

---

# CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS.

Our
Annual Report on Form 10-K contains a number of statements about our future operations. We
may make statements regarding anticipated product introductions, changes in markets,
customers and customer order rates, expenditures in research and development, growth in
revenue, taxation levels, the effects of pricing, and the ability to continue to price
foreign transactions in US currency, all of which represent our expectations and beliefs
about future events. Our actual results may vary from these expectations because of a
number of factors that affect our business, the most important of which include the
following:

| |  |  | We
operate in a very cyclical market  the electronics capital equipment market. We
have been unable to predict with accuracy the timing of periodic downturns in this
market. Further, because we sell to manufacturers (both OEM manufacturers of production
equipment and end-user circuit board assembly companies) in the market and do not have
immediate access to trends in their sales, it has been difficult for us to predict the
affect of these downturns on our sales, which typically lag general market conditions by
several months. These downturns, particularly the severe downturn in electronics
production markets from 2001 through 2003, have severely affected our operations,
necessitating a series of reductions in workforce and expenses, and generating several
years of unprofitable operations. We may be unable to foresee additional changes in these
markets before they affect our operations in the future.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | Our
operations and markets could be negatively affected by world events that effect economies
and commerce in countries, such as China and Japan, in which we do business, including
any additional outbreaks of infectious disease such as SARS.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | We
have been dependent on two original equipment manufacturer customers for a large portion
of our revenue (41%, 28% and 40% of revenues in 2003, 2002 and 2001, respectively). Our
operations were significantly negatively affected by reduced order rates from these two
customers during the past two years, and have been favorably impacted by increased order
rates in the past two quarters. If these customers are unsuccessful selling the products
into which our sensors are incorporated, design their products to function without our
sensors, purchase sensors from other suppliers, or otherwise terminate their
relationships with us, our results of operations would be significantly negatively
affected.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | During
2003, approximately 29% of our total revenue was generated by sales of a single SMT
Systems product line, the SE 300. If we are not successful in continuing to sell and
differentiate this product line relative to our competition, our results of operations
would be negatively affected.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | We
generate more than half of our revenue (approximately 79% in 2003) from export sales. Our
export sales are subject to many of the risks of international operations, including
changes in economic and business climate in foreign countries that affect the business
health of our customers, changes in exchange rates that affect the willingness of
customers to purchase our products, different laws that may affect our ability to protect
our intellectual property, and the expense of long-distance commerce.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | Our
current products, as well as the products we have under development, are designed to
operate with the technology we believe currently exists or may exist for electronic
components and printed circuit boards. The technology for these components changes
rapidly and if we incorrectly anticipate technology developments, or have inadequate
resources to develop our products to deal with changes in technology, our products could
become obsolete.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | Our
electronic assembly sensor products compete with products made by larger machine vision
companies, other optical sensor companies, and by solutions internally developed by our
customers.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | The
electronics capital equipment market for surface mount technologies is becoming more
mature, resulting in increased price pressure on suppliers of equipment. Consequently,
our electronic assembly system and sensor products may become subject to increased levels
of price competition and competition from other technologies.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | We
use a different distribution network to sell our end-user systems products, such as the
SE 300, and generate lower margins from these products, than the distribution system and
margins from our electronic assembly sensor products. To the extent our end-user systems
constitute a larger portion of our business, our profitability may be affected.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | We
compete with large multinational systems companies in sales of end-user systems products,
many of which are able to take advantage of greater financial resources and larger sales
distribution networks.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | We
compete in large part based on the technology we have developed and our success will
depend in part on how successful we are in protecting that technology and enforcing our
technology rights in the United States and other countries.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | We
use outside contractors to manufacture the components used in many of our products and
some of the components we order require significant lead times that could effect our
ability to sell our products if not available. In addition, if these components do not
meet stringent quality requirements or become subject to obsolescence, there could be
delays in product availability, and we could be required to make significant investments
in designing replacement components.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | We
plan to introduce a number of new products during fiscal 2004 and if those introductions
are delayed, our revenue and profitability could be negatively affected. In particular,
we are currently devoting significant resources to complete development and commence sale
of our embedded process verification (EPV) products. These products have yet to
generate substantial commercial sales.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

2

---

# PART I.

# ITEM 1.   DESCRIPTION OF BUSINESS

# BACKGROUND

CyberOptics® Corporation
was founded in 1984 by Dr. Steven K. Case (Chairman of the Board of CyberOptics
and full-time employee), a former professor at the University of Minnesota, with
the goal of commercializing technology for non-contact three-dimensional
sensing. Our world headquarters are located at 5900 Golden Hills Drive in Golden
Valley, Minnesota.

We
are a leading global supplier of optical process control sensors and inspection systems
that are used to control the manufacturing process and to ensure the quality of electronic
circuit boards manufactured by our customers using surface mount technology (SMT) and the
placement and transport of wafers during semiconductor fabrication. Our products enable
the global SMT and semiconductor industries to meet the rigorous quality demands for
printed circuit board assembly and semiconductor wafer transport. Using a variety of
proprietary technologies such as lasers, optics and machine vision, combined with
software, electronics and mechanical design, our products enable manufacturers to increase
production volume, product yields and quality by measuring the characteristics and
placement of components both during and after manufacturing processes.

Most
of our products (84% of revenue in 2003) are developed and sold for use in SMT electronic
circuit board assembly or with equipment used in SMT electronic circuit board assembly. We
sell products in this market both as sensor components that are incorporated into products
manufactured by other companies for sale to circuit board assembly companies, and as more
complete systems that are sold directly to circuit board assembly companies.
Our sensor products are sold to manufacturers of pick-and-place machines to align
electronic surface mount components during placement on the circuit board. Our systems
products are sold to contract manufacturers and other companies with surface mount
assembly lines, to control quality both off-line and as in-line systems. These systems
level products are used by manufacturers of circuit boards to measure screen printed
solder paste, to inspect circuit boards and components after component placement, to
confirm proper placement after full assembly of circuit boards and to inspect solder
joints on printed circuit boards.

We
also develop and sell products for use with the robotic equipment that handles
semiconductor wafers during the semiconductor fabrication process. In addition, we sell a
frame grabber product line for general industrial applications. These product lines are
sold through CyberOptics Semiconductor, Inc. which was formed from the combination of
HAMA Sensors, Inc. and Imagenation® Corporation, companies acquired in 1999 and
2000. Semiconductor products were 16% of total revenues in 2003.

# MARKET CONDITIONSRECENT DEVELOPMENT OF THE BUSINESS

Our
operations have historically been heavily influenced by market conditions in worldwide
electronics markets, and particularly in the SMT electronic assembly segment of these
markets. These markets have been very cyclical, with periods of strong growth followed by
periods of excess capacity and reduced levels of capital spending. Periods of growth in
the electronics equipment markets from 1997 through the second quarter of 1998, and from
the third and fourth quarters of 1999 to the second quarter of 2001, resulted in strong
sales of our products, particularly OEM sensor products. These same market cycles have
influenced sales of our Semiconductor Products lines. The semiconductor equipment cycles
have historically followed a similar pattern to those of the SMT market and resulted in a
period of strong sales of our products in 2000 and early 2001.

The
worldwide electronics equipment market experienced a dramatic decline starting in the
second quarter of 2001, which continued through early 2003. Although we maintained
relatively strong sales of SMT Systems products during this period through new product
introductions, our sensor products, which had constituted $43.4 million or 68% of sales in
2000, declined to $20.2 million or 53% of sales in 2001 and to $8.1 million or 33% of
sales in 2002. For several quarters during 2001 and 2002, our two largest electronic
assembly sensor (EAS) customers, who had purchased a large amount of inventory of our
products in anticipation of a continued robust market, ordered no products at all. These
customers began ordering product again during 2002, but their order rates remained low in
2002 compared to 2000 and early 2001. Our semiconductor products line, which had
experienced a record year in 2000, was also severely impacted by the decline in the market
for capital equipment for the semiconductor fabrication industry.

In
response to these market conditions, we took aggressive cost reduction actions during
2001, 2002 and 2003, reducing our worldwide employment by over 50% from 2001 peaks, and
closing or downsizing facilities. As part of these measures we eliminated separate
executive management within our three principal product groups, combined our former
Redwood City, California office for CyberOptics SemiConductor into our Portland Oregon
office, began to transition our research and development for KS series AOI systems
products from the UK to our main office in Minneapolis, with a plan of retaining primarily
a sales presence in the UK, decreased the amount of office space we occupy in the U.K. as
well as in our main office in Minneapolis, streamlined production in part by divesting or
making obsolete low volume products and substantially reduced personnel levels in all
departments. The last of these internal restructuring measures occurred in the fourth
quarter of 2003 and we do not anticipate any further restructuring measures in 2004.

3

---

While
we reduced the scope of our operations, we continued to invest heavily during 2002 and
early 2003 in new product development in anticipation of market recoveries. We introduced
the next generation of our laser align products and have devoted significant resources to
the development and introduction of other new or enhanced sensor and system products for
the electronic assembly and semiconductor markets and to the development of sensors that
contain embedded image processing (embedded process verification  EPV) which we are
introducing in late 2004.

Starting
in the second quarter of 2002, our two principal sensor customers began ordering product
at higher levels, although still at significantly lower levels than experienced in 2000.
This increased level of orders continued throughout 2003, with steady increases in order
rates, resulting in more than a 100% increase in sales of sensor products from 2002 to
2003. Although the order level from these customers continues to be below the peak level
of orders achieved in 2000, we anticipate continued improvement in order rates in the
first quarter of 2004. At the same time, we increased levels of sales of our systems level
products, particularly to original design manufacturer customers (ODMs) in China.
With the movement of more circuit board assembly plants to China, we focused our sales
efforts during 2003 on sales of system level products to original design manufacturer
customers operating in China, resulting in a 34% increase in sales of system products.

# OBJECTIVE

Our
objective is to build on the new products and product enhancements that we have developed
during the market downturn to further expand our sales of product into the SMT circuit
board assembly market as the market recovers. Although still in final customer testing, we
recently announced an agreement with a manufacturer of pick and place machines to
integrate our new embedded process verification (EPV) sensor into its machines, are
discussing integration with other manufacturers and currently plan to introduce a version
for sale as an enhancement to the installed base of a manufacturer later this year. We
also intend to capitalize on new lower cost sensor products introduced in 2003 for one of
our largest OEM customers. We are establishing an office in China to further penetrate the
growing market for manufacturing production equipment there and to increase the percentage
of worldwide production lines that use inspection in their production process to improve
production yields and reduce cost.

Our
strategy for Semiconductor Products is to capitalize on selected original equipment
manufacturer (OEM) sensor and end-user sensor opportunities in the wafer fabrication
capital equipment market. We currently sell sensors used in the wafer handling segment of
this market, and we are developing several new products used to calibrate wafer transport
tools.

Our
ability to implement our strategy effectively is subject to numerous uncertainties and
risks, the most significant risk being the timing of recovery in the global SMT circuit
board assembly and semiconductor fabrication capital equipment markets and completion of
development and successful commercial introduction of planned new products. We cannot
assure you that our efforts will be successful.

# OPERATIONS AND PRODUCTS

We
develop, manufacture and sell intelligent, non-contact sensors and systems for process
control and inspection. Our products are used primarily in the SMT electronic assembly and
semiconductor fabrication sectors of the electronics industry and enable manufacturers to
increase operating efficiencies, product yields and quality. In addition to proprietary
hardware designs that combine precision optics, various light sources, and multiple
detectors, our products incorporate software that controls the hardware and filters and
converts raw data into application specific information. Our product offerings are sold
both to original equipment manufacturers that supply the SMT and semiconductor fabrication
industries and to end-user customers who use our SMT Systems products directly for process
and quality control in the circuit board manufacturing process.

# SMT Electronic Assembly Sensors

Our
SMT electronic assembly sensor product line, which has generated the largest component of
our sales during the past seven years, is a family of sensors that use similar technology,
but that are customized for each customer and incorporated into the products of equipment
manufactured by our customers for use in SMT circuit board assembly. We work closely with
our original equipment manufacturer customers to integrate sensors into their equipment.

LaserAlign.   Our
LaserAlign sensor family has accounted for the vast majority of sales in the SMT
electronic assembly sensors product line. These sensors are sold for
incorporation into component placement machines used in the SMT production line
that are manufactured by a number of different OEM customers. Sales of these
products, including service repairs, to Juki Corporation and Assembleon N.V.,
accounted for approximately 21% and 20% of our revenue in 2003 and approximately
15% and 13% of our revenue in 2002. Accordingly, revenues and operations are
currently heavily influenced by the level of purchases from these two customers
and by the health of the SMT production industry.

4

---

The
LaserAlign family of products aligns components during transport on a pick and place
machine prior to placement on a circuit board. After solder paste has been deposited and
inspected, extremely small surface mount components known as chip capacitors and resistors
are placed on the solder pads by component placement machines. LaserAlign sensors are
incorporated into the placement heads of component placement machines to ensure accurate
component placement at high production speeds. Various high-speed component placement
machines use between one and sixteen LaserAlign sensors per machine. LaserAlign integrates
an intelligent sensor, composed of a laser, optics and detectors with a microprocessor and
software for making specific measurements. LaserAlign enables quick and accurate alignment
of each component as it is being transported by the pick-and-place arm for surface mount
assembly. Using non-contact technology, LaserAlign facilitates orientation and placement
of components at much higher speeds than can be achieved using conventional mechanical or
machine vision component centering systems.

The
LaserAlign sensor is offered in several different configurations to satisfy the
requirements of the different machines on which it is used. The latest version of the
LaserAlign sensor technology was introduced in a new sensor for Assembleon N.V. during
2003. Revenue from new product shipments of LaserAlign sensors has been a principal
contributor to our growth during the past five years and accounted for 30%, 19% and 38% of
our total revenue in the years ended December 31, 2003, 2002 and 2001, respectively.

Laser
Lead Locator. The Laser Lead Locator, which is incorporated directly into fine
pitch component placement machines, inspects components immediately before placement on
the circuit board to identify defective or damaged leads and determines if all lead tips
lie within the same plane. Sales of Laser Lead Locator have decreased over the last four
years as customers have found alternative products for lead coplanarity inspection and as
the need for inspection has decreased due to the continuing transition toward area array
type packages for which Laser Lead Locator does not apply. We expect to make our last
shipments of Laser Lead Locator products in early 2004.

DRS
Range Sensors. Our first commercial product was a range sensor known as a Point
Range Sensor or PRS. We developed and introduced Digital Range Sensor (DRS) in late
1997, a new generation of sensors, designed to replace the PRS product line. During March
2003, we transferred to the Optical Gaging Products Division of Quality Vision
International, Inc., which was previously our primary customer for the DRS products, the
rights and technology to manufacture and sell the DRS products. Quality Vision also
purchased all of remaining inventory of DRS sensors and prepaid royalties for a specified
number of DRS sales during the first five years after the transfer.

# Semiconductor Products

Although
we had sold some sensors for semiconductor wafer inspection prior to 1999, the
semiconductor product line became a significant part of our business with the acquisition
of certain assets of HAMA Laboratories, Inc. in 1999 and was further expanded with the
acquisition of Imagenation Corporation in 2000. Currently, our principal semiconductor
products are sensors that inspect the presence and orientation of semiconductor wafers in
cassettes during the fabrication process. Other products include frame grabber and machine
vision subsystems that were developed and sold by Imagenation. All semiconductor products
are sold to original equipment manufacturers for incorporation into their workstations and
systems.

