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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

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x
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) of the Securities Exchange
Act of 1934 for the Year Ended December 31, 2008.

o
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)

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CYBEROPTICS
 CORPORATION

(Exact
 name of registrant as specified in its charter)

|                                          |  |                     
|----------------------------------------- |  | --------------------
|Minnesota                                 |  | 41-1472057          
|(State
 or other jurisdiction of          |  | (I.R.S.
 Employer   
|incorporation
 or organization)           |  | Identification
 No.)
|                                          |  |                     
|                                          |  |                     
|5900 Golden Hills Drive                   |  |                     
|MINNEAPOLIS, 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: Title of each class: Common Stock, no par value Name of Exchange:
NASDAQ Stock Market LLC

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

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|                                                                                                                              
|------------------------------------------------------------------------------------------------------------------------------
|Indicate by check mark if
 the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
 Securities Act.     
|YES   o   NO   x                                                                                                              
|                                                                                                                              
|Indicate by check mark if
 the registrant is not required to file reports pursuant to Section 13 or
 Section 15(d) of the Act.
|YES   o   NO   x                                                                                                              

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 o

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. x

Indicate by check mark
whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company.

|                                                                                                                  |   |                   |   |                       |   |                           |  
|----------------------------------------------------------------------------------------------------------------- | - | ----------------- | - | --------------------- | - | ------------------------- | -
|Large accelerated filer                                                                                           | o | Accelerated filer | x | Non-accelerated filer | o | Smaller Reporting Company | o
|                                                                                                                  |   |                   |   |                       |   |                           |  
|Indicate by checkmark
 whether the registrant is a shell company (as defined in Rule 12b-2 of the
 Exchange Act).
|YES   o   NO   x                                                                                                 

State the aggregate market
value of the voting and non-voting common equity held by non-affiliates
computed by reference to the price at which the common equity was last sold, or
the average bid and asked price of such common equity, as of the last business
day of the registrants most recently completed second fiscal quarter:
$76,986,850.

As of February 28, 2009,
there were 6,769,295 shares of the registrants Common Stock, no par value,
issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:





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CYBEROPTICS CORPORATION
FORM 10-K 
For the Fiscal Year Ended December 31, 2008

|         |  |                                                                                                                |  |   
|-------- |  | -------------------------------------------------------------------------------------------------------------- |  | --
|PART I   |  |                                                                                                                |  |   
|ITEM 1.  |  | DESCRIPTION
 OF BUSINESS                                                                                       |  | 3 
|ITEM 1A. |  | RISK
 FACTORS                                                                                                  |  | 13
|ITEM 1B. |  | UNRESOLVED
 STAFF COMMENTS                                                                                     |  | 16
|ITEM 2.  |  | PROPERTIES                                                                                                     |  | 16
|ITEM 3.  |  | LEGAL
 PROCEEDINGS                                                                                             |  | 16
|ITEM 4.  |  | SUBMISSION
 OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                           |  | 16
|         |  |                                                                                                                |  |   
|PART II  |  |                                                                                                                |  |   
|ITEM 5.  |  | MARKET FOR
 REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
 OF EQUITY SECURITIES |  | 17
|ITEM 6.  |  | SELECTED
 FINANCIAL DATA                                                                                       |  | 19
|ITEM 7.  |  | MANAGEMENTS
 DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                         |  | 20
|ITEM 7A. |  | QUANTITATIVE
 AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                    |  | 34
|ITEM 8.  |  | FINANCIAL
 STATEMENTS AND SUPPLEMENTARY DATA                                                                   |  | 35
|ITEM 9.  |  | CHANGES IN
 AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
 FINANCIAL DISCLOSURE                         |  | 59
|ITEM 9A. |  | CONTROLS
 AND PROCEDURES                                                                                       |  | 59
|ITEM 9B. |  | OTHER
 INFORMATION                                                                                             |  | 59
|         |  |                                                                                                                |  |   
|PART III |  |                                                                                                                |  |   
|ITEM 10. |  | DIRECTORS,
 EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE MATTERS                                                |  | 60
|ITEM 11. |  | EXECUTIVE
 COMPENSATION                                                                                        |  | 60
|ITEM 12. |  | SECURITY
 OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
 STOCKHOLDER MATTERS               |  | 60
|ITEM 13. |  | CERTAIN
 RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                                     |  | 60
|ITEM 14. |  | PRINCIPAL
 ACCOUNTANT FEES AND SERVICES                                                                        |  | 60
|         |  |                                                                                                                |  |   
|PART IV  |  |                                                                                                                |  |   
|ITEM 15. |  | EXHIBITS
 AND FINANCIAL STATEMENT SCHEDULES                                                                    |  | 60
|         |  |                                                                                                                |  |   
|         |  | SIGNATURES                                                                                                     |  | 64

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Table of Contents

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 headquarters are located at 5900
Golden Hills Drive in Golden Valley, Minnesota. Our website address is www.cyberoptics.com.
You can access, free of charge, our filings with the Securities and Exchange
Commission, including our annual report on Form 10-K, our quarterly reports on
Form 10-Q, current reports on Form 8-K and any other amendments to those
reports, at our website, or at the Commissions website at www.sec.gov.
Proxy materials for our upcoming 2009 annual shareholders meeting to be held on
May 18, 2009 may be accessed electronically via the internet at the following
address: http://www.idelivercommunications.com/proxy/cybe.

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 yield improvement, and 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 wafers. 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 the manufacturing process.

Our
business is organized in two operating segments. Our Electronic Assembly segment
designs, manufactures and sells optical process control sensors and inspection
systems for the electronic assembly equipment market. Our Semiconductor segment
designs, manufactures and sells optical and other process control sensors and
related equipment for the semiconductor capital equipment market.

Most
of our products (88% of revenue in 2008) are developed and sold for use in SMT
electronic circuit board assembly or with equipment used in SMT electronic
circuit board assembly as part of our Electronic Assembly segment. 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 and to solder paste printer companies to align
stencils with circuit boards. Our systems products are sold to contract
manufacturers and other companies with surface mount assembly lines, to control
quality as in-line systems. These system 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. Manufacturers of DRAM memory also use our system
products to inspect assembly of their memory modules.

Our
Semiconductor segment develops and sells products that assist with yield
improvement in semiconductor fabrication, and 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 2008.

Market ConditionsRecent Developments 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. Historically, these markets have been very cyclical, with periods of
strong growth followed by periods of excess capacity and reduced levels of
capital spending.

Our
results were favorably impacted in 2006 and 2007 as our markets experienced
periods of strong demand, with revenue hitting a peak in the third quarter of
2007. Following this period of strong demand, our revenue declined sequentially
each quarter throughout 2008, as our results were negatively impacted by
reduced levels of capital spending for electronic manufacturing capacity
brought about by deepening weakness in the global economy. The weakness in the
United States capital markets caused by the deepening global recession, as well
as our reduced level of profitability, caused a significant drop in our market
capitalization, resulting in a $3.9 million non-cash pre-tax goodwill
impairment charge in the fourth quarter of 2008. We presently anticipate that
significant weakness in our markets and the global economy will continue, at
least through the first half of 2009.

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In
addition to the impact of global economic conditions on our sales, we have
determined not to pursue new alignment products for use with future generations
of equipment being developed by Assembleon. Sales of alignment products to
Assembleon constituted 10% of revenue in 2008. Assembleon has informed us that
they currently plan to start transitioning away from our alignment products in
the third quarter of 2009, with the transition continuing into the second
quarter of 2010.

In
February 2008, we announced plans to move a significant portion of our systems
related product development and manufacturing for all system products to
Singapore, the location of our Asian sales office. The transition of systems
related product development to Singapore was substantially complete by the end
of the fourth quarter of 2008. We anticipate that the transition of
manufacturing for our system products will be complete by the middle of 2009.
These moves will allow us to become more responsive to the needs of our growing
base of Asian SMT systems customers, permit our core Minneapolis based optical
engineering resources to work on future OEM opportunities, and attain
significant cost savings.

In
response to the significant weakness in our markets and the global economy, and
also due to our transition of a significant portion of our business to Singapore,
we will have reduced our workforce by approximately 50 employees or 25% from
the start of the fourth quarter of 2008 through the end of the second quarter
of 2009. Other cost saving measures include salary reductions of 12% for all
officer and internal director level positions, 10% for other employees with
salaries exceeding $100,000 and a smaller percentage reduction for employees
with salaries ranging between $35,000 and $100,000. In addition, we will also
reduce spending for non-labor costs such as travel, supplies and the like.

Consistent
with our past practice, we continue to invest heavily in new product
development for both our electronic assembly sensor and inspection system
products and our WaferSense semiconductor products. We expect this trend to
continue in 2009, even given the current weak global economic conditions.

Late
in 2006 we completed development of our 5th generation LaserAlign
sensor for the industry leading line of pick-and-place machines of Juki
Corporation. The new sensor provides Juki with a 25% throughput improvement,
alignment capability for the smallest components, improved reliability and the
lowest cost of ownership. Sales to Juki accounted for 21% of our total revenue
in 2008. We believe that the introduction of this new sensor will help ensure
that Juki remains a significant customer for the foreseeable future.

Within
the last three years, we have introduced an enhanced version of our Flex series
automated optical inspection (AOI) system, the Flex Ultra. We subsequently
introduced the Flex Ultra HR, a new version of our Flex Ultra system that
provides higher image resolution for the smaller component sizes used in the
latest electronic devices. We have made continual improvements to both our Flex
AOI and industry leading SE 300 solder paste inspection system products to
improve speed, measurement performance, reliability and ease of use, including
simplified operator interfaces with foreign language capability.

We
expect to introduce our next-generation solder paste inspection system, as
scheduled, in the second quarter of 2009. To be manufactured in Singapore and
based on a new cost-reduced platform, it will be the fastest and most accurate
solder paste inspection system available on the market. We believe this system
will have capabilities not available on our current SE 300, thus strengthening
our competitive position in the inspection market. In early 2009, we will also
start working on our next generation automated optical inspection (AOI) system.

We
are continuing to pursue several promising R&D initiatives for our
inspection technology. Our efforts related to these projects are aimed at
lowering the cost of inspection, while providing faster production through-put
speeds, better ease of use, and improved resolution for inspecting
progressively smaller electronic components. Reflecting our progress, we have
signed an OEM contract in third quarter of 2008 for our embedded inspection
technology. We expect to generate revenue from this contract starting in 2010.
We are currently pursuing several other promising business opportunities for
this technology as well.

We
have introduced and continue to develop various new sensors for our WaferSense
family of precision measurement tools, including new automated leveling,
gapping, teaching, vibration and particle detection sensors to assist with
process optimization and yield improvement in the semiconductor fabrication
process.

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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, automated optical inspection and component
alignment, with new sensing products that will be embedded inside SMT
production equipment. We eventually intend to tie these products together as a
full-line process control solution. We believe our new embedded process
verification (EPV) sensor will eventually gain acceptance among manufacturers
of pick and place machines as a further enhancement to inspection and control.
Our research and development efforts are creating new inspection technologies
for both OEM and end user markets which we believe will lower the cost of
inspection and provide faster production through-put speeds, better ease of
use, and improved resolution for inspecting progressively smaller electronic
components. In addition, we expect that our research and development efforts
will have applicability to new markets, including solar wafer manufacturing and
printed electronics, among others.

During
the last several years, our Semiconductor segment continued to invest in our
WaferSense  product line, a family of wireless, wafer like precision
measurement tools for in-situ setup, calibration and process optimization in
semiconductor processing equipment. Our first WaferSense product, the Automatic
Leveling Sensor (ALS) was introduced late in 2004. During 2007 and 2008, we
introduced several new additions to the WaferSense family of products,
including gapping, teaching and vibration sensors that will improve up-time and
yield for semiconductor manufacturers.

We
established a sales office in Singapore in 2001 and in China in 2004 to further
penetrate the growing market for manufacturing production equipment in Asia and
to increase the percentage of worldwide production lines that use inspection in
their production process to improve production yields and reduce cost. In order
to bring our development and manufacturing closer to these markets, to reduce
cost and to free development personnel at our home office in Minneapolis to
focus on sensor technology development, we initiated a plan in 2008 to
transition a portion of our development, and all manufacturing operations for
our systems products, to Singapore. The transition of our systems related
product development to Singapore was substantially complete by the end of 2008.
We anticipate that transition of manufacturing operations for all of our system
products to Singapore will be complete by the middle of 2009. During 2008 we
entered into a new lease for a larger facility in Singapore to accommodate all
of our development, manufacturing and sales office activities located in that
country.

Our
ability to implement our strategy effectively is subject to numerous
uncertainties and risks, including the risks identified in Item 1A of this
Annual Report on Form 10-K. 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 ten years, is a family of sensors that
uses similar technology, but that are customized for each customer and
incorporated into the 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.

Sales
of these products, including service repairs, to Juki Corporation accounted for
approximately 21% of our revenue in 2008 and 28% of our revenue in 2007. Sales
of these products, including service repairs, to Assembleon B.V., accounted for
approximately 15% of our revenue in 2008 and 20% of our revenue in 2007.
Accordingly, revenues and operations are currently heavily influenced by the
level of purchases from these two customers and by the cyclical nature of the
SMT production industry.

We
have decided not to pursue new alignment sensor products for use with evolving
pick and place technology being developed by one of our key OEM customers,
Assembleon, for future generations of its equipment. Sales of alignment sensors
to Assembleon (consisting of LaserAlign sensors and board alignment cameras)
constituted 10% of revenue in 2008. Assembleon has informed us that they
currently plan to start transitioning away from our sensor products in the
third quarter of 2009, with the transition continuing into the second quarter
of 2010. We anticipate that we will continue to repair older generations of our
products for Assembleon, so repair revenue will continue into the future. We
will continue to work with current and prospective new customers to integrate
our new OEM inspection technologies into their platforms.

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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.

The
LaserAlign family of products aligns extremely small surface mount components,
known as chip capacitors and resistors during transport on a pick-and-place
machine prior to placement on a circuit board. 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 twenty 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 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 2006 in a 5th
generation sensor for Juki Corporation. Revenue from new product shipments of
LaserAlign sensors has been a principal contributor to our growth during the
past five years and accounted for 26% of our revenue in 2008, 35% in 2007 and
36% in 2006.

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 B.V. during
2003 to be incorporated into their latest version component placement machine.
Revenue from shipments of BA Camera sensors to Assembleon B.V. accounted for 6%
of our revenue in 2008, 7% in 2007 and 6% in 2006.

InPrinter Inspection Camera. The InPrinter
Inspection Camera, which is
mounted directly in screen printers manufactured by DEK International GmbH, identifies
fiducial markings on a circuit board to ensure accurate board registration
prior to placement of solder paste, as well as to provide an upgraded
capability for 2D solder paste and stencil inspection. The Inprinter Inspection
Camera was introduced for DEK International GmbH during the third quarter 2005.
Revenue from shipments of the InPrinter Inspection Camera accounted for 5% of
our revenue in 2008 and 4% of our revenue in both 2007 and 2006.

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 Ultra. We
introduced the SE 300, our first in-line solder paste measurement machine, in
March 2000. During 2005, we introduced the SE 300 Ultra, an enhanced version of
our SE 300 product that offers faster inspection speeds, a conveyor that can
accommodate a greater range of board sizes than the SE 300, flexible conveyor
options and additional defect review options in run-time software. In addition,
we introduced a sensor upgrade for the SE 300 that will provide some of the
performance improvements that are available in the SE 300 Ultra.

The
SE 300 Ultra 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. The SE 300 Ultra inspects
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 Ultra can be 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.

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We
have continued to enhance the SE 300 Ultra to improve speed, reliability and
ease of use, including simplified operator interfaces with foreign language
capability, to provide an inspection capability for flexible circuits, and to
offer a MicroPad sensor as an option to improve inspection measurement
performance for the smallest solder paste deposits. In 2007, we started work on
our next generation system product for solder paste inspection. Introduction of
this machine, which incorporates a cost-reduced platform with enhanced
performance, is scheduled for introduction during the second quarter of 2009.
We believe that this system will be the fastest and most accurate solder paste
inspection system available on the market and that it will strengthen our
competitive position in the inspection market.

Revenues
from shipments of the SE 300, SE 300 Ultra and sensor upgrades accounted for
24% of our revenue in 2008, 23% of our revenue in 2007 and 20% in 2006.

Automated Optical Inspection (Flex
Ultra and Flex Ultra HR) Products. The Flex Ultra series of
Automated Optical Inspection (AOI) products were initially introduced in the
fourth quarter of 2000 and incorporate technology acquired from Kestra, Ltd. in
1999. Our Flex Ultra products allow for a variety of machine configurations
(different number of cameras based on board size and resolution requirements)
based on customer needs. 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 measure the quality
of solder joints after reflow. These products incorporate high-resolution color
cameras for improved imaging, and are designed to inspect the placement of the
smallest components on circuit boards. The principal advantage of the Flex
Ultra series of AOI products is the low level of false calls at in line speeds
compared to other AOI machines.

We
have introduced a number of versions of the Flex series AOI products since
their initial introduction in 2000. The latest Flex version introduced in 2007,
the Flex Ultra HR, is capable of inspecting down to 0105 components with 5.0
megapixel camera technology. We continue to sell both our Flex Ultra and Flex
Ultra HR products. Flex Ultra HR offers improved imaging resolution, while Flex
Ultra offers faster inspection speeds than the Flex Ultra HR. In early 2009, we
will also start working on our next generation automated optical inspection
(AOI) system.

Revenues
from shipments of the Flex and Flex Ultra accounted for 15% of our revenue in
2008, 12% of our revenue in 2007 and 11% in 2006.

Semiconductor Products

Our
principal semiconductor products, the WaferSense family of products, are a
series of wireless sensors that provide measurements of critical factors in the
semiconductor fabrication process. Other semiconductor products include sensors
that inspect the presence and orientation of semiconductor wafers in cassettes
and FOUPS during the fabrication process, and frame grabber and machine vision
subsystems that were developed and sold by Imagenation Corporation, a company
we acquired in 2000. We sell our semiconductor products to both original
equipment manufacturers and to end-user customers through a network of
distributors. Sales of our semiconductor products constituted 12% of our
revenue in 2008, 9% of our revenue in 2007, and 10% in 2006.

WaferSense Sensors. Our
WaferSense family of sensors are intended to go where
wafers go in semiconductor fabrication and provide measurements of critical
factors that are currently impossible or extremely difficult to obtain without
powering down the fabrication process equipment.

We
introduced our first WaferSense product, the automatic leveling sensor (ALS),
a 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 coplanar. We have continued to enhance our WaferSense ALS products
and recently introduced a thinner version of WaferSense ALS.

In
2007, we introduced three new products in the WaferSense family, the automatic
gapping sensor (AGS), the automatic teaching sensor (ATS) and the automatic
vibration sensor (AVS). AGS is a gapping tool that measures the gap in three
places between the shower head and pedestal in semiconductor process equipment.
The automatic teaching sensor (ATS), measures X-Y-Z offset from robotic
transfers of wafers to the pedestal in semiconductor process equipment. The
amount of gap and offset after robotic transfer of wafers to the shower
pedestal can affect film thickness and uniformity when material is deposited on
semiconductor wafers, impacting quality and product yields. The automatic
vibration sensor (AVS) measures X-Y-Z acceleration for shock and vibration,
which can generate wafer particles, scratches or wafer breakage, thereby
reducing yield. Because the user is not required to break down semiconductor
fabrication equipment when using our WaferSense products, we believe
significant time is saved and accuracy is increased compared to the manual
techniques currently used by many customers when checking the process
parameters measured by our WaferSense products. As a result, up-time,
through-put and process yield for semiconductor fabrication equipment is
improved.

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In
2008 we continued to make improvements to our existing WaferSense products and
also started development of additional products for the WaferSense family,
including a particle detection sensor.

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, and a new
smaller form factor of this product, the EXQS, in 2005.

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 brand.

Markets and Customers

We
sell the vast majority of our products into the electronics manufacturing
market (88% of total revenues in 2008); 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,
smaller circuit paths and extremely small components 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 with
computer-related equipment. Our LaserAlign products are sold to OEMs serving
this market and the SE 300 Ultra, Flex Ultra and Flex Ultra HR 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 WaferSense family of precision measurement tools for process optimization
in semiconductor processing equipment is sold directly to semiconductor
fabrication facilities for use by process and equipment engineers during the
production of semiconductor wafers.

A
large proportion of our end-user SMT system sales are being originated in the
low cost geographies of Asia where a significant portion of the new worldwide
production capacity for circuit board assembly has been added. Consequently,
most capital equipment suppliers are increasing their sales and operational
capabilities in Asia 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.

In
February 2008, in part to be more responsive to our growing base of Asian SMT
systems customers, we announced plans to move a portion of our systems related
product development and all manufacturing for our system products to Singapore,
the location of our Asian sales office. The move of systems related product
development to Singapore was substantially complete by the end of 2008. We anticipate
that the transition of all manufacturing operations for our system products
will be complete by the middle of 2009.

We
sell our products worldwide to many of the leading manufacturers of electronic
circuit board assembly equipment, manufacturers of semiconductor DRAM memory,
semiconductor capital equipment manufacturers and end-user electronic assembly
manufacturers, including Asian original design manufacturers (ODMs) and EMSs,
who manufacture cell phones, notebook computers and server boards, among other
electronic devices. Although we maintain sales offices in the UK, Singapore and
China, all manufacturing of our products through the end of 2008 occurred in
the United States and all sales originate in the United States. Singapore based
manufacturing of SMT systems is expected to commence in the first quarter of
2009 and be completely transitioned to Singapore by the middle of 2009.

Export
sales represented a large percentage of our total sales from 2006 to 2008 as
the result of the majority of new worldwide electronics and semiconductor
capacity being added outside the United States. 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.

8

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Table of Contents

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, |  
|                                                                                                        |  | 2008                    |   | 2007 |    | 2006 | 
|                                                                                                        |  |                         |   |      |    |      | 
|Asia                                                                                                    |  | 49                      | % |      | 51 | %    |  | 50 | % | 
|                                                                                                        |  |                         |   |      |    |      |  |    |   | 
|Europe                                                                                                  |  | 33                      | % |      | 34 | %    |  | 33 | % | 
|                                                                                                        |  |                         |   |      |    |      |  |    |   | 
|Other (1)                                                                                               |  | 4                       | % |      | 2  | %    |  | 1  | % | 
|                                                                                                        |  |                         |   |      |    |      |  |    |   | 
|(1) Includes export sales
 in the Americas, primarily export sales to Canada, Mexico and Latin America.

See
Note 11 to the Companys Consolidated Financial Statements contained in item 8
of this Form 10-K.

All
export sales are negotiated, invoiced and paid in 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 are sold to large OEM customers by direct sales
staff located in Minnesota. 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 14 representatives and distributors in North and South America
who focus primarily on SMT systems products sold to end-users. We make most of
our sales to international end-users of systems products through 26
representatives and distributors covering Europe (15) and the Pacific Rim (11).

We
have established a worldwide sales representative organization for our
WaferSense semiconductor products. We currently have agreements in place or in
process with sales representatives in the U.S. (3), Europe (3) and the Pacific
Rim (7). Most of these sales representatives will also be authorized to sell
wafer mapping semiconductor products. Our wafer mapping semiconductor products are sold to large OEM
customers by a direct sales staff located in Oregon. We sell our semiconductor
frame grabber products through direct sales staff located in Portland, Oregon,
and through 13 sales representatives throughout the world. These
representatives are not under contract, but are authorized to sell frame
grabber products and in many cases act as system integrators for our products.

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

Backlog

Our
products are typically shipped two weeks to two months after the receipt of an
order. Product backlog was $3.9 million at December 31, 2008, compared to $6.1
million on December 31, 2007, and $6.9 million on December 31, 2006. Backlog at
December 31, 2008 totaling $3.3 million is deliverable in the first quarter of
2009. Sales of some surface mount technology (SMT) products may require
customer acceptance due to performance or other acceptance criteria included in
the terms of sale. For these SMT product sales, revenue is recognized at the
time of customer acceptance. Although our business is generally not of a highly
seasonal nature, sales may vary based on the capital procurement practices in
the electronics and semiconductor industries. For example, production capacity
expansion for anticipated holiday or back to school demands can impact our
revenue. In addition, New Year celebrations in Asia may have some impact on
first quarter sales. We are not able to quantify with any level of precision,
the impact of these events on our sales in any given quarterly period. 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.

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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 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 allow 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 play a critical role in maintaining
and advancing our position as a leading provider of optical sensors and
systems. During 2006 through 2008, research and development efforts were
focused on a number of development activities, including a 5th
generation LaserAlign sensor for Juki, continued development of our Embedded
Process Verification (EPV®) technology initiative, and continued development of
and enhancements to the SE and Flex series inspection systems, including our SE
300 Ultra solder paste inspection system, new Flex Ultra and Flex Ultra HR
automated optical inspection systems and a next generation system product for
solder paste inspection scheduled for introduction in the second quarter of
2009.

