# ** **

# **UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-KSB**

 

**ý ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the fiscal year ended October 31,2005**

 

**Commission File Number:  0-11518**

 

**PPT VISION, INC.**

(Name of Small Business Issuer in its Charter)

 
| **MINNESOTA**                     |   | **41-1413345**      |
|-----------------------------------|--------|---------------------|
| (State or other jurisdiction      |   | (I.R.S. Employer    |
| of incorporation or organization) |   | Identification No.) |

 

**12988 Valley View RoadEden Prairie, MN  55344**

(Address of principal executive offices, including zipcode)

 

Registrant’s telephone number, including areacode:  **(952) 996-9500**

 

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

 

Securities registered pursuant to Section 12(g) ofthe Act:

**(1) Common Stock $.10 par value (2) PreferredStock Purchase Rights**

 

Checkwhether the issuer is not required to file reports pursuant to Section 13or 15(d) of the Exchange Act o

 

Checkwhether the issuer (1) has filed all reports required to be filed by Section 13or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports) and (2) hasbeen subject to such filing requirements for the past 90 days.  YES    ý    NO    o

 

Checkif there is no disclosure of delinquent filers in response to Item 405 ofRegulation S-B contained in this form, and no disclosure will be contained, tothe best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-KSBor any amendment to this Form 10-KSB.  o

 

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

 

Stateissuer’s revenues for its most recent fiscal year:  $5,648,000

 

Theaggregate market value of the voting stock held by nonaffiliates of the issuer(based on the closing sale price of its stock as reported by the Nasdaq SmallCap Market) as of January 6, 2006 was approximately $2.2 million.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Theinformation called for by Part III of this Form 10-KSB will be incorporatedby reference from the definitive proxy statement for the annual meeting of shareholdersto be held on March 9, 2006.

 

 

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**PART I**

 

This Annual Report on Form 10-KSB containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934, including statements regarding PPT VISION, Inc.’s (the Company’s)expectations, beliefs, intentions and strategies regarding the future.Forward-looking statements include, without limitation, statements regardingthe extent and timing of future revenues and expenses and customer demand. Allforward-looking statements included in this document are based on informationavailable to the Company as of the date hereof, and the Company assumes noobligation to update any forward-looking statements.

 

The Company’s actual results are subject to risks anduncertainties and could differ materially from those discussed in theforward-looking statements. These statements are based upon the Company’sexpectations regarding a number of factors, including the Company’s ability toobtain additional working capital if necessary to support its operations,changes in worldwide general economic conditions, cyclicality of capitalspending by customers, the Company’s ability to keep pace with technologicaldevelopments and evolving industry standards, worldwide competition, and theCompany’s ability to protect its existing intellectual property from challengesfrom third parties. A detailed description of the factors that could causefuture results to materially differ from the Company’s recent results or thoseprojected in the forward-looking statements are contained in the section ofthis Form 10-KSB entitled “Important Factors Regarding Forward-LookingStatements.”

 

During the fourth quarter of fiscal 2004, weimplemented a revised operating strategy that called for a total focus of ourresources on our core 2D machine vision business.  Accordingly, we initiated and completed thesale of our 3D business unit, and all the related patents, intellectualproperty, inventory and equipment.  Inaccordance with appropriate accounting rules, we have reclassified ourpreviously reported financial results to exclude the results of our 3D businessand these results are presented on a historical basis as a separate line in ourstatements of operations and balance sheets entitled “Discontinued Operations.”  Our continuing operations represent our 2Dbusiness only.  All references tofinancial information and description of business in this Form 10-KSB havebeen revised to reflect only our continuing operations and all references toour now discontinued 3D business have been eliminated.

 

**Item 1. DESCRIPTION OF BUSINESS**

 

**CORPORATE PROFILE**

 

PPT VISION, Inc. designs,manufactures, and markets camera-based intelligent systems for automatedinspection in manufacturing applications. The Company’s products, commerciallyknown as machine vision systems, enable manufacturers to realize significanteconomic paybacks by increasing the quality of manufactured parts and improvingthe productivity of manufacturing processes. The Company’s machine visionproduct line is sold on a global basis to end-users, system integrators,distributors and original equipment manufacturers (OEMs) primarily in theelectronic and semiconductor component, automotive, medical device, andpackaged goods industries.

