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, 2004.

[   ]   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   X      No ____

As of June 30, 2004 (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 $217,734,379 (based on the closing sale price of common stock as of June 30, 2004 as quoted on the Nasdaq National
Market).

As of March 11, 2005, there were 8,870,480 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 16,
2005.

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# CYBEROPTICS CORPORATION
FORM 10-K
For the Fiscal Year Ended December 31, 2004

# TABLE OF CONTENTS

|                                                          |                                                                                                              |   
|--------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------ | --
|CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS | 3                                                                                                           
|ITEM 1.                                                   | DESCRIPTION OF BUSINESS                                                                                      | 4 
|ITEM 2.                                                   | PROPERTIES                                                                                                   | 11
|ITEM 3.                                                   | LEGAL PROCEEDINGS                                                                                            | 11
|ITEM 4.                                                   | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                          | 11
|PART II                                                   |                                                                                                              | 12
|ITEM 5.                                                   | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES | 12
|ITEM 6.                                                   | SELECTED FINANCIAL DATA                                                                                      | 12
|ITEM 7.                                                   | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                        | 13
|ITEM 7A.                                                  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                   | 20
|ITEM 8.                                                   | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                  | 21
|ITEM 9.                                                   | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                         | 38
|ITEM 9A.                                                  | CONTROLS AND PROCEDURES                                                                                      | 38
|ITEM 9B.                                                  | OTHER INFORMATION                                                                                            | 38
|PART III                                                  |                                                                                                              | 39
|ITEM 10.                                                  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                           | 39
|ITEM 11.                                                  | EXECUTIVE COMPENSATION                                                                                       | 39
|ITEM 12.                                                  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS               | 39
|ITEM 13.                                                  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                               | 39
|ITEM 14.                                                  | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                       | 39
|PART IV                                                   |                                                                                                              | 39
|ITEM 15.                                                  | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                                   | 39
|SIGNATURES                                                |                                                                                                              | 42

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# 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 U.S. 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.
These downturns, particularly the severe downturn in electronics production markets from
2001 through 2003, have severely affected our operations and generated 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | We have been dependent on two original equipment manufacturer customers for a large
portion of our revenue (50%,41% and 28% of revenues in 2004, 2003 and 2002,
respectively). Our operations were significantly negatively affected by reduced order
rates from these two customers during 2001, 2002 and the first half of 2003, and were
favorably impacted by increased order rates in the last half of 2003 and the first three
quarters of 2004. 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 2004, approximately 26% 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 81% in 2004) 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | All of our international export sales are negotiated, invoiced and paid on U.S. dollars,
and accordingly, currency fluctuations do not affect our revenue and income per unit.
However, significant fluctuations in the value of the U.S. dollar relative to other
currencies could have an impact on the price competitiveness of our products relative to
foreign suppliers, which could impact the willingness of customers to purchase our
products and have an impact on our results of operations.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | 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 have become subject to increased levels of
price competition and competition from other suppliers and 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 and semiconductor 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 also compete with new Asian based suppliers of
end-user systems products, many of which have lower overall production costs and are
willing to offer their products at lower selling prices to customers.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | 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
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  |  | 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.
| |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | New regulations have been enacted in various countries requiring the reduction of
hazardous substances in electronics products and capital equipment in future years. When
effective, these regulations will impact production processes of our customers and require
us to incorporate lead-free components into our products. If the production processes or
our customers are interrupted, or we are not able to complete the transition to lead-free
components in our products by the effective date of these regulations, our results of
operations could be negatively affected.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | We plan to continue to introduce a number of new products during fiscal 2005 and if those
introductions are delayed, our revenue and profitability could be negatively affected. For
example, we have devoted and continue to devote significant resources to complete
development and commence sale of our embedded process verification (EPV) products. The
introduction of these products has been delayed because of economic conditions affecting
our customers, required adaptations for OEM requirements and other issues and these
products have yet to generate substantial commercial sales.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | Our ability to capture, process and report transactions in a timely and accurate manner in
compliance with accounting principles generally accepted in the United States is dependant
upon the operation of our internal controls over financial reporting. Although we believe
our controls, policies, practices and systems are adequate to ensure the integrity of our
financial reporting, unanticipated and unauthorized actions of employees (both domestic
and internationally), temporary lapses in internal controls due to shortfalls in
transition planning and oversight, or resource constraints could lead to improprieties and
undetected errors that could impact our financial condition or results of operations.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# 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). We also
manufacture and sell sensors that assist with the placement and transport of wafers during
semiconductor fabrication. Our products assist the global SMT and semiconductor industries
in meeting 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 (88% of revenue in 2004) 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 12% of total revenues in 2004.

# Market
ConditionsRecent Development of the Business

Our
operations are 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, from the third and fourth quarters of 1999 to the
second quarter of 2001, and from the third

4

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quarter of 2003 through the end of 2004,
resulted in strong sales of our products, particularly OEM sensor products. These same
market cycles have influenced sales of our semiconductor products line. 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. 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 virtually no products at all. 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, consolidated several office
locations, 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.

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 high speed image acquisition capability to allow for point of placement images in
a pick-and-place machine for the first time and embedded image processing (embedded
process verification  EPV).

Starting
in the second quarter of 2002, our two principal sensor customers began ordering product
at higher levels, although still at lower levels than experienced in 2000. This increased
level of orders continued throughout 2003 and we reported substantially improved results
for the 2003 fiscal year, resulting in more than a 100% increase in sales of sensor
products from 2002 to 2003.

The
strong market continued through the third quarter of 2004, with steady increases in order
rates, and a 94% increase in sales of our sensor products from 2003 to 2004. At the same
time, we increased levels of sales of our systems products, particularly to original
design manufacturer customers (ODMs) in China. In a new market use, we began selling
our end-user systems products for use in inspection of assembly of DRAM memory modules
during 2004. To further capitalize on the rapidly growing ODM electronics markets in
China, we incorporated a wholly owned subsidiary in China during the fourth quarter of
2004 and continued a focused sales effort during 2004 on sales of system level products to
ODMs in China and throughout Asia. With several new or enhanced product offerings
and a strong market during the first three quarters of 2004, our sales increased 63% to
$58 million in 2004, and we reported strong earnings. We reported our second highest
quarterly revenue in the history of the Company in the quarter ended September 30, 2004.

Nevertheless,
toward the end of the third quarter of 2004, the global markets for electronics again
began to soften. Although the economies in the countries where most of our products are
sold continue to be strong, the semiconductor market has weakened and with it the circuit
board production market. We began seeing reduced order rates toward the end of the third
quarter and those reduced rates continued into the first quarter of 2005. Although they
were relatively flat as compared to sales in the last quarter of 2003, our revenue
declined 42%in the last quarter of 2004, as compared to the record revenue we
recorded in the third quarter. Order rates stabilized in the fourth quarter and improved
somewhat in the first few months of 2005. Accordingly, and although we cannot predict with
precision the trends in markets for electronic inspection, we do not anticipate any
further deterioration in the markets or in revenue in the near future.

# Objective

Our
objective is to develop complete surface mount technology process control solutions for
our customers. We intend to build upon our innovative products in systems for solder paste
inspection and component alignment, with new sensing products that will be embedded inside
SMT production equipment and we eventually intend to tie these products together as a
full-line process control solution. We believe our new embedded process verification (EPV)
sensor, which we expect to introduce during the first half of 2005 for sale to end-user
customers as an enhancement to an existing pick-and-place machine and later as an OEM
product with Universal Instruments, will gain acceptance among OEMs as a further
enhancement to inspection and control. In another step towards embedding sensing products
inside production equipment, we plan to introduce during 2005 a fiducial/inspection camera
for DEK International Gmbh to be mounted inside their industry leading screen printer to
ensure accurate board registration as well as to provide DEK with upgraded capability for
solder paste and stencil inspection. We have established 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.

In
our Semiconductor Products group, during 2004, we introduced our Automatic Leveling Sensor
(ALS), a wireless wafer-like sensor designed to calibrate semiconductor automation
equipment and process tools and are investigating several new products used to calibrate
semiconductor process tools.

5

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Our
ability to implement our strategy effectively is subject to numerous uncertainties and
risks, including market conditions in the global SMT circuit board assembly and
semiconductor fabrication capital equipment markets and our timely 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 eight years, is a family of sensors that uses 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 22% and 19% of our revenue in 2004, respectively,
          and approximately 21% and 15% of our revenue in 2003, respectively. Accordingly,
          revenues and operations are currently heavily influenced by the level of
          purchases from these two customers (including Assembleon N.V. purchases of Board
          Align Camerasee below) and by the health of the SMT production industry.

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 32% of our revenue
in 2004, 30% in 2003, and 19% in 2002.

BoardAlign
Camera (BA Camera). The BA Camera, which is incorporated directly into the
placement head of component placement machines, identifies fiducial markings on a circuit
board and aligns the board in the component placement machine prior to component
placement. The BA Camera was introduced in a sensor for Assembleon N.V. during 2003 to be
incorporated into their latest version component placement machine. Revenue from shipments
of BA Camera sensors to Assembleon N.V. accounted for approximately 9% and 5% of our
revenue in 2004 and 2003, 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 five
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 made our last shipments of
Laser Lead Locator products in early 2004.

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# 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.

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 26% of our revenue in 2004, 29% in 2003, and 27% in 2002.