Throughout
the last several years, we have continued to development our WaferSense family
of precision measurement tools, including new automated leveling, gapping,
teaching and vibration sensors to assist with process automation and yield
improvement in the semiconductor fabrication process, along with development of
other new planned product additions for the WaferSense family.

Research
and development expenses were $10.4 million in 2008, $9.8 million in 2007 and
$8.1 million in 2006. These amounts represented 23% of revenues in 2008, 17% of
revenues in 2007 and 14% of revenues in 2006. 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. We expect research
and development expenses in 2009 to decrease as our transition of a portion of
our development for systems to Singapore is now complete, eliminating further
transition expense and reducing our overall cost structure. In addition, the
workforce reductions we initiated in November 2008 and February 2009 will also
reduce development costs in 2009.

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.

Both
our electronic assembly sensor products and SMT systems products were assembled
in Minneapolis, Minnesota through the end of 2008. Although we continue to
manufacture sensor products in Minneapolis, all SMT system products will be
manufactured in Singapore by the middle of 2009. We believe that sourcing of
mechanical components for our system products in Asia and distribution of these
products from Singapore to our customers, the majority of whom are located in
Asia, will be less expensive than if we continued these activities at our U.S.
headquarters facility. Our semiconductor products were assembled in Portland,
Oregon through the end of 2008. We intend to transition the assembly of these
products to our Minneapolis Minnesota headquarters facility by the middle of
2009.

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.
We believe we have identified alternative assembly contractors for most of our
subassemblies. Use of those alternative contractors could require substantial
rework of the product designs, resulting in periods during which we could not
satisfy customer orders. 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).

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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 and Electro Scientific
Industries, Inc. We compete in this market 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. We believe our sensor products are also better suited to
align the smaller electronic component sizes currently available in the market.
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) technology initiative, which could give us a competitive
advantage in this market.

The
primary competition for sales of our SE 300 Ultra solder paste inspection
product has been from Asian based companies such as KohYoung Technology
(Korea), and Test Research, Inc. (Taiwan). Agilent Technologies, Inc., CKD
Corporation (Japan) and Orbotech, Ltd. (Israel) have also been competitors. We
believe that a few of these competing systems have a lower price position than
our SE 300 Ultra product. Although we believe our SE 300 Ultra product 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 our SE 300 Ultra product in some markets. 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. In
the second quarter of 2009 we will introduce our next generation 3-D solder
paste inspection system, which will replace our current SE 300 machine, and
incorporate a cost-reduced platform with enhanced performance. We believe that
this system will be the fastest and most accurate solder paste inspection
system available on the market and that it will strengthen our competitive
position in the inspection market.

Our
AOI inspection system products (Flex Ultra and Flex Ultra HR products) face
competition from a large number of AOI companies, the most significant being
Agilent (formerly MVT), MirTech, Ltd. (Korea), Viscom (Germany), Saki
Corporation (Japan) and Omron, Ltd. (Japan). We believe that the technology
used in the Flex Ultra series is differentiated from the competition and that
it will compete effectively in this market based on measurement accuracy, cost,
ease of use at rapid production line speeds and the low rate of false calls.

Our
WaferSense family of sensors is intended to go where wafers go in
semiconductor fabrication and provide measurements of critical factors that are
currently impossible or extremely difficult to obtain. We believe our
WaferSense products are unique to the marketplace and primarily face
competition from the manual techniques currently used by most customers to
monitor their semiconductor fabrication equipment. Because the user is not
required to break down semiconductor fabrication equipment, or pressurize a
vacuum chamber, we believe that our WaferSense products will save significant
time and increase measurement accuracy over the manual techniques currently
used by customers and will improve equipment up-time, through-put and process
yield.

Our
other 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.

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Employees

As
of December 31, 2008, we had 179 full-time employees worldwide, including 40 in
sales, marketing and customer support, 64 in manufacturing, purchasing and
production engineering, 56 in research and development and 19 in finance,
administration and information services. Of these employees, 110 are located at
our corporate headquarters in Minneapolis and 69 are located in other offices
(7 in the UK, 18 in Oregon, 33 in Singapore, 10 in China and 1 in Japan). All
of our employees located in Oregon work in our Semiconductor business. In
February 2009, we announced a further reduction in work force that will
decrease our aggregate work force by 24 additional employees. 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 97 patents (63 U.S. and 34 foreign) on a number of technologies, including
those used in the LaserAlign systems 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, we have 156 pending patents (41 U.S. and
115 foreign). We protect the proprietary nature of our software primarily
through copyright and license agreements, but also through close integration
with our hardware offerings. We utilize 21 trademarks, 15 of which are
registered trademarks, and 3 of which are foreign. We currently have 6
trademarks pending registration. We also have 13 domain names and several
common law trademarks. It is our policy to protect the proprietary nature of
our new product developments whenever they are likely to become significant
sources of revenue. No guarantee can be given that we will be able to obtain
patent or other protection for other products.

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

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.

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ITEM 1A.
RISK FACTORS

Our
operations are subject to a number of risks and uncertainties that may effect
our financial results, our accounting, and the accuracy of the forward looking
statements we make in this Form 10-K. We 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:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our business has been and may continue to
 be significantly impacted by the recent deterioration in worldwide economic
 conditions, and the current uncertainty in the outlook for the global economy
 makes it more likely that our actual results will differ materially from
 expectations. Global
 credit and financial markets have been experiencing extreme disruptions in
 recent months, including severely diminished liquidity and credit
 availability, declines in consumer confidence, declines in economic growth,
 increases in unemployment rates, and uncertainty about economic stability.
 There can be no assurance that there will not be further deterioration in
 credit and financial markets and confidence in economic conditions. These
 economic uncertainties affect businesses such as ours in a number of ways,
 making it difficult to accurately forecast and plan our future business
 activities. The current tightening of credit in financial markets may lead
 consumers and businesses to postpone spending, which may cause our customers
 to cancel, decrease or delay their existing and future orders with us. In
 addition, financial difficulties experienced by our suppliers or distributors
 could result in product delays, increased accounts receivable defaults and
 inventory challenges. The original equipment manufacturers to which we sell
 our sensors supply SMT manufacturers, and those manufacturers, as well as the
 circuit board manufacturers that purchase our SMT systems products directly,
 are largely dependent on continued demand for consumer and commercial
 electronics, including cell phones and computers. Demand for electronics is a
 function of the health of the economies in the United States and around the
 world and as these economies have moved into a recession, the demand for
 overall electronics has been adversely affected and therefore, demand for our
 products and our operating results has been adversely affected. We cannot
 predict the timing, strength or duration of any economic disruption or
 subsequent economic recovery, worldwide, in the United States, in our
 industry, or in the electronics market. These and other economic factors have
 had and may continue to have a material adverse effect on demand for our
 products and on our financial condition and operating results.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | Pending loss of significant customer for
 our electronic assembly sensors.Historically, we
 have been dependent on two customers for a significant amount of our revenue.
 Sales to Assembleon constituted 15% of our total revenue in 2008 and 20% of
 our total revenue in 2007. Assembleon has informed us that they plan to start
 transitioning away from our sensor products in the third quarter of 2009,
 with the transition continuing into the second quarter of 2010. Although we
 expect to continue to generate some repair revenue from Assembleon and its
 customers, we expect that the 10% of our revenue that was generated from new
 product sales to Assembleon will be eliminated by the end of 2010. Our
 results of operations and cash flows would be further negatively impacted if
 Assembleon transitions away from our products sooner than expected.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | Sales to one customer constitute a
 significant portion of our revenue and loss of that customer, or a decline in
 the customers business, would have a materially adverse impact on our
 results of operation. Sales to our largest customer constituted 21% of our total
 revenue in 2008 and 28% of our total revenue in 2007. Although we believe our
 relationship with this customer is excellent and we continue to pursue joint
 development projects with them, like most suppliers to the electronics
 manufacturing markets, their business has been impacted by the global
 economic downturn and they have advised us that their orders for additional
 sensor products from us during the first and second quarters of 2009 well be
 unusually low due to the difficult global economic conditions. If their order
 rate does not return to its historical level or if they are unsuccessful in
 selling the products into which our sensors are incorporated, or if they
 design their products to function without our sensors, purchase sensors from
 other suppliers, or otherwise terminate their relationship with us, our
 long-term results of operations would be significantly adversely affected.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | Although our move of systems product
 development and manufacturing operations to Singapore is intended to save
 cost, increase responsiveness to Asian systems customers and free US
 development staff for sensor development, we might not achieve these
 objectives and the move could prove costly or result in reduced control and
 efficiency of systems operations.Our move to
 Singapore presents a number of risks related to the retention of personnel,
 management of development and manufacturing, control over administrative,
 manufacturing and business processes, regulatory and legal issues we may
 encounter and other matters relating to foreign operations. We cannot be
 certain that we will be able to retain software development personnel in
 Singapore of the caliber required for our products, we will be able to retain
 management on whom we can rely, or that these personnel, or manufacturing
 personnel, can be retained at attractive rates. Although we anticipate that
 components for our systems products may be more readily available there, we
 cannot be certain that we will be able to import the hardware
 components used in our systems products necessary for manufacture in
 Singapore at efficient rates. Our future financial performance, ability to
 serve our customers and manufacture products could be negatively impacted if
 the move of our systems related manufacturing operations to Singapore takes
 longer than intended, costs more than expected to hire experienced employees
 in a timely manner, or if we are unable to locate suitable sources of supply
 for our products manufactured in Asia.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

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| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The market for capital equipment for the
 electronics industry in which we operate is cyclical and we cannot predict
 with precision when market downturns will occur.We
 operate in a very cyclical marketthe electronics capital equipment
 market-that periodically adjusts independent of global economic conditions.
 We have been unable to predict with accuracy the timing or magnitude 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 in the past and generated several years of
 unprofitable operations. We are currently experiencing another significant
 downturn in our markets due to the current severe global economic recession.
 We are presently unable to determine the duration or severity of the downturn
 in our markets, and the long-term impact that it may have on our business.                                                                                
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                         
| |  | World events beyond our control may effect our operations.Our
 operations and markets could be negatively affected by world events that
 effect economies and commerce in countries, such as China, Singapore and
 Japan, in which we do business. Natural disasters, such as the SARS outbreak,
 have affected travel patterns and accessibility in these countries in the
 past and other natural occurrences, such as a bird flu outbreak, could affect
 the business we do in these countries in the future. Further, these countries
 may be affected by economic forces that are different from the forces that
 affect the United States and change the amount of business we conduct.                                                                                                                                                                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                         
| |  | We are dependent upon a single product line in our systems business
 for approximately a quarter of our revenue.During
 2008, approximately 24% of our total revenue was generated by sales of a
 single SMT systems product line, the SE 300 Ultra. Sales of this product have
 been subject to increasing competition in the Asian markets, negatively
 impacting our market share and sales prices for our products. 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.
 In addition, we will be introducing a next generation solder paste inspection
 system to replace the SE 300 Ultra during the second quarter of 2009. Our revenue could be negatively affected
 if we encounter unanticipated product quality or performance issues with this
 new product, if we experience further delays in its introduction, or if the
 product is not accepted by the marketplace in the manner we currently expect.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                         
| |  | We generate more than three quarters of our revenue (approximately
 86% in 2008) from export sales that are subject to risks of international
 operations. Our export sales are subject to many of
 the risks of international operations including:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | currency
 controls and fluctuations in currency exchange rates;                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | changes in
 local market business requirements and increased cost and development time
 required to modify and translate our products for local markets;
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | inability to
 recruit qualified personnel in a specific country or region;                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | difficulty
 in establishing and maintaining relationships with local vendors;                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | differing
 foreign technical standards;                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | differing
 regulatory requirements;                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | export
 restrictions and controls, tariffs and other trade barriers;                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | difficulties
 in staffing and managing international operations;                                                                                        
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | reduced
 protection for intellectual property rights;                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | changes in
 political and economic conditions;                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | seasonal
 reductions in business activity;                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | potentially
 adverse tax assessments; and                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | terrorism,
 disease, or other events that may affect local economies and access.                                                                        
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                         
| |  | Because we price our products in US
 dollars, our products may have difficulty competing in periods of increasing
 strength of the dollar. All of our international
 export sales are negotiated, invoiced and paid in 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 competitors, which could
 impact the willingness of customers to purchase our products and have an
 impact on our results of operations.                                                                                                                                                                                                                                                                                                                                                                               

14

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Table of Contents

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our products could become obsolete. 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, printed circuit boards and memory modules. The technology for
 these components changes rapidly and, because it takes considerable time to
 develop new products, we must anticipate technological developments in order
 to effectively compete. Further, because we do not have unlimited development
 resources, we might choose to forgo the pursuit of what becomes a leading
 technology and devote our resources to technology that is less successful. 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.                                                                                                                                                                                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | We compete in the electronics assembly sensor market with larger
 companies. 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.
 Advances in machine vision technology in recent years have eliminated some,
 but not all, of the features that have differentiated our products from some
 of these competitors.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | The market for surface mount capital equipment has become very price
 competitive.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, including suppliers in Asia who have specifically designed
 their products to compete favorably against our products.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Our systems products carry lower margins.We
 use a different distribution network to sell our end-user systems products,
 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 profit margins may be affected.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Competitors in Asia may be able to compete favorably with us based on
 lower production and employee costs. 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 may have lower overall
 production and employee costs and are willing to offer their products at
 lower selling prices to customers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | We are dependent upon outside suppliers for
 components of our products, and delays in or unavailability of those
 components would adversely affect our results. 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 affect our ability to sell our products if not available. In
 addition, if these components do not meet stringent quality requirements or
 become subject to obsolescence, there could be delays in product
 availability, and we could be required to make significant investments in
 designing replacement components.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Our operations could be effected by
 lead-free regulations. New regulations have been
 enacted in various countries requiring the reduction of hazardous substances
 in electronics products and capital equipment in future years. New
 regulations are also increasing the obligations of manufacturers of
 electronics products and capital equipment to ensure proper disposal of their
 products when they are no longer being used by the customer. 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 of 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. In addition the new regulations requiring us to ensure proper
 disposal of our products will increase our costs, and our results of
 operations could be negatively affected.                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | Our growth has been dependent on technical
 innovation and is affected by the timing and success of product
 introductions. Although our results are cyclical, our objective is to grow
 revenue and profitability over the long term. Our growth has been in the
 past, and we anticipate that it will be in the future, dependent upon our
 ability to introduce new and innovative products. We
 plan to continue to introduce new products during 2009 and beyond. If those
 introductions are delayed, our revenue and profitability could be negatively
 affected. We have devoted and continue to devote significant resources to our
 SMT system products, including enhancements to SE 300 Ultra, Flex Ultra, Flex
 Ultra HR, next generation system products and also our WaferSense family of
 products. In addition, 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 and other new products could be 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.

15

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Table of Contents

ITEM 1B.
UNRESOLVED STAFF COMMENTS

None.

ITEM 2.
PROPERTIES

We
lease a 60,217 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 for our sensor products. The
lease for this space will expire in June 2011. During 2008 we entered into a
new lease for a mixed office and warehouse facility in Singapore, to serve as a
sales, development and manufacturing facility for our systems products. The
lease for our new facility in Singapore expires in May 2011. As of December 31,
2008, we also have operating leases in Oregon (for our semiconductor business),
the United Kingdom, and Shanghai, China, which expire in December 2009, June
2010 and August 2010, respectively. We believe that our leased facilities are
adequate for our anticipated needs for the foreseeable future.

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 2008.

16

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Table of Contents

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

|        |  |      |   |       |  |      |  |     |      |  |  |  |   |       |  |  |  |   |       |  | 
|------- |  | ---- | - | ----- |  | ---- |  | --- | ---- |  |  |  | - | ----- |  |  |  | - | ----- |  | 
|        |  | 2008 |   | 2007  | 
|Quarter |  | High |   | Low   |  | High |  | Low |     
|        |  |      |   |       |  |      |  |     |      |  |  |  |   |       |  |  |  |   |       |  | 
|First   |  |      | $ | 12.41 |  |      |  | $   | 9.69 |  |  |  | $ | 14.60 |  |  |  | $ | 12.73 |  | 
|Second  |  |      | $ | 11.70 |  |      |  | $   | 7.88 |  |  |  | $ | 14.80 |  |  |  | $ | 11.73 |  | 
|Third   |  |      | $ | 10.74 |  |      |  | $   | 8.51 |  |  |  | $ | 13.75 |  |  |  | $ | 11.50 |  | 
|Fourth  |  |      | $ | 9.60  |  |      |  | $   | 4.26 |  |  |  | $ | 13.75 |  |  |  | $ | 10.51 |  | 

As
of February 28, 2009, there were approximately 200 holders of record of common
stock and approximately 3,000 beneficial holders. We have never paid a dividend
on our 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.

Equity Compensation Plan Information

The
following table describes shares of our common stock that are available on
December 31, 2008 for purchase under outstanding stock-based awards, or
reserved for issuance under stock-based awards or other rights that may be
granted in the future, under our equity compensation plans:

|                                                                                      |  |                                                                                                      |         |                                                                                      |   |                                                                                                                                                  |  |  |         | 
|------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------- | ------- | ------------------------------------------------------------------------------------ | - | ------------------------------------------------------------------------------------------------------------------------------------------------ |  |  | ------- | 
|Plan Category                                                                         |  | (a)
 Number of securities
 to be issued upon
 exercise of
 outstanding options,
 warrants and rights |         | (b)
 Weighted-average
 exercise price of
 outstanding
 options, warrants
 and rights |   | (c)
 Number of securities
 remaining available for
 future issuance under
 equity compensation plans
 (excluding those
 reflected in column (a)) | 
|Equity compensation plans approved by
 security holders                               |  |                                                                                                      |         |                                                                                      |   |                                                                                                                                                  |  |  |         | 
|                                                                                      |  |                                                                                                      |         |                                                                                      |   |                                                                                                                                                  |  |  |         | 
|Restated Stock Option Plan                                                            |  |                                                                                                      | 80,125  |                                                                                      | $ | 8.16                                                                                                                                             |  |  |        | 
|1998 Stock Incentive Plan (1)                                                         |  |                                                                                                      | 503,222 |                                                                                      | $ | 8.79                                                                                                                                             |  |  | 230,857 | 
|Stock Option Plan for Non Employee
 Directors                                         |  |                                                                                                      | 125,000 |                                                                                      | $ | 14.43                                                                                                                                            |  |  |        | 
|Stock Grant Plan for Non Employee
Directors                                           |  |                                                                                                      | N/A     |                                                                                      |   | N/A                                                                                                                                              |  |  | 27,000  | 
|Employee Stock Purchase Plan (2)                                                      |  |                                                                                                      | N/A     |                                                                                      |   | N/A                                                                                                                                              |  |  | 112,812 | 
|                                                                                      |  |                                                                                                      |         |                                                                                      |   |                                                                                                                                                  |  |  |         | 
|Equity compensation plans not approved by
 security holders                           |  |                                                                                                      |         |                                                                                      |   |                                                                                                                                                  |  |  |         | 
|                                                                                      |  |                                                                                                      |         |                                                                                      |   |                                                                                                                                                  |  |  |         | 
|Options issued to executives and certain
 other employees upon initial employment (3) |  |                                                                                                      | 50,000  |                                                                                      | $ | 11.87                                                                                                                                            |  |  |        | 
|                                                                                      |  |                                                                                                      |         |                                                                                      |   |                                                                                                                                                  |  |  |         | 
|Total                                                                                 |  |                                                                                                      | 758,347 |                                                                                      | $ | 9.85                                                                                                                                             |  |  | 370,669 | 

|    |                                                                                                                                                                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In addition
 to options, shares may be issued in restricted stock awards, performance
 awards and other stock-based awards.                                                                                                                                                                        
|(2) | Shares are
 issued based on employees elections to participate in the plan.                                                                                                                                                                                                                       
|(3) | Represent
 options received by executives and certain other employees prior to 2003 upon
 their initial employment and granted on the same terms as those options
 granted under equity compensation plans approved by security holders. None of
 these options qualify as incentive stock options.

17

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Table of Contents

Shareholder
Return

The
following graph compares the cumulative total shareholder return on our common
stock from January 1, 2004 through December 31, 2008 with the
cumulative total return on a broad market index (the Nasdaq US Index) and a
peer group index (the Nasdaq Computer and Data Processing Index). In each case,
we have calculated the cumulative return assuming an investment of $100 on
January 1, 2004, and reinvestment of all dividends.

(LINE GRAPH)

18

---

Table of Contents

ITEM 6.
SELECTED FINANCIAL DATA

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

|                               |  |         |         |      |   |        |  |         |        |      |   |        |  |   |        | 
|------------------------------ |  | ------- | ------- | ---- | - | ------ |  | ------- | ------ | ---- | - | ------ |  | - | ------ | 
|Year Ended
 December 31        |  | 2008(1) |         | 2007 |   | 2006   |  | 2005(2) |        | 2004 |  
|                               |  |         |         |      |   |        |  |         |        |      |   |        |  |   |        | 
|Revenues                       |  | $       | 45,452  |      | $ | 58,776 |  | $       | 57,089 |      | $ | 42,179 |  | $ | 58,037 | 
|Income
 (loss) from operations |  | $       | (10,463 | )    | $ | 5,540  |  | $       | 7,121  |      | $ | 3,104  |  | $ | 12,325 | 
|Net income
 (loss)             |  | $       | (6,671  | )    | $ | 5,028  |  | $       | 6,390  |      | $ | 7,150  |  | $ | 10,626 | 
|Net income
 (loss) per share:  |  |         |         |      |   |        |  |         |        |      |   |        |  |   |        | 
|Basic                          |  | $       | (0.87   | )    | $ | 0.57   |  | $       | 0.71   |      | $ | 0.80   |  | $ | 1.23   | 
|Diluted                        |  | $       | (0.87   | )    | $ | 0.56   |  | $       | 0.70   |      | $ | 0.79   |  | $ | 1.18   | 
|                               |  |         |         |      |   |        |  |         |        |      |   |        |  |   |        | 
|Cash and
 cash equivalents     |  | $       | 4,516   |      | $ | 18,864 |  | $       | 30,056 |      | $ | 19,592 |  | $ | 25,416 | 
|Marketable
 securities         |  |         | 25,267  |      |   | 33,754 |  |         | 18,951 |      |   | 21,548 |  |   | 14,868 | 
|Working
 capital               |  |         | 30,461  |      |   | 47,939 |  |         | 55,662 |      |   | 48,515 |  |   | 38,921 | 
|Total assets                   |  |         | 58,949  |      |   | 87,039 |  |         | 82,010 |      |   | 73,027 |  |   | 65,096 | 
|Stockholders
 equity          |  |         | 50,880  |      |   | 78,116 |  |         | 73,020 |      |   | 66,190 |  |   | 57,951 | 

|    |                                                                                                                                                                                                                                                                                            
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | 2008 results
 include a non-cash pre-tax charge for goodwill impairment of $3.9 million, a
 $650,000 pre-tax charge for inventory obsolescence, and a $770,000 pre-tax
 charge for severance and recruitment costs related to our move to Singapore
 and November 2008 workforce reduction.
|    |                                                                                                                                                                                                                                                                                            
|(2) | 2005 results
 include a $3.7 million non-cash income tax benefit related to a reduction in
 the valuation allowance for deferred income taxes.                                                                                                                                             

19

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Table of Contents

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

Results of Operations for the Three Years Ended December 31,
2008:

General Overview

Our
products are sold primarily into the electronics assembly, semiconductor DRAM
memory, 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.

Our
results were favorably impacted in 2006 and 2007 as the worldwide demand for
cell phones, laptops and other consumer electronics remained strong, driving
the need for increased production of printed circuit boards and memory modules,
and thereby increasing demand for our electronic assembly and semiconductor
products. After peaking in the third quarter of 2007, our revenue declined
sequentially each quarter throughout 2008, as our results were negatively
impacted by reduced levels of capital spending for electronics manufacturing
capacity brought about by the deepening weakness in the global economy. New
orders dropped off particularly sharply late in the fourth quarter of 2008 as
the global economy fell into a severe recession.