Wafer
Mapping and Alignment Sensors. We manufacture and sell laser based reflective
sensors that improve the performance of robotic wafer handling equipment. During the
fabrication process, semiconductor wafers are stored in slotted cassettes during transport
to various fabrication tools. Robotic equipment removes the wafers from the cassettes and
inserts them into a fabrication tool. Our wafer mapping sensors inspect for the presence
of wafers in the cassettes and determine if the wafer is properly present and located in
the cassette. We introduced an improved version of the wafer mapper product, the EXQ
mapper, in late 2003 that we expect will generate increased sales in 2004.

Frame
Grabber Products and Machine Vision Subsystems. Frame grabber products are a
machine vision component that captures, digitizes, and stores video images. These products
are currently sold into a broad array of applications in a number of different industries,
with strategic emphasis on semiconductor customers.

# SMT Systems Products

Our
SMT systems product line consists of stand-alone measurement and inspection systems used
in the SMT electronic assembly industry for process control and inspection. These systems
are sold directly to end-user manufacturing customers that use them in a production line
or along side a production line to maintain process and quality control. Our products
incorporate proprietary sensors as well as substantial, off the shelf, translation or
robotics hardware and complete computer systems or processors with internally developed
software.

SE
300.   The SE 300 is an in-line system that measures in three dimensions the amount
of solder paste applied to the circuit board after the first step of the SMT assembly
process. Because of the small size of the components that must be placed on each pad of
solder paste and the density of components placed on the circuit board, a significant
amount of SMT assembly problems are related to the quality of solder paste deposition.
Misplaced solder paste or excess or inadequate amounts of paste can lead to improper
connections or bridges between leads causing an entire circuit board to malfunction.

5

---

We
first introduced the SE 300 in March 2000 and recorded our first revenues from sale of the
SE 300 in the fourth quarter of 2000. The SE 300 is designed to inspect the height, area
and volume of 100% of a circuit board at production line speeds and with resolution that
allows it to measure the smallest chip scale packages and micro ball array component
sites. The SE 300 can be retrofitted and integrated into most SMT production lines,
providing real time quality control immediately after a printed circuit board leaves the
screen printer and before component placement commences. Revenues from shipments of the SE
300 accounted for 29%, 27%, and 10% of our total revenue in the years ended December 31,
2003, 2002, and 2001, respectively.

LSM
300.   The Laser Section Microscope (LSM 300) is a low cost off-line instrument for
making height and registration measurement of screen printed solder paste during the
assembly of surface mount circuit boards. One of the principal advantages of the LSM 300
is its ease of use, as unskilled operators can make non-contact measurements with only
minimal training. During 2003, we decided to discontinue the LSM 300 product and
ship-end-of-life quantities to customers during 2004 due to engineering investments
required to replace obsolete parts and our focus on in-line inspection systems.

Automated
Optical Inspection (KS) Products.   The KS 100 is the first Automated Optical
Inspection (AOI) product we introduced using in-process technology acquired from Kestra
Ltd. This in-line product measures and inspects the circuit board after component
placement and before reflow to determine whether components have been placed correctly.
The principal advantage of the KS 100 is ease of use for the operator compared to other
AOI machines and the low level of false calls. We recognized initial revenues on the KS
100 in the fourth quarter of 2000.

During
late 2000, we released the KS 50 AOI system, using in-process technology purchased from
Kestra Ltd. This product screens populated circuit boards for missing components either
before or after the reflow oven. During 2002, in response to customer requests, we decided
to introduce KS systems that incorporate high resolution color video display (see KS 75,
KS 200 and KS Flex below). During 2003, we discontinued the KS 50 and KS 100 products due
to demand for the capabilities provided by KS 75, KS 200 and KS Flex.

We
introduced the KS 75 and KS 200 AOI systems, which incorporate high resolution color
cameras for improved imaging, in early 2002. The KS 75 is for inspection of circuit boards
before and after the reflow oven and is capable of inspecting solder joints, currently the
largest market application for AOI equipment. The KS 200 is designed to inspect the
placement of very small (0201) components on circuit boards. In 2003, we introduced KS
Flex, which provides improved performance and allows for a variety of machine
configurations (different number of cameras based on board size and resolution
requirements) based on customer needs. The KS Flex common platform will ultimately replace
the KS 75 and KS 200 product offerings.

# Markets and Customers

We
sell the vast majority of our products into the electronics manufacturing market (84% of
total revenues in 2003), particularly the portion servicing manufacturers doing SMT
circuit board assembly. The value of automation is high in this market because the
products produced have high unit costs and are manufactured at speeds too high for
effective human intervention. Moreover, the trend in these industries toward smaller
devices with higher circuit densities and smaller circuit paths requires manufacturing and
testing equipment capable of extremely accurate alignment and multidimensional measurement
such as achieved using non-contact optical sensors. Customers in these industries also
employ knowledgeable engineers who are competent to work with computer-related equipment.
Our LaserAlign and Laser Lead Locator products are sold to OEMs serving this market
and the SE, KS and LSM series inspection systems are sold to end user electronic assembly
manufacturers in this market.

We
sell our semiconductor products into the semiconductor capital equipment market, for use
in the fabrication of semiconductor devices. This market has many of the same
characteristics as the SMT electronics assembly market and requires non-contact optical
measurement tools that enable the production of more complex, higher density and smaller
semiconductor devices. We sell our wafer mapping and alignment sensors to manufacturers of
equipment that transport wafers during the semiconductor manufacturing (front end
fabrication) process. Wafer mapping and wafer/tool alignment type sensors will become
increasingly critical to this market when the use of 300 millimeter semiconductor wafers
and sub 90nm linewidth features become widespread.

An
increasing proportion of our end user SMT System sales are being originated in the low
cost geographies of Asia, and particularly in the Peoples Republic of China. While
there is a limited amount of new worldwide production capacity being added due to excess
capacity for circuit board assembly, the new facilities that are being built are primarily
in China. Consequently, most capital equipment suppliers are increasing their sales and
operational capabilities in China to pursue sales in this market. In response, we opened
our Singapore office in 2001 to support SMT Systems sales throughout Asia and are planning
to open a sales office in China later in 2004. This market is also important to our OEM
electronic assembly sensor product lines as our OEM customers are looking to sell their
pick-and-place equipment into this market.

We
sell our products worldwide to many of the leading manufacturers of electronic circuit
assembly equipment, semiconductor capital equipment manufacturers and end user electronic
assembly manufacturers. Although we maintain a sales office in the UK and in Singapore,
all manufacturing of our products occurs in the United States and all sales originate in
the United States.

6

---

The
following table sets forth the percentage of total sales revenue represented by total
export sales (sales for delivery to countries other than the United States, including
sales delivered through distributors) by location during the past three years:

|         | Year Ended December 31,
|-------- | -----------------------
|
|Asia     | 53%                    
|Europe   | 25%                    
|Other(1) | 1%                     

(1)   Includes
export sales in North America, primarily export sales to Canada, Mexico and Latin
America.

See
Note 10 to the Companys Consolidated Financial Statements contained in item 8 of
this Form 10-K.

All
export sales are negotiated, invoiced and paid in United States dollars. Accordingly,
although changes in exchange rates do not affect revenue and income per unit, they can
influence the willingness of customers to purchase units.

# Sales and Marketing

Our
electronic assembly sensors and wafer mapping semiconductor products are sold to large OEM
customers by direct sales staff located in Minnesota and Oregon. Our systems products are
primarily sold through independent representatives and distributors managed by direct
sales personnel located in Minnesota, as well as in the UK and Singapore. We have
agreements with 14 representatives and distributors in North and South America who focus
primarily on SMT Systems products sold to end-users. We make most of our sales to
international end-users of systems products through 18 representatives and distributors
covering Europe (12) and the Pacific Rim (6).

We
sell our semiconductor frame grabber products through direct sales staff located in
Portland, Oregon, and through 25 sales representatives throughout the world. These
representatives are not under contract, but are authorized to sell frame grabber products
and in many cases act as system integrators for our products.

We
market our products through appearances at industry trade shows, advertising in industry
journals, articles published in industry and technical journals and on the Internet. In
addition, we have strategic relationships with certain key customers that serve as highly
visible references.

# Backlog

Our
products are typically shipped two weeks to two months after the receipt of an order.
Since 1993, however, our two large laser align customers have placed orders for delivery
over as many as 12 months. Product backlog was $6.6 million on December 31, 2003, compared to $2.8 million on December 31, 2002, and $3.1
million at December 31, 2001. Substantially all of the 2003 backlog is deliverable in the
first quarter of 2003, or was delivered at December 31, 2003, however, on a relatively
small portion of system products, revenue is not recognized until final customer
acceptance. Although our business is generally not of a seasonal nature, sales may vary
seasonally based on the capital procurement practices in the electronics and semiconductor
industries. Our scheduled backlog at any time may vary significantly based on the timing
of orders from OEM customers. Accordingly, backlog may not be an accurate indicator of
performance in the future.

# Research and Development

We
differentiate our products primarily on the basis of customer benefits afforded by the use
of clever and proprietary technology and on our unique ability to combine several
different technical disciplines to address industry and customer needs. CyberOptics was
founded by research scientists and has retained relationships with academic institutions
to ensure that the most current information on technological developments is obtained. In
addition, we actively seek ongoing strategic customer relationships with leading product
innovators in our served markets and actively investigate the needs of, and seek input
from, these customers to identify opportunities to improve manufacturing processes. Our
engineers have frequent interactions with our customers to ensure adoption of current
technologies. In some instances, we receive funding from these customers through
development contracts that provide the customer with an exclusive selling period but
allows us to retain technology and distribution rights.

7

---

We
believe that continued and timely development of new products and enhancements to existing
products is essential to maintaining our industry leading position in the market. As a
technology based company, we commit substantial resources to research and development
efforts, which plays a critical role in maintaining and advancing our position as a
leading provider of optical sensors and systems. During 2003 and 2002, research and
development efforts were primarily focused on initial development activities for several
new sensor products, including development activities on the new Embedded Process
Verification sensor family (EPV), continued development of the SE and KS series inspection
systems, next generation LaserAlign products, board alignment and on-head linescan cameras
and enhancements to the semiconductor wafer mapping sensor product family. During 2004, we
intend to continue to expend significant sums on completion and introduction of our EPV
and new semiconductor products, further improvements in the versions of our LaserAlign
products as sold to our two principal customers, enhancements and upgrades of the SE
product families and on various other product opportunities.

Research
and development expenses were $7.1 million, $8.0 million and $8.6 million for the years
ended December 31, 2003, 2002, and 2001, respectively. These amounts represented 20%, 33%
and 22% of revenues, respectively. Research and development expenses consist primarily of
salaries, project materials and other costs associated with ongoing product development
and enhancement efforts. Research and development resource utilization is centrally
managed based on market opportunities and the status of individual projects.

# Manufacturing

Much
of our product manufacturing, which is primarily circuit board manufacturing, lens
manufacturing, and metal parts production, is contracted with outside suppliers. Our
production personnel inspect incoming parts, assemble sensor heads and calibrate and
perform final quality control testing of finished products. Our products are not well
suited for the large production runs that would justify the capital investment necessary
for complete internal manufacturing. Our electronic assembly sensor products and SMT
systems products are assembled in Minneapolis, MN, and our semiconductor products are
assembled in Portland, OR.

A
variety of components used in our products are available only from single sources and
involve relatively long order cycles, in some cases over one year. Although we have
located sources for substitute components, use of those alternative components could
require substantial rework of the product designs, resulting in periods during which we
could not satisfy customer orders. Further, although we believe we have identified
alternative assembly contractors for most of our subassemblies, an actual change in such
contractors would likely require a period of training and testing. Accordingly, an
interruption in a supply relationship or the production capacity of one or more of such
contractors could result in the inability to deliver one or more products for a period of
several months. To help prevent delays in the shipment of our products, we maintain in
inventory, or on scheduled delivery from suppliers, what we believe to be a sufficient
amount of certain components based on forecasted demand (forecast extends a minimum of 6
months).

# Competition

Although
we believe that our products offer unique capabilities, competitors offer technologies and
systems that perform some of the visual inspection and alignment functions performed by
our products. We face competition from a number of companies in the machine vision, image
processing and inspection systems market, some of which are larger and have greater
financial resources.

Our
electronic assembly sensor products face competition in the market for alignment and
inspection on OEM component placement machines primarily from manufacturers of vision
(camera and software based) systems. Potential competitors in these markets include Cognex
Corporation, Electro Scientific Industries, Inc. and ICOS Vision Systems, NV (Belgium).
Competition in this market is based on our ability to custom design products with
stringent physical form requirements, speed, flexibility, cost and ease of control. In
addition, our products compete with systems developed by OEMs using their own design staff
for incorporation into their products. Our electronic assembly sensor products have
historically competed favorably on the basis of these factors, and particularly on the
basis of speed and product cost. Nevertheless, advances in terms of speed by vision
systems have reduced some of the advantages of our products in some configurations. We
have introduced newer configurations adapted by several customers that we believe allow
our sensors, and the component placement machines in which they are incorporated, to
compete favorably based on the speed and accuracy of their performance, and their price.
In addition, we are expanding our focus to incorporate additional inspection capabilities
into our sensors, including our embedded process verification (EPV), which could give us a
competitive advantage in this market.

Our
semiconductor products face competition in the wafer mapping and alignment market
primarily from manufacturers of through-beam sensors developed by our customers using
inexpensive sensors from general industrial market suppliers like Banner Engineering
Corporation, Omron, Ltd (Japan) and Keyence, Ltd (Japan). We believe that our sensors
compete favorably in this market based on performance and the unique advantages of the
reflective mode of operations. Through-beam sensing is generally less desirable due to
concerns about potential wafer contamination and the lack of flexibility in certain
robotic system configurations.

8

---

The
primary competitor for sales of our SE 300 products is GSI Lumonics, Inc. (SVS division),
and more recently Agilent Technologies, Inc. and Orbotech, Ltd. (Israel). In addition,
some manufacturers of screen printing equipment provide optional 2-D solder paste
inspection, and other machine vision companies (AOI companies) have started offering 2-D
and occasionally 3-D solder paste inspection products. The Company believes that it
currently competes effectively in this market on the basis of performance, ease of
installation and operation, and price.

Our
AOI inspection system products (KS Products) face competition from a large number of AOI
companies, the most significant being Agilent (formerly MVT), Orbotech,
Ltd. (Israel), Viscom (Germany) and Omron, Ltd. (Japan). We believe that the technology
used in the KS series is differentiated from the competition and that it will compete
effectively in this market based on measurement accuracy, ease of use and the low rate of
false calls.

Although
we believe our current products offer several advantages in terms of price and suitability
for specific applications and although we have attempted to protect the proprietary nature
of such products, it is possible that any of our products could be duplicated by other
companies in the same general market.

# Employees

As
of December 31, 2003, we had 138 full-time and 3 part-time employees worldwide, including
30 in sales and marketing and customer support, 49 in manufacturing, purchasing and
production engineering, 41 in research and development and 21 in finance, administration
and information services. Of these employees, 100 are located at our corporate
headquarters in Minneapolis and 41 are located at subsidiary locations (5 in the UK, 31 in
Oregon and 5 in Singapore). To date, we have been successful in attracting and retaining
qualified technical personnel, although there can be no assurance that this success will
continue. None of our employees are covered by collective bargaining agreements or are
members of a union.