 

PPT VISION was incorporated under the laws of theState of Minnesota in 1981.

 

**WHAT IS MACHINE VISION?**

 

A machine vision system consists of industrialcomputer hardware and software working together with cameras and lighting tocapture images of products as they are being manufactured. By capturing theseimages and comparing them to images of standard or correct products, aneffective machine vision system will prevent defective products from beingshipped to consumers and enable manufacturers to improve their processes andreduce costs. Commercial use of machine vision technology for manufacturingquality control began to emerge in the early 1980s. However, machine visionsystems at that time were complex to program and maintain, difficult toinstall, limited in performance and not cost-effective. Through advances inmicroprocessor and software technologies, these barriers have been removed,enabling machine vision to emerge as a powerful process control technology thatenables manufacturers to improve quality and increase productivity.

 

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**THE MACHINE VISION MARKET**

 

The machine vision market is large and highlyfragmented with over 200 machine vision suppliers around the world. Many arevery small companies focusing on niche applications or niche technologies. Asmall handful of competitors such as Cognex or Orbotech have emerged as large,global competitors. The Automated Imaging Association estimates that the totalglobal market for machine vision technologies in 2004 was approximately $8.1billion with a projected growth rate in revenue of approximately 12% to 14% peryear over the next five years.  Thistotal global machine vision market includes hundreds of different market andtechnology niches ranging from very simple vision sensors priced at $1,000 tovery high application specific machines priced at more than $1,000,000.  The Company believes that its existing andplanned machine vision product lines can potentially address approximately 5%of this total global machine vision market. Demand for machine vision systems comes from end-user manufacturers whoapply these systems as an integral part of their manufacturing process, OEMs,system integrators and machine builders.

 

 The growth of the end-user machine vision marketis being driven by global competitive trends that have led manufacturersworldwide to redesign manufacturing processes in order to reduce cost andincrease productivity and quality. In order to meet today’s manufacturingquality requirements, statistical sampling methods are often insufficient and100% inspection is required.  Manufacturersare increasingly adopting machine vision solutions.

 

Manufacturers are demanding expanded capabilities frommachine vision systems, including faster processing capabilities and greaterease of use. Manufacturers are also demanding more comprehensive services frommachine vision providers, including application engineering, technical supportand training. Furthermore, manufacturers are seeking the ability to monitortrends, to better comprehend the manufacturing process and to identifyproblems. In addition, manufacturers are being challenged to maintain highproduction levels that require rapid set up times, flexibility and seamlessnetworking with the host manufacturing control system to provide comprehensive diagnosticand process control feedback.

 

**BUSINESS STRATEGY**

 

The Company’s objective is to be a worldwide leader inthe design, manufacture, and marketing of machine vision-based automatedinspection systems for manufacturing applications. Through the successfulintegration of the Company’s core competencies, including image acquisition,image processing, application development software, and application expertise,the Company believes it will be able to meet its objective and successfullyimplement its strategy.

 

**Key elements of the Company’s strategy include:**

 

•                    First is an intense focus on continuouscustomer-driven product development.  TheCompany continues to introduce new hardware products and new software tools andfeatures in direct response to customer feedback.  This enables the Company to continually addnew customers, better serve existing customers, and expand the size of theCompany’s market.

 

•                    Second is a focus on supporting,training, and growing the number of our selling partners.  Selling partners include distributors, systemintegrators, machine builders, OEMs and in-house equipment development groupsat end-user manufacturers.  Often aselling partner is a hybrid of two or more of these five categories of sellingpartners.  As the size of our trainedinfrastructure of selling partners grows, we expect our sales results to growright with it.  Thus, the Company isfocusing heavily on building up and supporting our selling partner networkworldwide.

 

•                  Third is a concentration on rolling outand promoting application specific software solutions developed in ourpowerful, easy to use Inspection BuilderTM software environment.  The Company has successfully deployed severalniche applications in the medical device, electronic component, packaging, andautomotive markets, and will continuously target emerging, high value-add nicheapplications.