Reflecting
the impact of the weakening economy, our consolidated revenues decreased by 23%
in 2008 from 2007 levels to $45.5 million. The decline in revenue was the
principle reason for our 2008 operating loss of $10.5 million. We also
continued to experience pricing pressure for our products, particularly our SMT
system products. In addition to the drop in revenue and pricing pressure,
several significant charges and strategic investments also contributed to our
operating loss, including the following:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In February 2008, we
 announced plans to move a significant portion of our systems related product
 development and manufacturing for all system products to Singapore, the
 location of our Asian sales office. The transition of systems related product
 development to Singapore was substantially complete by the end of the fourth
 quarter of 2008. We anticipate that the transition of manufacturing for our
 system products will be complete by the middle of 2009. We estimate that the
 transition to Singapore increased our 2008 expenses by approximately $1.5
 million. Transition costs in 2009 are not expected to be significant.                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | The weakness in the United
 States capital markets caused by the deepening global recession, as well as
 our reduced level of profitability, caused a significant drop in our market
 capitalization, resulting in a $3.9 million non-cash pre-tax goodwill
 impairment charge in the fourth quarter of 2008. We presently anticipate that
 significant weakness in our markets and the global economy will continue, at
 least through the first half of 2009.                                                                                                                                                                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | In addition to the impact
 of global economic conditions on our sales, we have determined not to pursue
 new alignment products for use with future generations of equipment being
 developed by Assembleon. Sales of alignment products to Assembleon constituted
 10% of revenue in 2008. Assembleon has informed us that they currently plan
 to start transitioning away from our alignment products in the third quarter
 of 2009, with the transition continuing into the second quarter of 2010. The
 timing of Assembleons transition away from our sensor products, combined
 with the sharp drop-off in orders in the fourth quarter of 2008 and our
 expectation for continued weakness into 2009, resulted in a $650,000 charge
 for excess and obsolete inventory in the fourth quarter of 2008.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | In response to the
 significant weakness in our markets and the global economy, we reduced our
 workforce by approximately 20 employees or 10% in November 2008, resulting in
 a $234,000 severance charge in the fourth quarter of 2008. Further cost
 savings measures were implemented in February 2009, including additional
 workforce and salary reductions, consolidation of manufacturing operations
 for our semi-conductor products into our Minneapolis Minnesota facility and
 reductions in spending for non-labor costs such as travel, supplies and the
 like.                                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | From the start of the
 fourth quarter of 2008 through the end of the second quarter of 2009, we will
 have reduced our workforce by 50 employees or approximately 25%, resulting
 from the move to Singapore, relocation of manufacturing for our semiconductor
 operations, and the November 2008 and February 2009 workforce reductions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

20

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Table of Contents

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | During 2008, we invested
 heavily in our next-generation solder past inspection system which we expect
 to introduce in the second quarter of 2009. To be manufactured in Singapore
 and based on a new cost-reduced platform, we believe this machine will be the
 fastest and most accurate solder paste inspection system available and that
 it will strengthen our competitive position in the inspection market.

During
2008 we repurchased 2.1 million shares of our common stock for $20.9 million.
Our balance sheet remains strong and we are well positioned financially. We
have no debt and our cash and marketable securities of $29.8 million at
December 31, 2008 are more than adequate to fund our operations and various
growth opportunities for an extended period of time, even given our expectation
for weak financial results through at least the first half of 2009, due to the
severe global economic recession.

We
continue to pursue several promising R&D initiatives for our inspection
technology. Our efforts related to these projects are aimed at lowering the
cost of inspection, while providing faster production through-put speeds,
better ease of use, and improved resolution for inspecting progressively
smaller electronic components.

Segment Results

Our
business consists of two operating segments, the electronic assembly
and semiconductor segments. The electronic assembly segment designs,
manufactures and sells optical process control sensors and inspection systems
for the electronic assembly equipment market. The semiconductor segment
designs, manufactures and sells optical and other process control sensors and
related equipment for the semiconductor capital equipment market. Segment
information follows:

|                                    |  |                         |         |      |   |        |  |   |        |  
|----------------------------------- |  | ----------------------- | ------- | ---- | - | ------ |  | - | ------ | -
|                                    |  | Year Ended December 31, |        
|(In
 thousands)                     |  | 2008                    |         | 2007 |   | 2006   | 
|                                    |  |                         |         |      |   |        |  |   |        |  
|Revenue:                            |  |                         |         |      |   |        |  |   |        |  
|Electronic assembly                 |  | $                       | 40,193  |      | $ | 53,203 |  | $ | 51,142 |  
|Semiconductor                       |  |                         | 5,259   |      |   | 5,573  |  |   | 5,947  |  
|Total                               |  | $                       | 45,452  |      | $ | 58,776 |  | $ | 57,089 |  
|                                    |  |                         |         |      |   |        |  |   |        |  
|Gross margin:                       |  |                         |         |      |   |        |  |   |        |  
|Electronic assembly                 |  | $                       | 15,867  |      | $ | 26,631 |  | $ | 25,926 |  
|Semiconductor                       |  |                         | 3,198   |      |   | 3,616  |  |   | 3,975  |  
|Total                               |  | $                       | 19,065  |      | $ | 30,247 |  | $ | 29,901 |  
|                                    |  |                         |         |      |   |        |  |   |        |  
|Operating expense:                  |  |                         |         |      |   |        |  |   |        |  
|Electronic assembly                 |  | $                       | 26,206  |      | $ | 21,223 |  | $ | 18,110 |  
|Semiconductor                       |  |                         | 3,322   |      |   | 3,484  |  |   | 4,670  |  
|Total                               |  | $                       | 29,528  |      | $ | 24,707 |  | $ | 22,780 |  
|                                    |  |                         |         |      |   |        |  |   |        |  
|Income (loss) from
 operations:     |  |                         |         |      |   |        |  |   |        |  
|Electronic assembly                 |  | $                       | (10,339 | )    | $ | 5,408  |  | $ | 7,816  |  
|Semiconductor                       |  |                         | (124    | )    |   | 132    |  |   | (695   | )
|Total income (loss) from operations |  | $                       | (10,463 | )    | $ | 5,540  |  | $ | 7,121  |  
|Interest income and other           |  |                         | 1,193   |      |   | 2,214  |  |   | 1,943  |  
|Income (loss) before income taxes   |  | $                       | (9,270  | )    | $ | 7,754  |  | $ | 9,064  |  

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Revenues

Our
revenues decreased by 23% to $45.5 million in 2008 from $58.8 million in 2007
and increased by 3% in 2007 from $57.1 million in 2006. The following table
sets forth, for the years indicated, revenues by product line (in thousands):

|                          |  |      |        |      |   |        |  |   |        | 
|------------------------- |  | ---- | ------ | ---- | - | ------ |  | - | ------ | 
|                          |  | 2008 |        | 2007 |   | 2006   | 
|Electronic Assembly       |  |      |        |      |   |        |  |   |        | 
|OEM Sensors               |  | $    | 20,250 |      | $ | 31,774 |  | $ | 32,006 | 
|SMT Systems               |  |      | 19,943 |      |   | 21,429 |  |   | 19,136 | 
|Total Electronic Assembly |  |      | 40,193 |      |   | 53,203 |  |   | 51,142 | 
|Semiconductor             |  |      | 5,259  |      |   | 5,573  |  |   | 5,947  | 
|Total                     |  | $    | 45,452 |      | $ | 58,776 |  | $ | 57,089 | 

Electronic Assembly

Revenue
from our electronic assembly sensors was down $11.5 million or 36% in 2008
compared to 2007 due to the negative impact of reduced levels of capital spending
for electronics manufacturing capacity brought about by the weak global
economy. Revenues from our electronic assembly sensors were down approximately
$200,000 or 1% in 2007 compared to 2006 and increased $10.4 million or 48 % in
2006 compared to 2005. During 2007 and 2006, revenue from electronic assembly
sensors were positively impacted by favorable worldwide demand for cell phones,
laptops and other consumer electronics, driving the need for increased
production of printed circuit boards and memory modules. In addition, the
economies in the countries where most of our products are sold remained strong.
In addition to the impact of the economic recession, which has caused orders of
our sensors to drop significantly, our decision not to develop sensors for the
next generation of equipment for Assembleon will adversely effect our sensor
revenue in future periods.

Revenues
from our SMT systems products decreased by $1.5 million or 7% in 2008, after
increasing $2.3 million or 12% in 2007 and increasing $4.0 million or 27% in
2006. Revenue from our SMT system products was negatively impacted by the
deepening global recession in 2008, after being positively impacted during 2007
and 2006 by favorable worldwide demand for electronics and favorable market
conditions in the countries where most of our products are sold. Unlike our
sensor revenue, which is closely tied to the need for added production capacity
for printed circuit boards, a portion of our SMT systems revenue is derived
from the retro-fit of existing production lines as companies seek to improve
their production yields, thereby reducing manufacturing costs.

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 caused increased demand for our inspection equipment, prior to
the recent global economic recession. However, our revenue has been impacted by
increasing competition and price pressure on our SMT inspection systems,
particularly in Asia.

Revenue
from our systems products is impacted by the timing of the introduction of new
system products, including our Flex Ultra and our Flex Ultra HR automated
optical inspection (AOI) systems. Sales of our Flex AOI systems remained
virtually unchanged in 2008 at $6.9 million, after increasing $339,000 or 5% in
2007 and increasing $2.3 million or 55% in 2006. Sales of our SE 300 Ultra
solder paste inspection system decreased $1.5 million or 10% in 2008, after
increasing $2.0 million or 16% in 2007 and increasing $1.7 million or 16% in
2006. We believe that the introduction of our next generation solder paste
inspection system in the second quarter of 2009, with its improved speed and
other new capabilities will strengthen our competitive position in the
inspection market.

Export
revenue from electronic assembly sensors and SMT systems totaled $36.7 million
in 2008, $49.4 million in 2007, and $46.5 million in 2006, comprising 91% of
electronic assembly revenue in 2008, 93% of electronic assembly revenue in
2007, and 91% of electronic assembly revenue in 2006. Sales to international
customers continue to be significant, as manufacturing of electronic components
has migrated offshore, particularly to China and other areas of Asia.

We
believe the market trend toward automated inspection using SMT inspection
systems is continuing to grow and emerge due to ongoing miniaturization of SMT
circuit board components. Required for downsizing products, some new generation
components have become so small that it is now virtually impossible for the
human eye to inspect circuit boards for defects in solder paste quality,
component placement and solder joints. For this reason, we believe automated
inspection has become the only viable means for inspecting SMT circuit boards
with such tiny components, and we believe that our SMT systems products will be
one of our primary growth drivers over the next few years. We presently
anticipate that significant weakness in our markets and the global economy will
have a negative impact on our sales, at least through the first half of 2009.

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Semiconductor

Revenues
from semiconductor products decreased by $314,000 or 6% in 2008 compared to
2007 and decreased by $374,000 or 6% in 2007 compared to 2006. The decrease in
revenue for both years was due to difficult conditions in the market for
semiconductor fabrication equipment and declining revenue from our older wafer
mapper and frame grabber products, partially offset by additional revenue from
our new WaferSense family of products. Total WaferSense revenue increased to
$1.7 million in 2008 from $1.1 million in 2007 and $517,000 in 2006.

Our
wafer mapping and frame grabber products are relatively mature. We anticipate
that future growth in our semiconductor revenues, exclusive of changes related
to capital procurement cycles, will come from our new WaferSense products.
WaferSense is a family of wireless, wafer like precision measurement tools for
in-situ setup, calibration and process optimization in semiconductor processing
equipment. We have recently introduced several new additions to the WaferSense
product line, including additional leveling sensors, along with new gapping,
teaching and vibration sensors.

Export
revenue from semiconductor products totaled $2.4 million or 46% of total
semiconductor revenue in 2008, $1.8 million or 32% of total semiconductor
revenue in 2007 and $1.8 million or 31% of total semiconductor revenue in 2006.
The level of international sales and percentage of sales coming from
international markets increased substantially in 2008 due to the large increase
in WaferSense sales, which have a higher concentration of international sales
that our other semiconductor products. In addition, sales of our wafer mapping
products, which do not generate significant international sales, declined more
in 2008 than our frame grabber products, which do generate significant
international sales.

Gross Margin

Electronic Assembly

Gross
margin as a percentage of electronic assembly sales were 39% in 2008, 50% in
2007 and 51% in 2006. Significantly lower sales of higher margin electronic
assembly sensors accounted for most of the decrease in gross margin percentage
in 2008. Other factors having a negative impact on our gross margin for 2008
included Jukis transition to our next generation LNC 60 sensor, which carries
a lower gross margin than the older sensors we sell to Juki and increasing
price competition for our SMT system products. In addition, our gross margin in
2008 was negatively impacted by a $650,000 charge for excess and obsolete
inventory (2% gross margin reduction). As discussed earlier, Assembleon intends
to start their transition away from our sensor products in the third quarter of
2009. The timing of Assembleons transition away from our sensor products,
combined with the sharp drop-off in orders in the fourth quarter of 2008 and
our expectation for continued weakness into 2009, resulted in a $650,000 charge
for excess and obsolete inventory in the fourth quarter of 2008.

The
decrease in gross margin as a percentage of sales in 2007 compared to 2006 was
due to increasing competition resulting in lower sales prices for our
electronic assembly products, particularly our SMT system products. Increased
competition and resulting price pressure on our SMT system products reduced
gross margin as a percentage of electronic assembly sales in 2007 by four
percentage points, offset in part by a one percentage point improvement from cost
reduction programs. Increasing price competition for our electronic assembly
sensor products also impacted our gross margin. The gross margin decrease in
2007 resulting from the increase in price competition was partially offset by a
$250,000 benefit from a warranty recovery. Our gross margin as a percentage of
sales is generally lower for our system products as compared to our sensor
products.

The
market for automated inspection has become increasingly competitive, causing us
to decrease the selling prices of our products in some markets. With respect to
our systems products, we anticipate that pricing pressures will continue in
2009 due to the competitive nature of the marketplace for all forms of
automated circuit board inspection, The severe global economic recession may
also have a further negative impact on pricing, as some competitors may be
inclined to discount their prices in order to deal with excess inventory
levels.

We
have implemented our own cost reduction programs to reduce the impact of these
pricing pressures on our gross margins. We expect to introduce our
next-generation solder paste inspection system, as scheduled, in the second
quarter of 2009. To be manufactured in Singapore and based on a new
cost-reduced platform, we believe it will be the fastest and most accurate
solder paste inspection system available on the market. We believe this system
will have capabilities not available on our current SE 300, thus strengthening
our competitive position in the inspection market. Other new systems platforms
we expect to introduce in the future will be based on new technology that will
allow for reduced cost and improvement in margins.

In
response to significant weakness in our markets resulting from the global recession,
and transition of manufacturing for our SMT system products to Singapore, we
will have reduced our manufacturing workforce by over 30 employees or 45% by
the end of the second quarter of 2009. We anticipate that transition of
manufacturing for our SMT system products to Singapore will be complete by the
middle of 2009. We will also consolidate manufacturing for our semiconductor
products into our Minneapolis Minnesota headquarters facility. These actions
will allow us to reduce our overall manufacturing costs and better leverage our
manufacturing operations, thereby favorably impacting our gross margins not
only in the second half of 2009, but also in future periods. We estimate
savings by the middle of 2009 from our factory cost reduction actions and
transition to Singapore of approximately $2.0 million per year.

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Semiconductor

Gross
margin as a percentage of sales were 61% in 2008, 65% in 2007 and 67% in 2006.
Gross margin as a percentage of sales for the semiconductor segment is
dependent on revenue mix and the level of production volume over which to
spread fixed manufacturing overhead costs. Gross margins decreased as a
percentage of revenue in 2008 and 2007 due to a change in revenue mix, with our
highest margin wafer mapping sensors representing a smaller percentage of total
semiconductor revenue.

We
currently expect gross margins as a percentage of revenue from our
semiconductor products to remain consistent or increase slightly in 2009 from
2008 levels, due to anticipated revenue from new WaferSense product
introductions as these products have higher gross margins than our existing
products. The consolidation of manufacturing for our semiconductor products
into our Minneapolis Minnesota headquarters facility will also have a favorable
impact on semiconductor gross margins.

Operating Expenses

We
believe continued investment in research and development of new products,
coupled with continued investment in and development of our sales channel is
critical to future growth and profitability. We maintain research and
development and sales and marketing expenses at relatively high levels, even
during periods of downturn in our electronic assembly and semiconductor capital
equipment markets, as we continue to fund development of important new
products, and continue to invest in our sales channels and develop new sales
territories.

In
February 2008, we announced plans to move a significant portion of our systems
related product development and manufacturing for all system products to
Singapore, the location of our Asian sales office. The transition of systems
related product development to Singapore was substantially complete by the end
of the fourth quarter of 2008. We anticipate that the transition of
manufacturing for our system products will be complete by the middle of 2009.
These moves will allow us to become more responsive to the needs of our growing
base of Asian SMT systems customers, permit our core Minneapolis based optical
engineering resources to work on future OEM opportunities, and attain
significant cost savings. We estimate that the transition to Singapore
increased our 2008 expenses by approximately $1.5 million. Transition costs in
2009 are not expected to be significant.

In
response to the significant weakness in our markets and the global economy, and
also due to our transition of a significant portion of our operations to
Singapore, we will have reduced our workforce by 50 employees or 25% (over 30
in manufacturing and approximately 20 in development, sales and marketing) from
the start of the fourth quarter of 2008 through the end of the second quarter
of 2009. Other cost saving measures include salary reductions of 12% for all
officer and internal director level positions, 10% for other employees with
salaries exceeding $100,000 and a smaller percentage reduction for employees
with salaries ranging between $35,000 and $100,000. In addition, we will also
reduce spending for non-labor costs such as travel, supplies and the like. We
anticipate that the workforce reductions, salary reductions and other cost
saving measures, combined with savings from our transition to Singapore will
provide annual operating expense savings by the middle of 2009 of almost $3.0
million per year. These savings are in addition to the $2.0 million of annual
factory cost reductions noted above.

We
are continually evaluating existing and new research and development projects,
and may elect to increase or decrease expenditures based on an assessment of
the future revenue and profit potential of these projects.

Electronic Assembly

Research
and development expenses for our electronic assembly segment were $8.8 million
or 22% of revenue in 2008, $8.1 million or 15% of revenue in 2007 and $6.3
million or 12% of revenue in 2006. The 7% increase in research and development
expense in 2008 compared to 2007 resulted from costs incurred to transition our
systems related research and development to Singapore. Throughout most of 2008, we maintained our
Minneapolis-based systems development team while we trained our new Singapore
based team, resulting in extra costs for wages, training, travel, and other
costs, during the initial start-up and training period. Singapore transition costs totaled $1.5
million in 2008. Of this amount, transition costs included in 2008 research and
development expense totaled $879,000.

The
29% increase in research and development expense in 2007 compared to 2006 was
due to increased costs for contract labor of $1.4 million, excluding customer
funded expenses, $231,000 for employee compensation associated with annual wage
increases and new employees, and $73,000 for proto-type expenses and lab
supplies. A significant portion of our product development efforts in 2007 were
targeted at next generation SMT inspection system products and continued
enhancements to our SE 300 Ultra solder paste inspection system and Flex Ultra
and Flex Ultra HR automated optical inspection systems.

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Selling,
general and administrative expenses for our electronic assembly segment were
$12.7 million or 32% of revenue in 2008, $13.0 million or 24% of revenue in
2007 and $11.7 million or 23% of revenue in 2006. The slight decrease in
selling, general and administrative expenses in 2008 compared to 2007 was due
to a $178,000 reduction in wage expense resulting from reduced incentive and
stock compensation costs and a $105,000 reduction in commissions for third
party sales representatives resulting from the lower level of system sales.
Selling general and administrative expense in 2007 included approximately
$200,000 of expense related to a canceled acquisition. The savings from this
non-recurring activity were partially offset by additional expense related to
our Singapore transition.

The
11% increase in selling, general and administrative expenses in 2007 compared
to 2006 was due to a $406,000 increase in sales commissions to distributors and
other third parties and an approximate $300,000 increase in travel. We also
incurred approximately $200,000 of expenses in 2007 from a cancelled
acquisition. The remaining increase in selling, general and administrative
expense for 2007 was due to the 12% increase in SMT system sales in 2007
compared to 2006.

Semiconductor

Research
and development expenses for our semiconductor segment were $1.7 million or 31%
of revenue in 2008, $1.7 million or 31% of revenue in 2007 and $1.8 million or
31% of revenue in 2006. Research and development expenses for semiconductor
have remained relatively constant during the last three years, as we have
continued to develop various new sensors for our WaferSense family of precision
measurement tools, including new automated leveling, gapping, teaching and vibration
sensors to assist with process optimization and yield improvement in the
semiconductor fabrication process.

Selling,
general and administrative expenses for our semiconductor segment were $1.5
million or 29% of revenue in 2008, $1.7 million or 30% of revenue in 2007 and
$2.3 million or 39% of revenue in 2006. The decrease in selling, general and
administrative expense for both 2008 and 2007 was due to a small workforce
reduction which occurred early in 2007, and lower costs for incentive compensation.

Severance, Recruitment and Singapore Transition

We
started to incur severance costs in February 2008 in connection with our
decision to move a significant portion of development and manufacturing for our
systems products to Singapore. The transition of development was substantially
complete by the fourth quarter of 2008; and transition of manufacturing is
expected to be complete by the middle of 2009. Severance costs incurred in 2008
in connection with the February 2008 decision totaled $302,000. We also
incurred expenses totaling $234,000 for outside service providers to assist us
with recruitment of our new Singapore based development and manufacturing team.
We maintained our Minneapolis-based systems development team while we
trained our new Singapore based team, resulting in extra costs totaling
$879,000 for wages, training, travel, and other costs, during the initial
start-up and training period. These costs have been classified in our statement
of operations as research and development expense. Other start-up costs
totaling $112,000 have been classified in our statement of operations as
selling, general and administrative expense. Singapore transition costs totaled approximately $1.5 million in 2008.
Transition costs in 2009 are not expected to be significant.

Additional
severance costs of $234,000 were incurred in November 2008 when we reduced our
workforce by approximately 10% or 20 employees in response to the weak global
economic conditions. All of the aforementioned costs related to the November
2008 workforce reduction have been classified as severance and recruitment in
our statement of operations.

A
summary of our severance and recruitment accruals follows:

|                            |  |                                 |     |                  |   |                                      |   |       |     |                                      |   |       |   |   |     |   |   |      |  
|--------------------------- |  | ------------------------------- | --- | ---------------- | - | ------------------------------------ | - | ----- | --- | ------------------------------------ | - | ----- | - | - | --- | - | - | ---- | -
|                            |  | Electronic Assembly             |     | Semi-
 conductor |   |                                      |  
|(in thousands)              |  | February
 2008
 Singapore
 Move |     | Recruitment      |   | November
 2008
 Workforce
 Reduction |   | Total |     | November
 2008
 Workforce
 Reduction |   | Total |  
|Balance,
 January 1, 2008   |  | $                               |    |                  | $ |                                     |   | $     |    |                                      | $ |      |   | $ |    |   | $ |     |  
|Costs incurred              |  |                                 | 302 |                  |   | 234                                  |   |       | 155 |                                      |   | 691   |   |   | 79  |   |   | 770  |  
|Payments made               |  |                                 | (95 | )                |   | (234                                 | ) |       | (51 | )                                    |   | (380  | ) |   | (75 | ) |   | (455 | )
|Balance,
 December 31, 2008 |  | $                               | 207 |                  | $ |                                     |   | $     | 104 |                                      | $ | 311   |   | $ | 4   |   | $ | 315  |  

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In
February 2009, we further reduced our workforce by 24 positions in response to
weakening conditions in the global economy and our decision to consolidate
manufacturing for our semiconductor products in our Minneapolis facility. We
anticipate that all of these employees will have departed by the end of the
second quarter of 2009. Severance expense related to these actions of
approximately $325,000 is expected in the first half of 2009.

Goodwill Impairment and Amortization of Intangibles

We
assess our goodwill for impairment in the fourth quarter of each year, and
whenever events or changes in circumstances indicate that the carrying value
may not be recoverable. For 2008, our annual impairment review coincided with a
series of facts and circumstances indicating that our goodwill might be
impaired, including weakness in the United States capital markets, caused by
the deepening global recession, as well as our reduced level of profitability,
causing a significant drop in our market capitalization.

We
measure for potential impairment of goodwill associated with each of our
reporting units 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. 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.

Upon
completion of our analysis, we concluded that the goodwill related to our
electronic assembly segment was fully impaired, resulting in a $3.9 million
pre-tax impairment charge. We also concluded that the goodwill related to semiconductor
segment in the amount of $569,000 was not impaired.

No
change in the amount of amortization expense related to acquired intangible
assets for either our electronic assembly or semiconductor segments is expected
in 2009.

Interest Income and Other

Interest
income and other includes interest earned on investments, realized gains and
losses from sales of investments, gains and losses associated with foreign
current transactions and in 2008, an unrealized loss on an available for sale
equity security.