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 series of Automated Optical Inspection
(AOI) products was initially introduced in the fourth quarter of 2000 and incorporates
in-process technology acquired from Kestra Ltd in 1999. These in-line products measure and
inspect circuit boards after component placement to determine whether all components are
present, that all components have been placed correctly and the quality of solder joints
after reflow. The principal advantage of the KS series AOI products is ease of use for the
operator compared to other AOI machines and the low level of false calls.

We
have introduced a number of versions of the KS series AOI products since their initial
introduction in 2000. The latest version, KS Flex introduced in 2003, incorporates
high-resolution color cameras for improved imaging, and is designed to inspect the
placement of very small (0201) components on circuit boards. In addition, KS Flex allows
for a variety of machine configurations (different number of cameras based on board size
and resolution requirements) based on customer needs.

# 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 and FOUPS 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 to become a larger proportion of our sales in future
periods.

7

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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. We offer both digital and analog
versions of frame grabbers under the Imagenation trademark.

Auto
Leveling Sensor.We introduced the WaferSense auto leveling sensor
(ALS), our level calibration tool for semiconductor process tools, in late 2004. The
WaferSense ALS is a wireless, vacuum-compatible sensor that can be placed in cassettes,
FOUPS, on end effectors, aligners, in load locks and process chambers used in
semiconductor fabrication to ensure that all stations are level and coplaner. Because the
user is not required to break down semiconductor fabrication equipment, or evacuate a
vacuum chamber, we believe that WaferSense ALS will save significant time over the manual
leveling currently used by customers and increase equipment up-time, through-put and
process yield.

# Markets and Customers

We
sell the vast majority of our products into the electronics manufacturing market (88% of
total revenues in 2004), 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 products are sold to OEMs serving this market and the SE 300 and KS
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. Our new WaferSense ALS will be sold directly to semiconductor
fabrication facilities for use by process and equipment engineers during the production of
semiconductor wafers.

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 opened a
sales office in China in October 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
board assembly equipment, semiconductor capital equipment manufacturers and end-user
electronic assembly manufacturers. Although we maintain sales offices in the UK, Singapore
and China, all manufacturing of our products occurs in the United States and all sales
originate in the United States.

There
has been a significant increase in export sales from 2002 to 2004 as the result of the
majority of new worldwide electronics and semiconductor capacity being added in Asia. In
addition, a significant portion of our export sales to Europe are OEM electronic assembly
sensors that ultimately are sold by our OEM customer into Asia. 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                                                                                                              |                        
|                                                                                                                 
|Europe                                                                                                            |                        
|                                                                                                                 
|Other (1)                                                                                                         |                        
|                                                                                                                 
|(1) Includes export sales in North America, primarily export sales to Canada,
          Mexico and Latin America.

See
Note 12 to the Companys Consolidated Financial Statements contained in item 8 of
this Form 10-K.

8

---

All
export sales are negotiated, invoiced and paid in U.S. 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, Oregon and California. 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, Singapore and China.
We have agreements with 17 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 20 representatives and distributors
covering Europe (12) and the Pacific Rim (8).

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 are in the process of
establishing a worldwide sales representative organization for WaferSense semiconductor
products. We currently have agreements in place or in process with sales representatives
in the U.S. (2), Europe (3) and Pacific Rim (8). Most of these sales representatives will
also be authorized to sell wafer mapping semiconductor 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 $3.7 million at December 31, 2004, compared
to $6.6 million on December 31, 2003, and $2.8 million on December 31, 2002. Substantially
all of the 2004 backlog is deliverable in the first quarter of 2005. 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.

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 2004 and 2003, research and
development efforts were primarily focused on initial development activities for several
new sensor products, including development of our new Embedded Process Verification sensor
family (EPV®), continued development of the SE and KS series inspection systems, next
generation LaserAlign products, board alignment cameras and enhancements to the
semiconductor wafer mapping sensor family. In addition, we are continuing development of
new products for the semiconductor market, and completing development of the recently
introduced WaferSense auto leveling sensor (ALS). During 2005, we intend to complete
the development and introduction of our first EPV sensors and to adapt that sensor for
additional OEM customers, to complete development of new semiconductor products, to
complete an enhancement and upgrade of the SE product family and to fund various other
product opportunities.

Research
and development expenses were $7.6 million in 2004, $7.2 million in 2003, and $8.0 million
in 2002. These amounts represented 13% of revenues in 2004, 20% in 2003 and 33% in 2002.
Research and development expenses consist primarily of salaries, project materials,
contract labor 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.

9

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# 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.

The
primary competition for sales of our SE 300 products has been GSI Lumonics, Inc. (SVS
division), Agilent Technologies, Inc. and Orbotech, Ltd. (Israel). More recently Asian
based companies such as Koh Young Technology (Korea), CKD Corporation (Japan) and Test
Research, Inc. (Taiwan) have introduced lower cost three dimensional inspection systems
that provide less performance than the SE 300, but are increasingly competing for SE 300
sales in the Pacific Rim. 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. Although we believe the SE 300 competes favorably against these competitive
products on the basis of performance and reliability, the introduction of lower cost
competitive models has required us to decrease the price of the SE 300 in some markets.

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), Saki Corporation (Japan) 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.

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.

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.

10

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# Employees

As
of December 31, 2004, we had 163 full-time and 2 part-time employees worldwide, including
35 in sales, marketing and customer support, 64 in manufacturing, purchasing and
production engineering, 46 in research and development and 20 in finance, administration
and information services. Of these employees, 116 are located at our corporate
headquarters in Minneapolis and 49 are located in other offices (4 in the UK, 30 in
Oregon, 6 in Singapore and 3 in China). 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 84patents (51U.S. and 33foreign) 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 94pending patents
(26U.S. and 68foreign). 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 15registered trademarks, 3of which
are foreign. We also have 10domain 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.

# 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.

# 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. As of
December 31, 2004, we also have operating leases in Oregon (CyberOptics Semiconductor,
Inc.), Singapore (CyberOptics (Singapore) Pte. Ltd.), Massachusetts, and Shanghai which
expire in May 2007, May 2005, August 2006, and August 2006, respectively.

# 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 2004.

11

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# 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.

|       | 2004 |  | 2003
|------ | ---- |  | ----
|
|       |      |  |     
|      
|First  |      |  |     
|      
|Second |      |  |     
|      
|Third  |      |  |     
|      
|Fourth |      |  |     

As of March 11, 2005, there
were approximately 216 holders of record of common stock and approximately 3,250 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.

# ITEM 6. SELECTED FINANCIAL DATA

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

|Year Ended December 31         | 2004 (1) |  | 2003 (2) |        | 2002 (3) |   | 2001 (4) |   | 2000 (5)
|------------------------------ | -------- |  | -------- | ------ | -------- | - | -------- | - | --------
|                               |          |  |          |        |          |   |          |   |         
|                              
|Revenues                       |          |  | $        | 58,037 |          | $ | 35,636   |   | $       
|Income (loss) from Operations  |          |  |          | 12,325 |          |   | (2,814   | ) |         
|Cumulative Effect of Change in |          | 
|Accounting Principle           |          |  |          |        |          |   |          |   |         
|Net Income (loss)              |          |  |          | 10,626 |          |   | (2,637   | ) |         
|Net Income (loss) per Share:   |          | 
|Basic                          |          |  |          | 1.23   |          |   | (0.32    | ) |         
|Diluted                        |          |  |          | 1.18   |          |   | (0.32    | ) |         
|                              
|Cash and Marketable Securities |          |  | $        | 40,284 |          | $ | 24,822   |   | $       
|Working Capital                |          |  |          | 38,921 |          |   | 26,963   |   |         
|Total Assets                   |          |  |          | 65,096 |          |   | 47,926   |   |         
|Stockholders Equity           |          |  |          | 57,951 |          |   | 41,752   |   |         

_________________

|(1) |  | 2004 results include charges of $169 related to reduced
assumptions for estimated sub-lease income.
|--- |  | ---------------------------------------------------------------------------------------------------

|(2) |  | 2003 results include a $1.2 million charge for workforce
reductions, leased facility consolidation 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.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | 2002 results include an increase in the valuation allowance for
deferred income taxes of approximately $4.3 million. In addition, 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.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

12

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# 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 and devices. Historically these markets have been very cyclical, with
periods of rapid growth as worldwide capacity is added to support increased consumer
demand for electronic products, and new capital equipment is purchased as a result of
technology changes in electronics components, such as miniaturization, and changing
production requirements. These periods of growth have historically been followed by
periods of excess capacity and reduced capital spending.

We
experienced an exceptionally strong year in 2004, as increased revenues were driven by
growth in the electronic assembly and semiconductor fabrication capital equipment markets
that began in the second half of 2003, and continued for much of 2004. In addition, market
acceptance of new and enhanced products developed during the industry downturn from 2001
to early 2003, and our expanded Asian distribution channel allowed us to increase market
penetration and participate more fully in this industry recovery. As a result we reported
sequential quarter over quarter revenue growth from the third quarter of 2003 through the
third quarter of 2004, where we reported near record revenues of $19.4 million and
increased consolidated revenues for fiscal 2004 by 63% over 2003. This strong 2004
followed a period from 2001 to early 2003 where the electronics and semiconductor
fabrication capital equipment markets were significantly depressed. During a portion of
this period (second half of 2001 to mid 2002) our two largest OEM customers, which
accounted for 50% of our revenue in 2004, virtually ceased ordering products. The level of
revenues from our Semiconductor and SMT systems product groups was also significantly
impacted by this severe industry decline.