 

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**PRODUCTS**

 

The Company designs, manufactures, and markets machinevision-based automated inspection systems for manufacturing applications suchas electronic and mechanical assembly verification, verification of printedcharacters, packaging integrity, surface flaw detection, and gauging andmeasurement tasks. A machine vision system is a combination of cameras,lighting, and industrial computer hardware and software working together tocapture and analyze images of moving parts to determine if the parts match adefined standard. Machine vision-based inspection systems enable manufacturersto realize significant economic paybacks by increasing the quality ofmanufactured parts and improving the productivity of manufacturing processes.The Company’s vision systems are sold throughout the Americas, Europe and Asiato a broad range of industry categories, including automotive, electronic andsemiconductor components, consumer goods, medical devices, pharmaceuticals andplastics.

 

The Company’s machine vision systems are primarilytargeted at providing manufacturers with 100% inspection in high speed,discrete part manufacturing applications. This typically replaces olderoff-line random sampling techniques or human vision inspection techniques as ameans of monitoring quality. The Company’s machine vision systems enablemanufacturers to achieve zero defect production.

 

The Company’s family of machine vision systems, whichinclude complete software tools for application development, providesignificant performance advantages that meet manufacturers’ criticalrequirements. These requirements include high speed, flexibility, ease-of-use,networkability and statistical feedback, all without sacrificing performance.

 

The Company has developed products that have specificadvantages in terms of speed and ease-of-use. Many of the Company’s machinevision systems are capable of operating at speeds over 10,000 parts per minuteperforming 100% inspection. This speed can be critical to successfullyemploying machine vision in many applications.

 

**IMPACTTM  T-series Intelligent Camera Family**

 

In fiscal 2004, PPT VISIONintroduced its first IMPACT T-series intelligent camera.  Intelligent cameras contain the imageprocessing computer right inside the camera, which is a cost effectivealternative to full-scale vision systems. Early intelligent cameras did not have the horsepower or features offull-scale vision systems and therefore could only be used for simpleapplications.  The IMPACT T-series modelsof intelligent cameras include all the power of a full scale vision system.  The IMPACT T-series powerful processingcapabilities, together with its broad family of product offerings, includinghigh-resolution, color, micro-head models, and high performance software, makeit highly applicable for a broad range of manufacturing automation requirements.

 

Each member of the IMPACT T-series family contains ahigh performance microprocessor and real-time operating system, plus a digitalimaging sensor.  The electroniccomponents are contained in a sealed industrial unit that can be installeddirectly into assembly lines and manufacturing equipment.  A broad configuration of discrete, serial,and ethernet I/O make the IMPACT T-series compatible with a full spectrum ofindustrial control equipment and instrumentation.

 

There are currently nine intelligent camera productofferings in the T-series family, offering manufacturers the mostcost-effective solution for a broad range of machine vision applications.  An array of T-series cameras can be installedin a TCPIP network configuration for multiple camera installations.

 

**IMPACTTM  C-series Micro-System Family**

 

TheIMPACT C-series was introduced in fiscal 2002 with a remote image processingcomputer for ultra high-speed applications, high density I/O and third partycamera configurations.  Each IMPACTC-series contains the highest performing microprocessors available today in amachine vision micro-system category. PPT Vision pioneered the high-performance micro-system concept, whichhas been deployed in 100’s of applications worldwide.

 

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At theheart of the IMPACT C-series is a high performance microprocessor plusoperating system.  Each C-seriesprocessor contains high density memory and flash on board.  The enhanced memory enables numerous highperformance features, such as on-line simulation, intelligent calibration,recipe management, and multi-tasking. IMPACT C-series remains the only micro-system in the market with afeature set which could previously be found only in the full-scale visionsystem categories.

 

  Together with the T-series, the IMPACTproduct family offers the most complete range of cost-effective options formanufacturers requiring a broad range of machine vision tasks.

 

**IMPACTTM  Inspection Builder Software**

 

InspectionBuilder software, which was designed specifically for the IMPACT machine visionfamily, was designed from the ground up, using the latest software developmenttechnologies.  The end result is asoftware package that is easy-to-use and does not require users to utilizeadvanced programming techniques such as C++ or Visual Basic.  This single software platform supports theentire IMPACT family of intelligent camera product offerings.  The software contains the latest innovationsin image processing technology plus a broad range of tools for deployingcomplete solutions in the factory environment.