# Proprietary Protection

We
rely on the technical expertise and know-how of our personnel and trade secret protection,
as well as on patents, to maintain our competitive position. We attempt to protect
intellectual property by restricting access to proprietary methods by a combination of
technical and internal security measures. In addition, we make use of non-disclosure
agreements with customers, consultants, suppliers and employees. Nevertheless, there can
be no assurance that any of the above measures will be adequate to protect our proprietary
technology.

We
hold 74 patents (47 US and 27 foreign) on a number of technologies, including those used
in the LaserAlign systems, Laser Lead Locator and other products. Some of the patents
relate to equipment such as pick and place machines, into which our sensor products are
integrated. In addition, the Company has 106 pending patents, 29 US and 77 foreign. We
protect the proprietary nature of our software primarily through copyright and license
agreements, but also through close integration with our hardware offerings. We utilize 14
registered trademarks, 3 of which are foreign. An additional 2 trademarks are pending. We
also have 10 domain names and several common law trademarks. It is our policy to protect
the proprietary nature of our new product developments whenever they are likely to become
significant sources of revenue. No guarantee can be given that we will be able to obtain
patent or other protection for other products.

As
the number of our products increases and the functionality of those products expands, we
may become increasingly subject to attempts to duplicate our proprietary technology and to
infringement claims. In addition, although we do not believe that any of our products
infringe the rights of others, there can be no assurance that third parties will not
assert infringement claims in the future or that any such assertion will not require us to
enter into a royalty arrangement or result in litigation.

In
February 2003, the intellectual property of Avanti Optics Corporation (Avanti)
became our property (See Management Discussion and Analysis of Financial Condition and
Results of Operations and Financial Statements and Supplementary Data for additional
details). Avanti held one patent related to automated assembly of optical components. In
addition, Avanti had 24 patents pending and 12 provisional patent filings, all related to
automated assembly of optical components and machines for assembly of optical components.

# Government Regulation

Many
of our products contain lasers. Products containing lasers are classified as
either Class I, Class II or Class IIIb Laser Products under
applicable rules and regulations of the Center for Devices and Radiological
Health (CDRH) of the Food and Drug Administration. Such regulations generally
require a self-certification procedure pursuant to which a manufacturer must
file with the CDRH with respect to each product incorporating a laser device,
periodic reporting of sales and purchases and compliance with product labeling
standards. Our lasers are generally not harmful to human tissue, but could
result in injury if directed into the eyes of an individual or otherwise
misused. We are not aware of any incident involving injury or a claim of injury
from our laser devices and believe that our sensors and sensor systems comply
with all applicable laws for the manufacture of laser devices.

9

---

# ITEM 2.   PROPERTIES

We
lease a 70,000 square foot mixed office and warehouse facility built to our specifications
in Golden Valley, Minnesota, which functions as our corporate headquarters and primary
manufacturing facility. The lease, which is on a triple net basis for a ten year term
(from May 1996) with two three year renewal options, provides for rental payments at
approximately $7.50 per square foot initially, increasing to $8.50 per square foot. In
December 2003, we vacated approximately 18,000 square feet of this space and are
attempting to sublease this space for the remainder of the term of the lease. As of
December 31, 2003, we also have operating leases in Oregon (CyberOptics Semiconductor,
Inc.), Singapore (CyberOptics (Singapore) Pte. Ltd.) and Massachusetts, which expire in
May 2007, May 2004 and August 2004, respectively. In December 2003, we negotiated a
buy-out of our remaining lease obligation in the UK. We have signed a new lease for less
square feet in our current UK facility, with terms allowing for cancellation with 60 days
notice.

# ITEM 3.   LEGAL PROCEEDINGS

We are not currently subject to any material pending or threatened legal proceedings.

# ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted during the fourth quarter of 2003.

# PART II.

# ITEM 5.   MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our
common stock is traded on the Nasdaq National Market. The following table sets forth, for
the fiscal periods indicated, the high and low quotations for our common stock as reported
by the Nasdaq National Market. These prices do not reflect adjustments for retail markups,
markdowns or commissions.

|       | 2003 | 2002
|------ | ---- | ----
|
|First  |      |     
|Second |      |     
|Third  |      |     
|Fourth |      |     

As
of March 25, 2004, there were approximately 250 holders of record of common stock and
approximately 4,500 beneficial holders. We have never paid a dividend on common stock.
Dividends are payable at the discretion of the Board of Directors out of funds legally
available therefore. Our board has no current intention of paying dividends.

10

---

# ITEM 6.   SELECTED FINANCIAL DATA

Five-Year Financial Summary
CyberOptics Corporation
(In thousands, except per share information)

|Year Ended December 31            | 2003 (1) |  | 2002 (2)(3) |        | 2001 (4) |   | 2000 (5) |   | 1999 (6)
|--------------------------------- | -------- |  | ----------- | ------ | -------- | - | -------- | - | --------
|Revenues                          |          |  | $           | 35,636 |          | $ | 24,634   |   | $       
|Income (loss) from Operations     |          |  |             | (2,814 | )        |   | (13,908  | ) |         
|Cumulative Effect of Change       |          | 
|In Accounting Principle           |          |  |             |       |          |   |         |   |         
|Net Income (loss)                 |          |  |             | (2,637 | )        |   | (13,555  | ) |         
|Net Income (loss) per Share:      |          | 
|Basic                             |          |  |             | (0.32  | )        |   | (1.66    | ) |         
|Diluted                           |          |  |             | (0.32  | )        |   | (1.66    | ) |         
|Cash and Marketable Securities(7) |          |  | $           | 24,822 |          | $ | 20,818   |   | $       
|Working Capital                   |          |  |             | 26,963 |          |   | 25,268   |   |         
|Total Assets                      |          |  |             | 47,926 |          |   | 48,274   |   |         
|Stockholders' Equity              |          |  |             | 41,752 |          |   | 44,062   |   |         

(1)    2003
results include a $1.2 million charge for workforce reductions and other
restructuring charges and a $632 charge for accelerated amortization of intangible
assets. In addition, 2003 includes a $645 gain from a technology transfer and license.
(2)    2002
results include an increase in the valuation allowance for deferred income taxes of
approximately $4.3 million. See Notes to Consolidated Financial Statements and
Managements Discussion and Analysis of Financial Condition and Results of Operations in
this Form 10-K for further details.
(3)    2002
results include a pre-tax charge of $1.6 million for workforce reduction costs and
other restructuring charges. 
(4)    2001
results include a pre-tax charge of $419 for workforce reduction charges. 
(5)    2000
results include a pre-tax charge of $2.1 million for acquired in-process research
and development and a $308 pre-tax charge for the write-off of impaired technology.  
(6)    1999
results include a pre-tax charge of $7.3 million for acquired in-process research
and development.
(7)    Includes
amounts classified as current and long term.

# ITEM 7.   MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

# General Overview:

Our
products are sold primarily into the electronics assembly and semiconductor fabrication
capital equipment markets, where we sell products both to original equipment manufacturers
of production equipment and to end-user customers that produce circuit boards and
semiconductor wafers/devices. Historically these markets have been very cyclical, with
periods of rapid growth as worldwide capacity is added to support consumer demand for
electronic products, followed by periods of excess capacity and reduced capital spending.
During 2000, these markets experienced historically high growth rates and reached record
volume levels. However, in early 2001 the electronics capital equipment markets
experienced a significant decline that continued through 2002 and into early 2003. In the
third quarter of 2001, our two largest electronic assembly sensor customers, which had
accounted for 54% of our revenue in 2000, virtually ceased ordering product and have only
begun ordering significant quantities of product again in 2003. Similarly, because of
significant decline in semiconductor production and drastic decline in capital equipment
purchased by semiconductor fabricators, our semiconductor products, which are sold
primarily to capital equipment suppliers to the semiconductor business, declined
significantly. This prolonged market decline resulted in significant price pressure on
both consumer electronics products and on capital equipment suppliers, resulting in a
migration of worldwide electronics production capacity to low cost geographies in Asia and
Eastern Europe. This drive to reduce manufacturing costs has also impacted pricing levels
on our products, requiring us to invest in cost reduction initiatives and in SG&A
resources to support growing Asian sales volumes. Our operating results have been heavily
impacted by these market conditions, resulting in net losses during the period of 2001 to
2003.

In
response to declining revenues and operating losses, we have taken aggressive cost
reduction actions during 2001, 2002, and 2003, including reducing our worldwide employment
by over 50% from 2001 peaks, and closing or downsizing facilities. Nevertheless, in order
to continue new product development initiatives required to maintain our competitive
position in the marketplace, as well as to continue to support existing products and make
investments in Asia, we were not able to reduce our expense structure to keep pace with
the dramatic reduction in revenue levels until the fourth quarter of 2003 when we returned
to profitability. Further compounding these market effects, we determined during 2002
that, based on accounting guidance, we were required to record a valuation allowance
against our deferred tax assets, eliminating a significant portion of the tax benefit that
would be recorded against pre-tax losses.

11

---

During
2003 we have significantly improved our operating results, as quarterly revenues have
grown sequentially from $6.4 million in the first quarter to $11.2 million in the fourth
quarter. In addition we returned to profitability in the fourth quarter reporting net
income of $896,000 or $0.11 per share, which included a $609,000 charge for restructuring
costs. Revenue growth in 2003 is the result of both improvement in market conditions and
the success of new and improved products developed over the past three years. The return
to profitability is a result of both higher revenue levels and a more efficient
organization with a much lower cost structure. Our balance sheet is also well positioned
as a result of effective management of working capital and other assets over the past
three years. We have no debt and our cash and marketable securities are $24.8 million at
December 31, 2003 compared to $20.8 million at December 31, 2002. We generated $4.0
million of cash in 2003, primarily from operating activities. We believe that cash
reserves are sufficient to fund operations and to make investments such as new product
development initiatives.

# Results of Operations for the Three Years Ended December 31, 2003:

Revenues

Our
revenues increased by 45% to $35.6 million in 2003 from $24.6 million in 2002, and
decreased by 36% in 2002 from $38.4 million in 2001. The following table sets forth, for
the years indicated, revenues by product line (in thousands):

|                            | 2003 |  | 2002 |        | 2001
|--------------------------- | ---- |  | ---- | ------ | ----
|OEM Solutions:              |      |  |      |        |     
|Electronic Assembly Sensors |      |  | $    | 16,122 |     
|Semiconductor Products      |      |  |      | 5,550  |     
|SMT Systems                 |      |  |      | 13,964 |     
|                            |      |  |      |        |     
|Total                       |      |  | $    | 35,636 |     

Revenues
from our electronic assembly sensors products increased $8.1 million or 100% during 2003
compared to 2002, and decreased $12.2 million or 60% during 2002 compared to 2001. During
2003, revenues from electronic assembly sensors, primarily our LaserAlign sensors, were
positively impacted by improved market conditions in the worldwide market for SMT capital
equipment and by the introduction of two new sensors for one of our large customers. These
sensors were designed for the latest generation pick-and-place machine of this customer,
which was introduced during 2003. An earlier version of this machine, which is still being
sold, also incorporated our sensors, but the new machine will have higher content of our
products per machine. During 2002, revenues were negatively impacted by the depressed
market conditions in the worldwide market for SMT capital equipment. This slowdown began
in the first half of 2001 and continued throughout 2002 and early 2003. The market impact
was compounded by the relatively large inventory of LaserAlign sensors that had been
accumulated by our two principal customers during 2001, resulting in virtually no new
orders from those customers during the second half 2001 and early 2002. In the second and
third quarters of 2002, these two customers began ordering new sensors, but the order
rates were depressed by overall weakness in the SMT capital equipment markets.

Revenues
from Semiconductor Products (including revenues from Imagenation frame grabber products
for semiconductor and other applications) decreased $635,000 or 10% in 2003 compared to
2002, following a decrease of $534,000 or 8% in 2002 compared to 2001. The decrease in
2003 was primarily the result of lower frame grabber revenues, reflecting a technology
change away from analog frame grabbers like those we sell and weakness in the general
industrial capital equipment market. Revenues from wafer mapping sensors were
approximately flat with 2002 as a result of improved market conditions in the
semiconductor fabrication capital equipment markets in the later part of 2003. The
decrease in 2002 compared to 2001 was primarily the result of lower revenues from wafer
mapping sensors reflecting market weakness. Revenues from products developed by
Imagenation for broader industrial application were flat in 2002 compared to 2001.

Revenues
from our SMT systems products increased $3.6 million or 34% during 2003 compared to 2002
and decreased $1.1 million or 9% during 2002 compared to 2001. During 2003, revenues from
SMT systems, primarily our SE 300 solder paste inspection system were positively impacted
by improved market conditions in the SMT capital equipment markets and by success in
selling systems to many of the large manufacturers of circuit boards in Asia (particularly
China). A large portion of the worldwide production capacity for printed circuit boards is
being added in China, and we have been successful in selling inspection systems to new and
existing customers in that region. During 2002, revenues from SMT systems suffered from
the same market conditions as our other product groups and were also impacted by
significant price pressure. SMT Systems revenue levels in 2001 and 2002 were not as
volatile as in our other product groups due to new product introductions and the success
of those products in a depressed market. The SE 300 and the KS series products generated
initial revenue in the fourth quarter of 2000. The market acceptance of these products,
particularly the SE 300, allowed for relatively modest revenue declines in a severely
depressed market during 2001 and 2002 and have been the primary reason for growth in 2003.
We believe that increasing use of outsourcing for circuit board assembly, production
difficulties associated with smaller component sizes, increased production speeds and
increased cost pressure on companies manufacturing circuit boards has caused increased
demand for our inspection equipment.

12

---

International
revenue totaled $28.2 million in 2003, $16.5 million in 2002 and $25.7 million in 2001,
comprising 79%, 67% and 67% of total revenue, respectively. The international markets of
China and the rest of Asia, Japan and Europe account for a significant portion of the
production capability of capital equipment for the manufacture of electronics, the primary
market for our electronic assembly sensor and SMT system product lines.

Gross Margin

Gross margin
increased to 52% of sales in 2003 from 41% in 2002 and 51% in 2001. Gross margin is highly
dependent on the level of revenues and resulting production levels over which to spread
fixed manufacturing costs such as facilities and other compensation and non-compensation
expenses that do not vary with activity levels. In addition, with higher production
volumes, manufacturing processes become more efficient and reduce the overall cost of
producing products for sale. Revenue levels increased 45% in 2003 compared to 2002 and
declined 36% in 2002 compared to 2001, and although we have reduced costs as part of cost
reduction actions in an effort to better match manufacturing costs with volume levels, the
volatility of revenues over the past three years has had a significant impact on gross
margin.

In
addition, during 2003 increased revenues from electronic assembly sensors, which increased
100% in 2003 compared to 2002 and carry higher gross margins than SMT systems products, as
well as significantly reduced obsolete inventory expense and cost reduction actions,
including workforce reductions, contributed to higher gross margins. These positive
factors were somewhat offset by continued price pressure on both SMT systems and
electronic assembly sensor products, as weak market conditions and the drive to reduce
manufacturing costs in the SMT electronic assembly capital equipment market over the past
three years has had a negative impact on the selling price of our products. During 2002,
gross margins were negatively impacted by a higher proportion of revenues from systems
products and the decision to discontinue, over time, the sales of certain older version
SMT systems, which resulted in increased reserves for obsolete inventory on these older
systems. If revenue, particularly higher gross margin revenue from our electronic assembly
sensor and semiconductor products, continues to improve, we expect incremental improvement
in our gross margins in 2004 compared to 2003.