2004
operating results also significantly benefited from a lower cost structure implemented
during 2001, 2002 and 2003. In response to reduced revenues and operating losses, we took
aggressive cost reduction actions, including reducing our worldwide employment by over 50%
from 2001 peaks, and closing or downsizing facilities. As a result, 2004 operating profits
reached $12.3 million and net income reached $10.6 million or $1.18 per diluted share,
compared to net losses reported from 2001 to 2003. Net income in 2004 reflects a 16%
effective tax rate, which is significantly lower than statutory rates. See Note 7 of this
Form 10-K for a further discussion of the accounting treatment for income taxes. Our
balance sheet is also well positioned as the result of improved operating results and
effective management of working capital and other assets. We have no debt and our cash and
marketable securities are $40.3 million at December 31, 2004 compared to $24.8 million at
December 31, 2003. We generated $15.5 million of cash and marketable securities in 2004,
of which approximately $10.5 million was from operating activities, including capital
purchases, and approximately $5.1 million from issuing shares as the result of option
exercises and participation in the Employee Stock Purchase Plan.

Toward
the end of the third quarter of 2004, the global markets for electronics again began to
soften. Although the economies in the countries where most of our products are sold
continue to be strong, the semiconductor market has weakened and with it the circuit board
production market. We began seeing reduced order rates toward the end of the third quarter
and those reduced rates continued into the first quarter of 2005. Although they were
relatively flat as compared to sales in the last quarter of 2003, our revenue declined
42%in the last quarter of 2004 as compared to the near record revenue we recorded
in the third quarter. Order rates stabilized in the fourth quarter and in the first few
months of 2005. Accordingly, and although we cannot predict with precision the trends in
markets for electronic inspection, we do not anticipate any further deterioration in the
markets or in revenue in the near future.

# Results of Operations
for the Three Years Ended December 31, 2004:

Revenues

Our
revenues increased by 63% to $58.0 million in 2004 from $35.6 million in 2003, and
increased 45% in 2003 from $24.6 million in 2002. The following table sets forth, for the
years indicated, revenues by product line (in thousands):

|                            | 2004 |  | 2003 |        | 2002
|--------------------------- | ---- |  | ---- | ------ | ----
|                            |      |  |      |        |     
|OEM Solutions:              |      |  |      |        |     
|Electronic Assembly Sensors |      |  | $    | 31,275 |     
|Semiconductor Products      |      |  |      | 7,018  |     
|SMT Systems                 |      |  |      | 19,744 |     
|                            |      |  |      |        |     
|Total                       |      |  | $    | 58,037 |     

Revenues from our electronic
assembly sensors products increased $15.2 million or 94% during 2004 compared to 2003, and by $8.1 million or 100% during 2003
compared to 2002. During 2004, 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 and result in a higher content of our products per

13

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machine than in the previous version. During 2003, revenues began to improve
during the second half of the year due to improved market conditions and the initial introduction of the previously discussed new
sensors. 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.

Revenues from Semiconductor
Products (including revenues from Imagenation frame grabber products for semiconductor and other applications) increased $1.5
million or 26% in 2004 compared to 2003, following a decrease of $635,000 or 10% in 2003 compared to 2002. The increase in 2004
was primarily due to higher revenues from wafer mapping sensors as a result of improved market conditions in the semiconductor
fabrication capital equipment market for much of 2004. Frame grabber revenues increased slightly in 2004 compared to 2003, as the
result of improved conditions in the general industrial capital equipment markets. The decrease in 2003 as compared to 2002 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
between 2003 and 2002.

Revenues
from our SMT systems products increased $5.8 million or 41% during 2004 compared to 2003
and increased $3.6 million or 34% during 2003 compared to 2002. During 2004 and 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 Asia, and we have been successful in selling inspection
systems to new and existing customers in that region through our expanded distribution
capability (opened Singapore sales office in 2001 and a sales office in China in 2004). In
addition, during 2004 revenues from our KS series AOI systems increased $1.5 million
compared to 2003 levels. We believe that increased 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.

International
revenue totaled $46.8 million in 2004, $28.2 million in 2003 and $16.5 million in 2002,
comprising 81%, 79% 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. As manufacturing
of electronic components has migrated offshore, and particularly to China, an increasing
proportion of our sales have been to international customers.

Gross
Margin

Gross
margin increased to 59% of sales in 2004 from 52% in 2003 and 41% in 2002. There are three
primary reasons for improved gross margins as a percentage of revenues in 2004 and 2003:
increased revenue volume, a change in our revenue mix with higher levels of OEM sensor
revenues and the impact of cost reduction measures implemented during 2001 to 2003. Our
gross margin is highly dependent on the level of revenues and resulting production levels
over which to spread fixed manufacturing overhead costs that do not vary with activity
levels. In addition, with higher production volumes manufacturing processes become more
efficient and we are able to negotiate lower material costs from our suppliers as the
result of volume discounts which reduces the overall cost of producing products for sale.
Revenue levels increased 63% in 2004 compared to 2003 and increased 45% in 2003 compared
to 2002, significantly contributing to higher gross margins. Further, our OEM sensor
products carry higher gross margins as a percentage of revenues than end-user systems
products, and our sensor products constituted a growing proportion of our total revenue in
2004 and 2003. Also contributing to higher gross margins in 2003 compared to 2002, was
significantly reduced cost for obsolete inventory.

Partially
offsetting these positive influences on gross margins are continued price pressure
resulting in lower selling prices for our products, particularly our end-user systems
products, and increased warranty costs in 2004 compared to 2003. We expect lower
forecasted sales levels in early 2005, and continued pricing pressure as a result of
additional competitors in the marketplace to have a negative impact on gross margins.

Research
and Development Expenses

We
increased research and development expenses by 6% to $7.6 million in 2004, following a
decrease of 10% to $7.2 million in 2003 compared to $8.0 million in 2002. As a percentage
of revenue, research and development expenses decreased to 13% in 2004, compared to 20%
in 2003 and 33% in 2002. As a percentage of revenue, research and development expense was
maintained at relatively high levels during 2002 and 2003, as we continued to fund
product development on important new products even as revenue levels declined. Although
in early 2004 our investment in research and development remained relatively constant
with 2003 levels, as revenue levels continued to grow throughout 2004 we increased the
level of research and development spending to accelerate completion of projects and to
increase the number of development projects in process. In addition, costs of company
wide incentive programs associated with increased revenue and profits significantly
contributed to increased research and development expense in

14

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2004. Reduced research and
development expense in 2003 compared to 2002 was primarily the result of a series of cost
reduction initiatives implemented during those periods in reaction to declining revenues.

During
2004 and 2003, 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 cameras and enhancements to the semiconductor wafer mapping sensor family. In
addition, we are continuing development of new products for the semiconductor market, and
are completing development of the recently introduced WaferSense auto leveling
sensor (ALS). Customer-funded research and development is recognized as a reduction of
research and development expense. During 2004, customer-funded research and development
expense totaled $90,000 compared to $14,000 in 2003 and $75,000 in 2002. We are currently
expecting research and development expenditures to be flat or slightly lower in 2005 as
compared to 2004. 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 2005 operating results.

Selling,
General and Administrative Expenses

We
increased our selling, general and administrative expenses by 11% to $13.1 million in
2004, following a decrease of 10% to $11.8 million in 2003 compared to $13.2 million in
2002. As a percentage of revenue, selling, general and administrative expenses decreased
to 23% in 2004, compared to 33% in 2003 and 54% in 2002. The dollar increase in selling,
general and administrative expense is primarily due to additional investment in sales and
marketing, primarily in Asia, increases in other costs associated with supporting a
growing end-user systems revenue base and company wide incentive programs associated with
higher revenue and profit levels. In addition, increased corporate governance costs,
including costs associated with implementing an internal control framework in accordance
with section 404 of the Sarbanes Oxley Act of 2002 had a significant impact on increased
selling, general and administrative expenses. The dollar decrease in selling, general and
administrative expenses in 2003 compared to 2002 was primarily due to the effect of cost
reduction measures implemented during those periods, which primarily included workforce
reductions and related costs and reductions in other discretionary spending. We are
currently expecting selling, general and administrative expenses in 2005 to be at or about
the levels recorded in 2004.

Restructuring
and Severance Costs

During
2001 to 2003, we implemented a series of workforce reductions, closed our facility in
California, downsized facilities in the UK and Minneapolis and made other reductions in
discretionary spending designed to reduce our cost structure in light of declining
revenues during those periods caused by the depressed capital equipment markets for
suppliers to electronics manufacturing.

During
2004, we recorded restructuring charges of $169,000. These charges reflected our change in
estimate relative to the amount of sub-lease income we will receive from space vacated
during the corporate restructuring in December 2003. Although this space is being marketed
for sub-lease, we have not been successful in securing a sub-lease tenant and our lease
term ends in May 2006. Consequently, we determined it was appropriate to record an
additional charge assuming that no sub-lease income would be received on the property
vacated during 2003.

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 was paid as of December 31,
2003. Severance and associated costs of $180,000 were accrued as of December 31, 2003, and
paid as of September 30, 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 was 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.

15

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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 was 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.