Interest
income and other decreased in 2008 compared to 2007 due to lower rates of
interest earned on invested funds and lower invested balances of cash and
marketable securities resulting from significant repurchases of our common
stock in 2008 totaling $20.9 million. We recognized a $166,000 unrealized loss
on an available for sale equity security in the second quarter of 2008. The
decline in market value for this security was determined to be other than temporary
resulting in recognition of the unrealized loss in our statement of operations.
We also incurred net UK sterling related foreign currency losses of $176,000 in
2008, compared to net UK sterling related foreign currency gains of $38,000 in
2007.

Interest
income and other increased during 2007 and 2006 as the result of additional
invested funds and higher rates of interest earned on those funds.

Income Taxes

We
recorded an income tax benefit of $2.6 million in 2008, reflecting an effective
income tax rate of 28.0%, compared to an effective income tax rate of 35.2% in
2007 and 29.5% in 2006. Our effective income tax rate for 2008 was negatively
impacted by 10.5% due to the non-deductibility of a large portion of our goodwill
impairment charge. A reduction in our reserve for income tax exposures reduced
our effective rate by approximately1.1% in 2008. Our effective rate was 2.3%
higher in 2007 due to an increase in our reserve for income tax exposures.

Our
effective tax rate was higher in 2007 compared to 2006 due to elimination of
the extra territorial income exclusion in 2007 and an approximate $200,000
income tax benefit recorded in 2006 from favorable resolution of a tax
contingency accrual for prior years income taxes, resulting from the closing
of a domestic statute of limitations.

Our
2006 federal income tax return is currently being audited by the Internal
Revenue Service. We are not able to reasonably estimate the timing of any
potential payments that may result from this audit.

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

Significant
judgment is required in determining the realizability of our deferred tax
assets. The assessment of whether valuation allowances are required considers,
among other matters, the nature, frequency and severity of current and
cumulative losses, forecasts of future profitability, the duration of statutory
carry forwards periods, our experience with loss carry forwards not expiring
unused and tax planning alternatives.

Our
analysis of the need for valuation allowances considered that we have positive
cumulative profit over the past three years even without the exclusion of the
$2.9 million non-deductible goodwill impairment in 2008. We also considered the
forecasts of future profitability, the duration of statutory carry forward
periods and tax planning alternatives. We further evaluated our past cycles
which tend to average five years in length (from peak to trough) and also considered
our five year cumulative results ended December 31, 2008 which also had strong
profits. Finally, we evaluated where these cumulative three and five year
measures might be at the end of 2009 and considered other positive evidence to
conclude no incremental valuation allowance was needed at December 31, 2008.

While
we have a recent history of profits, our results have been impacted by the
recent global economic slowdown, and we incurred a loss in the United States in
2008 where most of our net deferred tax assets are recorded. Therefore,
achievement of profitability in the United States will be a significant factor
in determining our continuing ability to carry these deferred tax assets
without recording a valuation allowance.

If
future results from our operations are less than projected, a valuation
allowance may be required to reduce the deferred tax assets. If we continue to
incur losses for several more quarters, and if our operations and outlook show
no sign of improvement by as early as the second quarter of 2009, we may be
required to record as much as a full valuation allowance against virtually all
of our deferred tax assets, which could have a material impact on our results
of operations in the period in which it is recorded.

Liquidity and Capital Resources

Our
cash and cash equivalents decreased by $14.3 million during 2008 primarily
because of repurchases of $20.9 million of common stock, and purchases of $2.2
million of capital assets, partly offset by $8.6 million of maturities and
sales of marketable securities, net of purchases, $94,000 of cash generated
from operating activities and $241,000 of cash received from the exercise of
stock options and share purchases under our employee stock purchase plan. Our cash
and cash equivalents fluctuate in part because of maturities of marketable
securities, and investment of cash balances in marketable securities, 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. Combined balances of cash and
marketable securities declined by $22.8 million to $29.8 million as of December
31, 2008 from $52.6 million as of December 31, 2007.

We
generated $94,000 of cash from operations in 2008. Cash generated from
operations included our net loss of $6.7 million, which included a $3.9 million
non-cash goodwill impairment charge and other non-cash expenses totaling $3.1 million
for depreciation and amortization, provisions for inventory obsolescence and
doubtful accounts, deferred taxes, non-cash gains and losses from foreign
currency transactions, gain and loss activity from marketable securities and
stock compensation expenses.

Changes
in operating assets and liabilities include a decrease in accounts receivable
of $2.9 million. Cash generated from the reduction in accounts receivable was
mostly offset by an increase in inventories of $880,000, an increase in other
current assets of $1.3 million, a decrease in accounts payable of $441,000, and
decreases in accrued expenses and advance customer payments of $452,000. The
reduction in accounts receivable and the increase in inventory resulted from
the significant and rapid decline in our sales during the later half of 2008.
We recorded revenue of $6.7 million in the fourth quarter of 2008 compared to
$14.9 million in the fourth quarter of 2007. The increase in other current
assets reflects the anticipated tax refund we expect to receive from the carry
back of our 2008 taxable loss to earlier years. The decrease in accounts
payable resulted from a reduction in new inventory purchases late in the year,
in anticipation of the current global economic recession and its impact on near
term sales in 2009. The decrease in accrued expenses and advance customer
payments primarily resulted from the elimination of incentive bonuses in 2008
given our financial performance.

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We
generated $5.6 million of cash from operations during 2007. Cash generated from
operations included net income of $5.0 million, which included $3.5 million of
net non-cash expenses for depreciation and amortization, provisions for
inventory obsolescence, doubtful accounts and deferred taxes, foreign currency
transactions and stock compensation expense. Changes in operating assets and
liabilities included a decrease in accounts receivable of $592,000 and an
increase in advance customer payments of $718,000. This cash generated was
offset partly by increases in inventory of $3.1 million and other assets of
$484,000 and a decrease in accounts payable of $571,000. The decrease in
accounts receivable was due to a heightened emphasis on collections during the
fourth quarter of 2007. The increase in advance customer payments is due to
more sales to customers who pay prior to recognition of revenue. Inventories
were up due to a shift in the mix of products sold compared to our original
sales forecast. Other assets were higher because of more value added and income
tax refunds due from various governmental authorities. The decrease in accounts
payable is the result of the timing of inventory purchases. Inventory purchases
were down in the fourth quarter of 2007 compared to 2006, resulting in a
reduction in the accounts payable balance, as payments for inventory exceeded
new purchases.

We
generated $6.4 million of cash from investing activities in 2008 compared to
using $15.8 million of cash for investing activities in 2007. Changes in the
level of investment in marketable securities, resulting from the purchases,
sales and maturities of those securities provided $8.6 million of cash in 2008
and used $14.5 million of cash in 2007. We used $2.2 million of cash in 2008
and $1.3 million of cash in 2007 for the purchase of fixed asset and
capitalized patent costs.

We
used $20.7 million of cash for financing activities in 2008, compared to
$930,000 of cash for financing activities in 2007. We spent $20.9 million in
2008 to repurchase 2.1 million shares of our common stock. Cash spent for share
repurchases totaled $1.9 million in 2007. There are currently no share
repurchase authorizations in effect. Stock option exercises and issuance of
common stock under our Employee Stock Purchase Plan generated $241,000 of cash
in 2008 compared to $971,000 of cash in 2007.

At
December 31, 2008, 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.

Except
for our obligations under facilities leases and purchase contracts, we had no
material commitments for expenditures as of December 31, 2008. 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, cash equivalents and marketable securities totaled $29.8 million at
December 31, 2008. We believe that on-hand cash, cash equivalents and
marketable securities, coupled with anticipated future cash flow from
operations, 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, 2008, and the
effect such obligations are expected to have on our liquidity and cash flow in
future periods.

|                                            |  |       |       |                   |   |             |  |               |       |  |   |   | 
|------------------------------------------- |  | ----- | ----- | ----------------- | - | ----------- |  | ------------- | ----- |  | - | - | 
|December
 31, 2008 (in 000s)               |  | Total |       | Less Than
 1 Year |   | 1  4 Years |  | After 4 Years |      
|                                            |  |       |       |                   |   |             |  |               |       |  |   |   | 
|Contractual Obligations:                    |  |       |       |                   |   |             |  |               |       |  |   |   | 
|Non-cancelable operating
 lease obligations |  | $     | 3,600 |                   | $ | 1,556       |  | $             | 2,044 |  | $ |  | 
|Purchase obligations                        |  |       | 4,603 |                   |   | 4,603       |  |               |      |  |   |  | 
|Reserve for income taxes
 under FIN 48      |  |       | 1,578 |                   |   |            |  |               | 1,578 |  |   |  | 
|Total contractual cash obligations          |  | $     | 9,781 |                   | $ | 6,159       |  | $             | 3,622 |  | $ |  | 

We
lease a 60,217 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 for this space is
set to expire in June 2011. During 2008, we entered into a new three year
lease for a mixed office and warehouse facility in Singapore. The lease provides
for a 3 year term from May 15, 2008, annual rent of approximately $350,000 and
a two year renewal option.

Purchase
obligations are defined as agreements to purchase goods or services that are
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.

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Our
2006 federal income tax return is currently being audited by the Internal
Revenue Service. We are not able to reasonably estimate the timing of any
potential payments that may result from this audit. See Note 6 for further
discussion on income taxes.

Fair Value
Measurements

In
September 2006, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 157 Fair Value Measurements, which defines fair value, establishes
a framework for measuring fair value in generally accepted accounting
principles (GAAP), and expands disclosures about fair value measurements. SFAS
No. 157 will apply whenever another standard requires (or permits) assets or
liabilities to be measured at fair value. The standard does not expand the use
of fair value to any new circumstances, and was effective for fiscal years
beginning after December 31, 2007. The FASB has provided a one year deferral
for certain non-financial assets and liabilities. We adopted SFAS No. 157,
effective January 1, 2008, for all financial assets and liabilities that were
not deferred. The adoption of SFAS No. 157 for our financial assets and
liabilities had no impact on our financial position or results of operations.
We do not expect the standard to have a material impact on our consolidated
results of operations and financial condition when fully adopted in 2009.

In
accordance with SFAS No. 157, we value our cash equivalents and marketable
securities based on a three-level fair value hierarchy. The fair value hierarchy
gives the highest priority to quoted prices in active markets for identical
assets or liabilities (Level 1). The next highest priority is based on
quoted prices for similar assets or liabilities in active markets or quoted
prices for identical or similar assets or liabilities in non-active markets or
other observable inputs (Level 2). The lowest priority is given to unobservable
inputs (Level 3).

The
following table provides information regarding fair value measurements for our
cash equivalents and marketable securities as of December 31, 2008 according to
the three-level fair value hierarchy:

|                                       |  |                                                 |        |                                                                   |   |                                                  |  |                                              |        |  |   |   | 
|-------------------------------------- |  | ----------------------------------------------- | ------ | ----------------------------------------------------------------- | - | ------------------------------------------------ |  | -------------------------------------------- | ------ |  | - | - | 
|                                       |  | Fair Value Measurements at Reporting Date Using |       
|                                       |  |                                                 |       
|(In
 thousands)                        |  | Balance
 December 31,
 2008                     |        | Quoted Prices in
 Active Markets for
 Identical Assets
 (Level 1) |   | Significant Other
 Observable
 Inputs
 (Level 2) |  | Significant
 Unobservable
 Inputs
 (Level 3) |       
|                                       |  |                                                 |        |                                                                   |   |                                                  |  |                                              |        |  |   |   | 
|Cash equivalents                       |  | $                                               | 2,421  |                                                                   | $ |                                                 |  | $                                            | 2,421  |  | $ |  | 
|U.S. government and agency obligations |  | $                                               | 21,151 |                                                                   | $ |                                                 |  | $                                            | 21,151 |  | $ |   | 
|Corporate debt securities              |  | $                                               | 2,527  |                                                                   | $ |                                                 |  | $                                            | 2,527  |  | $ |  | 
|Asset backed securities                |  | $                                               | 1,559  |                                                                   | $ |                                                 |  | $                                            | 1,559  |  | $ |  | 
|Equity securities                      |  | $                                               | 30     |                                                                   | $ | 30                                               |  | $                                            |       |  | $ |  | 

Changes
in the fair value of these investments for the year ended December 31, 2008
resulting from our adoption of SFAS No. 157 had no impact on our consolidated
financial statements. Our foreign currency swap agreements are structured to
mature on the last day of each quarter. As a result, the fair value associated
with these agreements is inconsequential.

In
February 2007, the FASB issued Statement No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities, which provides companies with
an option to report selected financial assets and liabilities at fair value.
This standard was effective beginning after December 31, 2007. We elected
not to adopt the provisions of SFAS No. 159 in 2008.

Related Party Transactions

We
did not engage in any related party transactions during the three year period
ended December 31, 2008.

Inflation and Foreign Currency Transactions

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.

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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 near the last day of each
quarter, and are designated as cash flow hedges. At December 31, 2008, we had
one open swap agreement that was purchased on that day. As a result, any
unrealized gains or losses as of December 31, 2008 were inconsequential. During
the year ended December 31, 2008, gains from the settlement of foreign currency
swap agreements totaling $277,000 partially offset non-cash transaction losses
on the underlying inter-company balance of $453,000.

We
have sales offices located in the UK, Singapore, and China. We do not believe
that currency fluctuations will have a material impact on our consolidated
financial statements.

Recent Accounting Developments

In
December 2007, the FASB issued Statement No. 141R, Business
Combinations, which establishes principles for how an acquirer recognizes and
measures in its financial statements the identifiable assets acquired and
liabilities assumed in a business combination, recognizes and measures the
goodwill acquired in a business combination, and determines what information to
disclose to enable users of the financial statements to evaluate the nature and
financial effects of a business combination. We are required to apply this
standard prospectively to business combinations for which the acquisition date
is on or after January 1, 2009. Earlier application is not permitted.

In
March 2008, the FASB issued Statement No. 161 Disclosures about Derivative
Instruments and Hedging Activities which amends and expands Statement No. 133
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 161
requires disclosure of the fair value of derivative instruments and their gains
or losses in tabular format, information about credit-risk-related contingent
features in derivative agreements, counterparty credit risk, along with
strategies and objectives for using derivative instruments. This standard must
be applied prospectively for interim periods and fiscal years beginning after
November 15, 2008. We are presently analyzing the impact of SFAS No. 161 on our
financial statement disclosures.

Critical Accounting Policies and Estimates

Our
discussion and analysis of financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate these estimates, including those related to revenue
recognition, bad debts, warranty obligations, inventory valuation, intangible
assets, and income taxes. We base these estimates on historical experience and
on various other assumptions that we believe are 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. Our 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:

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. Sales of some surface mount technology (SMT)
products may require customer acceptance due to performance or other acceptance
criteria included in the terms of sale. For these SMT product sales, 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
undelivered elements of the arrangement is based on fair value of the element
being sold on a stand-alone basis.

Costs
related to products delivered are recognized in the period revenue is
recognized. Cost of goods sold consists primarily of direct labor, allocated
manufacturing overhead, raw materials and components and excludes amortization
of intangible assets.

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Allowance for
Doubtful Accounts.

We
maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. In making the
determination of the appropriate allowance for doubtful accounts, we consider
specific accounts, historical write-offs, changes in customer relationships and
credit worthiness and concentrations of credit risk. Specific accounts
receivable are written-off once a determination is made that the account is
uncollectible. 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 $250,000 as
of December 31, 2008.

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 $823,000 at
December 31, 2008.

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, 2008, we had a reserve
for obsolete and excess inventory of $1.1 million.

Valuation of
Intangible and Long-Lived Assets.

We
assess the impairment of identifiable intangible assets, long lived assets and
related goodwill whenever events or changes in circumstances indicate the
carrying value may not be recoverable. Factors we consider important, which
could trigger an impairment review include the following:

| |   |                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------
| |  | Significant
 under-performance relative to expected historical or projected future
 operating results.                                
| |  | Significant
 changes in the manner of our use of the acquired assets or the strategy for
 our overall business.                       
| |  | Significant
 negative industry or economic trends.                                                                                    
| |  | Significant
 decline in our stock price for a sustained period; and our 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 for each of our reporting
units by estimating their fair value, utilizing a discounted cash flow
methodology to determine 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.

In
the fourth quarter of 2008, we reviewed our identifiable intangible assets,
long-lived assets and goodwill for impairment because facts and circumstances
similar to those noted above indicated that the assets might be impaired,
including weakness in the United States capital markets caused by the deepening
global recession, and our reduced level of profitability, causing a significant
drop in our market capitalization.

An
impairment loss for our identifiable intangible and long lived assets would be
recognized when future undiscounted cash flows expected to result from use of
the asset and eventual disposition are less than the carrying amount. As of
December 31, 2008, we projected our future undiscounted cash flows associated
with these assets and concluded that there was no impairment.

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In
evaluating whether goodwill was impaired, we compared the fair value of our two
reporting units to which goodwill is assigned to their carrying value (Step 1of
the impairment test). In calculating fair value, we used the income approach.
The income approach is a valuation technique under which we estimate future
cash flows using the reporting units financial forecasts. Future estimated
cash flows are discounted to their present value to calculate fair value. The
summation of our reporting units fair values is compared and reconciled to our
market capitalization as of the date of our impairment test. In the situation where
a reporting units carrying amount exceeds its fair value, the amount of the
impairment loss must be measured. The measurement of the impairment (Step 2 of the impairment test) is calculated by
determining the implied fair value of a reporting units goodwill. In
calculating the implied fair value of goodwill, the fair value of the reporting
unit is allocated to all other assets and liabilities of that unit based on
their fair values. The excess of the fair value of a reporting unit over the
amount assigned to its other assets and liabilities is the implied fair value
of goodwill. The goodwill impairment is measured as the excess of the carrying
amount of goodwill over its implied fair value.

In
determining the fair value of our reporting units under the income approach,
our expected cash flows are affected by various assumptions. Fair value on a
discounted cash flow basis uses forecasts over a 3 year period with an
estimation of residual growth rates thereafter. We use our business plans and projections
as the basis for expected future cash flows. The significant assumptions
incorporated in these forecasts for the most recent goodwill impairment tests
include our expectations regarding revenue during the 3 year period, a 7
percent terminal growth rate and a 25% discount rate for both our electronic
assembly and semiconductor reporting units. The selection of discount rates may
have a significant impact on the determination of fair value. However, for the
2008 test, an increase or decrease of one percent in the discount rate would
have had no impact on the impairment recorded for our electronic assembly
reporting unit.

For
purposes of our goodwill impairment test, we reconciled the fair value for each
of our reporting units to our overall fair value. The publicly traded market
price of our common stock and a control premium of 30 percent was used in our
determination of fair value, which represents the value an investor would pay
above minority interest transaction prices in order to obtain a controlling
interest in the company. The control premium was determined by a review of
premiums paid for similar companies over the past five years. While the control
premium is a significant assumption in determining our overall fair value, it
had a minimal impact on the determination of goodwill impairment in 2008. An
increase in the assumed control premium by five percent to 35 percent would
have had no impact on the impairment recorded for our electronic assembly
reporting unit.

Our
remaining goodwill at December 31, 2008, in the amount of $569,000 relates to
our semiconductor reporting unit. Our recent analyses indicate that this
goodwill is not impaired. However, our conclusion could change in the future,
if our assumptions about future economic conditions, revenue growth or
profitability change. Any resulting impairment charge could have a material
effect on our financial position and results of operations in the future.

Income Taxes.

Significant
judgment is required in determining worldwide income tax expense based upon tax
laws in the various jurisdictions in which we operate. We have established
reserves for uncertain tax positions by applying the more likely than not
criteria of FIN 48, under which the recognition threshold is met when an
entity concludes that a tax position, based solely on its technical merits, is
more likely than not to be sustained upon examination by the relevant tax
authority. All tax positions are analyzed periodically and adjustments are made
as events occur that warrant modification, such as the completion of audits or
the expiration of statutes of limitations, which may result in future charges
or credits to income tax expense.

As
part of the process of preparing consolidated financial statements, management
is required to estimate income taxes in each of the jurisdictions in which we
operate. This process involves estimating the current tax liability, as well as
assessing temporary differences arising from the different treatment of items
for financial statement and tax purposes. These differences result in deferred
tax assets and liabilities, which are recorded on our balance sheet.

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

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Significant
judgment is required in determining the realizability of our deferred tax
assets. The assessment of whether valuation allowances are required considers,
among other matters, the nature, frequency and severity of current and
cumulative losses, forecasts of future profitability, the duration of statutory
carry forward periods, our experience with loss carry forwards not expiring
unused and tax planning alternatives.

Our
analysis of the need for valuation allowances considered that we have positive
cumulative profit over the past three years even without the exclusion of the
$2.9 million non-deductible goodwill impairment in 2008. We also considered the
forecasts of future profitability, the duration of statutory carry forward
periods and tax planning alternatives. We further evaluated our past cycles
which tend to average five years in length (from peak to trough) and also
considered our five year cumulative results ended December 31, 2008 which also
had strong profits. Finally, we evaluated where these cumulative three and five
year measures might be at the end of 2009 and considered other positive
evidence to conclude no incremental valuation allowance was needed at December
31, 2008.

While
we have a recent history of profits, our results have been impacted by the
recent global economic slowdown, and we incurred a loss in the United States in
2008 where most of our net deferred tax assets are recorded. Therefore,
achievement of profitability in the United States will be a significant factor
in determining our continuing ability to carry these deferred tax assets
without recording a valuation allowance.

If
future results from our operations are less than projected, a valuation
allowance may be required to reduce the deferred tax assets. If we continue to
incur losses for several more quarters, and if our operations and outlook show
no sign of improvement by as early as the second quarter of 2009, we may be
required to record as much as a full valuation allowance against virtually all
of our deferred tax assets, which could have a material impact on our results
of operations in the period in which it is recorded.

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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 our management. The investment policy dictates that marketable securities
consist of U.S. Government or U.S. Government agency securities, various tax
exempt securities or certain approved corporate instruments with effective
maturities of five years or less and an average portfolio maturity of not more
that 18 months. The policy also provides for investment in certain specified
marketable equity securities. As of December 31, 2008 our portfolio of
marketable securities had a weighted average maturity of 1.2 years. 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 decrease the market value of our marketable securities by approximately $325,000.
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 near the last day of each
quarter, and are designated as cash flow hedges. At December 31, 2008, we had
one open swap agreement that was purchased on that day. As a result, any
unrealized gains or losses as of December 31, 2008 were inconsequential. During
the year ended December 31, 2008, gains from the settlement of foreign currency
swap agreements totaling $277,000 partially offset non-cash transaction losses
on the underlying inter-company balance of $453,000.

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. We
minimize such risk by limiting our counter-parties to major financial
institutions. We do not expect material losses as a result of defaults by other
parties.