Research
and Development Expenses

We
reduced our research and development expenses in 2003 by 10% to $7.2 million, and reduced
those expenses by 6% to $8.0 million in 2002 from $8.6 million in 2001. As a percentage of
revenue, research and development expenses decreased to 20% in 2003, compared to 33% in
2002 and 22% in 2001. The 2003 and 2002 reductions in research and development expense are
primarily the result of a series of cost reduction initiatives implemented during the past
three years. Research and development expenses were maintained at relatively high levels
through the first half of 2002 as CyberOptics continued to fund several new product
development initiatives on important new products even as revenues levels declined
significantly. Cost reduction measures implemented during the second quarter of 2002
enabled us to significantly reduce research and development expenses, which have since
been maintained at approximately current levels.

During
2003 and 2002, research and development efforts were primarily focused on initial
development activities for several new sensor products, including development activities
on the new Embedded Process Verification sensor family (EPV), continued development of the
SE and KS series inspection systems, next generation LaserAlign products, board alignment
and on-head linescan cameras and enhancements to the semiconductor wafer mapping sensor
product family. Customer funded research and development is recognized as a reduction of
research and development expense. During 2003, customer funded research and development
expense totaled $14,000 compared to $75,000 in 2002 and $1.1 million in 2001. As the
result of cost reduction actions implemented in 2003, we have budgeted research and
development expenditures to be slightly lower in 2004 as compared to 2003. However, we are
currently considering several additional projects and may increase expenditures based on
an assessment of the future revenue and profit potential of new products and our expected
2004 operating results relative to our budget.

Selling, General and Administrative Expenses

We
reduced our selling, general and administrative expenses by 10% to $11.8 million in 2003,
and reduced those expenses by 22% to $13.2 million in 2002 from $16.9 million in 2001. As
a percentage of revenue, selling, general and administrative expenses decreased to 33% in
2003, compared to 54% in 2002 and 44% in 2001. The dollar decrease in selling, general and
administrative expenses in 2003 and 2002 were primarily due to the effect of cost
reduction measures implemented over the past three years, which primarily included
workforce reductions and related costs and reductions in other discretionary spending.
These spending reductions were offset somewhat by investments made to develop the end-user
sales and service channel in Asia, including the costs of opening and operating our
Singapore sales office since May 2001 to better serve Asian markets.

13

---

Restructuring and Severance Costs

We
have implemented a series of workforce reductions over the past three years, closed our
facility in California, downsized facilities in the U.K. and Minneapolis and made other
reductions in discretionary spending designed to reduce the losses and negative cash flow
resulting from the severe decline in our revenues caused by the depressed capital
equipment markets for suppliers to electronics manufacturing. In addition, we are in the
process of implementing a planned consolidation of UK R&D operations to our
Minneapolis headquarters.

In
December 2003, we completed the buy-out of our UK facility lease effective in the first
quarter of 2004. Following this buyout, we signed a new lease for less space in the same
facility. The cost of the buy-out, paid in December 2003, was approximately $219,000. In
addition, during December 2003 we permanently vacated approximately 18,000 square feet of
our primary Minneapolis facility and recorded a restructure charge of approximately
$390,000 for future lease payments (reduced for estimated sub-lease income of
approximately $201,000) and related costs.

In
September 2003, we incurred approximately $463,000 of severance and costs associated with
restructuring measures. Cost reduction measures included workforce reductions associated
with downsizing direct sales and marketing resources in North America and Europe, the
consolidation of UK R&D operations into our Minneapolis headquarters and other general
cost reduction measures. Severance costs were associated with a planned workforce
reduction of 20 people. Of these costs, approximately $283,000 were paid as of December
31, 2003. Severance and associated costs of $180,000 were accrued as of December 31, 2003.
Remaining costs will be paid during the first nine months of 2004.

In
January 2003, we incurred approximately $170,000 of severance costs and facility closure
costs associated with further consolidation of our semiconductor product group from
Redwood City, California to Portland, Oregon. Severance costs were associated with a
workforce reduction of 5 people. Substantially all of these costs were paid as of March
31, 2003.

In
June 2002, we incurred approximately $800,000 of severance and related costs associated
with cost reduction measures. Cost reduction measures included a workforce reduction, and
discretionary spending reductions. Severance costs were associated with a workforce
reduction of 48 people. Approximately $640,000 of these costs were paid as of December 31,
2002. Severance costs of approximately $160,000 were accrued as of December 31, 2002, and
substantially paid as of June 30, 2003.

In
January 2002, we incurred approximately $847,000 of severance costs associated with cost
reduction measures. Cost reduction measures included a workforce reduction, discretionary
spending reductions, and the consolidation of semiconductor product manufacturing in
Portland, Oregon. Severance costs were associated with a workforce reduction of 22 people.
Approximately $655,000 of these costs were paid as of December 31, 2002. Facility exit and
severance costs of $192,000 were accrued as of December 31, 2002 and all were paid in
January 2003.

In
April 2001, we incurred approximately $250,000 of severance related costs associated with
cost reduction measures. In September 2001, the Company incurred approximately $169,000 of
additional severance related costs associated with a second round of 2001 cost reduction
measures. A total of 23 and 22 employees were terminated in April and September 2001,
respectively. Substantially all of these costs were paid as of December 31, 2001.

|                                           | Employee
Termination
Benefits | Lease
Commitment
Costs | Other | Total 
|------------------------------------------ | ----------------------------- | ---------------------- | ----- | ------
|Restructuring liability, December 31, 2001 |                               |                        | $     |      
|Initial expense and accrual                |                               |                        |       | 1,362 
|Cash payments                              |                               |                        |       | (1,214
|                                           |                               |                        |       |       
|Restructuring liability, December 31, 2002 |                               |                        |       | 148   
|Initial expense and accrual                |                               |                        |       | 541   
|Cash payments                              |                               |                        |       | (509  
|                                           |                               |                        |       |       
|Restructuring liability, December 31, 2003 |                               |                        | $     | 180   

14

---

Amortization of Goodwill and Other Intangible Assets

Amortization of
acquired intangible assets was approximately $1.8 million in 2003 compared to $1.1 million
in 2002 and $2.4 million in 2001. The decrease in amortization during 2003 and 2002 is
attributed to the adoption of the goodwill non-amortization provisions of SFAS No. 142
which eliminated the systematic amortization of the approximately $9 million balance of
goodwill. Amortization is primarily attributable to developed technology, patents,
trademarks and other assets acquired from Kestra Ltd. and HAMA Laboratories Inc. during
the second quarter of 1999 and from Imagenation Corporation during the fourth quarter of
2000. Amortization of these intangible assets is expected to be approximately $1.1 million
in 2004.

During
the third quarter of 2003, the amortization of certain intangible assets established as
the result of the acquisition of HAMA Laboratories, Inc. in 1999 was accelerated. The
asset values were originally established through an independent appraisal, and related to
product lines and core technologies that were determined to be non-strategic during the
third quarter of 2003. These general-purpose sensor product lines will be discontinued
over the next few quarters, and consequently, amortization of the developed technology was
accelerated. The acceleration of the amortization resulted in approximately $632,000 of
additional amortization expense during the third quarter of 2003.

Effective Tax Rate

We
recorded a tax provision of $214,000 in 2003 resulting from tax on income generated by our
foreign subsidiaries. There was no tax benefit recorded on U.S. based operating losses in
2003 as the result of establishing a valuation allowance against deferred tax assets in
2002.

We
recorded a tax benefit of $1.0 million in 2002 resulting in an effective income tax rate
of 7%. The effective tax rate was substantially lower than the U.S. statutory tax rate of
35% primarily as the result of establishing a valuation allowance against deferred tax
assets during the third quarter of 2002 (see disclosure in Critical Accounting
Policies and Estimates and the Notes to the Consolidated Financial Statements in
this Form 10-K). The tax benefit and effective income tax benefit rate in 2002 were
impacted by establishing valuation allowances of approximately $4.3 million, offsetting
deferred tax assets that require future taxable income to be realized. Of the $4.3 million
valuation allowance established in 2002, $2.5 million represents deferred tax assets
established in prior years with the balance reflecting deferred tax assets generated as
the result of 2002 taxable losses.

We
recorded a tax benefit of $3.0 million in 2001, resulting in an effective tax benefit rate
of 43%. The effective tax rate was higher than the U.S. statutory rate of 35% primarily as
a result of foreign sales corporation benefits and research and development tax credits.
These benefits were partially offset by non-deductible goodwill amortization, and
valuation allowances established to eliminate the future tax benefit of net operating loss
carry forwards generated by CyberOptics UK, Ltd. (formerly Kestra) following the
acquisition due to uncertainty about realization.

Interest Income and Other

Interest
income and other primarily includes interest earned on investments. Interest income
declined during 2003 compared to 2002 as a result of declining interest rates on invested
funds. In addition, during 2002, we reduced the carrying value of a $1.5 million loan to
Avanti Optics Corporation, a related party, by our ownership percentage in the cumulative
losses of Avanti, which resulted in a charge of $1.5 million (remaining carrying value of
loan was written off in exchange for assets received in the liquidation of Avanti during
2003). Interest income and other was higher in 2001, primarily as a result of higher
investment balances and higher interest rates. Foreign currency translation charges and
certain other expenses are also included in interest income and other.

Liquidity and Capital Resources

Our
cash and cash equivalents increased by $345,000 during 2003, primarily because of the
purchase of $3.8 million of marketable securities, net of maturities of marketable
securities during 2003, and the purchase of $506,000 of capital assets, offset by $3.2
million of cash generated by operating activities and $660,000 of cash generated from
financing activities. Our cash and cash equivalents fluctuate in part because of
maturities of marketable securities and investment of cash balances resulting from those
maturities, or from other sources of cash, in additional to marketable securities.
Accordingly, we believe the combined balances of cash and marketable securities provide a
more reliable indication of our available liquidity. Our combined balances of cash and
marketable securities increased $4.0 million to $24.8 million as of December 31, 2003 from
$20.8 million as of December 31, 2002.

15

---

We
generated $3.2 million of cash from operations during 2003. We used cash in operations
primarily to fund a net loss of $2.6 million, which included a $645,000 gain from a
technology transfer and license agreement and $3.9 million of non-cash expenses for
depreciation and amortization and other non-cash items, and to fund a $3.7 million
increase in accounts receivable. These uses of cash were more than offset by a $2.9
million reduction in income taxes receivable, a $2.1 million reduction in inventory and a
$1.6 million increase in accounts payable and accrued expenses. Reduced income taxes
receivable are the result of refunds received during 2003 from the carry back of 2002
losses to prior year tax returns. Reduced inventory, increased accounts receivable and
increased accounts payable and accrued expenses are primarily the result of increased
revenue levels during the second half of 2003, as well as focused programs to bring down
inventory balances.

We
used $5.9 million of cash from operations during 2002, primarily due to a net loss of
$13.6 million, which included $9.1 million of non-cash expenses for depreciation and
amortization, provisions for inventory obsolescence, equity in losses of Avanti,
establishing a valuation allowance on deferred tax assets and other non-cash items. Cash
used by operations included a $1.2 million increase in accounts receivable, a $536,000
decrease in accounts payable and a $484,000 increase in taxes receivable. The increase in
accounts receivable in 2002 was primarily due to growing revenues at the end of the year
and the decrease in accounts payable was primarily due to reduced inventory purchases and
operating expenses. The increase in taxes receivable was the result of tax losses in 2002
that was collected as a refund from taxes paid in prior years, offset by tax refunds of
approximately $3.5 million received in 2002. These items were offset somewhat by $621,000
of inventory reductions and by an increase of $258,000 in accrued expenses. Reduced
inventory is primarily the result of increased revenue in the second half of 2002 and
increased accrued expenses are primarily due to approximately $352,000 of facility and
severance costs associated with workforce reductions and other cost reduction measures
implemented in 2002.

We
used $3.5 million of cash in investing activities during 2003 compared to generating $4.1
million in 2002. Cash used in investing activities during 2003 includes $3.8 million of
net purchases of marketable securities and $506,000 for the acquisition of fixed assets
and capitalized patent costs, offset somewhat by $750,000 of cash from the technology
transfer and license agreement relating to our DRS sensor family. Cash used in investing
activities in 2002 includes $1.5 million for the loan to Avanti Optics Corporation, a
related party and $872,000 for the acquisition of fixed assets and capitalized patent
costs. These uses were more than offset by net maturities of marketable securities that
generated approximately $6.4 million in 2002

We
generated $660,000 of cash from financing activities in 2003, and generated $503,000 in
2002. During 2003 and 2002, all of the cash was generated by common stock related
transactions, primarily stock option exercises and Employee Stock Purchase Plan share
purchases. We used $85,000 to repurchase stock and for other financing activities in 2003
compared to $175,000 in 2002.

We
had no material commitments for expenditures as of December 31, 2003. While there were no
material commitments, we evaluate investment opportunities that come to our attention and
could make a significant commitment in the future. Our cash and equivalents and
investments totaled $24.8 million at December 31, 2003. With this level of cash and cash
equivalents, and the fact that we began generating net profits and cash at the end of
2003, we believe that cash and cash equivalents will be adequate to fund our cash flow
needs.

At
December 31, 2003, we did not have any relationships with unconsolidated entities or
financial partnerships, such as entities often referred to as structured finance or
special purpose entities, which would have been established for the purpose of
establishing off-balance sheet arrangements or other contractually narrow or limited
purposes. We do not believe we are exposed to any financing, liquidity, market or credit
risk that could arise if we had engaged in such relationships.

The
following summarizes the Companys contractual obligations at December 31, 2003, and
the effect such obligations are expected to have on its liquidity and cash flow in future
periods.

|December 31 (In 000's)                     | TOTAL | LESS THAN
1 YEAR | 1 - 3 YEARS | AFTER
3 YEARS
|------------------------------------------ | ----- | ---------------- | ----------- | -------------
|CONTRACTUAL OBLIGATIONS:                   |       |                  |             |              
|Borrowings                                 |       |                  | $           |             
|Non-cancelable operating lease obligations |       |                  |             | 2,634        
|Purchase Obligations                       |       |                  |             | 4,584        
|                                           |       |                  |             |              
|Total contractual cash obligations         |       |                  | $           | 7,218        
|                                           |       |                  |             |              

Purchase
obligations are defined as an agreement to purchase goods or services that is enforceable
and legally binding. Included in the purchase obligations category above are obligations
related to purchase orders for inventory purchases under our standard terms and conditions
and under negotiated agreements with vendors and utilities. We expect to receive
consideration (products or services) for these purchase obligations. The purchase
obligation amounts do not represent all anticipated purchases in the future, but represent
only those items for which we are contractually obligated. The majority of our products
and services are purchased as needed, with no contractual commitment. Consequently, these
amounts will not provide a reliable indicator of our expected future cash outflows on a
stand-alone basis.

16

---

Related Party Transactions

On
April 30, 2002, we loaned $1.5 million to Avanti Optics Corporation (Avanti),
a company founded by Steven K. Case, our Chairman, founder and a significant shareholder
of CyberOptics. Erwin Kelen, one of our directors, also served as director of Avanti, was
a shareholder in Avanti, and was a representative of one of the principal venture capital
investors in Avanti. We held approximately 12% of the outstanding capital stock of Avanti
prior to the loan, which we had acquired in consideration of the contribution of $190,000
cash and intellectual property to Avanti when Avanti was formed. The loan transaction was
approved by our Board of Directors without the participation of Dr. Case or Mr. Kelen and
only after a determination that the loan was in our best interests.