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

|                                           | EmployeeTerminationBenefits |  | LeaseCommitmentCosts |        | Other |   | Total
|------------------------------------------ | --------------------------- |  | -------------------- | ------ | ----- | - | -----
|                                           |                             |  |                      |        |       |   |      
|Restructuring liability, December 31, 2001 |                             |  | $                    |       |       | $ |     
|Initial expense and accrual                |                             |  |                      | 1,362  |       |   | 250  
|Cash payments                              |                             |  |                      | (1,214 | )     |   | (62  
|                                           |                             |  |                      |        |       |   |      
|                                          
|Restructuring liability, December 31, 2002 |                             |  |                      | 148    |       |   | 188  
|                                          
|Initial expense and accrual                |                             |  |                      | 541    |       |   | 694  
|Cash payments                              |                             |  |                      | (509   | )     |   | (510 
|                                           |                             |  |                      |        |       |   |      
|                                          
|Restructuring liability, December 31, 2003 |                             |  |                      | 180    |       |   | 372  
|                                          
|Change in estimate                         |                             |  |                      |        | 169   |   |      
|Cash payments                              |                             |  |                      | (180   | )     |   | (236 
|                                           |                             |  |                      |        |       |   |      
|                                          
|Restructuring liability, December 31, 2004 |                             |  | $                    |       |       | $ | 305  
|                                           |                             |  |                      |        |       |   |      

Gain
on Technology Transfer and License

In
March 2003, we transferred to the Optical Gaging Products (OGP) 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. The agreement called for QVI
to pay $750,000 as a one-time fee for the purchase of fixtures, a technology transfer fee
and a non-refundable royalty payment. In addition, we sold QVI raw material inventories
associated with the product line. The gain was determined as the difference between the
proceeds received and our carrying value of product line inventory and fixed assets prior
to the sale. As a result of this transaction, we recorded a $645,000 gain in the
three-month period ended March 31, 2003.

Amortization
of Intangible Assets

Amortization
of acquired intangible assets was approximately $908,000 in 2004 compared to $1.8 million
in 2003 and $1.1 million in 2002. The decrease in amortization during 2004 compared to
2003 is primarily the result of a $632,000 charge in 2003 to accelerate the amortization
of certain intangible assets established as the result of the acquisition of HAMA
Laboratories, Inc. in 1999. In addition, certain acquired intangible assets became fully
amortized during 2004. Amortization of intangible assets is expected to be approximately
$1.0 million in 2005.

During
the third quarter of 2003, the amortization of intangible assets related to certain
product lines and technologies were determined to be non-strategic. These general-purpose
sensor product lines were discontinued during 2004, 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
carry the benefit we will derive in future accounting periods from tax losses and credits
and deductible temporary differences as a deferred tax asset on our balance
sheet. In the third quarter of fiscal 2002, however, we recorded a full valuation
allowance (a charge to income to fully reserve against the net deferred tax asset) against
our deferred tax assets. We recorded this valuation allowance because the cumulative
losses we had incurred over the three years prior to that date and the operating losses we
continued to incur made it questionable whether we would realize value from the deferred
tax assets and because we fully utilized our loss carryback potential in 2002. Since the
third quarter of fiscal 2002, we have continued to record in each quarter a full valuation
allowance against all future tax benefits produced by our operating results. We assess the
realizability of our deferred tax assets and

16

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the need for this valuation allowance
based on Statement of Financial Accounting Standards No. 109. We expect to continue to
record a full valuation allowance until we can sustain a level of profitability that
demonstrates our ability to use these assets. At that time, the valuation allowance will
be reassessed, and could be eliminated, resulting in the recognition of deferred tax
assets.

During
2004, we recorded an income tax provision of approximately $2.0 million resulting in an
effective income tax rate of approximately 16%. Income earned in 2004 will result in our
fully utilizing remaining tax operating loss carryforwards with the result that we paid
income taxes in 2004. Because we continue to maintain a valuation allowance on deferred
tax assets (deferred tax assets not available to reduce taxable income or taxes payable in
2004) these taxes paid are recorded as an expense, resulting in an effective rate of 16%.

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. 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.

Interest
Income and Other

Interest income
and other primarily includes interest earned on investments and losses associated
with foreign currency translation. Interest income increased during 2004 as the result of
additional invested funds. These increases were offset by increased translation losses and
other items resulting in a slight decline in interest income and other compared to 2003.
Interest income declined during 2003 compared to 2002 as a result of declining interest
rates on invested funds. In addition, during 2002, we recorded losses of $1.5 million on
equity method investments related to Avanti Optics Corporation, a related party.

# Liquidity and Capital
Resources

Our
cash and cash equivalents increased by $14.1 million during 2004 primarily because of
$11.7 million of cash generated from operating activities and approximately $5.1 million
of cash generated from financing activities, offset by the purchase of $1.6 million of
marketable securities, net of maturities of marketable securities, and the purchase of
$1.2 million of capital assets. 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 addition 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 $15.5 million to $40.3 million as of December 31, 2004
from $24.8 million as of December 31, 2003.

We
generated $11.7 million of cash from operations during 2004. Cash generated from
operations primarily included net income of $10.6 million, which included $2.6 million of
net non-cash expenses for depreciation and amortization, provision for inventory
obsolescence, foreign deferred taxes and other non-cash items, tax benefits from the
exercise of stock options of $678,000, reduced accounts receivable of $326,000, advance
customer payments of $429,000 and increased accrued expenses of $2.1 million. This cash
generated more than offset investments in inventory of $3.1 million and other assets of
$388,000 as well as reductions in accounts payable of $1.6 million. Increased accrued
expenses are primarily due to increased incentive and warranty accruals during 2004.
Investments in inventory are the result of significantly reduced revenues and order rates
during the fourth quarter of 2004, which caused build-up in inventory as we aligned
production rates with customer order rates. Reduced accounts payable are the result of
lower levels of inventory purchases during the fourth quarter as we attempted to bring
inventory levels down.

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 $2.8 million of cash in investing activities during 2004 compared to using $3.5
million in 2003. Changes in the level of investments in marketable securities resulting
from the purchases and maturities of those securities used $1.6 million of cash in 2004
and used $3.8 million of cash in 2003. We used approximately $1.2 million and $506,000 of
cash for the purchase of fixed

17

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assets, capitalized patent costs and
the acquisition of a patent license in 2004 and 2003, respectively. In addition, during
2003, we generated $750,000 of cash from a technology transfer and license agreement.

We
generated approximately $5.1 million of cash from financing activities during 2004
compared to $660,000 in 2003. Cash generated from financing activities represents cash
from stock option exercises and issuance of common stock under the Employee Stock Purchase
Plan, offset by $85,000 of cash used in 2003 for the repurchase of common stock.

At
December 31, 2004, 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.

We
had no material commitments for expenditures as of December 31, 2004. 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 $40.3 million at December 31, 2004. With this level of cash and cash
equivalents, and the fact that we are generating net profits and cash during 2004, we
believe that cash and cash equivalents will be adequate to fund our cash flow needs for
the foreseeable future, including contractual obligations discussed below.

The
following summarizes our contractual obligations at December 31, 2004, and the effect such
obligations are expected to have on our 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 |       |  |                  | 1,628 |             |   | 1,124        
|Purchase obligations                       |       |  |                  | 3,597 |             |   | 3,459        
|                                           |       |  |                  |       |             |   |              
|Total contractual cash obligations         |       |  | $                | 5,225 |             | $ | 4,583        

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.

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.

18

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# Inflation and Foreign
Currency Translation

Changes
in our revenues have resulted primarily because of changes in the level of unit shipments
and the relative strength of the worldwide electronics and semiconductor fabrication
capital equipment markets. We believe that inflation has not had a 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 or have had a sales and software development
office located in the UK. We also opened a sales office in Singapore during 2001and China
during 2004. We do not believe that currency fluctuations will have a material impact on
our consolidated financial statements.

# Recent Accounting
Developments

In
December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R),
Share-Based Payment, which is a revision of SFAS No. 123 and supersedes APB
Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be valued at fair value on the date of grant, and to
be expensed over the applicable vesting period. SFAS No. 123(R) is effective for all
stock-based awards granted on or after July 1, 2005, and companies must also recognize
compensation expense related to any awards that are not fully vested as of the effective
date. SFAS No. 123(R) will be effective for public companies for interim or annual periods
beginning after June 15, 2005 and may be adopted under either the modified prospective
method or alternative methods, which allow for restatement of prior interim periods or
prior years. We are currently evaluating how we will adopt the standard and the impact of
adopting SFAS No. 123(R) on our financial position and results of operations.

In
November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 (SFAS
151), Inventory Cost  and amendment of ARB No. 43. SFAS 151 requires
idle facility expenses, freight, handling costs, and wasted material spoilage costs to be
recognized as current-period charges. It also requires that allocations of fixed
production overheads to the costs of conversion be based on normal capacity of the
production facilities. SFAS 151 will be effective for inventory costs incurred during
fiscal years beginning after June 15, 2005. We are currently evaluating the impact of
adopting the standard on our financial position and results of operations.

# 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. 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 $345,000 as of December 31, 2004.

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 allowance for
warranties is $646,000 at December 31, 2004.

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, or if in the future
we decide to discontinue sales and marketing of any of our products, additional inventory
write-downs may be required. At December 31, 2004, we had a reserve for obsolete and
excess inventory of approximately $1.1 million.

19

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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.
| | - |  | --------------------------------------------------------------------------------------------

| |  |  | significant changes in the manner of our use of the acquired assets or the strategy for our overall.
| | - |  | ----------------------------------------------------------------------------------------------------

| |  |  | 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. The evaluation of asset impairment requires us to make assumptions
about future cash flows over the life of the asset being evaluated. These assumptions
require significant judgment and actual results may differ from assumed or estimated
amounts.

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 that we fully utilized our loss
carryback benefit 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 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
the recognition of deferred tax assets.

As
of December 31, 2004 and 2003, our deferred tax assets and the related valuation allowance
were approximately $6.1 million and $7.7 million, respectively. Included in these amounts
are deferred tax assets related to our UK subsidiary of approximately $1.7 million as of
December 31, 2004. 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.