 

PPTVision has a reputation for easy to use, yet powerful software – and InspectionBuilder expands further upon the Company’s expertise.  Modern software technologies such as patternmatching, character reading and high speed defect analysis, form the basis ofthe software platform, plus a broad range of application-specific tools are availableto all users.

 

InspectionBuilder software substantially reduces the need to use third party software packages,such as Visual Basic for application deployment.  This is a unique concept in machine visionapplications and has given manufacturers a significant advantage in reducinginstallation time, thus greatly improving productivity.  In fiscal 2004 and 2005 several majorenhancements were made to Inspection Builder software, including Ethernet IP, awidely utilized fieldbus standard, and Activex controls, for greaterdissemination of data across manufacturing enterprises.  In addition, over 20 new image processingalgorithms were added to Inspection Builder software in fiscal 2004.

 

**MARKETS AND CUSTOMERS**

 

The Company sells its products to a broad range ofindustries, including manufacturers of electronic and semiconductor components,pharmaceuticals, medical devices, automotive components, consumer products and plastics.As of October 31, 2005, the Company had sold more than 6,300 machinevision systems to over 400 customers since inception.

 

In fiscal 2005, one customeraccounted for over 10% of net revenues. This customer, SimacMasic BV PDC, accounted for 12.3% of net revenues.   During fiscal 2004, two customerseach accounted for over 10% of net revenues. The largest of these customers, Tokyo Weld, Co, Ltd. accounted for 22.9% of net revenues while, Simac Masic BVPDC accounted for 10.2% of net revenues. The loss of, or significantcurtailment of purchases by, any of the Company’s principal customers couldhave a material adverse effect on the Company’s results of operations. See RiskFactors – “We are dependent upon a limited number of principal customers.”

 

**SALES, MARKETING AND CUSTOMER SUPPORT**

 

The Company sells its products to end-users, systemintegrators, distributors, machine builders and OEMs. The Company marketsits products through supporting its industrial automation distributionpartners, appearances at industry trade shows, advertising in industry tradejournals, articles published in industry and technical journals, its ownwebsite and through direct-selling certain key accounts.   Inaddition, the Company’s strong customer relationships serve as valuablereferences.

 

The Company focuses on delivering a high level ofvalue-added applications engineering support to its industrial automationdistribution partners and end-user customers through its own in-houseapplications engineering resources. The Company also provides extensivetraining opportunities for its industrial automation distributors and customers,either at the Company’s facilities or on-site at their facilities.

 

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The following table sets forth the percentage of theCompany’s net revenues (including sales delivered through internationaldistributors) by geographic location during the past two years:

 
| **YEAR ENDED OCTOBER 31,** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| United States                   |       | 46       | %          | 41       | %          |
|                            |       |     |       |     |       |
| Europe &  Canada       |       | 27       | %          | 20       | %          |
|                            |       |     |       |     |       |
| Asia-Pacific                    |       | 24       | %          | 38       | %          |
|                            |       |     |       |     |       |
| South America                   |       | 3        | %          | 1        | %          |
|                            |       |     |       |     |       |
|                            |       | 100      | %          | 100      | %          |

 

Substantially all of the Company’s export sales arenegotiated, invoiced and paid in United States dollars. However, the Companywill from time to time enter into export sales negotiated, invoiced and paid inforeign currencies.

 

**BACKLOG**

 

The Company does not believe backlog is a keyindicator of future revenues in the end-user machine vision market. PPT VISIONproducts are typically shipped within 30 days after receipt of an order. TheCompany believes that maintaining as short a time as practical for delivery isa competitive advantage in the end-user machine vision market. Customers in theend-user machine vision market do not normally place orders for large multiplesof units with scheduled deliveries over many months. Rather, end-user machinevision addresses a specific application or problem at a specific manufacturingsite.

 

**RESEARCH AND PRODUCT DEVELOPMENT**

 

PPT VISION’s products are distinguished by the Company’sproprietary technology and its significant commitment to research and productdevelopment efforts. The Company’s research and product development efforts arefocused on its core technical competencies. The Company believes that the ability to integrate these corecompetencies is a key strength of the Company and is essential to achievinglong term success in the machine vision market. The Company’s core competenciescan be described as follows:

 

Image Acquisition. This refers to the means andmethods by which an image is captured, stored, and then made available forsubsequent processing and display. Image acquisition combines the disciplinesof photo-optics and electrical engineering.