The
loan was represented by a convertible promissory note that bore interest at 3% above the
prime rate of interest and was repayable on April 30, 2003, or upon an earlier event of
default. The loan was secured by all of the intellectual property of Avanti (consisting
primarily of rights in United States patents and patent applications in the area of
photonics component manufacture), and provided us with the exclusive rights to manufacture
and distribute manual and semi-automated equipment for the assembly of surface mountable
optical components that were under development by Avanti. During 2002, we reduced the
carrying value of the term loan by $1,450,000 to reflect our equity in the cumulative
losses of Avanti and to reduce our investment to reflect its net realizable value as of
December 31, 2002. In December 2002, we were notified that, as a result of not being able
to raise additional third party funding, Avanti decided to cease operations and liquidate
its remaining assets. In February 2003, Avantis Board of Directors and its
significant shareholders passed a resolution to cease business operations. Consequently,
all of the Avanti intellectual property rights were transferred to us under the terms of
the loan. At December 31, 2003, there is no remaining carrying value for the loan.

Inflation and Foreign Currency Translation

Our
revenue has declined during the past three years primarily because of decreases in the
level of unit shipments resulting from a down turn in the worldwide electronics capital
equipment market. We believe that inflation has not had any significant effect on our
operations. All of our international export sales are negotiated, invoiced and paid in
U.S. dollars. Accordingly, although currency fluctuations do not significantly affect our
revenue and income per unit, they can influence the price competitiveness of our products
and the willingness of existing and potential customers to purchase units.

As
a result of the Kestra acquisition, we have a sales and software development office
located in the UK. We also opened a sales office in Singapore during 2001. We do not
believe that currency fluctuations will have a material impact on our consolidated
financial statements.

Recent Accounting Developments

In
December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation
 Transition Disclosure  an amendment of FAS 123 (SFAS No. 148). This
statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of Statement 123 to require prominent disclosures in
both the annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported results.
The provisions of SFAS No. 148 are effective for financial statements for fiscal years
ending after December 15, 2002, and disclosure requirements are effective for interim
periods beginning after December 31, 2002. We intend to continue to account for
stock-based compensation to our employees and directors using the intrinsic value method
prescribed by APB Opinion No. 25, and related interpretations. We have made certain
disclosures required by SFAS No. 148 in the consolidated financial statements for the year
ended December 31, 2002 and began making the additional disclosures required by SFAS No.
148 in the first quarter of 2003. Accordingly, adoption of SFAS No. 148 will not have a
material impact on our results of operations.

In
January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable
Interest Entities. This interpretation addresses the requirements for business
enterprises to consolidate related entities in which they are determined to be the primary
beneficiary as a result of their variable economic interests. The interpretation is
intended to provide guidance in judging multiple economic interests in an entity and in
determining the primary beneficiary. The interpretation outlines disclosure requirements
for Variable Interest Entities in existence prior to January 31, 2003 and outlines
consolidation requirements for Variable Interest Entities created after January 31, 2003.
We do not have investments or relationships with third parties subject to the requirements
of this interpretation.

17

---

# Critical Accounting Policies and Estimates:

Our
discussion and analysis of financial condition and results of operations are based upon
the consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America. The preparation
of these financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate estimates, including
those related to bad debts, warranty obligations, inventory valuation, intangible assets,
income taxes, and restructuring costs. Management bases these estimates on historical
experience and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or conditions. The
estimates and judgments that we believe have the most effect on our reported financial
position and results of operations are as follows:

Allowance
for Doubtful Accounts. We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required. The allowance for
doubtful accounts is $340,000 as of December 31, 2003.

Allowance
for Warranty Expenses. We provide for the estimated cost of product warranties at the time
revenue is recognized. While we engage in extensive product quality programs and
processes, including actively monitoring and evaluating the quality of component
suppliers, warranty obligations are affected by product failure rates, material usage and
service delivery costs incurred in correcting a product failure. Should actual product
failure rates, material usage or service delivery costs differ from our estimates,
revisions to the estimated warranty liability would be required. The provision for
warranties is $325,000 at December 31, 2003.

Reserve
for Inventory Obsolescence. We write down inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of inventory and the
estimated market value based upon assumptions about future demand and market conditions.
If actual market conditions are less favorable than those projected, additional inventory
write-downs may be required. At December 31, 2003, we had a provision for obsolete and
excess inventory of approximately $1.6 million.

Valuation
of Intangible and Long-Lived Assets. We assess the impairment of identifiable intangible
assets, long lived assets and related goodwill whenever events or changes in circumstances
indicate the carrying value may not be recoverable. Factors management considers
important, which could trigger an impairment review include the following:

- significant under-performance relative to expected historical or projected future operating results;
- significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
- significant negative industry or economic trends;
- significant decline in the Companys stock price for a sustained period; and the Companys market capitalization relative to net book value.
- For intangible assets and long-lived assets, if the carrying value of the asset exceeds the undiscounted cash flows from such asset.

When
we determine that the carrying value of intangibles, long-lived assets and related
goodwill may not be recoverable based upon the existence of one or more of the above
indicators of impairment, we measure any potential impairment based on a projected
discounted cash flow method using a discount rate that we believe is commensurate with the
risk inherent in our current business model. Annually, we also test for impairment of
goodwill by estimating the fair value utilizing several methodologies, including
consideration of our market capitalization and discounted cash flows, in determining a
reasonable valuation.

Deferred
Tax Assets. We currently have significant deferred tax assets as a result of net operating
loss carryforwards, tax credit carryforwards and temporary differences between taxable
income on our tax returns and income before income taxes under U.S. generally accepted
accounting principals. A deferred tax asset generally represents future tax benefits to be
received when these carryforwards can be applied against future taxable income or when
expenses previously reported in our financial statements become deductible for income tax
purposes.

In
the third quarter of fiscal 2002, we recorded a full valuation allowance against our
deferred tax assets. Our decision to record this valuation allowance was based on the
cumulative losses we had incurred over the three years prior to that date, the fact that
we were continuing to generate operating losses and full utilization of our loss carryback
potential in 2002. From the third quarter of fiscal 2002 to date, we have continued to
provide a full valuation allowance against all future tax benefits produced by our
operating results. We assess the realizability of our deferred tax assets and the need for
this valuation allowance based on Statement of Financial Accounting Standards No. 109. We
expect to continue to provide a full valuation allowance (financial statements will not
reflect a tax provision on U.S. based income or benefit on U.S. based losses) until we can
sustain a level of profitability that demonstrates our ability to utilize these assets. At
that time, the valuation allowance will be reassessed, and could be eliminated, resulting
in recognition of deferred taxes. We anticipate a nominal tax provision related to foreign
operating results.

18

---

As
of December 31, 2003 and 2002, our deferred tax assets and the related valuation allowance
were $7.7 million and $6.6 million, respectively. Included in these amounts are deferred
tax assets related to our UK subsidiary of approximately $2.2 million as of December 31,
2003 and 2002. Because of uncertainty as to future realization of these assets, a
valuation allowance had been established prior to the third quarter of 2002, and the
valuation allowance on these UK based deferred tax assets will continue to be assessed
separately. See Note 5 of this Form 10-K for a further discussion of the accounting
treatment for income taxes.

Restructuring
Reserve for Lease Commitment Cost. We maintain a reserve for future rental costs under the
terms of our lease for a portion of our primary Minneapolis facility that has been
permanently vacated. As required by Financial Accounting Standards No. 146
Accounting for Costs Associated with exit or Disposal Activities, this reserve
has been reduced by estimated sub-lease rentals of approximately $201,000. Should actual
sub-lease rental and other amounts differ from our estimates, revisions to the
restructuring reserve will be required. At December 31, 2003, reserves for losses on lease
commitments were approximately $372,000.

# ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We
invest excess funds not required for current operations in marketable securities. The
investment policy for these marketable securities is approved annually by the Board of
Directors and administered by management. A third party, approved by our Board of
Directors, manages the portfolio at the direction of management. The investment policy
dictates that marketable securities consist of U.S. Government or U.S. Government agency
securities or certain approved corporate instruments with maturities of three years or
less and an average portfolio maturity of not more that 18 months. As of December 31, 2003
our portfolio of marketable securities had an average term to maturity of less than one
year. All marketable securities are classified as available for sale and carried at fair
value. We estimate that a hypothetical 1% increase in market interest rates would result
in a decrease in the market value of the portfolio of marketable securities of
approximately $115,000. If such a rate increase occurred, our net income would only be
impacted if securities were sold prior to maturity.

We
enter into foreign currency swap agreements to hedge short term inter-company financing
transactions with our subsidiary in the United Kingdom. These currency swap agreements are
structured to mature on the last day of each quarter and are designated as cash flow
hedges. At December 31, 2003, the Company had one open swap agreement that was purchased
on that date. As a result, there were no unrealized gains or losses as of December 31,
2003. During the year ended December 31, 2003, we recognized a net loss of approximately
$591,000 from settlement of foreign currency swap agreements that offset the approximately
$422,000 translation gain on the underlying inter-company balance.

Our
foreign currency swap agreements contain credit risk to the extent that our bank
counter-parties may be unable to meet the terms of the agreements. The Company minimizes
such risk by limiting its counter-parties to major financial institutions. We do not
expect material losses as a result of defaults by other parties.

19

---

# ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

# CONSOLIDATED BALANCE SHEETS
CYBEROPTICS CORPORATION

|(In thousands)
December 31,                                              | 2003 |  | 2002
|------------------------------------------------------------------------ | ---- |  | ----
|                                                                        
|ASSETS                                                                   |      |  |     
|Cash and cash equivalents                                                |      |  | $   
|Marketable securities                                                    |      |  |     
|Accounts receivable, less allowance for                                  |      | 
|doubtful accounts of $340 and                                            |      | 
|$251 in 2003 and 2002, respectively                                      |      |  |     
|Inventories                                                              |      |  |     
|Income taxes receivable                                                  |      |  |     
|Other current assets                                                     |      |  |     
|                                                                        
|Total current assets                                                     |      |  |     
|Marketable securities                                                    |      |  |     
|Equipment and leasehold improvements, net                                |      |  |     
|Intangible and other assets, net                                         |      |  |     
|Goodwill, net                                                            |      |  |     
|                                                                        
|Total assets                                                             |      |  | $   
|                                                                        
|LIABILITIES AND STOCKHOLDERS' EQUITY                                     |      | 
|Accounts payable                                                         |      |  | $   
|Accrued expenses                                                         |      |  |     
|                                                                        
|Total current liabilities                                                |      |  |     
|Commitments                                                              |      | 
|Stockholders' equity:                                                    |      | 
|Preferred stock, no par value, 5,000 shares authorized, none outstanding |      | 
|Common stock, no par value, 37,500 authorized,                           |      | 
|8,291 and 8,190 shares issued and outstanding, respectively              |      |  |     
|Accumulated other comprehensive loss                                     |      |  |     
|Retained (deficit) earnings                                              |      |  |     
|                                                                        
|Total stockholders' equity                                               |      |  |     
|                                                                        
|Total liabilities and stockholders' equity                               |      |  | $   
|                                                                        

# THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.

20

---

# CONSOLIDATED STATEMENTS OF OPERATIONS
CYBEROPTICS CORPORATION

|(In thousands, except per share amounts)
Year ended December 31, | 2003 |  | 2002 |        | 2001
|---------------------------------------------------------------- | ---- |  | ---- | ------ | ----
|                                                                
|Revenues                                                         |      |  | $    | 35,636 |     
|Cost of revenues                                                 |      |  |      | 17,109 |     
|                                                                
|Gross margin                                                     |      |  |      | 18,527 |     
|Research and development expenses                                |      |  |      | 7,183  |     
|Selling, general and administrative expenses                     |      |  |      | 11,809 |     
|Restructuring and severance costs                                |      |  |      | 1,242  |     
|Gain from technology transfer and license                        |      |  |      | (645   | )   
|Amortization of goodwill and other intangibles                   |      |  |      | 1,752  |     
|                                                                
|Loss from operations                                             |      |  |      | (2,814 | )   
|Interest income and other                                        |      |  |      | 391    |     
|                                                                
|Loss before income taxes                                         |      |  |      | (2,423 | )   
|Income tax provision (benefit)                                   |      |  |      | 214    |     
|                                                                
|Net loss                                                         |      |  | $    | (2,637 | )   
|                                                                
|Net loss per share - Basic                                       |      |  | $    | (0.32  | )   
|Net loss per share - Diluted                                     |      |  | $    | (0.32  | )   
|                                                                
|Weighted average shares outstanding - Basic                      |      |  |      | 8,223  |     
|Weighted average shares outstanding - Diluted                    |      |  |      | 8,223  |     
|                                                                

# THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.

21

---

# CONSOLIDATED STATEMENTS OF CASH FLOWS
CYBEROPTICS CORPORATION

|(In thousands)
Year ended December 31,                | 2003 |  | 2002 |         | 2001
|----------------------------------------------------- | ---- |  | ---- | ------- | ----
|                                                     
|CASH FLOWS FROM OPERATING ACTIVITIES:                 |      |  |      |         |     
|Net loss                                              |      |  | $    | (2,636  | )   
|Adjustments to reconcile net (loss) to net cash       |      | 
|provided (used) by operating activities:              |      | 
|Depreciation and amortization                         |      |  |      | 3,651   |     
|Gain from technology transfer and license             |      |  |      | (645    | )   
|Provision for doubtful accounts                       |      |  |      | 132     |     
|Provision for inventory obsolescence                  |      |  |      | 116     |     
|Deferred income taxes                                 |      |  |      |         |     
|Amortization of restricted stock and other            |      |  |      |         |     
|Tax benefit from exercise of stock options            |      |  |      |         |     
|Equity in losses of related party                     |      |  |      |         |     
|Changes in operating assets and liabilities:          |      | 
|Accounts receivable                                   |      |  |      | (3,722  | )   
|Inventories                                           |      |  |      | 2,052   |     
|Other current assets                                  |      |  |      | (255    | )   
|Accounts payable                                      |      |  |      | 1,503   |     
|Income taxes payable/receivable                       |      |  |      | 2,851   |     
|Accrued expenses                                      |      |  |      | 148     |     
|                                                     
|Net cash provided (used) by operating activities      |      |  |      | 3,195   |     
|CASH FLOWS FROM INVESTING ACTIVITIES:                 |      | 
|Proceeds from sales of available for sale             |      | 
|marketable securities                                 |      |  |      | 7,034   |     
|Purchases of available for sale marketable securities |      |  |      | (10,788 | )   
|Proceeds from technology transfer and license         |      |  |      | 750     |     
|Purchases of businesses and technology,               |      | 
|net of cash acquired, and loan to related party       |      |  |      |         |     
|Additions to equipment and leasehold improvements     |      |  |      | (333    | )   
|Additions to patents                                  |      |  |      | (173    | )   
|                                                     
|Net cash provided (used) by investing activities      |      |  |      | (3,510  | )   
|CASH FLOWS FROM FINANCING ACTIVITIES:                 |      | 
|Proceeds from exercise of stock options               |      |  |      | 312     |     
|Proceeds from issuance of common stock                |      | 
|under Employee Stock Purchase Plan                    |      |  |      | 433     |     
|Repurchase of common stock and other                  |      |  |      | (85     | )   
|                                                     
|Net cash provided by financing activities             |      |  |      | 660     |     
|Net increase (decrease) in cash and cash equivalents  |      |  |      | 345     |     
|Cash and cash equivalents - beginning of year         |      |  |      | 11,009  |     
|                                                     
|Cash and cash equivalents - end of year               |      |  | $    | 11,354  |     
|                                                     

# THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.

22

---

# CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME
CYBEROPTICS CORPORATION

|                                           | Common Stock | Accumulated
Other
Comprehensive
Income (Loss) | Retained
Earnings | Total
Stockholders'
Equity
|------------------------------------------ | ------------ | --------------------------------------------- | ----------------- | --------------------------
|
|                                          
|BALANCE, DECEMBER 31, 2000                 |              |                                               |                   | 7,952                     
|Tax benefit from exercise                  |              |                                              
|of stock options                           |              |                                               |                   |                           
|Exercise of stock options                  |              |                                              
|net of shares exchanged as payment         |              |                                              
|and subsequently retired                   |              |                                               |                   | 131                       
|Issuance of common stock under             |              |                                              
|Employee Stock Purchase Plan               |              |                                               |                   | 41                        
|Amortization of restricted stock           |              |                                               |                   |                           
|Market value adjustments of                |              |                                              
|marketable securities                      |              |                                               |                   |                           
|Cumulative translation adjustment          |              |                                               |                   |                           
|Net loss                                   |              |                                               |                   |                           
|                                           |              |                                               |                   |                           
|Comprehensive loss                         |              |                                               |                   |                           
|                                          
|BALANCE, DECEMBER 31, 2001                 |              |                                               |                   | 8,124                     
|Tax benefit from exercise                  |              |                                              
|of stock options                           |              |                                               |                   |                           
|Exercise of stock options                  |              |                                              
|net of shares exchanged as payment         |              |                                              
|and subsequently retired                   |              |                                               |                   | 19                        
|Issuance of common stock under             |              |                                              
|Employee Stock Purchase Plan               |              |                                               |                   | 77                        
|Amortization of restricted stock and other |              |                                               |                   |                           
|Repurchase of common stock                 |              |                                               |                   | (30                       
|Market value adjustments of                |              |                                              
|marketable securities                      |              |                                               |                   |                           
|Cumulative translation adjustment          |              |                                               |                   |                           
|Net loss                                   |              |                                               |                   |                           
|                                           |              |                                               |                   |                           
|Comprehensive loss                         |              |                                               |                   |                           
|                                          
|BALANCE, DECEMBER 31, 2002                 |              |                                               |                   | 8,190                     
|Exercise of stock options                  |              |                                              
|net of shares exchanged as payment         |              |                                              
|and subsequently retired                   |              |                                               |                   | 49                        
|Issuance of common stock under             |              |                                              
|Employee Stock Purchase Plan               |              |                                               |                   | 71                        
|Repurchase of common stock and other       |              |                                               |                   | (19                       
|Market value adjustments of                |              |                                              
|marketable securities                      |              |                                               |                   |                           
|Cumulative translation adjustment          |              |                                               |                   |                           
|Net loss                                   |              |                                               |                   |                           
|                                           |              |                                               |                   |                           
|Comprehensive loss                         |              |                                               |                   |                           
|                                          
|BALANCE, DECEMBER 31, 2003                 |              |                                               |                   | 8,291                     
|                                          

# THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.

23

---

# NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CYBEROPTICS CORPORATION (In thousands, except share and per share amounts)

# NOTE 1  BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES

Principles of
ConsolidationThe consolidated financial statements include the accounts of
CyberOptics Corporation and its wholly-owned subsidiaries. In these Notes to the
Consolidated Financial Statements, these companies are collectively referred to
as CyberOptics, we, us, or our.
All significant inter-company accounts and transactions have been eliminated in
consolidation.

Use of EstimatesThe preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

Cash EquivalentsWe consider all highly liquid
investments purchased with an original maturity of 90 days or less to be cash equivalents.
Cash and cash equivalents consist of funds maintained in money market accounts, U.S.
Government backed obligations and state municipal instruments with a long-term credit
rating of AAA.

Marketable SecuritiesMarketable securities generally
consist of U.S. Government or U.S. Government backed obligations and state municipal
instruments with long-term credit ratings of AAA. Marketable securities are classified as
short-term or long-term in the balance sheet based on their maturity date and expectations
regarding sales. All marketable securities have maturities of three years or less. Certain
marketable securities held by us are subject to call provisions prior to their maturity
date.

As of December 31, 2003 and 2002, all
marketable securities are classified as available for sale, with a carrying amount of
$13,468 and $9,809, respectively. Available for sale securities are carried at fair value,
with unrealized gains and losses reported as a separate component of stockholders
equity until realized. These fair values are determined using quoted market prices. The
carrying amounts of securities, for purposes of computing unrealized gains and losses, are
determined by specific identification. The cost of securities sold is determined by
specific identification. Net unrealized holding gains and losses and realized gains and
losses were not significant for the periods presented. At December 31, 2003 and 2002,
unrealized gains of $96 and $295 were recorded as a component of accumulated other
comprehensive income (loss) in stockholders equity.

InventoriesInventories are stated at the lower
of cost or market, with cost determined using the first-in, first-out (FIFO) method.
Appropriate consideration is given to deterioration, obsolescence, and other factors in
evaluating net realizable value.

Equipment and Leasehold
ImprovementsEquipment and leasehold improvements
are stated at cost. Significant additions or improvements extending asset lives are
capitalized, while repairs and maintenance are charged to expense as incurred. In progress
costs are capitalized with depreciation beginning when assets are placed in service.
Depreciation is recorded using the straight-line method over the estimated useful lives of
the assets, ranging from three to ten years. Leasehold improvements are depreciated using
the straight-line method over the shorter of the asset useful life or the underlying lease
term. Gains or losses on dispositions are included in current operations.

Intangible AssetsIdentified intangible assets
(excluding goodwill) are being amortized on a straight-line basis over periods ranging
from 4 to 10 years, based upon their estimated life. Purchased in process research and
development costs (IPR&D) are expensed upon consummation of the purchase.

In June 2001, the Financial
Accounting Standards Board issued SFAS No. 141, Business Combinations, and
SFAS No. 142, Goodwill and Other Intangible Assets. We adopted these standards
in their entirety on January 1, 2002. Under the new rules, goodwill is no longer
amortized, but will be reviewed at least annually for impairment. Our other intangible
assets, consisting primarily of developed technology and patents, will continue to be
amortized over their estimated useful lives. Refer to Note 3 for details about the
adoption of this standard and the results of our impairment tests.

24

---

PatentsPatents consist of legal and patent
registration costs for protection of our proprietary sensor technology. We amortize such
expenditures over a three-year period on a straight-line basis commencing upon issuance of
the patent.

Valuation of Long-Lived
AssetsWe periodically assess the potential impairment of our intangible
and other long-lived assets based on anticipated un-discounted cash flows.

Revenue Recognition
Revenue from all customers, including distributors, is recognized when all
significant contractual obligations have been satisfied and collection of the
resulting receivable is reasonably assured. Generally, revenues are recognized
upon shipment under FOB shipping point terms. Estimated returns and warranty
costs are recorded at the time of sale. Some surface mount technology (SMT)
products require customer acceptance. For these SMT products, revenue is
recognized at the time of customer acceptance.

When a sale involves multiple
elements, revenue is allocated to each respective element in accordance with Emerging
Issues Task Force (EITF) 00-21 Accounting for Revenue Arrangements with Multiple
Deliverables, based on its relative fair value determined on the basis of the
element being sold on a stand-alone basis and recognized when revenue recognition criteria
for each element is met.

Foreign Currency
TranslationFinancial position and results of operations of our
international subsidiaries are measured using local currency as the functional
currency. Assets and liabilities of these operations are translated at the
exchange rates in effect at each fiscal year-end. Statements of operations
accounts are translated at the average rates of exchange prevailing during the
year. Translation adjustments arising from the use of differing exchange rates
from period to period are included as a cumulative translation adjustment in
stockholders equity.

Research and Development
Research and development (R&D) costs, including software development,
are expensed when incurred. Software development costs are required to be
expensed until the point that technological feasibility and proven marketability
of the product are established; costs otherwise capitalizable after such point
also are expensed because they are insignificant. Customer-funded R&D is
deferred and recognized as a reduction of R&D expenses as contractual
requirements are met in the accompanying statements of income. All other R&D
costs are expensed as incurred.

Income Taxes
Deferred income taxes are recorded to reflect the tax consequences in future
years of differences between the financial reporting and tax bases of assets and
liabilities. Income tax expense is the sum of the tax currently payable and the
change in the deferred tax assets and liabilities during the period. Valuation
allowances are established when, in the opinion of management, there is
uncertainty that some portion or all of the deferred tax assets will not be
realized.

Net Income Per ShareBasic net income (loss) per share is
computed by dividing net income (loss) by the weighted average number of common shares
outstanding during the period. Diluted net income (loss) per share is computed by dividing
net income (loss) by the weighted average number of common shares plus common equivalent
shares outstanding. Common equivalent shares consist solely of common shares issuable upon
exercise of common stock options. The calculation of diluted loss per common share for the
years ended December 31, 2003, 2002 and 2001 excludes 45,530, 43,678 and 206,873
potentially dilutive shares, respectively, because their effect would be anti-dilutive as
the result of losses incurred in those years.

Accounting for Stock-Based
CompensationIn December 2002, the Financial Accounting Standards Board
issued SFAS No. 148 Accounting for Stock-Based Compensation 
Transition and Disclosure  an amendment of FASB Statement No. 123".
We intend to continue to account for stock-based compensation to our employees
and directors using the intrinsic value method prescribed by APB Opinion No. 25.
We have adopted the disclosure requirements of SFAS No. 148 in these notes to
the consolidated financial statements.

As permitted by SFAS No. 123,
Accounting for Stock Based Compensation, we continue to measure compensation
cost for our stock incentive and option plans using the intrinsic value method of
accounting. Had we used the fair value method of accounting for our stock option and
incentive plans and charged compensation costs against income over the vesting period, net
income and net income per share for 2003, 2002 and 2001 would have been reduced to the
following pro forma amounts:

25

---

|                                      
|--------------------------------------
|
|Net loss as reported                  
|Add: Stock-based compensation         
|expense included in net loss,         
|net of related tax effects            
|Deduct: Total stock-based compensation
|expense determined under fair value,  
|net of related tax effects            
|                                      
|Net loss - Pro forma                  
|                                      
|Net loss per share:                   
|As reported - Basic                   
|Pro forma - Basic                     
|As reported - Diluted                 
|Pro forma - Diluted                   

In 2003 and 2002, no tax benefit
provision was applied to the fair value expense calculated under SFAS No. 123 due to
establishing valuation allowances on deferred tax assets during 2002 (see Note 5 for
further discussion on income taxes). In 2001 the tax benefit provision applied to fair
value expense is consistent with the tax provision in our Statement of Operations.
Compensation expense for pro forma purposes is reflected over the vesting period. Note 9
contains the significant assumptions used in determining the underlying fair value of
options.

Comprehensive Income (loss)
Components of comprehensive income (loss) include net income,
foreign-currency translation adjustments and unrealized gains (losses) on
available-for-sale securities and are presented on the consolidated statements
of shareholders equity and comprehensive income (loss).

Reclassifications
Certain prior-year amounts have been reclassified to conform to the current-year presentation.

Recent Accounting Developments
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation  Transition Disclosure  an amendment of
SFAS No. 123 (SFAS No. 148). This statement amends SFAS 123,
Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of Statement 123 to require prominent
disclosures in both the annual and interim financial statements about the method
of accounting for stock-based employee compensation and the effect of the method
used on reported results. The provisions of SFAS No. 148 are effective for
financial statements for fiscal years ending after December 15, 2002, and
disclosure requirements are effective for interim periods beginning after
December 31, 2002. We intend to continue to account for stock-based compensation
to our employees and directors using the intrinsic value method prescribed by
APB Opinion No. 25, and related interpretations. We have made certain
disclosures required by SFAS No. 148 in the consolidated financial statements
for the year ended December 31, 2002 and will begin making the additional
disclosures required by SFAS No. 148 in the first quarter of 2003. Accordingly,
adoption of SFAS No. 148 will not have a material impact on our results of
operations.

In January 2003, the FASB issued
Interpretation No. 46, Consolidation of Variable Interest Entities. This
interpretation addresses the requirements for business enterprises to consolidate related
entities in which they are the determined to be the primary beneficiary as a result of
their variable economic interests. The interpretation is intended to provide guidance in
judging multiple economic interests in an entity and in determining the primary
beneficiary. The interpretation outlines disclosure requirements for Variable Interest
Entities in existence prior to January 31, 2003 and outlines consolidation requirements
for Variable Interest Entities created after January 31, 2003. We do not have investments
or relationships with third parties subject to the requirements of this interpretation.

26

---

# NOTE 2  OTHER FINANCIAL STATEMENT DATA

# Inventories Consist of the Following:

|                          
|--------------------------
|
|Raw materials and         
|purchased parts           
|Work in process           
|Finished goods            
|                          
|                          
|Allowance for obsolescence
|                          
|                          
|                          

# Equipment and Leasehold Improvements consist of the following:

|                             
|-----------------------------
|
|Equipment                    
|Leasehold improvements       
|                             
|                             
|Accumulated                  
|depreciation and amortization
|                             
|                             
|                             

# Intangible and Other Assets Consist of the Following:

|                               
|-------------------------------
|
|Acquisition-related Intangibles
|Developed technologies         
|Customer base                  
|Trademarks                     
|Capitalized patent costs       
|Other                          
|                               
|                               
|Accumulated amortization       
|                               
|Total intangible and other     
|assets, net                    
|                               

As of December 31,
2003, the weighted average remaining life of acquisition related intangible
assets was approximately 3.31 years for developed technologies,
0.83 years for customer base and 2.42 years for trademarks.

27

---

As required by SFAS
No. 142, we periodically reassess the carrying value, useful lives and the
classification of identifiable intangible assets, and at December 31, 2003
we determined that they are appropriate. During the third quarter of 2003, the
amortization of certain intangible assets related to general-purpose sensor
product lines acquired in 1999 was accelerated as a result of our plan to
discontinue these product lines over the next few quarters, and consequently,
amortization of the developed technology was accelerated. The acceleration of
the amortization resulted in approximately $632 of additional amortization
expense during 2003. Estimated aggregate amortization expense based on current
intangibles for the next five years is expected to be as follows:
$1.1 million in 2004, $0.9 million in 2005, $0.6 million in 2006
and, $0.1 million in 2007 and 2008.

# Accrued Expenses Consist of the Following:

|                   
|-------------------
|
|Wages and benefits 
|Deferred revenue   
|Warranty costs     
|Restructuring costs
|Other              
|                   
|                   
|                   

We provide for the
estimated cost of product warranties at the time revenue is recognized. While we
engage in extensive product quality programs and processes, including actively
monitoring and evaluating the quality of component suppliers, warranty
obligations are affected by product failure rates, material usage and service
delivery costs incurred in correcting a product failure. Should actual product
failure rates, material usage or service delivery costs differ from our
estimates, revisions to the estimated warranty liability would be required. At
the end of each reporting period we revise our estimated warranty liability
based on these factors. A reconciliation of the changes in our estimated
warranty liability is as follows:

|                                  
|----------------------------------
|
|Balance at the beginning of period
|Accruals for Warranties           
|Settlements made during the period
|                                  
|                                  
|Balance at the end of period      
|                                  

# NOTE 3  GOODWILL

In June 2001, the FASB
issued SFAS No. 142, Goodwill and Other Intangible Assets.
Under SFAS No. 142, goodwill and intangible assets with indefinite lives
are no longer amortized but are reviewed at least annually for impairment. We
adopted SFAS No. 142 effective January 1, 2002. Actual results of
operations and pro forma results of operations for the three years ended
December 31, 2003, 2002 and 2001 had we applied the non-amortization
provisions of SFAS No. 142 are as follows (in thousands, except per share
amounts):

28

---

|                             
|-----------------------------
|
|Net loss as reported         
|Add: Amortization of goodwill
|net of related tax effects   
|                             
|Net loss - Pro forma         
|                             
|Net loss per share:          
|As reported - Basic          
|Pro forma - Basic            
|As reported - Diluted        
|Pro forma - Diluted          

At December 31, 2003, we
had net goodwill of $6.1 million compared to $5.8 million at December 31, 2002.
The increase in goodwill during 2003 is the result of the translation impact
($331) on foreign denominated goodwill balances. This increase was offset by a
$110 reduction in goodwill resulting from the utilization of pre-acquisition
deferred tax assets of CyberOptics UK, Ltd. We completed our annual test for
goodwill impairment as of December 31, 2003 and 2002. Our methodology for
estimating fair value included utilizing several valuation methodologies,
including consideration of our market capitalization and discounted cash flows,
in determining a reasonable valuation. The result of the tests performed
indicates goodwill was not impaired as of December 31, 2003 or December 31,
2002. Accordingly, no impairment charge has been recognized.