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ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED BALANCE SHEETS
CYBEROPTICS CORPORATION

|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------ | ---- | - | ------ | -
|                                                                                                                                                                                          |  | As of December 31, |       
|(In
 thousands, except share information)                                                                                                                                                 |  | 2008               |        | 2007 |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|ASSETS                                                                                                                                                                                    |  |                    |        |      |   |        |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|Cash and cash equivalents                                                                                                                                                                 |  | $                  | 4,516  |      | $ | 18,864 |  
|Marketable securities                                                                                                                                                                     |  |                    | 10,433 |      |   | 11,953 |  
|Accounts receivable, less allowance for doubtful accounts of $250 at
 December 31, 2008 and $310 at December 31, 2007                                                                     |  |                    | 6,951  |      |   | 9,781  |  
|Inventories                                                                                                                                                                               |  |                    | 9,869  |      |   | 10,640 |  
|Other current assets                                                                                                                                                                      |  |                    | 2,579  |      |   | 1,466  |  
|Deferred tax assets, net                                                                                                                                                                  |  |                    | 2,604  |      |   | 2,575  |  
|Total current assets                                                                                                                                                                      |  |                    | 36,952 |      |   | 55,279 |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|Marketable securities                                                                                                                                                                     |  |                    | 14,834 |      |   | 21,801 |  
|Equipment and leasehold improvements, net                                                                                                                                                 |  |                    | 2,615  |      |   | 1,944  |  
|Intangible and other assets, net                                                                                                                                                          |  |                    | 956    |      |   | 1,069  |  
|Goodwill                                                                                                                                                                                  |  |                    | 569    |      |   | 5,207  |  
|Other assets                                                                                                                                                                              |  |                    | 189    |      |   |       |  
|Deferred tax assets, net                                                                                                                                                                  |  |                    | 2,834  |      |   | 1,739  |  
|Total assets                                                                                                                                                                              |  | $                  | 58,949 |      | $ | 87,039 |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                      |  |                    |        |      |   |        |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|Accounts payable                                                                                                                                                                          |  | $                  | 2,753  |      | $ | 3,209  |  
|Advance customer payments                                                                                                                                                                 |  |                    | 684    |      |   | 794    |  
|Accrued expenses                                                                                                                                                                          |  |                    | 3,054  |      |   | 3,337  |  
|Total current liabilities                                                                                                                                                                 |  |                    | 6,491  |      |   | 7,340  |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|Reserve for income taxes                                                                                                                                                                  |  |                    | 1,578  |      |   | 1,583  |  
|Total liabilities                                                                                                                                                                         |  |                    | 8,069  |      |   | 8,923  |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|Commitments and contingencies (notes 7 and 14)                                                                                                                                            |  |                    |        |      |   |        |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|Stockholders equity:                                                                                                                                                                     |  |                    |        |      |   |        |  
|Preferred stock, no par value, 5,000,000 shares authorized, none
 outstanding                                                                                                             |  |                    |       |      |   |       |  
|Common stock, no par value, 37,500,000 shares authorized, 6,769,295
 shares issued and outstanding at December 31, 2008 and 8,793,059 shares
 issued and outstanding at December 31, 2007 |  |                    | 29,156 |      |   | 49,303 |  
|Accumulated other comprehensive loss                                                                                                                                                      |  |                    | (530   | )    |   | (112   | )
|Retained earnings                                                                                                                                                                         |  |                    | 22,254 |      |   | 28,925 |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|Total stockholders equity                                                                                                                                                                |  |                    | 50,880 |      |   | 78,116 |  
|                                                                                                                                                                                          |  |                    |        |      |   |        |  
|Total liabilities and stockholders equity                                                                                                                                                |  | $                  | 58,949 |      | $ | 87,039 |  

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

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CONSOLIDATED STATEMENTS OF OPERATIONS
CYBEROPTICS CORPORATION

|                                                                    |  |                         |         |      |   |        |  |   |        | 
|------------------------------------------------------------------- |  | ----------------------- | ------- | ---- | - | ------ |  | - | ------ | 
|                                                                    |  | Year ended December 31, |        
|(In
 thousands, except per share amounts)                           |  | 2008                    |         | 2007 |   | 2006   | 
|Revenues                                                            |  | $                       | 45,452  |      | $ | 58,776 |  | $ | 57,089 | 
|Cost of revenues                                                    |  |                         | 26,387  |      |   | 28,529 |  |   | 27,188 | 
|                                                                    |  |                         |         |      |   |        |  |   |        | 
|Gross margin                                                        |  |                         | 19,065  |      |   | 30,247 |  |   | 29,901 | 
|                                                                    |  |                         |         |      |   |        |  |   |        | 
|Research and development expenses                                   |  |                         | 10,406  |      |   | 9,824  |  |   | 8,112  | 
|Selling, general and administrative expenses                        |  |                         | 14,229  |      |   | 14,701 |  |   | 14,077 | 
|Amortization of intangibles                                         |  |                         | 182     |      |   | 182    |  |   | 591    | 
|Severance and recruitment                                           |  |                         | 770     |      |   |       |  |   |       | 
|Goodwill impairment                                                 |  |                         | 3,941   |      |   |       |  |   |       | 
|                                                                    |  |                         |         |      |   |        |  |   |        | 
|Income (loss) from operations                                       |  |                         | (10,463 | )    |   | 5,540  |  |   | 7,121  | 
|                                                                    |  |                         |         |      |   |        |  |   |        | 
|Interest income and other                                           |  |                         | 1,193   |      |   | 2,214  |  |   | 1,943  | 
|                                                                    |  |                         |         |      |   |        |  |   |        | 
|Income (loss) before income taxes                                   |  |                         | (9,270  | )    |   | 7,754  |  |   | 9,064  | 
|                                                                    |  |                         |         |      |   |        |  |   |        | 
|Income tax provision (benefit)                                      |  |                         | (2,599  | )    |   | 2,726  |  |   | 2,674  | 
|                                                                    |  |                         |         |      |   |        |  |   |        | 
|Net income (loss)                                                   |  | $                       | (6,671  | )    | $ | 5,028  |  | $ | 6,390  | 
|                                                                    |  |                         |         |      |   |        |  |   |        | 
|Net income (loss) per share  Basic                                 |  | $                       | (0.87   | )    | $ | 0.57   |  | $ | 0.71   | 
|Net income (loss) per share  Diluted                               |  | $                       | (0.87   | )    | $ | 0.56   |  | $ | 0.70   | 
|                                                                    |  |                         |         |      |   |        |  |   |        | 
|Weighted average shares outstanding  Basic                         |  |                         | 7,703   |      |   | 8,897  |  |   | 8,991  | 
|Weighted average and common equivalent shares outstanding 
Diluted |  |                         | 7,703   |      |   | 8,975  |  |   | 9,081  | 

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

36

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Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS
CYBEROPTICS CORPORATION

|                                                                                   |  |                         |         |      |   |         |   |   |         |  
|---------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- | - | ------- | - | - | ------- | -
|                                                                                   |  | Year ended December 31, |        
|(In
 thousands)                                                                    |  | 2008                    |         | 2007 |   | 2006    |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                              |  |                         |         |      |   |         |   |   |         |  
|Net income (loss)                                                                  |  | $                       | (6,671  | )    | $ | 5,028   |   | $ | 6,390   |  
|Adjustments to reconcile net income to net cash provided by operating
 activities: |  |                         |         |      |   |         |   |   |         |  
|Depreciation and amortization                                                      |  |                         | 2,246   |      |   | 1,907   |   |   | 1,884   |  
|Provision for doubtful accounts                                                    |  |                         | (34     | )    |   | 98      |   |   | 38      |  
|Provision for inventory obsolescence                                               |  |                         | 1,007   |      |   | 253     |   |   | 373     |  
|Deferred income tax provision (benefit)                                            |  |                         | (1,349  | )    |   | 604     |   |   | 735     |  
|Foreign currency transaction (gains) losses                                        |  |                         | 485     |      |   | (22     | ) |   | (294    | )
|Excess tax benefits from equity compensation plans                                 |  |                         | (2      | )    |   | (33     | ) |   | (185    | )
|Stock compensation expense                                                         |  |                         | 580     |      |   | 693     |   |   | 778     |  
|Unrealized loss on available for sale equity security                              |  |                         | 166     |      |   |        |   |   |        |  
|Realized gains on available for sale equity security                               |  |                         | (40     | )    |   |        |   |   |        |  
|Goodwill impairment                                                                |  |                         | 3,941   |      |   |        |   |   |        |  
|Changes in operating assets and liabilities:                                       |  |                         |         |      |   |         |   |   |         |  
|Accounts receivable                                                                |  |                         | 2,864   |      |   | 592     |   |   | (734    | )
|Inventories                                                                        |  |                         | (880    | )    |   | (3,115  | ) |   | (1,573  | )
|Other assets                                                                       |  |                         | (1,326  | )    |   | (484    | ) |   | 79      |  
|Accounts payable                                                                   |  |                         | (441    | )    |   | (571    | ) |   | 1,143   |  
|Advance customer payments                                                          |  |                         | (110    | )    |   | 718     |   |   | (352    | )
|Accrued expenses and other liabilities                                             |  |                         | (342    | )    |   | (111    | ) |   | 1,527   |  
|Net cash provided by operating activities                                          |  |                         | 94      |      |   | 5,557   |   |   | 9,809   |  
|                                                                                   |  |                         |         |      |   |         |   |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                              |  |                         |         |      |   |         |   |   |         |  
|Proceeds from maturities of available for sale marketable
securities               |  |                         | 15,199  |      |   | 17,591  |   |   | 16,670  |  
|Proceeds from sales of available for sales marketable
securities                   |  |                         | 6,860   |      |   |        |   |   |        |  
|Purchases of available for sale marketable securities                              |  |                         | (13,502 | )    |   | (32,064 | ) |   | (13,983 | )
|Additions to equipment and leasehold improvements                                  |  |                         | (1,834  | )    |   | (1,017  | ) |   | (1,131  | )
|Additions to patents                                                               |  |                         | (343    | )    |   | (279    | ) |   | (266    | )
|Net cash provided (used) by investing activities                                   |  |                         | 6,380   |      |   | (15,769 | ) |   | 1,290   |  
|                                                                                   |  |                         |         |      |   |         |   |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                              |  |                         |         |      |   |         |   |   |         |  
|Proceeds from exercise of stock options                                            |  |                         | 12      |      |   | 632     |   |   | 1,459   |  
|Excess tax benefits from equity compensation plans                                 |  |                         | 2       |      |   | 33      |   |   | 185     |  
|Proceeds from issuance of common stock under Employee Stock Purchase
 Plan         |  |                         | 227     |      |   | 306     |   |   | 326     |  
|Repurchase of common stock                                                         |  |                         | (20,949 | )    |   | (1,901  | ) |   | (2,579  | )
|Net cash used by financing activities                                              |  |                         | (20,708 | )    |   | (930    | ) |   | (609    | )
|                                                                                   |  |                         |         |      |   |         |   |   |         |  
|Effects of exchange rate changes on cash and cash
equivalents                      |  |                         | (114    | )    |   | (50     | ) |   | (26     | )
|                                                                                   |  |                         |         |      |   |         |   |   |         |  
|Net increase (decrease) in cash and cash equivalents                               |  |                         | (14,348 | )    |   | (11,192 | ) |   | 10,464  |  
|                                                                                   |  |                         |         |      |   |         |   |   |         |  
|Cash and cash equivalents  beginning of year                                      |  |                         | 18,864  |      |   | 30,056  |   |   | 19,592  |  
|                                                                                   |  |                         |         |      |   |         |   |   |         |  
|Cash and cash equivalents  end of year                                            |  | $                       | 4,516   |      | $ | 18,864  |   | $ | 30,056  |  

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

37

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Table of Contents

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND
COMPREHENSIVE INCOME
CYBEROPTICS CORPORATION


|                                                                                                                                      |  |              |        |                    |   |                                                  |   |   |                              |   |   |        |   |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ------------------ | - | ------------------------------------------------ | - | - | ---------------------------- | - | - | ------ | - | - | ------- | -
|                                                                                                                                      |  |              |        |                    |   | Accumulated
 Other
 Comprehensive
 Income (Loss) |   |   |                              |   |  
|                                                                                                                                      |  |              |        |                    |   |                                                  |   |   | Total
 Stockholders
 Equity |  
|                                                                                                                                      |  | Common Stock |        |                    |   |                                                  |  
|                                                                                                                                      |  |              |        | Retained
 Earnings |   |                                                 
|(In thousands)                                                                                                                        |  | Shares       |        | Amount             |   |                                                  |   |  
|BALANCE, DECEMBER 31, 2005                                                                                                            |  |              | 8,899  |                    | $ | 49,351                                           |   | $ | (700                         | ) | $ | 17,539 |   | $ | 66,190  |  
|                                                                                                                                      |  |              |        |                    |   |                                                  |   |   |                              |   |   |        |   |   |         |  
|Excess tax benefit from exercise of stock options                                                                                     |  |              |       |                    |   | 185                                              |   |   |                             |   |   |       |   |   | 185     |  
|Exercise of stock options net of shares exchanged                                                                                     |  |              | 144    |                    |   | 1,459                                            |   |   |                             |   |   |       |   |   | 1,459   |  
|Stock compensation                                                                                                                    |  |              |       |                    |   | 802                                              |   |   |                             |   |   |       |   |   | 802     |  
|Issuance of common stock under Employee Stock Purchase Plan                                                                           |  |              | 29     |                    |   | 326                                              |   |   |                             |   |   |       |   |   | 326     |  
|Repurchase of common stock                                                                                                            |  |              | (210   | )                  |   | (2,579                                           | ) |   |                             |   |   |       |   |   | (2,579  | )
|Comprehensive income:                                                                                                                 |  |              |        |                    |   |                                                  |   |   |                              |   |   |        |   |   |         |  
|Market value adjustments of marketable securities                                                                                     |  |              |       |                    |   |                                                 |   |   | 58                           |   |   |       |   |   | 58      |  
|Cumulative translation adjustment                                                                                                     |  |              |       |                    |   |                                                 |   |   | 189                          |   |   |       |   |   | 189     |  
|Net income                                                                                                                            |  |              |       |                    |   |                                                 |   |   |                             |   |   | 6,390  |   |   | 6,390   |  
|Total comprehensive income                                                                                                            |  |              |       |                    |   |                                                 |   |   |                             |   |   |       |   |   | 6,637   |  
|BALANCE, DECEMBER 31, 2006                                                                                                            |  |              | 8,862  |                    | $ | 49,544                                           |   | $ | (453                         | ) | $ | 23,929 |   | $ | 73,020  |  
|                                                                                                                                      |  |              |        |                    |   |                                                  |   |   |                              |   |   |        |   |   |         |  
|Reduction in retained earnings related to the adoption of FIN
48                                                                      |  |              |       |                    |   |                                                 |   |   |                             |   |   | (32    | ) |   | (32     | )
|Excess tax benefit from exercise of stock options                                                                                     |  |              |       |                    |   | 29                                               |   |   |                             |   |   |       |   |   | 29      |  
|Exercise of stock options and vesting of restricted stock units, net
 of shares exchanged                                             |  |              | 60     |                    |   | 632                                              |   |   |                             |   |   |       |   |   | 632     |  
|Stock compensation                                                                                                                    |  |              |       |                    |   | 693                                              |   |   |                             |   |   |       |   |   | 693     |  
|Issuance of common stock under Employee Stock Purchase Plan                                                                           |  |              | 29     |                    |   | 306                                              |   |   |                             |   |   |       |   |   | 306     |  
|Repurchase of common stock                                                                                                            |  |              | (158   | )                  |   | (1,901                                           | ) |   |                             |   |   |       |   |   | (1,901  | )
|Comprehensive income:                                                                                                                 |  |              |        |                    |   |                                                  |   |   |                              |   |   |        |   |   |         |  
|Market value adjustments of marketable securities                                                                                     |  |              |       |                    |   |                                                 |   |   | 268                          |   |   |       |   |   | 268     |  
|Cumulative translation adjustment                                                                                                     |  |              |       |                    |   |                                                 |   |   | 73                           |   |   |       |   |   | 73      |  
|Net income                                                                                                                            |  |              |       |                    |   |                                                 |   |   |                             |   |   | 5,028  |   |   | 5,028   |  
|Total comprehensive income                                                                                                            |  |              |       |                    |   |                                                 |   |   |                             |   |   |       |   |   | 5,369   |  
|BALANCE, DECEMBER 31, 2007                                                                                                            |  |              | 8,793  |                    | $ | 49,303                                           |   | $ | (112                         | ) | $ | 28,925 |   | $ | 78,116  |  
|                                                                                                                                      |  |              |        |                    |   |                                                  |   |   |                              |   |   |        |   |   |         |  
|Excess tax benefit from exercise of stock options, net of deferred
 tax shortfall related to stock options and restricted stock units |  |              |       |                    |   | (17                                              | ) |   |                             |   |   |       |   |   | (17     | )
|Exercise of stock options, vesting of restricted stock units, net of
 shares exchanged as payment                                     |  |              | 7      |                    |   | 12                                               |   |   |                             |   |   |       |   |   | 12      |  
|Share issuances to board members and officers for compensation
 purposes                                                              |  |              | 23     |                    |   | 127                                              |   |   |                             |   |   |       |   |   | 127     |  
|Stock compensation                                                                                                                    |  |              |       |                    |   | 453                                              |   |   |                             |   |   |       |   |   | 453     |  
|Issuance of common stock under Employee Stock Purchase Plan                                                                           |  |              | 28     |                    |   | 227                                              |   |   |                             |   |   |       |   |   | 227     |  
|Repurchase of common stock                                                                                                            |  |              | (2,082 | )                  |   | (20,949                                          | ) |   |                             |   |   |       |   |   | (20,949 | )
|Comprehensive income:                                                                                                                 |  |              |        |                    |   |                                                  |   |   |                              |   |   |        |   |   |         |  
|Market value adjustments of marketable securities, net of
 reclassification adjustment                                                |  |              |       |                    |   |                                                 |   |   | 120                          |   |   |       |   |   | 120     |  
|Cumulative translation adjustment                                                                                                     |  |              |       |                    |   |                                                 |   |   | (538                         | ) |   |       |   |   | (538    | )
|Net loss                                                                                                                              |  |              |       |                    |   |                                                 |   |   |                             |   |   | (6,671 | ) |   | (6,671  | )
|Total comprehensive loss                                                                                                              |  |              |       |                    |   |                                                 |   |   |                             |   |   |       |   |   | (7,089  | )
|BALANCE, DECEMBER 31, 2008                                                                                                            |  |              | 6,769  |                    | $ | 29,156                                           |   | $ | (530                         | ) | $ | 22,254 |   | $ | 50,880  |  

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE
CONSOLIDATED FINANCIALSTATEMENTS.

38

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Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
CYBEROPTICS CORPORATION

NOTE 1  BUSINESS DESCRIPTION AND SIGNIFICANT
ACCOUNTING POLICIES

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Description of Business                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|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 yield improvement, and the placement and transport of wafers
 during semiconductor fabrication.                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|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, corporate debt
 instruments and U.S. government backed obligations.                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Marketable Securities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|All
 marketable securities are classified as available for sale and consist of
 U.S. government backed obligations, corporate debt instruments, asset backed
 securities or equity securities. Marketable securities are classified as
 short-term or long-term in the balance sheet based on their maturity date and
 expectations regarding sales.                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Available
 for sale securities are carried at fair value, with unrealized gains and
 losses reported as a separate component of stockholders equity until
 realized, or an other-than temporary impairment is recognized in current
 operations. These fair values are primarily 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 also determined by specific identification.                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|We monitor
 the carrying value of our investments compared to their fair value to
 determine whether an other-than-temporary impairment has occurred. If a
 decline in fair value is determined to be other-than-temporary, an impairment
 charge related to that specific investment is recorded in current operations.                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|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.                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Allowance for Doubtful Accounts                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Allowances
 for doubtful accounts are maintained for estimated losses resulting from the
 inability of our customers to make required payments. In making the
 determination of the appropriate allowance for doubtful accounts, we consider
 specific accounts, historical write-offs, changes in customer relationships
 and credit worthiness and concentrations of credit risk. Specific accounts
 receivable are written-off once a determination is made that the account is
 uncollectible.                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|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.

39

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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Intangible Assets and Goodwill                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Identified
 intangible assets (excluding goodwill) primarily developed technology and
 trademarks are being amortized on a straight-line basis over periods ranging
 from four to ten years, based upon their estimated life. The straight-line
 method of amortization reflects an appropriate allocation of the cost of
 intangible assets to earnings in proportion to the economic benefits obtained
 by us in each reporting period.                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Intangible
 and other long lived assets are reviewed for impairment when events or
 changes in circumstances indicate that the carrying amount of the assets may
 not be recoverable. An impairment loss would be recognized when future
 undiscounted cash flows expected to result from use of the asset and eventual
 disposition are less than the carrying amount. We periodically assess the
 potential impairment of our intangible and other long-lived assets based on
 anticipated undiscounted cash flows.                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Goodwill
 represents the excess of purchase price over the fair value of net assets
 acquired in a business combination. We evaluate the carrying value of
 goodwill for our reporting units 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 comparing the fair
 value of each reporting unit, as determined based on their future estimated
 discounted cash flows, to the carrying value for each reporting unit.                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Patents                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Patents
 consist of legal and patent registration costs for protection of our
 proprietary sensor technology. We amortize patent costs on a straight-line
 basis over a three year period, based upon their estimated life.                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|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. Sales of some surface mount technology
 (SMT) products may require customer acceptance due to performance or other
 acceptance criteria included in the terms of sale. For these SMT product
 sales, 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
 undelivered elements of the arrangement is based on fair value of the element
 being sold on a stand-alone basis.                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Costs
 related to products delivered are recognized in the period revenue is recognized.
 Cost of goods sold consists primarily of direct labor, manufacturing
 overhead, raw materials and components and excludes amortization of
 intangible assets.                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|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. Foreign currency transaction gains and losses are
 included as a component of net income (loss).
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|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. All other R&D costs are
 expensed as incurred. Research and development expenses consist primarily of
 salaries, project materials, contract labor and other costs associated with
 ongoing product development and enhancement efforts.                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Advertising Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|We expense
 all advertising costs as incurred, and the amounts were not material for all
 periods presented.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|In July
 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
 Income Taxes. FIN 48 supersedes SFAS No. 5, Accounting for Contingencies,
 as it relates to income tax liabilities and lowers the minimum threshold a
 tax position is required to meet before being recognized in the financial
 statements from probable to more likely than not (i.e., a likelihood of
 occurrence greater than fifty percent). Under FIN 48, the recognition
 threshold is met when an entity concludes that a tax position, based solely
 on its technical merits, is more likely than not to be sustained upon
 examination by the relevant taxing authority. Those tax positions failing to
 qualify for initial recognition are recognized in the first interim period in
 which they meet the more likely than not standard, or are resolved through
 negotiation or litigation with the taxing authority, or upon expiration of
 the statute of limitations. De-recognition of a tax position that was
 previously recognized occurs when an entity subsequently determines that a
 tax position no longer meets the more likely than not threshold of being
 sustained.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|We adopted
 FIN 48 on January 1, 2007, at which time differences between the amounts
 recognized in the financial statements prior to the adoption of FIN 48 and
 the amounts recognized after adoption were accounted for as a cumulative
 effect adjustment recorded to the beginning balance of retained earnings.
 Under FIN 48, only the portion of the liability that is expected to be paid
 within one year is classified as a current liability. As a result,
 liabilities expected to be resolved without the payment of cash (e.g.
 resolution due to the expiration of the statute of limitations) or are not
 expected to be paid within one year are not classified as current. It is our
 policy to record estimated interest and penalties as income tax expense and
 tax credits as a reduction in income tax expense.                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|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,
 excluding changes in deferred tax assets recorded to equity and goodwill.
 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 (Loss) 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. Net
 income per diluted share is computed by dividing net income by the weighted
 average number of common and common equivalent shares outstanding during the
 period. Common equivalent shares consist of common shares to be issued upon
 exercise of stock options, restricted stock units and from participation in
 our employee stock purchase plan, as calculated using the treasury stock
 method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|No common
 equivalent shares were included in the calculation of net loss per diluted
 share for the year ended December 31, 2008 due to their anti-dilutive effect.
 The calculation of net income per diluted share includes 78,000 common
 equivalents for the year ended December 31, 2007 and 90,000 common
 equivalents for the year ended December 31, 2006. The calculation of net
 income (loss) per diluted share excludes potentially dilutive shares of
 813,000 for the year ended December 31, 2008, 304,000 for the year ended
 December 31, 2007 and 260,000 for the year ended December 31, 2006, because
 their effect would be anti-dilutive.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Stock-Based Compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|Effective
 January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment, applying
 the modified prospective method. This statement requires all equity-based
 payments to employees, including grants of employee stock options, to be
 recognized in the consolidated statement of operations based on the grant
 date fair value of the award.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Under the
 modified prospective method, we are required to record equity-based
 compensation expense for all awards granted after the date of adoption, and
 for all unvested shares granted prior to the date of adoption. We utilize the
 straight-line method of expense recognition over the awards service period for
 our graded vesting options. The fair values of stock options granted before
 and after adoption of SFAS No. 123(R) have been determined using the
 Black-Scholes model. The compensation expense recognized for all equity based
 awards is net of estimated forfeitures. We have classified equity based
 compensation within our statement of operations in the same manner as our
 cash based employee compensation costs. We elected to use the alternative
 transition guidance known as the short-cut method provided by FASB Staff
 Position No. FAS 123(R)-3 to determine our pool of windfall tax benefits at
 adoption of SFAS No. 123(R).                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|See Note 3
 to the Consolidated Financial Statements for additional information on
 stock-based compensation under SFAS No. 123(R).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Recent Accounting Developments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|In December
 2007, the FASB issued Statement No. 141R, Business Combinations, which
 establishes principles for how an acquirer recognizes and measures in its
 financial statements the identifiable assets acquired and liabilities assumed
 in a business combination, recognizes and measures the goodwill acquired in a
 business combination, and determines what information to disclose to enable
 users of the financial statements to evaluate the nature and financial
 effects of a business combination. We are required to apply this standard
 prospectively to business combinations for which the acquisition date is on
 or after January 1, 2009. Earlier application is not permitted.                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|In March
 2008, the FASB issued Statement No. 161 Disclosures about Derivative
 Instruments and Hedging Activities which amends and expands Statement No.
 133 Accounting for Derivative Instruments and Hedging Activities. SFAS No.
 161 requires disclosure of the fair value of derivative instruments and their
 gains or losses in tabular format, information about credit-risk-related
 contingent features in derivative agreements, counterparty credit risk, along
 with strategies and objectives for using derivative instruments. This
 standard must be applied prospectively for interim periods and fiscal years
 beginning after November 15, 2008. We are presently analyzing the impact of
 SFAS No. 161 on our financial statement disclosures.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Comprehensive Income (Loss)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Components
 of comprehensive income (loss) include net income (loss), foreign-currency
 translation adjustments, unrealized gains on available-for-sale securities
 and reclassification adjustments. At December 31, 2008 and 2007, components
 of accumulated other comprehensive loss is as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

|                                                                                                       |  |                                |      |                                  |   |                                   |  |   |      |  
|------------------------------------------------------------------------------------------------------ |  | ------------------------------ | ---- | -------------------------------- | - | --------------------------------- |  | - | ---- | -
|(In thousands)                                                                                         |  | Foreign
 Currency
 Translation |      | Net UnrealizedGains onSecurities |   | AccumulatedOtherComprehensiveLoss | 
|                                                                                                       |  |                                |      |                                  |   |                                   |  |   |      |  
|Balance
 December 31, 2007                                                                             |  | $                              | (368 | )                                | $ | 256                               |  | $ | (112 | )
|Unrealized gains on investments, net of tax
 of $20                                                    |  |                                |     |                                  |   | 38                                |  |   | 38   |  
|Reclassification adjustment for realized
 gains and impairment losses on securities, net of tax of $44 |  |                                |     |                                  |   | 82                                |  |   | 82   |  
|Translation adjustments                                                                                |  |                                | (538 | )                                |   |                                  |  |   | (538 | )
|Other
 comprehensive loss                                                                              |  |                                | (538 | )                                |   | 120                               |  |   | (418 | )
|                                                                                                       |  |                                |      |                                  |   |                                   |  |   |      |  
|Balance
 December 31, 2008                                                                             |  | $                              | (906 | )                                | $ | 376                               |  | $ | (530 | )

Net unrealized
gains on securities include deferred tax liabilities of $205,000 at December
31, 2008 and $141,000 at December 31, 2007.