# 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, 2004
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 $175,000. 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, 2004, 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,
2004. During the year ended December 31, 2004, we recognized a net loss of approximately
$464,000 from settlement of foreign currency swap agreements that offset the approximately
$268,000 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.

20

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# ITEM 8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA

# CONSOLIDATED BALANCE SHEETS
CYBEROPTICS CORPORATION

|                                                                              | Year ended December 31
|----------------------------------------------------------------------------- | ----------------------
|                                                                              |                       
|
|                                                                              |                       
|                                                                             
|ASSETS                                                                        |                       
|                                                                             
|Cash and cash equivalents                                                     |                       
|Marketable securities                                                         |                       
|Accounts receivable, less allowance for doubtful accounts of $345 and $340 in |                       
|2004 and 2003, respectively                                                   |                       
|Inventories                                                                   |                       
|Other current assets                                                          |                       
|                                                                              |                       
|Total current assets                                                          |                       
|                                                                             
|Marketable securities                                                         |                       
|Equipment and leasehold improvements, net                                     |                       
|Intangible and other assets, net                                              |                       
|Goodwill                                                                      |                       
|                                                                              |                       
|Total assets                                                                  |                       
|                                                                              |                       
|                                                                             
|LIABILITIES AND STOCKHOLDERS EQUITY                                          |                       
|                                                                             
|Accounts payable                                                              |                       
|Advance Customer Payments                                                     |                       
|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, 8,847 and 8,291 shares issued  |                       
|and outstanding, respectively                                                 |                       
|Accumulated other comprehensive loss                                          |                       
|Retained earnings (deficit)                                                   |                       
|                                                                              |                       
|                                                                             
|Total stockholders equity                                                    |                       
|                                                                              |                       
|                                                                             
|Total liabilities and stockholders equity                                    |                       
|                                                                              |                       

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

21

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# CONSOLIDATED STATEMENTS OF OPERATIONS
CYBEROPTICS CORPORATION

|                                              | Year ended December 31
|--------------------------------------------- | ----------------------
|                                              |                       
|
|                                              |                       
|                                             
|Revenues                                      |                       
|Cost of revenues                              |                       
|                                              |                       
|                                             
|Gross Margin                                  |                       
|                                             
|Research and development expenses             |                       
|Selling, general and administrative expenses  |                       
|Restructuring and severance costs             |                       
|Gain from technology transfer and license     |                       
|Amortization of intangibles                   |                       
|                                              |                       
|                                             
|Income (loss) from operations                 |                       
|                                             
|Interest income and other                     |                       
|                                              |                       
|                                             
|Income (loss) before income taxes             |                       
|                                             
|Income tax provision (benefit)                |                       
|                                              |                       
|                                             
|Net income (loss)                             |                       
|                                              |                       
|                                             
|Net income (loss) per share  Basic           |                       
|Net income (loss) per share  Diluted         |                       
|                                              |                       
|                                             
|Weighted average shares outstanding  Basic   |                       
|Weighted average shares outstanding  Diluted |                       
|                                              |                       

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

22

---

# CONSOLIDATED STATEMENTS OF CASH FLOWS
CYBEROPTICS CORPORATION

|                                                                     | Year ended December 31
|-------------------------------------------------------------------- | ----------------------
|                                                                     |                       
|
|                                                                     |                       
|                                                                    
|CASH FLOWS FROM OPERATING ACTIVITIES:                                |                       
|Net income (loss)                                                    |                       
|Adjustments to reconcile net (loss) to net cash provided (used) by   |                       
|operating activities:                                                |                       
|Depreciation and amortization                                        |                       
|Gain from technology transfer and license                            |                       
|Provision for doubtful accounts                                      |                       
|Provision for inventory obsolescence                                 |                       
|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                                                  |                       
|Inventories                                                          |                       
|Other current assets                                                 |                       
|Accounts payable                                                     |                       
|Income taxes payable/receivable                                      |                       
|Advance Customer Payments                                            |                       
|Accrued expenses                                                     |                       
|                                                                     |                       
|Net cash provided (used) by operating activities                     |                       
|                                                                    
|CASH FLOWS FROM INVESTING ACTIVITIES:                                |                       
|                                                                    
|Proceeds from sales of available for sale marketable securities      |                       
|Purchases of available for sale marketable securities                |                       
|Proceeds from technology transfer and license                        |                       
|Purchase of License                                                  |                       
|Loan to related party                                                |                       
|Additions to equipment and leasehold improvements                    |                       
|Additions to patents                                                 |                       
|                                                                     |                       
|Net cash provided (used) by investing activities                     |                       
|                                                                    
|CASH FLOWS FROM FINANCING ACTIVITIES:                                |                       
|Proceeds from exercise of stock options                              |                       
|Proceeds from issuance of common stock under Employee Stock Purchase |                       
|Plan                                                                 |                       
|Repurchase of common stock and other                                 |                       
|                                                                     |                       
|Net cash provided by financing activities                            |                       
|                                                                    
|Net increase (decrease) in cash and cash equivalents                 |                       
|                                                                    
|Cash and cash equivalents  beginning of year                        |                       
|                                                                     |                       
|                                                                    
|Cash and cash equivalents  end of year                              |                       
|                                                                     |                       

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

23

---

# 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, 2001                        |              |                                               |  | 8,124             |     | $                          | 41,176
|                                                 
|Tax benefit from exercise of stock options        |              |                                               |  |                   |     |                            | 5     
|Exercise of stock options net of shares           |              |                                              
|exchanged as payment and subsequently retired     |              |                                               |  | 19                |     |                            | 186   
|Issuance of common stock under Employee Stock     |              |                                              
|Purchase Plan                                     |              |                                               |  | 77                |     |                            | 492   
|Amortization of restricted stock and other        |              |                                               |  |                   | 71  |                            |       
|Repurchase of common stock                        |              |                                               |  | (30               | )   |                            | (175  
|Market value adjustments of marketable securities |              |                                               |  |                   |     |                            |       
|Cumulative translation adjustment                 |              |                                               |  |                   |     |                            |       
|Net loss                                          |              |                                               |  |                   |     |                            |       
|                                                  |              |                                               |  |                   |     |                           
|Comprehensive loss                                |              |                                               |  |                   |     |                            |       
|                                                  |              |                                               |  |                   |     |                            |       
|                                                 
|BALANCE, DECEMBER 31, 2002                        |              |                                               |  | 8,190             |     | $                          | 41,755
|                                                 
|Exercise of stock options net of shares exchanged |              |                                              
|as payment and subsequently retired               |              |                                               |  | 49                |     |                            | 312   
|Issuance of common stock under Employee Stock     |              |                                              
|Purchase Plan                                     |              |                                               |  | 71                |     |                            | 433   
|Repurchase of common stock and other              |              |                                               |  | (19               | )   |                            | (85   
|Market value adjustments of marketable securities |              |                                               |  |                   |     |                            |       
|Cumulative translation adjustment                 |              |                                               |  |                   |     |                            |       
|Net loss                                          |              |                                               |  |                   |     |                            |       
|                                                  |              |                                               |  |                   |     |                           
|Comprehensive loss                                |              |                                               |  |                   |     |                            |       
|                                                  |              |                                               |  |                   |     |                            |       
|                                                 
|BALANCE, DECEMBER 31, 2003                        |              |                                               |  | 8,291             |     | $                          | 42,415
|                                                 
|Tax benefit from exercise of stock options        |              |                                               |  |                   | 678 |                            |       
|Exercise of stock options net of shares exchanged |              |                                              
|as payment and subsequently retired               |              |                                               |  | 494               |     |                            | 4,702 
|Issuance of common stock under Employee Stock     |              |                                              
|Purchase Plan                                     |              |                                               |  | 62                |     |                            | 444   
|Market value adjustments of marketable securities |              |                                               |  |                   |     |                            |       
|Cumulative translation adjustment                 |              |                                               |  |                   |     |                            |       
|Net income                                        |              |                                               |  |                   |     |                            |       
|                                                  |              |                                               |  |                   |     |                           
|Comprehensive income                              |              |                                               |  |                   |     |                            |       
|                                                  |              |                                               |  |                   |     |                            |       
|                                                 
|BALANCE, DECEMBER 31, 2004                        |              |                                               |  | 8,847             |     | $                          | 48,239
|                                                  |              |                                               |  |                   |     |                            |       

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

24

---

# 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
Consolidation 
The 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 Estimates 

The 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 Equivalents

We 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 demand deposit accounts, money
market accounts and U.S. Government backed obligations.

Marketable Securities

Marketable securities generally
consist of U.S. Government or U.S. Government backed obligations. 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.

As of December 31, 2004 and 2003, all
marketable securities are classified as available for sale, with a carrying amount of
$14,868 and $13,468, 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. Unrealized
losses of $101 at December 31, 2004 and unrealized gains of $94 at December 31, 2003 were
recorded as a component of accumulated other comprehensive loss in stockholders equity.

Inventories 
Inventories 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
Improvements 

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

We evaluate the carrying value of
goodwill during the fourth quarter of each year and between annual evaluations if events
occur or circumstances change that indicate goodwill might be impaired. Goodwill is tested
by estimating the fair value based on several methodologies, including discounted cash
flow, and consideration of our total market capitalization.

25

---

Patents 
Patents 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
Assets
We 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. Allocation of revenue to elements of the arrangement is based on fair
value of the element being sold on a stand-alone basis.