# NOTE 4  TECHNOLOGY TRANSFER AND LICENSE AGREEMENT

In March 2003, we transferred to the
Optical Gaging Products Division of Quality Vision International, Inc. (QVI) the rights
and technology necessary to manufacture our Digital Range Sensors (DRS). In addition, we
granted QVI a non-exclusive license to the intellectual property associated with this
product line and sold a portion of our inventory as part of this transaction. QVI had been
the primary customer for DRS sensors prior to this agreement as part of a separate 1999
agreement. As part of the agreement, QVI paid a one-time technology transfer fee of $750
and a pre-paid non-refundable royalty fee covering a specified number of sensors built by
OGP for a period of five years from the effective date of the contract. As a result of
this transaction, we recorded a $645 gain in the three month period ended March 31, 2003.

# NOTE 5  RESTRUCTURING AND SEVERANCE COSTS

We have implemented a
series of workforce reductions over the past three years, closed our facility in
California, downsized other facilities and made other reductions in
discretionary spending designed to reduce the losses and negative cash flow
resulting from the severe decline in our revenues caused by the depressed
capital equipment markets for suppliers to electronics manufacturing. In
addition, we are in the process of implementing a planned consolidation of UK
R&D operations to our Minneapolis headquarters.

In April 2001, we incurred
approximately $250 of severance related costs associated with cost reduction
measures. In September 2001, the Company incurred approximately $169 of
additional severance related costs associated with a second round of 2001 cost
reduction measures. A total of 23 and 22 employees were terminated in April and
September 2001, respectively. Substantially all of these costs were paid as of
December 31, 2001.

In January 2002, we
incurred approximately $847 of severance costs associated with cost
reduction measures. Cost reduction measures included a workforce reduction,
discretionary spending reductions, and the consolidation of semiconductor
product manufacturing in Portland, Oregon. Severance costs were associated with
a workforce reduction of 22 people. Approximately $655 of these costs were
paid as of December 31, 2002. Facility exit and severance costs of $192 were
accrued as of December 31, 2002 and all were paid in January 2003.

In June 2002, we incurred
approximately $800 of severance and related costs associated with cost
reduction measures. Cost reduction measures included a workforce reduction, and
discretionary spending reductions. Severance costs were associated with a
workforce reduction of 48 people. Approximately $640 of these costs were
paid as of December 31, 2002. Severance costs of approximately $160 were
accrued as of December 31, 2002, and substantially paid as of June 30, 2003.

29

---

In January 2003, we
incurred approximately $170 of severance costs and facility closure costs
associated with further consolidation of our semiconductor product group from
Redwood City, California to Portland, Oregon. Severance costs were associated
with a workforce reduction of 5 people. Substantially all of these costs were
paid as of March 31, 2003.

In September 2003, we
incurred approximately $463 of severance and costs associated with
restructuring measures. Cost reduction measures included workforce reductions
associated with downsizing direct sales and marketing resources in North America
and Europe, the intended consolidation of UK R&D operations into our
Minneapolis headquarters and other general cost reduction measures. Severance
costs were associated with a planned workforce reduction of 20 people. Of these
costs, approximately $283 were paid as of December 31, 2003. Severance and
associated costs of $180 were accrued as of December 31, 2003. Remaining
costs will be paid during the first nine months of 2004.

In December 2003, we completed the
buy-out of our UK facility lease effective in the first quarter of 2004. Following this
buyout, we signed a new lease for less space in the same facility. The cost of the
buy-out, paid in December 2003, was approximately $219. In addition, during December
2003 we permanently vacated approximately 18,000 square feet of our primary Minneapolis
facility and recorded a restructure charge of approximately $390 for future lease
payments (reduced for estimated sub-lease income of approximately $201) and related
costs.

Changes to the restructuring
liability accounts included the following (in thousands):

|                           
|---------------------------
|
|                           
|Restructuring liability,   
|December 31, 2001          
|Initial expense and accrual
|Cash payments              
|                           
|Restructuring liability,   
|December 31, 2002          
|Initial expense and accrual
|Cash payments              
|                           
|Restructuring liability,   
|December 31, 2003          
|                           

# NOTE 6  INCOME TAXES

# The Provision for Income Taxes Consists of the Following:

|         
|---------
|
|Current: 
|Federal  
|State    
|Foreign  
|Deferred:
|Federal  
|State    
|Foreign  
|         
|         
|         

30

---

# A Reconciliation of the Statutory Rate to the Effective Income Tax Rate is as Follows:

|                       
|-----------------------
|
|Federal statutory rate 
|State income taxes, net
|of federal benefit     
|FSC benefit            
|R&E credit             
|Foreign rate difference
|Valuation allowance    
|Non-deductible goodwill
|Other, net             
|                       
|Effective rate         
|                       

# Deferred Tax Assets (Liabilities) Consist of the Following:

|                                              
|----------------------------------------------
|
|Current deferred tax assets (liabilities):    
|Inventory allowances                          
|Vacation accrual                              
|Accounts receivable                           
|allowances                                    
|Warranty accrual                              
|Deferred Revenue                              
|Other, net                                    
|                                              
|Sub-total                                     
|Valuation allowance                           
|                                              
|Total                                         
|                                              
|Non-current deferred tax assets (liabilities):
|Fixed asset and intangible amortization, net  
|Write down of equity investment               
|Tax credits                                   
|Net operating loss                            
|carryforwards                                 
|                                              
|Sub-Total                                     
|Valuation allowance                           
|                                              
|Total                                         
|                                              
|Net deferred tax asset                        
|                                              

31

---

During the third quarter of 2002, we
concluded that a valuation allowance against all of our deferred tax assets was
appropriate due to cumulative U.S. losses we had incurred over the prior three years,
continued operating losses and full utilization of our loss carryback potential in 2002. A
deferred tax asset generally represents future tax benefits to be received when certain
expenses and losses previously recognized in our U.S. GAAP-based financial statements
become deductible under applicable income tax laws. Consequently, realization of a
deferred tax asset is dependent on future taxable income against which these deductions
can be applied. During the year ended December 31, 2002, we reduced our effective tax rate
to reflect only the current benefit resulting from the ability to carry-back losses to
prior periods and recorded a valuation allowance against deferred tax assets..

During the year ended December 31,
2003, we have continued to provide a full valuation allowance against future tax benefits
produced by our U.S. based operating results. We do not expect to record tax expense or
benefit on U.S. based operating results until we are consistently profitable on a
quarterly basis. At that time, the valuation allowance will be reassessed and could be
eliminated, resulting in the recognition of deferred taxes. Tax expense of $214 recorded
during the year ended December 31, 2003, relates to income generated by foreign
subsidiaries.

Net operating loss carryforwards at
December 31, 2003, included approximately $2,158, relating to losses incurred in the UK by
CyberOptics UK, Ltd. a development stage company acquired in 1999. The utilization of net
operating loss carryforwards is dependent on CyberOptics UKs ability to generate
sufficient UK taxable income during the carryforward period. Because of uncertainty as to
future realization of the benefit associated with this net operating loss, a valuation
allowance equal to the related deferred tax asset has been recorded and will continue to
be evaluated discretely from U.S. based deferred tax assets. Approximately $900 of the
deferred tax asset related to net operating loss carryforwards relates to pre-acquisition
losses and would be recorded as an adjustment to the opening balance sheet, primarily
goodwill, if the valuation allowance is reversed.

Cash payments for income taxes for
the years ended December 31, 2003, 2002 and 2001, were approximately, $82, $86 and $725,
respectively.

# NOTE 7  OPERATING LEASES

We lease our primary office,
warehouse and manufacturing facility under a 10 year operating lease that expires in April
2006. We have an option to extend the lease for two additional three year periods. The
lease requires the Company to pay insurance, property taxes and other operating expenses
related to the leased facility. We also lease facilities for the operations of our three
subsidiaries, under operating leases that expire from May 2004 through June 2013.

Total rent expense for the years
ended December 31, 2003, 2002 and 2001, was approximately, $1,279, $1,368 and $1,369,
respectively.

At December 31, 2003, the future
minimum lease payments required under non-cancelable operating lease agreements, are as
follows:

|Year ending December 31, |         
|------------------------ | --------
|2004                     | $  1,088
|2005                     | 1,063   
|2006                     | 437     
|2007                     | 46      
|2008                     |        
|Thereafter               |        
|                        
|Total                    | $  2,634
|                        

During December 2003, we negotiated a
buy-out of our remaining lease obligation through 2013 for our UK facility for
approximately $200. The above amounts for our primary US facility represent anticipated
cash payments under the terms of our lease. We have vacated a portion of this facility and
are pursuing a sub-lease arrangement. In addition, we have recorded a 2003 restructure
charge for approximately $335 related to anticipated lease payments.

32

---

# NOTE 8  DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We enter into foreign currency swap
agreements to hedge short term inter-company financing transactions with our subsidiary in
the U.K. These currency swap agreements are structured to mature on or about the last day
of each quarter and are designated as cash flow hedges. At December 31, 2003, we had one
open swap agreement that was purchased on that date. As a result, there were no unrealized
gains or losses as of December 31, 2003. During year ended December 31, 2003, we
recognized a net loss of approximately $591 from the settlement of foreign currency swap
agreements that offset the $422 translation gain on the underlying inter-company balance.

Our foreign currency swap agreements
contain credit risk to the extent that its bank counter-parties may be unable to meet the
terms of the agreements. The Company minimizes such risk by limiting its counter-parties
to major financial institutions. Management does not expect material losses as a result of
defaults by other parties.

# NOTE 9  STOCKHOLDERS EQUITY

In October 2002, our Board of
Directors authorized the repurchase of up to 1,000,000 shares of common stock. During the
year ended December 31, 2002, approximately 30,000 shares were repurchased at an average
price of approximately $5.76 per share under the authorization. During the year ended
December 31, 2003, an additional 19,000 shares were repurchased at an average price of
approximately $4.76 per share. The authorization expired in October 2003.

# NOTE 10  BENEFIT PLANS

Stock Option Plan
We have three stock option plans which have 1,785,531 shares of common stock
reserved in the aggregate for issuance to employees, directors, officers and
others. In addition, there are 220,435 shares reserved, and included in the
following summaries that are not part of the three stock option plans. Reserved
shares underlying canceled options are available for future grant under all
plans. Options are granted at an option price per share equal to or greater than
the market value at the date of grant. Generally, options granted to employees
vest over a four-year period and expire five, seven or ten years after the date
of grant. The plans allow for option holders to tender shares of the
Companys common stock as consideration for the option price provided that
the tendered shares have been held by the option holder at least 6 months.

# The following is a summary of stock option plan activity:

|Shares                                    | 2003 |  | 2002 |           | 2001
|----------------------------------------- | ---- |  | ---- | --------- | ----
|Granted                                   |      |  |      | 202,200   |     
|Exercised                                 |      |  |      | (49,130   | )   
|Forfeited                                 |      |  |      | (232,914  | )   
|December 31:                              |      | 
|Outstanding                               |      |  |      | 1,531,567 |     
|Exercisable                               |      |  |      | 1,044,513 |     
|Weighted average exercise price per share | 2003 |  | 2002 |           | 2001
|Granted                                   |      |  | $    | 8.32      |     
|Exercised                                 |      |  |      | 6.36      |     
|Forfeited                                 |      |  |      | 13.33     |     
|December 31:                              |      | 
|Outstanding                               |      |  |      | 12.51     |     
|Exercisable                               |      |  |      | 12.50     |     
|                                         

33

---

Stock options outstanding as of
December 31, 2003, had a range of exercise prices of $2.23 to $36.87 and a weighted
average remaining contractual life of approximately 3.45 years

The following is a summary of outstanding options as of December 31, 2003:

|Exercise
Price   | Options
Outstanding | Options
Exercisable | Weighted
Average
Remaining Life
|---------------- | ------------------- | ------------------- | -------------------------------
|                
|Less than $7.00  | 183,300             | 89,800              | 4.64 years                     
|$7.00 to $9.99   | 196,945             | 191,820             | 0.45 years                     
|$10.00 to $19.99 | 967,010             | 616,633             | 4.13 years                     
|$20.00 to $29.99 | 146,712             | 116,810             | 1.99 years                     
|Over $30.00      | 37,600              | 29,450              | 1.50 years                     
|                
|Total            | 1,531,567           | 1,044,513          
|                

The weighted-average grant-date fair
value of options granted during 2003, 2002 and 2001 was $5.16, $6.88 and $6.41,
respectively. The weighted-average grant-date fair value of options was determined by
using the fair value of each option grant on the date of grant, utilizing the
Black-Scholes option-pricing model and the following key assumptions (see Note 1 for pro
forma statement of operations):

|                        
|------------------------
|
|Risk-free interest rates
|Expected life           
|Expected volatility     
|Expected dividends      

Employee Stock Purchase Plan
We have an Employee Stock Purchase Plan available to eligible employees.
Under terms of the plan, eligible employees may designate from 1 to 10% of their
compensation to be withheld through payroll deductions for the purchase of
common stock at 85% of the lower of the market price on the first or last day of
the offering period. Under the plan, 700,000 shares of common stock have been
reserved for issuance. As of December 31, 2003, 498,826 shares have been issued
under this plan.

401(k) Plan
We have a retirement savings plan pursuant to Section 401(k) of the Internal
Revenue Code (the Code), whereby eligible employees may contribute a portion of
their earnings, not to exceed annual amounts allowed under the Code. In
addition, the Company may also make contributions at the discretion of the Board
of Directors. In 2003, 2002 and 2001, the Company provided for matching
contributions totaling $241, $268, and $328, respectively.

# NOTE 11  BUSINESS SEGMENTS AND SIGNIFICANT CUSTOMERS

Effective at year-end 1998, the
Company adopted Statement of Financial Accounting Standards (SFAS) No. 131,
Disclosure about Segments of an Enterprise and Related Information. SFAS No.
131 requires the management approach in determining business segments. The management
approach designates the internal organization that is used by management for making
operating decisions and assessing performance as the source of the Companys
reportable segments. Management has determined that the Company operates its business as
one reportable segment  the design, manufacture and sale of optical process control
sensors and inspection systems for the electronics and semiconductor capital equipment
markets.