NOTE 2  MARKETABLE SECURITIES

Investments in
marketable securities classified as available for sale with a carrying amount
of $25,267,000 at December 31, 2008 and $33,754,000 at December 31, 2007
consist of the following:

|                                                       |  |                   |        |                   |  |                    |  |                 |     |   |  |        | 
|------------------------------------------------------ |  | ----------------- | ------ | ----------------- |  | ------------------ |  | --------------- | --- | - |  | ------ | 
|                                                       |  | December 31, 2008 |       
|                                                       |  |                   |       
|(In thousands)                                         |  | Cost              |        | Unrealized
 Gains |  | Unrealized
 Losses |  | Recorded
 Basis |    
|                                                       |  |                   |        |                   |  |                    |  |                 |     |   |  |        | 
|U.S. government and agency obligations                 |  | $                 | 8,793  |                   |  | 130                |  |                 |    |   |  | 8,923  | 
|Corporate debt securities and certificates
 of deposit |  |                   | 1,500  |                   |  | 10                 |  |                 |    |   |  | 1,510  | 
|Marketable securities  short term                     |  | $                 | 10,293 |                   |  | 140                |  |                 |    |   |  | 10,433 | 
|                                                       |  |                   |        |                   |  |                    |  |                 |     |   |  |        | 
|U.S. government and agency obligations                 |  | $                 | 11,739 |                   |  | 489                |  |                 |    |   |  | 12,228 | 
|Corporate debt securities                              |  |                   | 1,010  |                   |  | 9                  |  |                 | (2  | ) |  | 1,017  | 
|Asset backed securities                                |  |                   | 1,560  |                   |  | 9                  |  |                 | (10 | ) |  | 1,559  | 
|Equity securities                                      |  |                   | 84     |                   |  |                   |  |                 | (54 | ) |  | 30     | 
|Marketable securities  long term                      |  | $                 | 14,393 |                   |  | 507                |  |                 | (66 | ) |  | 14,834 | 

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|                                                       |  |                   |        |                   |  |                    |  |                 |     |   |  |        | 
|------------------------------------------------------ |  | ----------------- | ------ | ----------------- |  | ------------------ |  | --------------- | --- | - |  | ------ | 
|                                                       |  | December 31, 2007 |       
|                                                       |  |                   |        |                   |  |                    |  |                 |    
|(In thousands)                                         |  | Cost              |        | Unrealized
 Gains |  | Unrealized
 Losses |  | Recorded
 Basis |    
|                                                       | 
|U.S. government and agency obligations                 |  | $                 | 11,114 |                   |  | 44                 |  |                 |    |   |  | 11,158 | 
|Corporate debt securities and certificates
 of deposit |  |                   | 795    |                   |  |                   |  |                 |    |   |  | 795    | 
|Marketable securities  short term                     |  | $                 | 11,909 |                   |  | 44                 |  |                 |    |   |  | 11,953 | 
|                                                       |  |                   |        |                   |  |                    |  |                 |     |   |  |        | 
|U.S. government and agency obligations                 |  | $                 | 14,655 |                   |  | 342                |  |                 |    |   |  | 14,997 | 
|Corporate debt securities                              |  |                   | 3,008  |                   |  | 38                 |  |                 |    |   |  | 3,046  | 
|Asset backed securities                                |  |                   | 3,535  |                   |  | 43                 |  |                 |    |   |  | 3,578  | 
|Equity securities                                      |  |                   | 250    |                   |  |                   |  |                 | (70 | ) |  | 180    | 
|Marketable securities  long term                      |  | $                 | 21,448 |                   |  | 423                |  |                 | (70 | ) |  | 21,801 | 

Our long term
investments in marketable debt securities all had maturities of less than five
years. As of December 31, 2008, our investment in equity securities was in a
$54,000 unrealized loss position due to weak economic and stock market
conditions. In 2008 we recognized a $166,000 impairment charge for this
security resulting from a decline in market value which we determined to be
other than temporary. We intend to hold this security indefinitely. No other
impairment charges were recognized for marketable securities in 2008, 2007 or
2006. At December 31, 2008, marketable debt securities valued at $1,592,000
were in an unrealized loss position totaling $12,000 (all had been in an
unrealized loss position for less than twelve months). All remaining marketable
debt securities valued at $23,645,000 were in an unrealized gain position
totaling $647,000.

Net pre-tax
unrealized gains of $581,000 at December 31, 2008 and $397,000 at December 31,
2007 were recorded as a component of accumulated other comprehensive income
(loss) in stockholders equity. In 2008, we recognized a gain of $40,000 from
the sale of marketable securities and received sale proceeds totaling
$6,860,000. There were no sales of marketable securities in 2007 or 2006.

NOTE 3  ACCOUNTING FOR STOCK BASED
COMPENSATION

Share Based Compensation Information under
SFAS No. 123R

The following
is a summary of pre-tax equity based compensation expense for the three year
period ended December 31, 2008:

|                                                          |  |      |     |      |   |      |  |   |     | 
|--------------------------------------------------------- |  | ---- | --- | ---- | - | ---- |  | - | --- | 
|(In
 thousands)                                           |  | 2008 |     | 2007 |   | 2006 | 
|                                                          |  |      |     |      |   |      | 
|Pre-tax
 equity compensation expense                      |  | $    | 580 |      | $ | 693  |  | $ | 778 | 
|Income tax
 benefits related to equity based compensation |  | $    | 144 |      | $ | 132  |  | $ | 123 | 

Pre-tax equity
compensation expense for 2008 includes $366,000 for stock options and
restricted stock units, $87,000 for our employee stock purchase plan and
$127,000 for 23,040 shares issued to board members and officers for
compensation purposes (weighted average grant date fair value of $5.49).
Inventory balances include capitalized equity compensation costs totaling
$21,000 at December 31, 2008 and $24,000 at December 31, 2007.

We use
historical data to estimate pre-vesting forfeitures. At December 31, 2008, the
total unrecognized compensation cost related to non vested equity based
compensation arrangements was $956,000 and the related weighted average period
over which it is expected to be recognized is 2.3 years. The total fair value
of shares vested was $393,000 in 2008, $758,000 in 2007 and $1,089,000 in 2006.

The fair
values of the options granted to our employees were estimated on the date of
grant using the Black-Scholes model. The Black Scholes valuation model
incorporates ranges of assumptions that are disclosed in the table below. The
risk-free interest rate is based on the United States Treasury yield curve at
the time of grant with a remaining term equal to the expected life of the
awards. We estimated the expected term for our graded vesting options,
representing the length of time in years that the options are expected to be
outstanding, using the simplified method as specified in Staff Accounting
Bulletin No. 107, Valuation of Share-Based Payment Arrangements for Public
Companies. We continued to use the simplified method in 2008 because our
historical exercise experience is not expected to be representative of exercise
patterns in the future, due to our recent restructuring activities. For
immediate vesting options granted to our outside directors in 2007 and 2006,
the expected life representing the length of time in years that the options are
expected to be outstanding was calculated using historical exercise data. No
stock options were granted to our outside directors in 2008. Instead, each of
our three outside directors received 1,000 shares of our common stock and an
increase in their annual cash retainer for service on our board. Expected
volatility was computed based on historical fluctuations in the daily price of
our common stock.

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For stock
options granted during the three year period ended December 31, 2008, we
utilized the fair value of our common stock on the date of grant and employed
the following key assumptions in computing fair value using the Black-Scholes
option-pricing model:

|                                           |  |       |  |               |  |              | 
|------------------------------------------ |  | ----- |  | ------------- |  | ------------ | 
|                                           |  | 2008  |  | 2007          |  | 2006         | 
|                                           | 
|Risk-free
 interest rates                  |  | 1.67% |  | 3.51% - 4.73% |  | 4.0% - 5.04% | 
|Expected
 life in years                    |  | 4.75  |  | 4.75 - 6.86   |  | 4.75 - 6.33  | 
|Expected
 volatility                       |  | 44%   |  | 43% - 52%     |  | 48% - 60%    | 
|Expected
 dividends                        |  | None  |  | None          |  | None         | 
|Weighted
 average fair value on grant date |  | $1.95 |  | $5.99         |  | $6.65        | 

Stock Options

We have three
stock incentive plans that are administered under the supervision of the
Compensation Committee of the Board of Directors which have 989,204 shares of
common stock reserved in the aggregate for issuance of options and other stock
based benefits, including restricted stock units, to employees, officers and
others. Reserved shares underlying canceled options are available for future
grant under our active 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 our common stock as consideration for the option price
provided that the tendered shares have been held by the option holder at least
six months. In anticipation of adopting SFAS No. 123(R), we did not modify the
terms of any previously granted options. As of December 31, 2008, there are
230,857 shares of common stock available for future issuance under these plans.
In addition, there are 50,000 shares reserved and included in the plan
summaries below that are not part of the three stock incentive plans.

The following
is a summary of stock option activity for each of the years in the three year
period ended December 31, 2008:

|                                           |  |                        |         |      |   |          |   |   |          |  
|------------------------------------------ |  | ---------------------- | ------- | ---- | - | -------- | - | - | -------- | -
|                                           |  | Year ended December 31 |        
|Shares                                     |  | 2008                   |         | 2007 |   | 2006     |  
|                                           |  |                        |         |      |   |          |   |   |          |  
|Outstanding,
 beginning of year            |  |                        | 607,346 |      |   | 763,721  |   |   | 901,176  |  
|Granted                                    |  |                        | 133,900 |      |   | 48,800   |   |   | 55,970   |  
|Exercised                                  |  |                        | (2,250  | )    |   | (57,625  | ) |   | (148,500 | )
|Expired                                    |  |                        | (20,150 | )    |   | (145,300 | ) |   | (38,875  | )
|Forfeited                                  |  |                        | (3,200  | )    |   | (2,250   | ) |   | (6,050   | )
|Outstanding,
 end of year                  |  |                        | 715,646 |      |   | 607,346  |   |   | 763,721  |  
|                                           |  |                        |         |      |   |          |   |   |          |  
|Exercisable                                |  |                        | 515,134 |      |   | 491,543  |   |   | 601,851  |  
|                                           |  |                        |         |      |   |          |   |   |          |  
|Weighted
 average exercise price per share |  | 2008                   |         | 2007 |   | 2006     |  
|                                           |  |                        |         |      |   |          |   |   |          |  
|Outstanding,
 beginning of year            |  | $                      | 11.71   |      | $ | 12.11    |   | $ | 11.96    |  
|Granted                                    |  | $                      | 4.99    |      | $ | 12.54    |   | $ | 13.23    |  
|Exercised                                  |  | $                      | 5.20    |      | $ | 11.11    |   | $ | 10.26    |  
|Expired                                    |  | $                      | 12.57   |      | $ | 14.32    |   | $ | 17.31    |  
|Forfeited                                  |  | $                      | 14.06   |      | $ | 11.88    |   | $ | 12.64    |  
|Outstanding,
 end of year                  |  | $                      | 10.44   |      | $ | 11.71    |   | $ | 12.11    |  
|                                           |  |                        |         |      |   |          |   |   |          |  
|Exercisable                                |  | $                      | 11.56   |      | $ | 11.45    |   | $ | 12.15    |  

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The intrinsic
value of an option is the amount by which the fair value of the underlying
stock exceeds its exercise price. For options outstanding at December 31, 2008,
the weighted average remaining contractual term was 3.75 years and the
aggregate intrinsic value was $43,000. For options exercisable at December 31,
2008, the weighted average remaining contractual term was 2.80 years and the
aggregate intrinsic value was $15,000. The aggregate intrinsic value of stock
options exercised was $12,000 in 2008, $132,000 in 2007 and $631,000 in 2006.
We received proceeds of $12,000 and realized an income tax benefit of $2,000
from the exercise of stock options in 2008. New shares are issued for all
option exercises, upon vesting of restricted stock units, for share issuances
to board members and officers or for share issuances under our Employee Stock
Purchase Plan.

The following
is a summary of outstanding options as of December 31, 2008:

|                  |  |                    |         |                                         |  |                                  |  |                    |       |                                         |  |                                |  |  |      |  |   |       | 
|----------------- |  | ------------------ | ------- | --------------------------------------- |  | -------------------------------- |  | ------------------ | ----- | --------------------------------------- |  | ------------------------------ |  |  | ---- |  | - | ----- | 
|Exercise Price    |  | OptionsOutstanding |         | WeightedAverageRemaining Life(in years) |  | Weighted 
 AverageExercise Price |  | OptionsExercisable |       | WeightedAverageRemaining Life(in years) |  | Weighted AverageExercise Price | 
|                  |  |                    |         |                                         |  |                                  |  |                    |       |                                         |  |                                |  |  |      |  |   |       | 
|Less than
 $6.22  |  |                    | 223,150 |                                         |  | 4.71                             |  | $                  | 5.28  |                                         |  | 89,250                         |  |  | 1.37 |  | $ | 5.73  | 
|$6.22 to
 $9.45   |  |                    | 1,000   |                                         |  | 1.75                             |  | $                  | 9.45  |                                         |  | 1,000                          |  |  | 1.75 |  | $ | 9.45  | 
|$9.45 to
 $14.99  |  |                    | 455,096 |                                         |  | 3.30                             |  | $                  | 12.04 |                                         |  | 388,484                        |  |  | 3.06 |  | $ | 11.93 | 
|$14.99 to
 $19.01 |  |                    | 4,500   |                                         |  | 2.50                             |  | $                  | 18.55 |                                         |  | 4,500                          |  |  | 2.50 |  | $ | 18.55 | 
|Over $19.01       |  |                    | 31,900  |                                         |  | 3.64                             |  | $                  | 22.53 |                                         |  | 31,900                         |  |  | 3.64 |  | $ | 22.53 | 
|                  |  |                    |         |                                         |  |                                  |  |                    |       |                                         |  |                                |  |  |      |  |   |       | 
|Total             |  |                    | 715,646 |                                         |  | 3.75                             |  | $                  | 10.44 |                                         |  | 515,134                        |  |  | 2.80 |  | $ | 11.56 | 

Restricted Stock Units

Our 1998 Stock
Incentive Plan also permits our Compensation Committee to grant other
stock-based benefits, including restricted stock units. Restricted stock units
are valued at a price equal to the fair market value of our common stock on the
date of grant, vest over a four year period and entitle the holders to one
share of our common stock for each restricted unit. The weighted average grant
date fair value for each restricted stock unit was $4.99 in 2008, $12.34 in
2007 and $12.95 in 2006. The aggregate fair value of outstanding restricted
stock units based on the closing share price of our common stock as of December
31, 2008 was $222,000. The aggregate fair value of restricted stock units that
vested, based on the closing share price of our common stock on the vesting
date, was $25,000 for the year ended December 31, 2008 and $36,000 for the year
ended December 31, 2007. No restricted stock units vested during the year ended
December 31, 2006.

A summary of
activity in non vested restricted stock units for the year ended December 31,
2008 follows:

|                                   |  |        |        |                                         |   |       | 
|---------------------------------- |  | ------ | ------ | --------------------------------------- | - | ----- | 
|Non vested
 restricted stock units |  | Shares |        | Weighted  Average GrantDate Fair Value |  
|                                   |  |        |        |                                         |   |       | 
|Non vested
 at December 31, 2007   |  |        | 17,120 |                                         | $ | 12.65 | 
|Granted                            |  |        | 31,219 |                                         | $ | 4.99  | 
|Vested                             |  |        | (4,938 | )                                       | $ | 12.70 | 
|Forfeited                          |  |        | (700   | )                                       | $ | 12.65 | 
|Non vested
 at December 31, 2008   |  |        | 42,701 |                                         | $ | 7.05  | 

Employee Stock Purchase Plan

We have an Employee Stock
Purchase Plan available to eligible U.S. employees. Under terms of the plan,
eligible employees may designate from 1% to 10% of their compensation to be
withheld through payroll deductions, up to a maximum of $6,500 in each plan
year, 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, 800,000 shares
of common stock have been reserved for issuance. Share issuances under the
Employee Stock Purchase Plan were 28,505 for the year ended December 31, 2008,
28,859 for the year ended December 31, 2007 and 29,398 for the year ended
December 31, 2006. As of December 31, 2008, 112,812 shares remain available for
issuance under this plan.

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Stock Grant Plan for Non-Employee Directors

In 2008, our
shareholders approved a stock grant plan for our non-employees directors. The
plan provides for automatic grants of 1,000 shares of our common stock to each
of our non-employee directors upon their re-election to the board of directors.
The plan took the place of our stock option plan for non-employee directors,
under which each director received a stock option to purchase 4,500 shares of
common stock exercisable at market value on the date of their re-election.

The plan
provides for a total of 30,000 shares of our common stock for issuance to
directors and will expire on May 19, 2018. We issued 3,000 shares under this
plan in 2008 to non-employee directors, and 27,000 shares remain available at
December 31, 2008 for future issuance. The shares issued in 2008 had a fair
market value on the date of grant equal to $27,000.

NOTE 4  OTHER FINANCIAL STATEMENT DATA

Inventories
consist of the following:

|                                   |  |              |       |      |   |        | 
|---------------------------------- |  | ------------ | ----- | ---- | - | ------ | 
|                                   |  | December 31, |      
|(In
 thousands)                    |  | 2008         |       | 2007 |  
|                                   |  |              |       |      |  
|Raw
 materials and purchased parts |  | $            | 3,442 |      | $ | 4,563  | 
|Work in
 process                   |  |              | 724   |      |   | 1,280  | 
|Finished
 goods                    |  |              | 5,703 |      |   | 4,797  | 
|                                   |  |              |       |      |   |        | 
|                                   |  | $            | 9,869 |      | $ | 10,640 | 

Equipment and
Leasehold Improvements consist of the following:

|                                           |  |              |        |      |   |        |  
|------------------------------------------ |  | ------------ | ------ | ---- | - | ------ | -
|                                           |  | December 31, |       
|(In
 thousands)                            |  | 2008         |        | 2007 |  
|                                           |  |              |        |      |  
|Equipment                                  |  | $            | 10,657 |      | $ | 9,823  |  
|Leasehold
 improvements                    |  |              | 1,487  |      |   | 1,328  |  
|                                           |  |              | 12,144 |      |   | 11,151 |  
|                                           |  |              |        |      |   |        |  
|Accumulated
 depreciation and amortization |  |              | (9,529 | )    |   | (9,207 | )
|                                           |  |              |        |      |   |        |  
|                                           |  | $            | 2,615  |      | $ | 1,944  |  

Total
depreciation expense related to equipment and leasehold improvements was
$1,147,000 for the year ended December 31, 2008, $901,000 for the year ended
December 31, 2007 and $716,000 for the year ended December 31, 2006.

Intangible and
Other Assets consist of the following:

|                        |  |                        |        |                           |   |        |   |                        |     |                           |   |        |  |   |        |   |   |       | 
|----------------------- |  | ---------------------- | ------ | ------------------------- | - | ------ | - | ---------------------- | --- | ------------------------- | - | ------ |  | - | ------ | - | - | ----- | 
|                        |  | December 31, 2008      |        | December 31, 2007         |  
|(In
 thousands)         |  | Gross Carrying
 Amount |        | Accumulated
 Amortization |   | Net    |   | Gross Carrying
 Amount |     | Accumulated
 Amortization |   | Net    | 
|Developed
 technology   |  | $                      | 7,775  |                           | $ | (7,304 | ) | $                      | 471 |                           | $ | 7,775  |  | $ | (7,122 | ) | $ | 653   | 
|Patents and
 trademarks |  |                        | 2,730  |                           |   | (2,245 | ) |                        | 485 |                           |   | 2,562  |  |   | (2,146 | ) |   | 416   | 
|                        |  |                        |        |                           |   |        |   |                        |     |                           |   |        |  |   |        |   |   |       | 
|                        |  | $                      | 10,505 |                           | $ | (9,549 | ) | $                      | 956 |                           | $ | 10,337 |  | $ | (9,268 | ) | $ | 1,069 | 

Amortization
expense for the three years ended December 31, 2008, 2007 and 2006 is as
follows:

|                        |  |                        |     |      |   |      |  |   |     | 
|----------------------- |  | ---------------------- | --- | ---- | - | ---- |  | - | --- | 
|                        |  | Year ended December 31 |    
|(In
 thousands)         |  | 2008                   |     | 2007 |   | 2006 | 
|                        |  |                        |     |      |   |      |  |   |     | 
|Developed
 technology   |  | $                      | 182 |      | $ | 182  |  | $ | 582 | 
|Patents and
 trademarks |  |                        | 274 |      |   | 243  |  |   | 207 | 
|                        |  |                        |     |      |   |      |  |   |     | 
|                        |  | $                      | 456 |      | $ | 425  |  | $ | 789 | 

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As of December
31, 2008, the weighted average remaining life of our intangible assets was
approximately 2.7 years for developed technology and 1.8 years for patents and
trademarks. Estimated aggregate amortization expense based on current
intangibles for the next three years is expected to be as follows: $455,000 in
2009, $343,000 in 2010 and $158,000 in 2011.

In the fourth
quarter of 2008, we reviewed our identifiable intangible and long lived assets
for impairment because a series of facts and circumstances indicated that the
assets might be impaired, including weakness in the United States capital
markets caused by the deepening global recession, and our reduced level of
profitability, causing a significant drop in our market capitalization.

An impairment
loss for our identifiable intangible and long lived assets would be recognized
when future undiscounted cash flows expected to result from use of the asset
and eventual disposition are less than the carrying amount. As of December 31,
2008, we projected our future undiscounted cash flows associated with these assets
and concluded that there was no impairment.

Accrued
Expenses consist of the following:

|                      |  |             |       |      |   |       | 
|--------------------- |  | ----------- | ----- | ---- | - | ----- | 
|                      |  | December 31 |      
|(In
 thousands)       |  | 2008        |       | 2007 |  
|                      |  |             |       |      |   |       | 
|Wages and
 benefits   |  | $           | 1,429 |      | $ | 1,977 | 
|Warranty
 costs       |  |             | 823   |      |   | 819   | 
|Severance             |  |             | 315   |      |   |      | 
|Income taxes
 payable |  |             | 45    |      |   | 59    | 
|Other                 |  |             | 442   |      |   | 482   | 
|                      |  |             |       |      |   |       | 
|                      |  | $           | 3,054 |      | $ | 3,337 | 

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 |       
|(In
 thousands)                     |  | 2008                   |        | 2007 |  
|                                    |  |                        |        |      |   |      |  
|Balance at
 the beginning of period |  | $                      | 819    |      | $ | 796  |  
|Accruals for warranties             |  |                        | 1,084  |      |   | 961  |  
|Settlements made during the period  |  |                        | (1,080 | )    |   | (938 | )
|                                    |  |                        |        |      |   |      |  
|Balance at
 the end of period       |  | $                      | 823    |      | $ | 819  |  

NOTE 5  GOODWILL

During the
fourth quarter of 2005, we reorganized our business into two operating
segments, the electronic assembly and semiconductor segments, in order to
increase focus and management attention on growth opportunities in our markets.
As required by SFAS No. 142, when an entity reorganizes its reporting structure
in a manner that changes the composition of one or more of its reporting units,
goodwill is reassigned to the affected reporting units using a relative fair
value allocation approach. The fair value of each segment (reporting unit) is
compared to the fair value of the business immediately prior to the
reorganization. The fair value for our segments was determined using a
discounted cash flow methodology.