Foreign Currency
Translation 
Financial 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. We
assess the realizability of our deferred tax assets and the need for a valuation allowance
based on Statement of Financial Accounting Standards No. 109.

Net Income Per Share

Basic 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 income per common share for
the year ended December 31, 2004 includes 374,000 of such potentially dilutive
securities. The calculation of diluted loss per common share for the years ended December
31, 2003 and 2002 excludes 45,530 and 43,678 potentially dilutive shares, respectively,
because their effect would be anti-dilutive as the result of losses incurred in those
years.

Accounting for
Stock-Based Compensation

In 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 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 prescribed by APB Opinion No. 25. 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 2004, 2003 and
2002 would have been reduced to the following pro forma amounts:

26

---

|                                                          | Year ended December 31
|--------------------------------------------------------- | ----------------------
|                                                          |                       
|
|                                                          |                       
|Net income (loss) as reported                             |                       
|Add:  Stock-based compensation expense                    |                       
|included in net income (loss), net of related tax effects |                       
|Deduct:  Total stock-based compensation expense           |                       
|determined under fair value, net of related               |                       
|tax effects                                               |                       
|                                                          |                       
|Net income (loss)  Pro forma                             |                       
|                                                          |                       
|Net income (loss) per share:                              |                       
|As reported  Basic                                       |                       
|Pro forma  Basic                                         |                       
|                                                          |                       
|As reported  Diluted                                     |                       
|Pro forma  Diluted                                       |                       

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). 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. At December 31, 2004 and 2003, components of
accumulated other comprehensive loss are as follows:

|                          | Foreign
Currency
Translation |  | Unrealized
Gains
(losses) on
Securities |      | Accumulated
Other
Comprehensive
Income
|------------------------- | ---------------------------- |  | --------------------------------------- | ---- | --------------------------------------
|                          |                              |  |                                         |      |                                       
|                          |                              |  |                                         |      |                                       
|Balance December 31, 2003 |                              |  | $                                       | (520 | )                                     
|Current Year Change       |                              |  |                                         | (56  | )                                     
|                          |                              |  |                                         |      |                                       
|Balance December 31, 2004 |                              |  | $                                       | (576 | )                                     
|                          |                              |  |                                         |      |                                       

Recent Accounting
Developments 
In December 2004, the Financial
Accounting Standards Board (FASB) issued SFAS No. 123(R), Share-Based Payment,
which is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R)
requires all share-based payments to employees, including grants of employee stock
options, to be valued at fair value on the date of grant, and to be expensed over the
applicable vesting period. SFAS No. 123(R) is effective for all stock-based awards granted
on or after July 1, 2005, and companies must also recognize compensation expense related
to any awards that are not fully vested as of the effective date. SFAS No. 123(R) will be
effective for public companies for interim or annual periods beginning after June 15, 2005
and may be adopted under either the modified prospective method or alternative methods,
which allow for restatement of prior interim periods or prior years. We are currently
evaluating how we will adopt the standard and the impact of adopting SFAS No. 123(R) on
our financial position and results of operations.

In November 2004, The FASB issued
Statement of Financial Accounting Standards No. 151 (SFAS 151), Inventory Cost
 and amendment of ARB No. 43. SFAS No. 151 requires idle facility expenses,
freight, handling costs, and wasted material spoilage costs to be recognized as
current-period charges. It also requires that allocations of fixed production overheads to
the costs of conversion be based on normal capacity of the production facilities. SFAS No.
151 will be effective for inventory costs incurred during fiscal years beginning after
June 15, 2005. We are currently evaluating the impact of adopting the standard on our
financial position and results of operations.

27

---

# NOTE 2  OTHER FINANCIAL STATEMENT DATA

# Inventories Consist of the Following:

|                                  | December 31,
|--------------------------------- | ------------
|                                  |             
|
|                                  |             
|Raw materials and purchased parts |             
|Work in process                   |             
|Finished goods                    |             
|                                  |             
|                                  |             
|                                  |             
|Allowance for obsolescence        |             
|                                  |             
|                                  |             
|                                  |             

# Equipment and Leasehold Improvements consist of the following:

|                                          | December 31,
|----------------------------------------- | ------------
|                                          |             
|
|                                          |             
|Equipment                                 |             
|Leasehold improvements                    |             
|                                          |             
|                                          |             
|                                          |             
|Accumulated depreciation and amortization |             
|                                          |             
|                                          |             
|                                          |             

# Intangible and Other Assets Consist of the Following:

|                       | December 31, 2004 |  | December 31, 2003
|---------------------- | ----------------- |  | -----------------
|                       |                   |  |                  
|
|                       |                   |  |                  
|Developed technology   |                   |  | $                
|Patents and trademarks |                   |  |                  
|Customer base          |                   |  |                  
|                       |                   |  | $                
|                       |                   |  |                  

Amortization expense for the three years ended December 31, 2004, 2003 and 2002 is as follows:

|                       | Year ended December 31
|---------------------- | ----------------------
|                       |                       
|
|                       |                       
|Developed Technology   |                       
|Patents and Trademarks |                       
|Customer Base          |                       
|                       |                       
|                       |                       
|                       |                       

As of December 31, 2004, the weighted
average remaining life of acquisition related intangible assets was approximately 2.59
years for developed technologies and 1.42 years for trademarks.

28

---

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, 2004 we determined that they are
appropriate. Estimated aggregate amortization expense based on current intangibles for the
next five years is expected to be as follows: $1.0 million in 2005, $0.7 million in 2006,
$0.2 million in 2007 and, $0.2 million in 2008 and 2009.

# Accrued Expenses Consist
of the Following:

|                    | Year ended December 31
|------------------- | ----------------------
|                    |                       
|
|                    |                       
|Wages and benefits  |                       
|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:

|                                   | Year ended December 31
|---------------------------------- | ----------------------
|                                   |                       
|
|                                   |                       
|Balance at the beginning of period |                       
|Accruals for Warranties            |                       
|Settlements made during the period |                       
|                                   |                       
|                                   |                       
|Balance at the end of period       |                       
|                                   |                       

# NOTE 3  GOODWILL

At December 31, 2004, we had goodwill
of $6,119 compared to $6,056 at December 31, 2003. The increase in goodwill during 2004 is
the result of the translation impact ($243) on foreign denominated goodwill balances. This
increase was offset by a $180 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, 2004 and 2003. 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, 2004 or December 31, 2003. Accordingly, no impairment charge has been
recognized.

# NOTE 4 
ACQUISITION OF LICENSE

In September 2004, we acquired a
license to certain intangible assets required for our recently introduced WaferSense
auto leveling sensor (ALS) product. We made a cash payment of $500 for the license to
these patents. The cash payment was recorded as an asset to be amortized over its
estimated useful life of approximately seven years.

# NOTE 5  TECHNOLOGY
TRANSFER AND LICENSE AGREEMENT

In March 2003, we transferred to the
Optical Gaging Products (OGP) 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. The agreement called for QVI to pay $750 as a one-time fee for
the purchase of fixtures, a technology transfer fee and a non-refundable royalty payment.
In addition, we sold QVI raw material inventories associated with the product line. The
gain was determined as the difference between the proceeds received and our carrying value
of product line inventory and fixed assets prior to the sale. As a result of this
transaction, we recorded a $645 gain in the three-month period ended March 31, 2003.

29

---

# NOTE 6 
RESTRUCTURING AND SEVERANCE COSTS

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 was 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 was 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.

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 five
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 was paid as of December 31, 2003. Severance and
associated costs of $180 were accrued as of December 31, 2003, and paid as of September
30, 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.

During 2004, we recorded
restructuring charges of $169. These charges reflected our change in estimate relative to
the amount of sub-lease income we will receive from space vacated during the corporate
restructuring in December 2003. Although this space is being marketed for sub-lease, we
have not been successful in securing a sub-lease tenant and our lease term ends in May
2006. Consequently, we determined it was appropriate to record a restructure charge for
all remaining estimated net sub-lease income.

Changes to the restructuring
liability accounts included the following:

|                                           | Employee
Termination
Benefits |  | Lease
Commitment
Costs |        | Other |   | Total
|------------------------------------------ | ----------------------------- |  | ---------------------- | ------ | ----- | - | -----
|                                           |                               |  |                        |        |       |   |      
|Restructuring liability, December 31, 2001 |                               |  | $                      |       |       | $ |     
|Initial expense and accrual                |                               |  |                        | 1,362  |       |   | 250  
|Cash payments                              |                               |  |                        | (1,214 | )     |   | (62  
|                                           |                               |  |                        |        |       |   |      
|                                           |                               |  |                        |        |       |   |      
|Restructuring liability, December 31, 2002 |                               |  |                        | 148    |       |   | 188  
|                                           |                               |  |                        |        |       |   |      
|Initial expense and accrual                |                               |  |                        | 541    |       |   | 694  
|Cash payments                              |                               |  |                        | (509   | )     |   | (510 
|                                           |                               |  |                        |        |       |   |      
|                                           |                               |  |                        |        |       |   |      
|Restructuring liability, December 31, 2003 |                               |  |                        | 180    |       |   | 372  
|                                           |                               |  |                        |        |       |   |      
|Change in estimate                         |                               |  |                        |        |       |   | 169  
|Cash payments                              |                               |  |                        | (180   | )     |   | (236 
|                                           |                               |  |                        |        |       |   |      
|                                           |                               |  |                        |        |       |   |      
|Restructuring liability, December 31, 2004 |                               |  | $                      |       |       | $ | 305  
|                                           |                               |  |                        |        |       |   |      