34

---

Revenues by product line were as follows:

|Year ended December 31,     | 2003 |  | 2002 |        | 2001
|--------------------------- | ---- |  | ---- | ------ | ----
|                           
|OEM Solutions:              |      |  |      |        |     
|Electronic Assembly Sensors |      |  | $    | 16,122 |     
|Semiconductor Products      |      |  |      | 5,550  |     
|SMT Systems                 |      |  |      | 13,964 |     
|                           
|                            |      |  | $    | 35,636 |     
|                           

# The following summarizes certain significant customer information:

|                               | Significant
Customer | Revenues | Percentage
of Revenues
|------------------------------ | -------------------- | -------- | ----------------------
|                              
|Year ended   December 31, 2003 | A                    | $  7,157 | 20%                   
|                               | B                    | $  7,436 | 21%                   
|Year ended   December 31, 2002 | A                    | $  3,210 | 13%                   
|                               | B                    | $  3,571 | 15%                   
|Year ended   December 31, 2001 | A                    | $  8,438 | 22%                   
|                               | B                    | $  7,046 | 18%                   

As of December 31, 2003, accounts
receivable from significant customers A and B were $944 and $3,057, respectively. As of
December 31, 2002, accounts receivable from significant customers A and B were $690 and
$679, respectively.

Export sales amounted to 79%, 67% and
67% of revenues for 2003, 2002 and 2001, respectively. All of the Companys export
sales are negotiated, invoiced and paid in U.S. dollars. Export sales by geographic area
are summarized as follows:

|        
|--------
|
|        
|Americas
|Europe  
|Asia    
|Other   
|        
|        
|        

Long-lived assets include equipment
and leasehold improvements, intangible and other assets and goodwill attributable to each
geographic areas operations. Long-lived assets at December 31, 2003, 2002 and 2001
are as follows:

|                       
|-----------------------
|
|                       
|Long-lived assets:     
|United States          
|Europe                 
|Asia and other         
|                       
|Total long-lived assets
|                       

35

---

# NOTE 12  CONTINGENCIES

In the ordinary course of business,
we are a defendant in miscellaneous claims and disputes. While the outcome of these
matters cannot be predicted with certainty, management presently believes the disposition
of these matters will not have a material effect on the financial position, results of
operations or cash flows of the Company.

# NOTE 13  RELATED PARTY TRANSACTIONS

In May 2002, we funded a $1.5 million
term loan to Avanti Optics Corporation (Avanti). Avantis chief executive
officer was Steven K. Case, Ph. D., who is also the chairman and founder of CyberOptics.
The transaction was approved by the Board of CyberOptics without the participation of Dr.
Case or any other party who had a material interest in Avanti. We believe the loan was
made on terms at least as favorable to us as would have been obtained from an unaffiliated
party.

We had previously acquired 19% of the
outstanding capital stock of Avanti in 2000 for cash and other assets. Our carrying value
for accounting purposes of this investment had been reduced to zero in the first quarter
of 2001 by our equity in the losses of Avanti. During 2002, we reduced the carrying value
of the term loan by $1,450 (with the charge recorded against other income) to reflect our
equity in the cumulative losses of Avanti and to reduce our investment to reflect its net
realizable value as of December 31, 2002. In December 2002, we were notified that, as a
result of not being able to raise additional third party funding, Avanti decided to cease
operations and liquidate its remaining assets. In February 2003, Avantis Board of
Directors and its significant shareholders passed a resolution to cease business
operations. Consequently, all of the Avanti intellectual property rights were transferred
to us under the terms of the loan. During 2003, the remaining carrying value of the loan
was written off in exchange for the assets we received as a result of the Avanti
liquidation.

NOTE 14  QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(In thousands, except per share amounts)

|2003                                     | March 31 (2) | June 30 | Sept. 30 (3) | Dec. 31 (3)
|---------------------------------------- | ------------ | ------- | ------------ | -----------
|                                        
|Revenues                                 |              |         | $            | 6,425      
|Gross margin                             |              |         |              | 2,900      
|Income (loss) from operations            |              |         |              | (1,427     
|Net income (loss)                        |              |         |              | (1,482     
|Net income (loss) per share - Basic(1)   |              |         |              | 0.18       
|Net income (loss) per share - Diluted(1) |              |         |              | 0.18       

|2003                            | March 31 (2) | June 30 (4) | Sept. 30 (5) | Dec. 31
|------------------------------- | ------------ | ----------- | ------------ | -------
|                               
|Revenues                        |              |             | $            | 4,532  
|Gross margin                    |              |             |              | 1,599  
|Loss from operations            |              |             |              | (5,525 
|Net loss                        |              |             |              | (3,202 
|Net loss per share - Basic(1)   |              |             |              | (0.39  
|Net loss per share - Diluted(1) |              |             |              | (0.39  

(1)   The
summation of quarterly per share amounts may not equal the calculation for the
full year, as each quarterly calculation is performed discretely.
(2)   Includes a pre-tax charge of $170 in 2003 and $847 in
2002 for restructuring and severance costs. Also includes a $645 gain from a
technology transfer and license agreement in the first quarter of 2003.
(3)   The three month period ended September 30, 2003
includes a pre-tax charge of $463 for restructuring and severance costs and a
charge for $632 for accelerated amortization of intangible assets. The three
month period ended December 31, 2003 includes restructuring charges of $609.
(4)   Includes a pre-tax charge of $800 for
restructuring and severance costs.
(5)   Includes a charge of approximately $4,076 for
establishing a valuation allowance on deferred tax assets.

36

---

# REPORT OF INDEPENDENT AUDITORS

To the Stockholders and the
Board of Directors of
CyberOptics Corporation

In our opinion, the consolidated
balance sheets and the related consolidated statements of operations, of stockholders'
equity, and of cash flows present fairly, in all material respects, the consolidated
financial position of CyberOptics Corporation, and its subsidiaries at December 31, 2003
and 2002, and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America. These financial statements
are the responsibility of CyberOptics Corporations management; our responsibility is
to express an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally accepted in the
United States of America which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our
opinion.

As described in Note 3 to the
consolidated financial statements, in 2002 CyberOptics Corporation adopted the provisions
of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and other
Intangible Assets. Under SFAS No. 142, goodwill and indefinite-lived assets are no
longer amortized, but are reviewed at least annually for impairment.

PricewaterhouseCoopers LLP
Minneapolis, Minnesota
January 30, 2004

37

---

# ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

NONE.

# ITEM 9A.   CONTROLS AND PROCEDURES

a.    
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934 (the Exchange Act)). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that, as of the end of
the period covered by this report, our disclosure controls and procedures were
effective in timely alerting them to the material information relating to us (or
our consolidated subsidiaries) required to be included in the reports we file or
submit under the Exchange Act.

b.    
During the quarter ended December 31, 2003, there has been no change in our
internal control over financial reporting (as defined in Rule 13a-15(f) under
the Exchange Act) that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.

# PART III.

# ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The
information contained under the headings Proposal I 
Election of Directors, Information About our Board of Directors and
its Committees and Other Corporate Governance Matters and
Section 16(a) Beneficial Ownership Reporting Compliance of the
Companys definitive proxy statement for its annual meeting of shareholders
to be held May 14, 2004 (hereafter, the Proxy Statement), is hereby
incorporated by reference.

# ITEM 11.   EXECUTIVE COMPENSATION

The
information under the headings Information About our Board of Directors
and its Committees and Other Corporate Governance Matters 
Compensation of Directors, and Executive Compensation of the
Proxy Statement is hereby incorporated by reference.

# ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The
information contained under the headings Executive
Compensation  Equity Compensation Plan Information, and
Shares Outstanding of the Proxy Statement is hereby incorporated by
reference.

# ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The
information under the headings Election of Directors 
Compensation of Directors, and Certain Transactions of the
Proxy Statement is hereby incorporated by reference.

# ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES

The
information under the heading Relationship with Independent Accountants of the
Proxy Statement is hereby incorporated by reference.

# PART IV.

# ITEM 15.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)(1)       Financial
Statements: See Item 8 to this Form 10-K.

(a)(2)       Financial
Statement Schedule: Schedule II, Valuation and Qualifying Accounts for the years ended
December 31, 2003, 2002 and 2001, and the report of PricewaterhouseCoopers LLP thereon
are attached as Item 15(d).

38

---

(a)(3)       LIST OF EXHIBITS

| | ExhibitNumber         Description
| | ---------------------------------

| | 3.1 |  | Articles of
Incorporation of Company, as amended (incorporated by reference to Exhibit 3.1
to the Companys Annual Report on Form 10-K for the year ended December 31,
1997).
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.2 |  | Bylaws
of the Company (incorporated by reference to Exhibit 3.1 to the quarterly report
on form 10-Q for the quarter ended September 30, 1998).
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------

| | 3.3 |  | Rights
Agreement, dated as of December 7, 1998, between the Company and Norwest
Bank Minnesota, N.A., as Rights Agent, (incorporated by reference to the
Companys Registration Statement on Form 8-A, dated December 7, 1998).
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.4 |  | First
Amendment to the Rights Agreement, dated October 21, 2002, between the
Company and Wells Fargo Bank Minnesota, National Association, as successor in
interest to Norwest Bank Minnesota, National Association (incorporated by
reference to Exhibit 2 to the Companys Form 8-A amendment dated
November 4, 2002).
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.1 |  | Restated Stock
Option Plan of the Company, as amended (incorporated by reference to
Exhibit 4.1 of the Companys Registration Statement on Form S-8
filed August 18, 1998 (file no 333-61711)).
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.2 |  | CyberOptics
Corporation Stock Option Plan for Non-Employee Directors, as amended
(incorporated by reference to Exhibit 4.2 of the Companys
Registration Statement on Form S-8 filed October 30, 1997
(file no 33-39091)).
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.3 |  | CyberOptics
Corporation 1998 Stock Incentive Plan, as amended (incorporated by reference to
exhibit 4.1 to the Companys Registration Statement on Form S-8
filed December 4, 2000 (file no. 333-51200)
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.4 |  | CyberOptics
Corporation Employee Stock Purchase Plan (incorporated by reference to
Exhibit 4.7 to the Companys quarterly report on Form 10-Q for
the quarter ended September 30, 1992).
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.1 |  | Settlement
Agreement dated as of February 14, 2003 between the Company, Avanti Optics
Corporation, and Gyrus Group (incorporated by reference to Exhibit 10.1 to the
Company's annual report on Form 10-K for the year ended December 31, 2002).
| | ---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.2 |  | Lease Agreement
between MEPC American Properties, Inc. and the Company dated September 15,
1995 (incorporated by reference to Exhibit 10 of the Company's Form 10-QSB for the quarter ended
September 30, 1995).
| | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | *10.3 |  | Retirement
Agreement dated September 13, 2002, as amended November 21, 2002,
between Steven M. Quist and CyberOptics Corporation (incorporated by reference to
Exhibit 10.3 to the Company's annual report on Form 10-K for the year ended December
31, 2002).
| | ----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | *10.4 |  | Independent
Contractor  Services Agreement dated October 13, 2002 between
the Company and Steven M. Quist (incorporated by reference to Exhibit 10.4 to the
Company's annual report on Form 10-K for the year ended December 31, 2002).
| | ----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | *10.5 |  | Letter of
engagement dated September 13, 2002 between Kathleen Iverson and the
Company (incorporated by reference to Exhibit 10.5 to the Company's annual report
on Form 10-K for the year ended December 31, 2002).
| | ----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 21.0 |  | Subsidiaries of the Company.
| | ---- |  | ----------------------------

| | 23.1 |  | Consent of PricewaterhouseCoopers LLP
| | ---- |  | -------------------------------------

| | 31.1 |  | Certification
of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
| | ---- |  | --------------------------------------------------------------------------------------------------

| | 31.2 |  | Certification of
Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
| | ---- |  | --------------------------------------------------------------------------------------------------

| | 32.0 |  | Certification
of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
| | ---- |  | ------------------------------------------------------------------------------------------------------------------------------

39

---

| | 32.0 |  | Certification of
Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
| | ---- |  | ------------------------------------------------------------------------------------------------------------------------------

* Management Contract or Compensatory Plan or Arrangement

(b)       REPORTS ON FORM 8-K

| |   Form 8-K  CyberOptics Corporation published press release reporting third quarter and nine month 2003 operating results (10/30/03).
| | ---------------------------------------------------------------------------------------------------------------------------------------

(d)       FINANCIAL STATEMENT SCHEDULES:

# REPORT OF INDEPENDENT AUDITORS

To the Stockholders and
Board of Directors of
CyberOptics Corporation

Our report on the consolidated
financial statements of CyberOptics Corporation has been included in this Annual Report on
Form 10-K under Item 8. In connection with our audits of such financial statements, we
have also audited the related financial statement schedule listed in item 14 of this
Annual Report on Form 10-K.

In our opinion, the financial
statement schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the information
required to be included therein.

# PricewaterhouseCoopers LLP

Minneapolis, Minnesota
January 30, 2004

# SCHEDULE II

# CYBEROPTICS CORPORATION

# VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001

|Description                       |  |  | Balance atBeginning ofPeriod |           | Charged toCosts andExpenses |   | Deductions |  | Balanceat end ofPeriod |           
|--------------------------------- |  |  | ---------------------------- | --------- | --------------------------- | - | ---------- |  | ---------------------- | ----------
|                                 
|Allowance for doubtful accounts:  |  |  |                              |           |                             |   |            |  |                        |           
|Year ended December 31, 2003      |  |  | $                            | 251,000   |                             | $ | 132,000    |  | $                      | (43,000   
|Year ended December 31, 2002      |  |  | $                            | 192,000   |                             | $ | 96,000     |  | $                      | (37,000   
|Year ended December 31, 2001      |  |  | $                            | 158,000   |                             | $ | 42,000     |  | $                      | (8,000    
|                                 
|
|                                 
|Allowance for obsolete inventory: |  | 
|Year ended December 31, 2003      |  |  | $                            | 2,477,000 |                             | $ | 116,000    |  | $                      | (1,037,000
|Year ended December 31, 2002      |  |  | $                            | 1,431,000 |                             | $ | 1,621,000  |  | $                      | (575,000  
|Year ended December 31, 2001      |  |  | $                            | 497,000   |                             | $ | 1,058,000  |  | $                      | (124,000  

40

---

# SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

| |  | CYBEROPTICS CORPORATION                   | 
| |  | ----------------------------------------- | 
| |  | /s/   KATHLEEN P. IVERSON                 | 
| |  |                                          
| |  | By Kathleen P. Iverson, President and CEO | 

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities and on
the dates indicated.

|Name                                               | Title | Date                                                                                
|-------------------------------------------------- | ----- | ------------------------------------------------------------------------------------
|                                                  
|/s/   KATHLEEN P. IVERSON                          |       | Director and CEO                                                                    
|                                                   |       | (Principal Executive Officer)                                                       
|Kathleen P. Iverson                                |       |                                                                                     
|                                                  
|/s/   STEVEN K. CASESteven K. Case                 |       | Chairman and Director                                                               
|                                                  
|/s/   STEVEN M. QUISTSteven M. Quist               |       | Director                                                                            
|                                                  
|/s/   ALEX B. CIMOCHOWSKIAlex B. Cimochowski       |       | Director                                                                            
|                                                  
|/s/   MICHAEL M. SELZER, JR.Michael M. Selzer, Jr. |       | Director                                                                            
|                                                  
|/s/   IRENE M. QUALTERSIrene M. Qualters           |       | Director                                                                            
|                                                  
|/s/   ERWIN A. KELENErwin A. Kelen                 |       | Director                                                                            
|                                                  
|/s/   SCOTT G. LARSONScott G. Larson               |       | Vice President and CFO(Principal Financial Officer)and Principal Accounting Officer)

41

---