We assess our
goodwill for impairment in the fourth quarter of each year, and whenever events
or changes in circumstances indicate that the carrying value may not be
recoverable. For 2008, our annual impairment review coincided with a series of
facts and circumstances indicating that our goodwill might be impaired,
including weakness in the United States capital markets, caused by the
deepening global recession, as well as our reduced level of profitability,
causing a significant drop in our market capitalization.

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In evaluating
whether goodwill was impaired, we compared the fair value of our two reporting
units to which goodwill is assigned to their carrying value (Step 1of the
impairment test). In calculating fair value, we used the income approach. The
income approach is a valuation technique under which we estimate future cash
flows using the reporting units financial forecasts. Future estimated cash
flows are discounted to their present value to calculate fair value. The
summation of our reporting units fair values is compared and reconciled to our
market capitalization as of the date of our impairment test. In the situation
where a reporting units carrying amount exceeds its fair value, the amount of
the impairment loss must be measured. The measurement of the impairment (Step 2
of the impairment test) is calculated by determining the implied fair value of
a reporting units goodwill. In calculating the implied fair value of goodwill,
the fair value of the reporting unit is allocated to all other assets and
liabilities of that unit based on their fair values. The excess of the fair
value of a reporting unit over the amount assigned to its other assets and
liabilities is the implied fair value of goodwill. The goodwill impairment is
measured as the excess of the carrying amount of goodwill over its implied fair
value.

In determining
the fair value of our reporting units under the income approach, our expected
cash flows are affected by various assumptions. Fair value on a discounted cash
flow basis uses forecasts over a 3 year period with an estimation of residual
growth rates thereafter. We use our business plans and projections as the basis
for expected future cash flows. The significant assumptions incorporated in
these forecasts for the most recent goodwill impairment tests include our
expectations regarding revenue during the 3 year period, a 7 percent terminal
growth rate and a 25% discount rate for both our electronic assembly and
semiconductor reporting units. The selection of discount rates may have a
significant impact on the determination of fair value. However, for the 2008
test, an increase or decrease of one percent in the discount rate would have
had no impact on the impairment recorded for our electronic assembly reporting
unit.

For purposes
of our goodwill impairment test, we reconciled the fair value for each of our
reporting units to our overall fair value. The publicly traded market price of
our common stock and a control premium of 30 percent was used in our
determination of fair value, which represents the value an investor would pay
above minority interest transaction prices in order to obtain a controlling
interest in the company. The control premium was determined by a review of
premiums paid for similar companies over the past five years. While the control
premium is a significant assumption in determining our overall fair value, it
had a minimal impact on the determination of goodwill impairment in 2008. An
increase in the assumed control premium by five percent to 35 percent would
have had no impact on the impairment recorded for our electronic assembly
reporting unit.

Upon
completion of our analysis, we concluded that the goodwill related to our
electronic assembly reporting unit was fully impaired, resulting in a
$3,941,000 impairment charge. Our remaining goodwill at December 31, 2008, in
the amount of $569,000 relates to our semiconductor reporting unit. Our recent
analyses indicate that this goodwill is not impaired. However, our conclusion
could change in the future, if our assumptions about future economic
conditions, revenue growth or profitability change. Any resulting impairment
charge could have a material effect on our financial position and results of
operations in the future.

Changes to our
goodwill balance include the following:

|                             |  |                           |        |                        |   |       |  |   |        |  
|---------------------------- |  | ------------------------- | ------ | ---------------------- | - | ----- |  | - | ------ | -
|(In
 thousands)              |  | ElectronicAssemblySegment |        | Semiconductor
 Segment |   | Total | 
|Goodwill,
 December 31, 2006 |  | $                         | 4,591  |                        | $ | 569   |  | $ | 5,160  |  
|                             |  |                           |        |                        |   |       |  |   |        |  
|Translation
 adjustment      |  |                           | 47     |                        |   |      |  |   | 47     |  
|                             |  |                           |        |                        |   |       |  |   |        |  
|Goodwill,
 December 31, 2007 |  | $                         | 4,638  |                        | $ | 569   |  | $ | 5,207  |  
|                             |  |                           |        |                        |   |       |  |   |        |  
|Translation
 adjustment      |  |                           | (697   | )                      |   |      |  |   | (697   | )
|                             |  |                           |        |                        |   |       |  |   |        |  
|Impairment                   |  |                           | (3,941 | )                      |   |      |  |   | (3,941 | )
|                             |  |                           |        |                        |   |       |  |   |        |  
|Goodwill,
 December 31, 2008 |  | $                         |       |                        | $ | 569   |  | $ | 569    |  

Goodwill
translation adjustments on foreign denominated goodwill balances relate to our
wholly owned subsidiary in the UK, CyberOptics Holdings Ltd.

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NOTE 6  INCOME TAXES

Income (loss)
before income taxes consists of the following:

|                                               |  |                         |        |      |   |       |  |   |       | 
|---------------------------------------------- |  | ----------------------- | ------ | ---- | - | ----- |  | - | ----- | 
|                                               |  | Year ended December 31, |       
|(In
 thousands)                                |  | 2008                    |        | 2007 |   | 2006  | 
|                                               |  |                         |        |      |   |       | 
|Sources of
 income (loss) before income taxes: |  |                         |        |      |   |       |  |   |       | 
|United States                                  |  | $                       | (6,881 | )    | $ | 6,403 |  | $ | 7,708 | 
|Foreign                                        |  |                         | (2,389 | )    |   | 1,351 |  |   | 1,356 | 
|Total income (loss) before income taxes        |  | $                       | (9,270 | )    | $ | 7,754 |  | $ | 9,064 | 

The provision
(benefit) for income taxes consists of the following:

|                                           |  |                         |        |      |   |       |   |   |       | 
|------------------------------------------ |  | ----------------------- | ------ | ---- | - | ----- | - | - | ----- | 
|                                           |  | Year ended December 31, |       
|(In
 thousands)                            |  | 2008                    |        | 2007 |   | 2006  |  
|                                           |  |                         |        |      |   |       |   |   |       | 
|Current:                                   |  |                         |        |      |   |       |   |   |       | 
|Federal                                    |  | $                       | (1,196 | )    | $ | 2,025 |   | $ | 1,795 | 
|State                                      |  |                         | (78    | )    |   | 69    |   |   | 102   | 
|Foreign                                    |  |                         | 24     |      |   | 28    |   |   | 42    | 
|Total current                              |  | $                       | (1,250 | )    | $ | 2,122 |   | $ | 1,939 | 
|Deferred:                                  |  |                         |        |      |   |       |   |   |       | 
|Federal                                    |  | $                       | (1,431 | )    | $ | 311   |   | $ | 214   | 
|State                                      |  |                         | (80    | )    |   | (2    | ) |   | 86    | 
|Foreign                                    |  |                         | 162    |      |   | 295   |   |   | 435   | 
|Total deferred                             |  | $                       | (1,349 | )    | $ | 604   |   | $ | 735   | 
|Total provision (benefit) for income taxes |  | $                       | (2,599 | )    | $ | 2,726 |   | $ | 2,674 | 

A
reconciliation of the statutory rate to the effective income tax rate is as
follows:

|                                           |  |                         |       |      |  |      |   |  |      |  
|------------------------------------------ |  | ----------------------- | ----- | ---- |  | ---- | - |  | ---- | -
|                                           |  | Year ended December 31, |      
|                                           |  | 2008                    |       | 2007 |  | 2006 |  
|                                           |  |                         |       |      |  |      |   |  |      |  
|Federal
 statutory rate                    |  |                         | (34.0 | )%   |  | 34.0 | % |  | 34.0 | %
|                                           |  |                         |       |      |  |      |   |  |      |  
|State income taxes, net of federal benefit |  |                         | (2.0  | )    |  | (0.1 | ) |  | 0.5  |  
|Non-deductible goodwill impairment charge  |  |                         | 10.5  |      |  |     |   |  |     |  
|ETI and manufacturing tax incentives       |  |                         |      |      |  | (1.5 | ) |  | (4.3 | )
|U.S. Subpart F income                      |  |                         | 0.4   |      |  | 2.1  |   |  | 0.7  |  
|Stock based compensation                   |  |                         | 0.7   |      |  | 1.4  |   |  | 1.6  |  
|Research and experimentation credit        |  |                         | (3.1  | )    |  | (3.9 | ) |  | (3.2 | )
|Foreign rate difference                    |  |                         | (1.2  | )    |  | 0.1  |   |  | 0.2  |  
|Reserve for income taxes under FIN 48      |  |                         | (1.1  | )    |  | 2.3  |   |  |     |  
|Valuation allowance                        |  |                         | 1.5   |      |  | 0.7  |   |  | 0.9  |  
|Other, net                                 |  |                         | 0.3   |      |  | 0.1  |   |  | (0.9 | )
|                                           |  |                         |       |      |  |      |   |  |      |  
|Effective
 tax rate                        |  |                         | (28.0 | )%   |  | 35.2 | % |  | 29.5 | %

We recorded a
$3,941,000 non-cash goodwill impairment charge in 2008, of which $2,860,000 is
not tax deductible, resulting in a 10.5% increase in our effective income tax
rate for 2008.

In July 2006,
the FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes (FIN 48). FIN 48 supersedes SFAS No. 5,
Accounting for Contingencies, as it relates to income tax liabilities and
lowers the minimum threshold a tax position is required to meet before being
recognized in the financial statements from probable to more likely than
not (i.e. a likelihood of occurrence greater than fifty percent). Under
FIN 48, the recognition threshold is met when an entity concludes that a
tax position, based solely on its technical merits, is more likely than not to
be sustained upon examination by the relevant taxing authority.

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Those tax
positions failing to qualify for initial recognition are recognized in the
first interim period in which they meet the more likely than not standard, or
are resolved through negotiation or litigation with the taxing authority, or
upon expiration of the statute of limitations. De-recognition of a tax position
that was previously recognized occurs when an entity subsequently determines
that a tax position no longer meets the more likely than not threshold of being
sustained. Differences between the amounts recognized in the financial
statements prior to the adoption of FIN 48 and the amounts recognized
after adoption are accounted for as a cumulative effect adjustment recorded to
the beginning balance of retained earnings. Under FIN 48, only the portion
of the liability that is expected to be paid within one year is classified as a
current liability. As a result, liabilities expected to be resolved without the
payment of cash (e.g., resolution due to the expiration of the statute of
limitations) or are not expected to be paid within one year are not classified
as current. Accordingly, our liability for uncertain tax positions has been
classified as non-current at both December 31, 2008 and 2007.

We adopted the
provisions of FIN 48on
January 1, 2007. As a result of our implementation of FIN 48, we
recognized a $32,000 increase in the liability for unrecognized tax benefits,
which was accounted for as a reduction to the January 1, 2007, balance of
retained earnings. A reconciliation of the beginning and ending amount of gross
unrecognized tax benefits (UTB) is as follows:

|                                                              |  |      |       |      |   |       | 
|------------------------------------------------------------- |  | ---- | ----- | ---- | - | ----- | 
|(In
 thousands)                                               |  | 2008 |       | 2007 |  
|                                                              |  |      |       |      |   |       | 
|Gross UTB
 balance at beginning of year                       |  | $    | 2,381 |      | $ | 2,148 | 
|Additions
 based on tax positions related to the current year |  |      | 306   |      |   | 233   | 
|Additions
 for tax positions of prior years                   |  |      |      |      |   |      | 
|Reductions
 for tax positions of prior years                  |  |      |      |      |   |      | 
|Settlements                                                   |  |      |      |      |   |      | 
|Reductions
 due to lapse of applicable statute of limitations |  |      | (216  | )    |   |      | 
|Gross UTB
 balance at end of year                             |  | $    | 2,471 |      | $ | 2,381 | 
|Net UTB
 impacting the effective tax rate at end of year      |  | $    | 1,578 |      | $ | 1,583 | 

The total
amount of unrecognized tax benefits that, if recognized, would affect the
effective tax rate was $1,578,000 as of December 31, 2008, $1,583,000 as of
December 31, 2007 and $1,246,000 as of January 1, 2007. The ending net UTB
results from adjusting the gross balance for items such as Federal, State, and
non-U.S. deferred items, interest and penalties, and deductible taxes. The net
UTB is a long term income tax reserve within our Consolidated Balance Sheet. We
recognize interest and penalties accrued related to unrecognized tax benefits
in tax expense. Accrued interest and penalties on a gross basis were $167,000
as of December 31, 2008, $192,000 as of December 31, 2007 and $143,000 as of
January 1, 2007.

During the
year ended December 31, 2008, we recorded a $98,000 decrease in liabilities,
net of deferred taxes, for uncertain tax positions that were recorded as an
income tax benefit. The estimated gross reduction in interest and penalties
included in this amount total $25,000. During the year ended December 31,
2007, we recorded a $182,000 increase in liabilities, net of deferred tax
benefit, for uncertain tax positions that was recorded as income tax expense.
Estimated gross interest and penalties included in this amount total $49,000.

We file income
tax returns in the U.S. federal jurisdiction, and various state and foreign
jurisdictions. We are no longer subject to U.S. federal, state and local income
tax examinations by tax authorities for years before 2005. Our 2006 federal
income tax return is currently being audited by the Internal Revenue Service.
We are not able to reasonably estimate the timing of any potential payments that
may result from this audit. Our liability for unrecognized tax benefits could
decline by $200,000 during the next 12 months due to expiration of domestic
statute of limitations.

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Deferred tax
assets consist of the following:

|                                              |  |              |       |      |   |       |  
|--------------------------------------------- |  | ------------ | ----- | ---- | - | ----- | -
|                                              |  | December 31, |      
|(In
 thousands)                               |  | 2008         |       | 2007 |  
|                                              |  |              |       |      |   |       |  
|Fixed asset
 and intangible amortization, net |  | $            | 1,422 |      | $ | 1,073 |  
|Inventory
 allowances                         |  |              | 986   |      |   | 768   |  
|Accrued
 liabilities                          |  |              | 244   |      |   | 212   |  
|Warranty
 accrual                             |  |              | 290   |      |   | 292   |  
|Deferred
 revenue                             |  |              | 525   |      |   | 470   |  
|Accounts receivable
 allowance                |  |              | 88    |      |   | 113   |  
|Federal and
 state tax credits                |  |              | 1,491 |      |   | 673   |  
|Foreign net
 operating loss carry forwards    |  |              | 587   |      |   | 984   |  
|Stock based
 compensation                     |  |              | 295   |      |   | 232   |  
|Other, net                                    |  |              | 150   |      |   | 96    |  
|Sub-total                                     |  |              | 6,078 |      |   | 4,913 |  
|Valuation
 allowance                          |  |              | (640  | )    |   | (599  | )
|                                              |  |              |       |      |   |       |  
|Total net deferred tax assets                 |  | $            | 5,438 |      | $ | 4,314 |  

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

Significant
judgment is required in determining the realizability of our deferred tax
assets. The assessment of whether valuation allowances are required considers,
among other matters, the nature, frequency and severity of current and
cumulative losses, forecasts of future profitability, the duration of statutory
carry forward periods, our experience with loss carry forwards not expiring
unused and tax planning alternatives.

Our analysis
of the need for valuation allowances considered that we have positive
cumulative profit over the past three years even without the exclusion of the
$2.9 million non-deductible goodwill impairment in 2008. We also considered the
forecasts of future profitability, the duration of statutory carry forward
periods and tax planning alternatives. We further evaluated our past cycles
which tend to average five years in length (from peak to trough) and also
considered our five year cumulative results ended December 31, 2008 which also
had strong profits. Finally, we evaluated where these cumulative three and five
year measures might be at the end of 2009 and considered other positive
evidence to conclude no incremental valuation allowance was needed at December
31, 2008.

While we have
a recent history of profits, our results have been impacted by the recent
global economic slowdown, and we incurred a loss in the United States in 2008
where most of our net deferred tax assets are recorded. Therefore, achievement
of profitability in the United States will be a significant factor in
determining our continuing ability to carry these deferred tax assets without recording
a valuation allowance.

If future
results from our operations are less than projected, a valuation allowance may
be required to reduce the deferred tax assets. If we continue to incur losses
for several more quarters, and if our operations and outlook show no sign of
improvement by as early as the second quarter of 2009, we may be required to
record as much as a full valuation allowance against virtually all of our
deferred tax assets, which could have a material impact on our results of
operations in the period in which it is recorded.

Deferred tax assets at December
31, 2008, include $587,000 of net operating loss carry forwards incurred in the
UK by CyberOptics Ltd., which was acquired in 1999. The utilization of these
net operating loss carry forwards is dependent on CyberOptics Ltd.s ability to
generate sufficient UK taxable income during the carry forward period. We
reduced our deferred tax asset for UK net operating loss carry forwards by
$64,000 in 2007 due to a reduction in the future UK income tax rate. Deferred
tax assets at December 31, 2008 also include $739,000 of federal R&D tax
credits that will begin to expire in 2026 if unused.

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The valuation
allowances at December 31, 2008 and 2007 are needed for various state tax
credit carry forwards, state operating loss carry forwards and capital losses
for which recovery is not deemed to be more likely than not. The valuation
allowance was increased in 2008 for additional state tax credit carry forwards,
and an unrealized capital loss that failed to satisfy the more likely than not
criteria for recovery.

Cash payments
for income taxes, net of refunds received, were $100,000 for the year ended
December 31, 2008, $1,979,000 for the year ended December 31, 2007, and
$1,779,000 for the year ended December 31, 2006.

On October 22,
2004, the President signed the American Jobs Creation Act of 2004. The Act
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
(ETI) for foreign sales. Our 2006 effective tax rate includes a benefit from
the ETI. No benefit from the ETI was available starting in 2007 due to the
phase-out.

It is the
intention of management to permanently reinvest all undistributed earnings of
international subsidiaries, and accordingly, we have not provided United States
taxes on such earnings. These earnings relate to ongoing operations and were
not significant as of December 31, 2008. It is not practicable to
determine the income tax liability that would be payable if such earnings were
not indefinitely reinvested.

NOTE 7  OPERATING LEASES

On March 27,
2006 we signed a new lease for our primary office space consisting of 60,217
square feet. The lease has a term of 61 months and began on June 1, 2006. The
lease also provides for one month of free rent, other lease incentives and
escalating rents over the lease term. Rental expense, including the effects of
lease incentives, will be recognized on a straight-line basis over the term of
the lease. We are also required to pay insurance, property taxes and other
operating expenses related to the leased facility. Future minimum
lease payments under this lease due within one year from December 31, 2008 are
$1,032,000 and due from one to three years are $1,539,000. We have two
consecutive options to renew the lease, each for an additional term of 3 years,
at then current fair market rent as defined in the lease.

During 2008,
we entered into a new three year lease for a mixed office and warehouse
facility in Singapore. The lease provides for a 3 year term from May 15, 2008,
annual rent of approximately $350,000 and a two year renewal option. We also
lease other facilities for the operations of our subsidiaries under operating
leases that expire from December 2009 through August 2010.

Total rent
expense was $1,423,000 for the year ended December 31, 2008, $1,141,000 for the
year ended December 31, 2007 and $1,057,000 for the year ended December 31,
2006. At December 31, 2008, the future minimum lease payments required under
non-cancelable operating lease agreements, are as follows:

|1                         |  |                |       | 
|------------------------- |  | -------------- | ----- | 
|Year ending
 December 31, |  | (In thousands) |      
|2009                      |  | $              | 1,556 | 
|2010                      |  |                | 1,435 | 
|2011                      |  |                | 609   | 
|Total                     |  | $              | 3,600 | 

NOTE 8  DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES

We enter into
foreign currency swap agreements to hedge short term inter-company financing
transactions with our subsidiary in the 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, 2008, the Company had one open
swap agreement that was purchased on December 31, 2008. As a result, any
unrealized gains or losses as of December 31, 2008 were inconsequential. We
recognized net gains (losses) from settlement of foreign currency swap
agreements of $277,000 for the year ended December 31, 2008, ($61,000) for the
year ended December 31, 2007, and ($346,000) for the year ended December 31,
2006, that offset foreign currency transaction gains (losses) on the underlying
inter-company balance of ($453,000) for the year ended December 31, 2008,
$22,000 for the year ended December 31, 2007 and $294,000 for the year ended
December 31, 2006. These gains and losses are recognized in interest income and
other in our statement of operations.

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. We minimize
such risk by limiting our counter-parties to major financial institutions.
Management does not expect material losses as a result of defaults by other
parties.

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NOTE 9  COMMON STOCK REPURCHASES

We spent
$20,949,000 to repurchase a total 2,082,000 shares of our common stock in 2008.
These repurchases were accomplished through of series of repurchase programs
and a modified dutch auction tender approved by our board of directors. The
modified dutch auction tender offer closed on July 29, 2008, with the purchase
of 1,499,996 shares of our common stock at a price of $10.00 per share. We
spent $1,901,000 to repurchase a total of 158,000 shares of our common stock in
2007 through a series of repurchase programs approved by our board of
directors.

All common
share repurchase programs have been canceled and we presently have no
authorization from our board of directors to repurchase shares of our common
stock.

NOTE 10  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, we
may also make contributions at the discretion of the Board of Directors. We
provided matching contributions to employees totaling $301,000 in 2008,
$297,000 in 2007 and $274,000 in 2006.

NOTE 11  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 our reportable segments. We have determined that
our business operates as two reportable segments. Balance sheet and income
statement information for all periods presented has been allocated to our two
segments. The electronic assembly segment is the design, manufacture and sale
of optical process control sensors and inspection systems for the electronic
assembly equipment market. The semiconductor segment is the design, manufacture
and sale of optical and other process control sensors and related equipment for
the semiconductor capital equipment market.

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Information
regarding our segments is as follows:

|                                    |  |                         |         |      |   |        |  |   |        |  
|----------------------------------- |  | ----------------------- | ------- | ---- | - | ------ |  | - | ------ | -
|                                    |  | Year Ended December 31, |        
|(In
 thousands)                     |  | 2008                    |         | 2007 |   | 2006   | 
|                                    |  |                         |         |      |   |        |  |   |        |  
|Revenue:                            |  |                         |         |      |   |        |  |   |        |  
|Electronic assembly                 |  |                         |         |      |   |        |  |   |        |  
|OEM Sensors                         |  | $                       | 20,250  |      | $ | 31,774 |  | $ | 32,006 |  
|SMT Systems                         |  |                         | 19,943  |      |   | 21,429 |  |   | 19,136 |  
|Total electronic assembly           |  |                         | 40,193  |      |   | 53,203 |  |   | 51,142 |  
|Semiconductor                       |  |                         | 5,259   |      |   | 5,573  |  |   | 5,947  |  
|Total                               |  | $                       | 45,452  |      | $ | 58,776 |  | $ | 57,089 |  
|                                    |  |                         |         |      |   |        |  |   |        |  
|                                    |  |                         |         |      |   |        |  |   |        |  
|Income (loss) from operations:      |  |                         |         |      |   |        |  |   |        |  
|Electronic assembly                 |  | $                       | (10,339 | )    | $ | 5,408  |  | $ | 7,816  |  
|Semiconductor                       |  |                         | (124    | )    |   | 132    |  |   | (695   | )
|Total income (loss) from operations |  | $                       | (10,463 | )    | $ | 5,540  |  | $ | 7,121  |  
|Interest income and other           |  |                         | 1,193   |      |   | 2,214  |  |   | 1,943  |  
|Income (loss) before income taxes   |  | $                       | (9,270  | )    | $ | 7,754  |  | $ | 9,064  |  
|                                    |  |                         |         |      |   |        |  |   |        |  
|Depreciation and amortization:      |  |                         |         |      |   |        |  |   |        |  
|Electronic assembly                 |  | $                       | 1,978   |      | $ | 1,680  |  | $ | 1,280  |  
|Semiconductor                       |  |                         | 268     |      |   | 227    |  |   | 604    |  
|Total                               |  | $                       | 2,246   |      | $ | 1,907  |  | $ | 1,884  |  
|                                    |  |                         |         |      |   |        |  |   |        |  
|Expenditures for long-lived assets: |  |                         |         |      |   |        |  |   |        |  
|Electronic assembly                 |  | $                       | 1,998   |      | $ | 1,088  |  | $ | 1,262  |  
|Semiconductor                       |  |                         | 179     |      |   | 208    |  |   | 135    |  
|Total                               |  | $                       | 2,177   |      | $ | 1,296  |  | $ | 1,397  |  
|                                    |  |                         |         |      |   |        |  |   |        |  
|Total assets (end of year):         |  |                         |         |      |   |        |  |   |        |  
|Electronic assembly                 |  | $                       | 27,563  |      | $ | 31,326 |  | $ | 30,976 |  
|Semiconductor                       |  |                         | 3,698   |      |   | 3,658  |  |   | 3,453  |  
|Corporate                           |  |                         | 27,688  |      |   | 52,055 |  |   | 47,581 |  
|Total                               |  | $                       | 58,949  |      | $ | 87,039 |  | $ | 82,010 |  

The following
summarizes certain significant customer information:

|                             |  |  |                      |  |          |        |                       |    |   | 
|---------------------------- |  |  | -------------------- |  | -------- | ------ | --------------------- | -- | - | 
|(In
 thousands)              |  |  | Significant Customer |  | Revenues |        | Percentageof Revenues |   
|                             |  |  |                      |  |          |        |                       |    |   | 
|Year ended December 31, 2008 |  |  | A                    |  | $        | 9,592  |                       | 21 | % | 
|                             |  |  | B                    |  | $        | 6,672  |                       | 15 | % | 
|                             |  |  |                      |  |          |        |                       |    |   | 
|Year ended December 31, 2007 |  |  | A                    |  | $        | 16,213 |                       | 28 | % | 
|                             |  |  | B                    |  | $        | 11,661 |                       | 20 | % | 
|                             |  |  |                      |  |          |        |                       |    |   | 
|Year ended December 31, 2006 |  |  | A                    |  | $        | 16,683 |                       | 29 | % | 
|                             |  |  | B                    |  | $        | 11,196 |                       | 20 | % | 

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The
significant customers listed above are related to our electronic assembly
segment. As of December 31, 2008, accounts receivable from significant customer
A were $723,000 and accounts receivable from significant customer B were
$376,000. As of December 31, 2007, accounts receivable from significant
customer A were $1,313,000 and accounts receivable from significant customer B
were $1,363,000. Our LaserAlign sensor family has accounted for a significant
portion of our electronic assembly sales. Revenue from new product shipments of
LaserAlign sensors accounted for 26% of our revenue in 2008, 35% in 2007 and
36% in 2006.