30

---

# NOTE 7  INCOME TAXES

# The Provision for Income Taxes Consists of the Following:

|          | Year ended December 31
|--------- | ----------------------
|          |                       
|
|          |                       
|Current:  |                       
|Federal   |                       
|State     |                       
|Foreign   |                       
|Deferred: |                       
|Federal   |                       
|State     |                       
|Foreign   |                       
|          |                       
|          |                       
|          |                       

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

|                                           | Year ended December 31
|------------------------------------------ | ----------------------
|                                           |                       
|
|                                           |                       
|Federal statutory rate                     |                       
|                                           |                       
|State income taxes, net of federal benefit |                       
|FSC/ETI benefit                            |                       
|Research and experimentation credit        |                       
|Foreign rate difference                    |                       
|Valuation allowance                        |                       
|Other, net                                 |                       
|                                           |                       
|Effective rate                             |                       
|                                           |                       

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

|                                             | Year ended December 31
|-------------------------------------------- | ----------------------
|                                             |                       
|
|                                             |                       
|Deferred tax assets (liabilities):           |                       
|Inventory allowances                         |                       
|Accrued Liabilities                          |                       
|Accounts receivable allowances               |                       
|Fixed asset and intangible amortization, net |                       
|Tax credits                                  |                       
|Net operating loss carryforwards             |                       
|Other, net                                   |                       
|                                             |                       
|                                             |                       
|Sub-total                                    |                       
|Valuation allowance                          |                       
|                                             |                       
|Total net deferred tax asset                 |                       
|                                             |                       

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.

31

---

During the years ended December 31,
2004 and 2003, we have continued to provide a full valuation allowance against future tax
benefits produced by our U.S. based operating results. We will continue to assess carrying
or eliminating the full valuation allowance on U.S. based deferred tax assets on a
quarterly basis during 2005. Release of the full U.S. based valuation allowance would
result in the recognition of a significant deferred tax benefit. 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, 2004, included approximately $1,717, relating to losses incurred in the UK by
CyberOptics UK, Ltd., which was 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 $767 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.

Deferred tax assets of approximately
$582 as of December 31, 2004 relate to certain net operating loss and credit carryforwards
resulting from the exercise of stock options. When recognized, the tax benefit of these
loss and credit carryforwards will be accounted for as a credit to common stock rather
than a reduction of the income tax provision.

Cash payments for income taxes for
the years ended December 31, 2004, 2003 and 2002, were approximately, $1,236, $82 and $86,
respectively.

On October 22, 2004, the President
signed the American Jobs Creation Act of 2004. The Act creates a temporary incentive for
U.S. corporations to repatriate accumulated income earned abroad by providing an 85
percent dividends received deduction for certain dividends from controlled foreign
corporations. The deduction is subject to a number of limitations and, as of today, we are
not yet in a position to decide on whether, and to what extent, we might repatriate
foreign earnings that have not yet been remitted to the U.S. We expect to be in a position
to finalize our assessment by December 31, 2005.

The Act also provides a deduction for
income from qualified domestic production activities, which will be phased in from 2005
through 2010. In return, the Act also provides for a two-year phase-out of the
extraterritorial income exclusion for foreign sales. The Company is still assessing the
impact the new laws will have on the effective tax rate in 2005 and in future years.

It is the intention of management to
permanently reinvest all undistributed earnings of international subsidiaries, and
accordingly, the Company has not provided United States taxes on such earnings.

# NOTE 8  OPERATING
LEASES

We lease our primary office,
warehouse and manufacturing facility under a 10-year operating lease that expires in May
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 2005 through May 2007.

Total rent expense for the years
ended December 31, 2004, 2003 and 2002, was approximately, $893, $1,279 and $1,368,
respectively.

At December 31, 2004, the future
minimum lease payments required under non-cancelable operating lease agreements, are as
follows:

|                         | 
|------------------------ | 
|Year ending December 31, | 
|2005                     | 
|2006                     | 
|2007                     | 
|Thereafter               | 
|                         | 
|Total                    | 
|                         | 

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 U.S. facility represent anticipated
cash payments, including payments for vacated space, under the terms of our lease.

# NOTE 9  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 UK. 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, 2004, 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, 2004. During year ended December 31, 2004, we
recognized a net loss of approximately $464 from the settlement of foreign currency swap
agreements that offset the $268 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.

32

---

# NOTE 10 
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 11  BENEFIT
PLANS

# Stock Option Plan

We have three stock option plans that
have 1,352,872 shares of common stock reserved in the aggregate for issuance to employees,
directors, officers and others. In addition, there are 71,500 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 six months.

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

|             | Year ended December 31
|------------ | ----------------------
|             |                       
|
|             |                       
|Granted      |                       
|Exercised    |                       
|Forfeited    |                       
|             |                       
|December 31: |                       
|Outstanding  |                       
|             |                       
|Exercisable  |                       

|Weighted average exercise price per share | 2004 |  | 2003 |       | 2002
|----------------------------------------- | ---- |  | ---- | ----- | ----
|                                          |      |  |      |       |     
|Granted                                   |      |  | $    | 17.99 |     
|Exercised                                 |      |  |      | 10.07 |     
|Forfeited                                 |      |  |      | 22.20 |     
|                                          |      |  |      |       |     
|December 31:                              |      | 
|Outstanding                               |      |  |      | 13.44 |     
|                                          |      |  |      |       |     
|Exercisable                               |      |  |      | 14.90 |     
|                                          |      |  |      |       |     

Stock options outstanding as of
December 31, 2004, had a range of exercise prices of $2.23 to $36.87 and a weighted
average remaining contractual life of approximately 3.53 years.

The following is a summary of
outstanding options as of December 31, 2004:

|Exercise Price   |  | OptionsOutstanding |  | OptionsExercisable |  | Weighted AverageRemaining Life
|---------------- |  | ------------------ |  | ------------------ |  | ------------------------------
|                 |  |                    |  |                    |  |                               
|Less than $7.00  |  |                    |  | 130,025            |  |                               
|$7.00 to $9.99   |  |                    |  | 6,550              |  |                               
|$10.00 to $19.99 |  |                    |  | 672,402            |  |                               
|$20.00 to $29.99 |  |                    |  | 140,000            |  |                               
|Over $30.00      |  |                    |  | 24,600             |  |                               
|                 |  |                    |  |                    |  |                               
|                 |  |                    |  |                    |  |                               
|Total            |  |                    |  | 973,577            |  |                               
|                 |  |                    |  |                    |  |                               

33

---

The weighted-average grant-date fair value of options granted during 2004,
2003 and 2002 was $10.99, $5.16 and $6.88, 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):

|                         | 2004 |  | 2003 |         | 2002
|------------------------ | ---- |  | ---- | ------- | ----
|                         |      |  |      |         |     
|                         |      |  |      |         |     
|Risk-free interest rates |      |  |      | 2.70    | %   
|Expected life            |      |  |      | 4 years |     
|Expected volatility      |      |  |      | 82.08   | %   
|Expected dividends       |      |  |      | None    |     

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, 2004, 561,122 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 2004, 2003 and 2002, the Company provided for
matching contributions totaling $236, $241, and $268, respectively.

# NOTE 12  BUSINESS SEGMENTS AND SIGNIFICANT CUSTOMERS

Statement of Financial Accounting Standards (SFAS) No. 131, Disclosure
about Segments of an Enterprise and Related Information, 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.

Revenues by product line were as follows:

|Year Ended December 31,     | 2004 |  | 2003 |        | 2002
|--------------------------- | ---- |  | ---- | ------ | ----
|                            |      |  |      |        |     
|                            |      |  |      |        |     
|OEM Solutions:              |      |  |      |        |     
|Electronic Assembly Sensors |      |  | $    | 31,275 |     
|Semiconductor Products      |      |  |      | 7,018  |     
|SMT Systems                 |      |  |      | 19,744 |     
|                            |      |  |      |        |     
|                            |      |  | $    | 58,037 |     
|                            |      |  |      |        |     

# The following summarizes
certain significant customer information:

|                  | Significant
Customer |  | Revenues |  | Percentage
of Revenues
|----------------- | -------------------- |  | -------- |  | ----------------------
|                  |                      |  |          |  |                       
|Year ended        |                      |  | A        |  |                       
|December 31, 2004 |                      |  | B        |  |                       
|                  |                      |  |          |  |                       
|Year ended        |                      |  | A        |  |                       
|December 31, 2003 |                      |  | B        |  |                       
|                  |                      |  |          |  |                       
|Year ended        |                      |  | A        |  |                       
|December 31, 2002 |                      |  | B        |  |                       

34

---

As of December 31, 2004, accounts
receivable from significant customers A and B were $2,812 and $631, respectively. As of
December 31, 2003, accounts receivable from significant customers A and B were $944 and
$3,057, respectively.