We have
determined not to pursue new alignment products for use with future generations
of equipment being developed by Assembleon (significant customer B above).
Assembleon has informed us that they currently plan to start transitioning away
from our alignment products in the third quarter of 2009, with the transition
continuing into the second quarter of 2010. Our revenue, results of operations
and cash flows would be further negatively impacted if our other LaserAlign
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.

Export sales
as a percentage of total sales were 86% for the year ended December 31, 2008,
87% for the year ended December 31, 2007, and 85% for the year ended December
31, 2006. Export sales are attributed to the country where the product is
shipped. All export sales are negotiated, invoiced and paid in U.S. dollars.

Export sales
by geographic area are summarized as follows:

|               |  |      |        |      |   |        |  |   |        | 
|-------------- |  | ---- | ------ | ---- | - | ------ |  | - | ------ | 
|(In thousands) |  | 2008 |        | 2007 |   | 2006   | 
|               |  |      |        |      |   |        |  |   |        | 
|Americas       |  | $    | 1,740  |      | $ | 927    |  | $ | 381    | 
|Netherlands    |  |      | 6,338  |      |   | 10,717 |  |   | 10,285 | 
|Other Europe   |  |      | 8,871  |      |   | 9,508  |  |   | 8,813  | 
|China          |  |      | 7,176  |      |   | 6,038  |  |   | 5,231  | 
|Japan          |  |      | 10,066 |      |   | 16,901 |  |   | 16,746 | 
|Other Asia     |  |      | 4,901  |      |   | 7,077  |  |   | 6,847  | 
|Other          |  |      | 10     |      |   |       |  |   | 3      | 
|               |  |      |        |      |   |        |  |   |        | 
|               |  | $    | 39,102 |      | $ | 51,168 |  | $ | 48,306 | 

Long-lived
assets include equipment and leasehold improvements attributable to each
geographic areas operations. Long-lived assets at December 31, 2008, 2007 and
2006 are as follows:

|                        |  |      |       |      |   |       |  |   |       | 
|----------------------- |  | ---- | ----- | ---- | - | ----- |  | - | ----- | 
|(In
 thousands)         |  | 2008 |       | 2007 |   | 2006  | 
|                        |  |      |       |      |   |       |  |   |       | 
|Long-lived assets:      |  |      |       |      |   |       |  |   |       | 
|United States           |  | $    | 1,798 |      | $ | 1,906 |  | $ | 1,772 | 
|Europe                  |  |      | 5     |      |   | 10    |  |   | 12    | 
|Asia and other          |  |      | 812   |      |   | 28    |  |   | 30    | 
|                        |  |      |       |      |   |       |  |   |       | 
|Total long-lived assets |  | $    | 2,615 |      | $ | 1,944 |  | $ | 1,814 | 

NOTE 12  SEVERANCE, RECRUITMENT AND
SINGAPORE TRANSITION

We started to incur severance costs in February 2008 in connection with
our decision to move a significant portion of development and manufacturing for
our systems products to Singapore. The transition of development was
substantially complete by the fourth quarter of 2008; transition of
manufacturing is expected to be complete by the middle of 2009. Severance costs
incurred in 2008 in connection with the February 2008 decision totaled
$302,000. We also incurred expenses totaling $234,000 for outside service providers
to assist us with recruitment of our new Singapore based development and
manufacturing team. We maintained our Minneapolis-based systems
development team while we trained our new Singapore based team, resulting in
extra costs totaling $879,000 for wages, training, travel, and other costs,
during the initial start-up and training period. These costs have been
classified in our statement of operations as research and development expense.
Other start-up costs totaling $112,000 have been classified in our statement of
operations as selling, general and administrative expense. Singapore transition
costs totaled approximately $1.5 million in 2008. Transition costs in 2009 are
not expected to be significant.

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Additional severance costs of $234,000 were incurred in November 2008
when we reduced our workforce by approximately 10% or 20 employees in response
to the weak global economic conditions. All of the aforementioned costs related
to the November 2008 workforce reduction have been classified as severance and
recruitment in our statement of operations.

A summary of our severance and
recruitment accruals follows:

|                           |  |                                    |     |                  |   |                                        |   |       |     |                                        |   |       |   |   |     |   |   |      |  
|-------------------------- |  | ---------------------------------- | --- | ---------------- | - | -------------------------------------- | - | ----- | --- | -------------------------------------- | - | ----- | - | - | --- | - | - | ---- | -
|                           |  | Electronic Assembly                |     | Semi-
 conductor |   |                                        |   |      
|(in thousands)             |  | February 
 2008 
 Singapore 
 Move |     | Recruitment      |   | November 
 2008 
 Workforce
 Reduction |   | Total |     | November 
 2008 
 Workforce
 Reduction |   | Total |  
|Balance, January 1, 2008   |  | $                                  |    |                  | $ |                                       |   | $     |    |                                        | $ |      |   | $ |    |   | $ |     |  
|Costs incurred             |  |                                    | 302 |                  |   | 234                                    |   |       | 155 |                                        |   | 691   |   |   | 79  |   |   | 770  |  
|Payments made              |  |                                    | (95 | )                |   | (234                                   | ) |       | (51 | )                                      |   | (380  | ) |   | (75 | ) |   | (455 | )
|Balance, December 31, 2008 |  | $                                  | 207 |                  | $ |                                       |   | $     | 104 |                                        | $ | 311   |   | $ | 4   |   | $ | 315  |  

In February 2009, we further reduced our workforce by 24 positions in
response to weakening conditions in the global economy, our transition to
Singapore and our decision to consolidate manufacturing for our semiconductor
products in our Minneapolis facility. We anticipate that all of these employees
will have departed by the end of the second quarter of 2009. Severance expense
related to these actions of approximately $325,000 is expected in the first
half of 2009.

NOTE 13 FAIR VALUE
MEASUREMENTS

In September
2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No.
157 Fair Value Measurements, which defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles
(GAAP), and expands disclosures about fair value measurements. SFAS No. 157
will apply whenever another standard requires (or permits) assets or
liabilities to be measured at fair value. The standard does not expand the use
of fair value to any new circumstances, and was effective for fiscal years
beginning after December 31, 2007. The FASB has provided a one year deferral
for certain non-financial assets and liabilities. We adopted SFAS No. 157,
effective January 1, 2008, for all financial assets and liabilities that were
not deferred. The adoption of SFAS No. 157 for our financial assets and
liabilities had no impact on our financial position or results of operations.
We do not expect the standard to have a material impact on our consolidated
results of operations and financial condition when fully adopted in 2009.

In accordance
with SFAS No. 157, we value our cash equivalents and marketable securities
based on a three-level fair value hierarchy. The fair value hierarchy gives the
highest priority to quoted prices in active markets for identical assets or
liabilities (Level 1). The next highest priority is based on quoted prices
for similar assets or liabilities in active markets or quoted prices for
identical or similar assets or liabilities in non-active markets or other
observable inputs (Level 2). The lowest priority is given to unobservable
inputs (Level 3).

The following
table provides information regarding fair value measurements for our cash
equivalents and marketable securities as of December 31, 2008 according to the
three-level fair value hierarchy:

|                                       |  |                              |        |                                                                   |                                                 |                                                  |  |                                              |        |  |   |   | 
|-------------------------------------- |  | ---------------------------- | ------ | ----------------------------------------------------------------- | ----------------------------------------------- | ------------------------------------------------ |  | -------------------------------------------- | ------ |  | - | - | 
|                                       |  |                              |        |                                                                   | Fair Value Measurements at Reporting Date Using |                                                 
|                                       |  |                              |       
|(In
 thousands)                        |  | Balance
 December 31, 
 2008 |        | Quoted Prices in
 Active Markets for
 Identical Assets
 (Level 1) |                                                 | Significant Other
 Observable
 Inputs
 (Level 2) |  | Significant
 Unobservable
 Inputs
 (Level 3) |       
|                                       |  |                              |        |                                                                   |                                                 |                                                  |  |                                              |        |  |   |   | 
|Cash equivalents                       |  | $                            | 2,421  |                                                                   | $                                               |                                                 |  | $                                            | 2,421  |  | $ |  | 
|U.S. government and agency obligations |  | $                            | 21,151 |                                                                   | $                                               |                                                 |  | $                                            | 21,151 |  | $ |  | 
|Corporate debt securities              |  | $                            | 2,527  |                                                                   | $                                               |                                                 |  | $                                            | 2,527  |  | $ |  | 
|Asset backed securities                |  | $                            | 1,559  |                                                                   | $                                               |                                                 |  | $                                            | 1,559  |  | $ |  | 
|Equity securities                      |  | $                            | 30     |                                                                   | $                                               | 30                                               |  | $                                            |       |  | $ |  | 

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Changes in the
fair value of these investments for the   year
ended December 31, 2008 resulting from our adoption of SFAS No. 157 had no
impact on our consolidated financial statements. Our foreign currency swap
agreements are structured to mature on the last day of each quarter. As a
result, the fair value associated with these agreements is inconsequential.

In February
2007, the FASB issued Statement No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities, which provides companies with an
option to report selected financial assets and liabilities at fair value. This
standard was effective beginning after December 31, 2007. We elected not
to adopt the provisions of SFAS No. 159 in 2008.

NOTE 14  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 our financial position, results of operations or
cash flows.

In the normal
course of business to facilitate sales of our products and services, we at
times indemnify other parties, including customers, with respect to certain
matters. In these instances, we have agreed to hold the other parties harmless
against losses arising out of intellectual property infringement or other types
of claims. These agreements may limit the time within which indemnification
claims can be made and almost always limit the amount of the claim. It is not possible
to determine the maximum potential amount under these indemnification
agreements due to the limited history of prior indemnification claims and the
unique facts and circumstances involved in each particular agreement.
Historically, payments made, if any, under these agreements have not had a
material impact on our operating results, financial position or cash flows.

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

|                                          |  |              |        |             |   |              |   |             |        |   |   |        |  
|----------------------------------------- |  | ------------ | ------ | ----------- | - | ------------ | - | ----------- | ------ | - | - | ------ | -
|2008                                      |  | March 31 (2) |        | June 30 (2) |   | Sept. 30 (2) |   | Dec. 31 (3) |       
|                                          |  |              |        |             |   |              |   |             |        |   |   |        |  
|Revenues                                  |  | $            | 13,807 |             | $ | 13,391       |   | $           | 11,570 |   | $ | 6,684  |  
|Gross margin                              |  |              | 6,439  |             |   | 5,922        |   |             | 4,992  |   |   | 1,712  |  
|Income (loss) from operations             |  |              | 159    |             |   | (733         | ) |             | (1,716 | ) |   | (8,173 | )
|Net income (loss)                         |  |              | 427    |             |   | (269         | ) |             | (772   | ) |   | (6,057 | )
|Net income (loss) per share  Basic (1)   |  |              | 0.05   |             |   | (0.03        | ) |             | (0.11  | ) |   | (0.90  | )
|Net income (loss) per share  Diluted (1) |  |              | 0.05   |             |   | (0.03        | ) |             | (0.11  | ) |   | (0.90  | )

|                                   |  |          |        |         |   |          |  |         |        |  |   |        | 
|---------------------------------- |  | -------- | ------ | ------- | - | -------- |  | ------- | ------ |  | - | ------ | 
|2007                               |  | March 31 |        | June 30 |   | Sept. 30 |  | Dec. 31 |       
|                                   |  |          |        |         |   |          |  |         |        |  |   |        | 
|Revenues                           |  | $        | 13,741 |         | $ | 13,974   |  | $       | 16,173 |  | $ | 14,888 | 
|Gross margin                       |  |          | 7,132  |         |   | 7,094    |  |         | 8,263  |  |   | 7,758  | 
|Income from operations             |  |          | 1,174  |         |   | 1,274    |  |         | 1,806  |  |   | 1,286  | 
|Net income                         |  |          | 1,153  |         |   | 1,198    |  |         | 1,473  |  |   | 1,204  | 
|Net income per share  Basic (1)   |  |          | 0.13   |         |   | 0.13     |  |         | 0.17   |  |   | 0.14   | 
|Net income per share  Diluted (1) |  |          | 0.13   |         |   | 0.13     |  |         | 0.16   |  |   | 0.13   | 

|    |                                                                                                                                                                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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) | Severance
 and recruitment costs related to our move to Singapore in 2008 were $193,000
 in the first quarter, $185,000 in the second quarter and $98,000 in the third
 quarter.                                                                                                                         
|    |                                                                                                                                                                                                                                                                                                          
|(3) | 2008 fourth
 quarter results include a non-cash pre-tax charge for goodwill impairment of $3.9
 million, a $650,000 pre-tax charge for inventory obsolescence and $294,000
 pre-tax charge for severance and recruitment costs related to our move to
 Singapore and a November 2008 workforce reduction.

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Report of Independent Registered Public Accounting
Firm

To
Stockholders and the Board of Directors of CyberOptics Corporation:

In our
opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, consolidated statements of cash flows
and consolidated statements of stockholders equity and comprehensive income
present fairly, in all material respects, the financial position of CyberOptics
Corporation and its subsidiaries at December 31, 2008 and 2007, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2008 in conformity with accounting principles
generally accepted in the United States of America. Also in our opinion, the
Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2008, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Companys management is
responsible for these financial statements, for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting, included in Managements Report on
Internal Control over Financial Reporting appearing under Item 9A(i). Our
responsibility is to express opinions on these financial statements and on the
Companys internal control over financial reporting based on our integrated audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the
assessed risk. Our audits also included performing such other procedures as we
considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.

As described
in Note 6 to the consolidated financial statements, the Company changed the
manner in which it accounts for uncertain tax positions effective January 1,
2007.

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 9, 2009

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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 were effective in ensuring that information
required to be disclosed by us in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in applicable rules and forms and that such information is
accumulated and communicated to management, including our Chief Executive Officer
and Chief Financial Officer, in a manner that allows timely decisions regarding
required disclosure.

|     |                                                                  
|---- | -----------------------------------------------------------------
|(i). | 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, 2008. 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, 2008 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, 2008
based on the criteria in Internal
Control-Integrated Framework issued by the COSO.

The
effectiveness of the Companys internal control over financial reporting as of
December 31, 2008 has been audited by PricewaterhouseCoopers LLP, an
independent registered public accounting firm, as stated in their report which
appears herein.

(ii).     During
the quarter ended December 31, 2008, 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.

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PART III.

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

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 18, 2009 (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, AND
DIRECTOR INDEPENDENCE

The
information under the headings Election of DirectorsCompensation of
Directors 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: The Consolidated Financial Statements included in Item 8 to this
 Form 10-K consist of the following:
|                                                                                                                                              |  |                                                                                                                                  
|                                                                                                                                              |  | Consolidated Balance
 Sheets as of December 31, 2008 and 2007.                                                                   
|                                                                                                                                              |  | Consolidated Statements of
 Operations for the years ended December 31, 2008, 2007 and 2006.                                     
|                                                                                                                                              |  | Consolidated Statements of
 Cash Flows for the years ended December 31, 2008, 2007 and 2006.                                     
|                                                                                                                                              |  | Consolidated Statements of
 Stockholders Equity and Comprehensive Income for the years ended December
 31, 2008, 2007 and 2006. 
|                                                                                                                                              |  | Notes to the Consolidated
 Financial Statements                                                                                  
|                                                                                                                                              |  |                                                                                                                                  
|(a)(2)          Financial
 Statement Schedule:                                                                                               
|                                                                                                                                             
|                                                                                                                                              |  | Schedule II, Valuation and
 Qualifying Accounts for the years ended December 31, 2008, 2007 and 2006, is
 attached as Item 15(c).
|                                                                                                                                              |  | Report of Independent
 Registered Public Accounting Firm on Financial Statement Schedule, is
 attached as Item 15(c).            

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| |                 |                  |             |                                                                                                                                                                                                                                                                
| | --------------- | ---------------- | ----------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (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 3ii to the current report on Form 8-K
 dated November 9, 2007).                                                                                                                                   
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | 4.1             |                  |             | Restated Stock Option Plan
 of the Company, as amended (incorporated by reference to Exhibit 4.1 of the
 Companys Registration Statement on Form S-8 filed August 18, 1998 (file no
 333-61711)).                                                             
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | 4.2             |                  |             | CyberOptics Corporation
 Stock Option Plan for Non-Employee Directors, as amended (incorporated by
 reference to Exhibit 4.2 of the Companys Registration Statement on Form S-8
 filed August 10, 2006 (file no 333-136500)).                                 
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | 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 4.1 of the
 Companys Registration Statement on Form S-8 filed August 10, 2006 (file no
 333-136500)).                                                             
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | 4.5             |                  |             | CyberOptics Corporation
 Stock Grant Plan for Non-Employee Directors (incorporated by reference to
 Exhibit 4.1 of the Companys Registration Statement on Form S-8 filed August
 14, 2008 (file no 333-153015)).                                              
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | *10.1           |                  |             | 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).                                        
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | *10.2           |                  |             | Offer of employment
 between Steven J. DiMarco and the Company (incorporated by reference to
 Exhibit 10.2 to the Companys annual report on Form 10-K for the year ended
 December 31, 2005).                                                                 
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | 10.3            |                  |             | Lease Agreement between
 FirstCal Industrial 2 Acquisitions LLC and the Company dated March 27, 2006
 (incorporated by reference to Exhibit 10.1 to the Companys quarterly report
 on Form 10-Q for the quarter ended March 31, 2006).                        
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | *10.4           |                  |             | Severance
 Pay Agreement with Steven K. Case (incorporated by reference to Exhibit 10.1
 to the current report on Form 8-K dated June 23, 2008)                                                                                                                
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | *10.5           |                  |             | Severance
 Pay Agreement with Kathleen P. Iverson (incorporated by reference to Exhibit
 10.2 to the current report on Form 8-K dated June 23, 2008)                                                                                                           
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | *10.6           |                  |             | Severance
 Pay Agreement with Jeffrey A. Bertelsen (incorporated by reference to Exhibit
 10.3 to the current report on Form 8-K dated June 23, 2008)                                                                                                          
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | 10.7            |                  |             | Tenancy
 Agreement between Brilliant Manufacturing LTD and CyberOptics PTE LTD
 (Singapore) Term 15 May 2008 to 14 May 2011. (incorporated by reference to
 Exhibit 10.1 to the Companys quarterly report on Form 10-Q for the quarter
 ended March 31, 2008).
| |                 |                  |             |                                                                                                                                                                                                                                                                
| | 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.                                                                                                                                                           

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| |      |  |  |                                                                                                                                  
| | ---- |  |  | ---------------------------------------------------------------------------------------------------------------------------------
| | 31.2 |  |  | Certification of Chief
 Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                             
| |      |  |  |                                                                                                                                  
| | 32.0 |  |  | Certification of Chief
 Executive Officer and Chief Financial Officer Pursuant to Section 906 of the
 Sarbanes-Oxley Act of 2002.

* Management Contract or
Compensatory Plan or Arrangement

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

SCHEDULE II

CYBEROPTICS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|----------------------------------- |  | -------------------------------- | ------- | ------------------------------- | - | ----------------------------- | - | ---------------------- | -------- | - | - | --------- | 
|Description                         |  | Balance at
 Beginning of
 Period |         | Charged to
 Costs and
 Expenses |   | Deductions                    |   | Balanceat end ofPeriod |         
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Allowance for doubtful
 accounts:   |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Year ended December 31, 2008        |  | $                                | 310,000 |                                 | $ | (34,000                       | ) | $                      | (26,000  | ) | $ | 250,000   | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Year ended December 31, 2007        |  | $                                | 221,000 |                                 | $ | 98,000                        |   | $                      | (9,000   | ) | $ | 310,000   | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Year ended December 31, 2006        |  | $                                | 286,000 |                                 | $ | 38,000                        |   | $                      | (103,000 | ) | $ | 221,000   | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Description                         |  | Balance at
 Beginning of
 Period |         | Charged to
 Costs and
 Expenses |   | Deductions                    |   | Balanceat end ofPeriod |         
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Allowance for obsolete
 inventory:  |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Year ended December 31, 2008        |  | $                                | 520,000 |                                 | $ | 1,007,000                     |   | $                      | (442,000 | ) | $ | 1,085,000 | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Year ended December 31, 2007        |  | $                                | 882,000 |                                 | $ | 253,000                       |   | $                      | (615,000 | ) | $ | 520,000   | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Year ended December 31, 2006        |  | $                                | 802,000 |                                 | $ | 373,000                       |   | $                      | (293,000 | ) | $ | 882,000   | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Description                         |  | Balance at
 Beginning of
 Period |         | Charged to
 Costs and
 Expenses |   | Other Increases
 (Deductions) |   | Balanceat end ofPeriod |         
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Allowance for deferred tax
 assets: |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Year ended December 31, 2008        |  | $                                | 599,000 |                                 | $ | 135,000                       |   | $                      | (94,000  | ) | $ | 640,000   | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Year ended December 31, 2007        |  | $                                | 451,000 |                                 | $ | 54,000                        |   | $                      | 94,000   |   | $ | 599,000   | 
|                                    |  |                                  |         |                                 |   |                               |   |                        |          |   |   |           | 
|Year ended December 31, 2006        |  | $                                | 371,000 |                                 | $ | 80,000                        |   | $                      |         |   | $ | 451,000   | 

REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANACIAL STATEMENT
SCHEDULETo the Stockholders and the Board of Directors of CyberOptics
Corporation:

Our audits of the
consolidated financial statements and of the effectiveness of internal control
over financial reporting referred to in our report dated March 9, 2009
appearing in Item 8 of this Form 10-K also included an audit of the financial
statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion,
this financial statement schedule presents fairly, in all material respects,
the information set forth therein when read in conjunction with the related
consolidated financial statements.

PricewaterhouseCoopers LLP
Minneapolis, MinnesotaMarch 9, 2009

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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                  |       | March 4,
 2009
|Kathleen
 P. Iverson        |  | (Principal
 Executive Officer)     |       |               
|                            |  |                                    |       |               
|/s/
 STEVEN K. CASE         |  | Chairman
 and Director             |       | March 4,
 2009
|Steven
 K. Case             |  |                                    |       |               
|                            |  |                                    |       |               
|/s/ ALEX
 B. CIMOCHOWSKI    |  | Director                           |       | March 4,
 2009
|Alex B.
 Cimochowski        |  |                                    |       |               
|                            |  |                                    |       |               
|/s/
 MICHAEL M. SELZER, JR. |  | Director                           |       | March 4,
 2009
|Michael
 M. Selzer, Jr.     |  |                                    |       |               
|                            |  |                                    |       |               
|/s/
 IRENE M. QUALTERS      |  | Director                           |       | March 4,
 2009
|Irene M.
 Qualters          |  |                                    |       |               
|                            |  |                                    |       |               
|/s/
 JEFFREY A. BERTELSEN   |  | Vice
 President and CFO            |       | March 4,
 2009
|Jeffrey
 A. Bertelsen       |  | (Principal
 Financial Officer      |       |               
|                            |  | and
 Principal Accounting Officer) |       |               

64

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