Export sales amounted to 81%, 79% and
67% of revenues for 2004, 2003 and 2002, 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:

|             | 2004 |  | 2003 |        | 2002
|------------ | ---- |  | ---- | ------ | ----
|             |      |  |      |        |     
|             |      |  |      |        |     
|Americas     |      |  | $    | 142    |     
|Netherlands  |      |  |      | 14,881 |     
|Other Europe |      |  |      | 4,827  |     
|China        |      |  |      | 5,517  |     
|Japan        |      |  |      | 13,574 |     
|Other Asia   |      |  |      | 7,838  |     
|Other        |      |  |      | 29     |     
|             |      |  |      |        |     
|             |      |  |      |        |     
|             |      |  | $    | 46,808 |     
|             |      |  |      |        |     

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, 2004, 2003 and 2002
are as follows:

|                        | 2004 |  | 2003 |       | 2002
|----------------------- | ---- |  | ---- | ----- | ----
|                        |      |  |      |       |     
|                        |      |  |      |       |     
|Long-lived assets:      |      |  |      |       |     
|United States           |      |  | $    | 6,218 |     
|Europe                  |      |  |      | 3,464 |     
|Asia and other          |      |  |      | 17    |     
|                        |      |  |      |       |     
|                        |      |  |      |       |     
|Total long-lived assets |      |  | $    | 9,699 |     
|                        |      |  |      |       |     

# NOTE 13 
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 14  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.

35

---

NOTE 15  QUARTERLY FINANCIAL
INFORMATION (UNAUDITED)
(In thousands, except per share amounts)

|2004                               |  | March 31 |   | June 30 |  | Sept. 30(3) |        | Dec. 31
|---------------------------------- |  | -------- | - | ------- |  | ----------- | ------ | -------
|                                   |  |          |   |         |  |             |        |        
|                                   |  |          |   |         |  |             |        |        
|Revenues                           |  |          | $ | 12,690  |  | $           | 14,734 |        
|Gross margin                       |  |          |   | 7,410   |  |             | 8,948  |        
|Income from operations             |  |          |   | 2,583   |  |             | 3,509  |        
|Net income                         |  |          |   | 2,686   |  |             | 3,522  |        
|Net income per share  Basic (1)   |  |          |   | 0.32    |  |             | 0.41   |        
|Net income per share  Diluted (1) |  |          |   | 0.31    |  |             | 0.39   |        

|2003                                      |  | March 31(2) |   | June 30 |   | Sept. 30(3) |        | Dec. 31(4)
|----------------------------------------- |  | ----------- | - | ------- | - | ----------- | ------ | ----------
|                                          |  |             |   |         |   |             |        |           
|                                          |  |             |   |         |   |             |        |           
|Revenues                                  |  |             | $ | 6,425   |   | $           | 7,508  |           
|Gross margin                              |  |             |   | 2,900   |   |             | 3,827  |           
|Loss from operations                      |  |             |   | (1,427  | ) |             | (1,200 | )         
|Net income (loss)                         |  |             |   | (1,482  | ) |             | (1,258 | )         
|Net income (loss) per share  Basic (1)   |  |             |   | (0.18   | ) |             | (0.15  | )         
|Net income (loss) per share  Diluted (1) |  |             |   | (0.18   | ) |             | (0.15  | )         

|(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 for restructuring and severance costs.
          Also includes a $645 gain from a technology transfer and license agreement in
          the first quarter of 2003.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Includes a pre-tax charge of $131 in 2004 ($169 for full-year 2004) and $463 in
          2003 for restructuring and severance costs. Also includes a charge for $632 for
          accelerated amortization of intangible assets in the third quarter of 2003.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes a pre-tax charge of $609 for restructuring and severance costs.
|--- | ------------------------------------------------------------------------

36

---

# Report of Independent
Registered Public Accounting Firm

To Stockholders and the
Board of Directors of
CyberOptics Corporation:

We have completed an integrated audit
of CyberOptics Corporations 2004 consolidated financial statements and of its
internal control over financial reporting as of December 31, 2004 and audits of its 2003
and 2002 consolidated financial statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Our opinions, based on our audits, are
presented below.

Consolidated financial
statements and financial statement schedule

In our opinion, the consolidated financial
statements listed in the index appearing under Item 15(a)(1) present fairly, in all
material respects, the financial position of CyberOptics Corporation and its subsidiaries
at December 31, 2004 and 2003, and the results of their operations and their cash flows
for each of the three years in the period ended December 31, 2004 in conformity with
accounting principles generally accepted in the United States. In addition, in our
opinion, the financial statement schedule listed in the index appearing under Item
15(a)(2) presents fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit of financial statements 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.

Internal control over
financial reporting

Also, in our opinion,
managements assessment, included in Managements Report on Internal
Control Over Financial Reporting, appearing under Item 9A, that the Company
maintained effective internal control over financial reporting as of December 31, 2004
based on criteria established in Internal Control  Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is
fairly stated, in all material respects, based on those criteria. Furthermore, in our
opinion, the Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004, based on criteria established in Internal
Control  Integrated Framework issued by (COSO). The Companys management is
responsible for maintaining effective internal control over financial reporting and for
its assessment of the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on managements assessment and on the
effectiveness of the Companys internal control over financial reporting based on our
audit. We conducted our audit of internal control over financial reporting in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes obtaining an
understanding of internal control over financial reporting, evaluating managements
assessment, testing and evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we consider necessary in the
circumstances. We believe that our audit provides a reasonable basis for our opinions.

A companys internal control
over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and
procedures that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the
company; and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys assets
that could have a material effect on the financial statements.

Because of its inherent limitations,
internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

PricewaterhouseCoopers LLP
Minneapolis, Minnesota
March 8, 2005

37

---

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

NONE.

# ITEM 9A. CONTROLS AND
PROCEDURES

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, including the recording, processing,
summarizing and reporting of information, 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.

a.    
          MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management
is responsible for establishing and maintaining adequate internal control over financial
reporting, as defined in the Securities Exchange Act of 1934 Rule 13a  15(f), and
for performing an assessment of the effectiveness of our internal control over financial
reporting as of December 31, 2004. Internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. Our system of internal control over financial
reporting includes those policies and procedures that (i) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.

Management
performed an assessment of the effectiveness of the Companys internal control over
financial reporting as of December 31, 2004 based upon criteria inInternal Control
 Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on our assessment, management determined
that the Companys internal control over financial reporting was effective as of
December 31, 2004 based on the criteria in Internal Control  Integrated Framework
issued by the COSO.

Our
Managements assessment of the effectiveness of the Companys internal control
over financial reporting as of December 31, 2004 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in
their report which appears herein.

b.    
          During the quarter ended December 31, 2004, 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.

# ITEM 9B. OTHER
INFORMATION

NONE

38

---

# 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 16, 2005 (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 AND
FINANCIAL STATEMENT SCHEDULES

|(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, 2004,       
                    2003 and 2002, is attached as Item 15(d).
|------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | LIST OF EXHIBITS
|--- | ----------------

| |  |  | Exhibit Number |  | 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)).
| |  |  | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

39

---

| |  |  | 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 Independent Registered Public Accounting Firm.
| |  |  | ---- |  | ---------------------------------------------------------

| |  |  | 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 302of 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.
| |  |  | ---- |  | -------------------------------------------------------------------------------------------------------------------------------

* Management Contract or
Compensatory Plan or Arrangement

| |  | (c) |  |  | FINANCIAL STATEMENT SCHEDULES:
| |  | --- |  |  | ------------------------------

40

---

# SCHEDULE II

# CYBEROPTICS CORPORATION

# VALUATION AND QUALIFYING ACCOUNTS AND RESERVES 
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

|Description                      |  | Balance at
Beginning of
Period |   | Charged to
Costs and
Expenses |  | Deductions |         | Balance
at end of
Period
|-------------------------------- |  | ------------------------------ | - | ----------------------------- |  | ---------- | ------- | ------------------------
|                                 |  |                                |   |                               |  |            |         |                         
|                                 |  |                                |   |                               |  |            |         |                         
|Allowance for doubtful accounts: |  |                                |   |                               |  |            |         |                         
|                                 |  |                                |   |                               |  |            |         |                         
|Year ended December 31, 2004     |  |                                | $ | 340,000                       |  | $          | 23,000  |                         
|                                 |  |                                |   |                               |  |            |         |                         
|Year ended December 31, 2003     |  |                                | $ | 251,000                       |  | $          | 132,000 |                         
|                                 |  |                                |   |                               |  |            |         |                         
|Year ended December 31, 2002     |  |                                | $ | 192,000                       |  | $          | 96,000  |                         

|Description                       |  | Balance at
Beginning of
Period |   | Charged to
Costs and
Expenses |  | Deductions |           | Balance
at end of
Period
|--------------------------------- |  | ------------------------------ | - | ----------------------------- |  | ---------- | --------- | ------------------------
|                                  |  |                                |   |                               |  |            |           |                         
|                                  |  |                                |   |                               |  |            |           |                         
|Allowance for obsolete inventory: |  |                                |   |                               |  |            |           |                         
|                                  |  |                                |   |                               |  |            |           |                         
|Year ended December 31, 2004      |  |                                | $ | 1,556,000                     |  | $          | 303,000   |                         
|                                  |  |                                |   |                               |  |            |           |                         
|Year ended December 31, 2003      |  |                                | $ | 2,477,000                     |  | $          | 116,000   |                         
|                                  |  |                                |   |                               |  |            |           |                         
|Year ended December 31, 2002      |  |                                | $ | 1,431,000                     |  | $          | 1,621,000 |                         

41

---

# 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/   ALEX B. CIMOCHOWSKIAlex B. Cimochowski       |       | Director                                                                            
|                                                  
|/s/   MICHAEL M. SELZER, JR.Michael M. Selzer, Jr. |       | Director                                                                            
|                                                  
|/s/   IRENE M. QUALTERSIrene M. Qualters           |       | Director                                                                            
|                                                  
|Erwin A. Kelen                                     |       | Director                                                                            
|                                                  
|/s/   SCOTT G. LARSONScott G. Larson               |       | Vice President and CFO(Principal Financial Officer)and Principal Accounting Officer)

42

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