 

Imaging Processing. This refers to the means andmethods by which an image is analyzed or enhanced to produce some desiredinformation, measurements or results. Image processing combines the disciplinesof software engineering, mathematics, algorithm development and electricalengineering to implement efficient solutions to computationally complexproblems. Typical image processing tasks include real-time inspection,guidance, gauging and recognition.

 

Application Development Software. This refers to themeans and methods whereby a machine vision system is configured and controlled.The development and support of application development software requiresexpertise in the disciplines of object-oriented programming, graphicalprogramming environments, man-machine interfaces, device drivers and generalsoftware engineering.

 

Application Expertise. This refers to the capabilityand experience of individuals in the Company, who are a critical component ofsuccessfully deploying this highly specialized technology.  Application expertise encompasses the meansand methods whereby a machine vision system is interfaced to and combined withother factory automation equipment for purposes of creating a complete solutionfor the customer. This may include the development of application specificsolutions for certain vertical market

 

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applicationsalong with mechanical fixturing for mounting camera and lighting components,networking and programmable controllers for process control, and rejectmechanisms for ejection of defective parts.

 

Various configurations of the Company’s productsinclude proprietary design work performed by the Company’s employees in each ofthese areas.

 

PPT VISION believes that continued and timelydevelopment of new products and enhancements to existing productcharacteristics are essential to maintaining its competitive position. TheCompany has committed and expects to continue to commit substantial resourcesto its research and development effort, which plays a significant role inmaintaining and advancing its position as a leading provider of machine vision solutionsfor manufacturing applications.  TheCompany’s current research and development efforts are directed to increasingperformance in image acquisition, image processing and application developmentsoftware, which could produce systems with greater speed and accuracy whilealso providing customers with more expanded software tools.  Key software capabilities under developmentare targeted at expanding the number of software algorithms and tools andexpanding the ease-of use of the Company’s Inspection Builder software. willenable support for different hardware and user interfaces, as well asincreasing the development speed of application specific software tools. TheCompany also intends to expand the number of its intelligent camera productofferings to include a wider variety of price points and performanceconfigurations to better enable it to address a wider variety of applicationniches with the machine vision market.

 

Research and development expenditures were $1.3million, and $1.6 million in the fiscal years ended October 31, 2005, and2004, respectively.  We expect thesecosts to remain relatively flat, compared to fiscal 2005, in fiscal 2006.

 

**MANUFACTURING**

 

The Company assembles, configures and tests itsproducts at its suburban Minneapolis facility. The Company’s printed circuitboards are custom built by several manufacturers. Although most of thecomponents used in the Company’s machine vision systems are availableoff-the-shelf, some components are available from only a single supplier orfrom a limited number of suppliers. The Company typically purchases inventoryand builds products in response to quarterly sales forecasts, enabling it toship products within 30 days after receipt of an order.

 

Much of the Company’s product manufacturing,consisting primarily of circuit board manufacturing and assembly and machinedparts production, is contracted with outside vendors. Company personnel inspectincoming parts and perform final assembly and testing of finished products. TheCompany believes that its outsourcing strategy enables it to focus itsresources on the key core competency areas from which it derives itscompetitive advantages.

 

**COMPETITION**

 

The machine vision industry is highly fragmented.Currently, no competitor holds a significant aggregate market share percentage,although some dominate individual niches within the overall machine visionindustry. The Company believes that over the next several years, the industrywill experience a continuing trend toward consolidation. However, given theapplication-specific nature of the industry, the Company also believes that themachine vision industry will continue to have a relatively large number ofcompetitors focusing on specific niches.

 

The Company believes the major competitive factors inthe industry are performance, quality, support and price. Although the Companybelieves that its products are unique, competitors offer technologies andsystems that are capable of certain of the functions performed by the Company’sproducts. The Company faces competition from a number of companies in themachine vision market, some of which have greater manufacturing and marketingcapabilities and greater financial, technological and personnel resources.

 

Although the Company believes that its currentproducts offer several advantages in terms of speed and ease-of-use, andalthough the Company has attempted to protect the proprietary nature of suchproducts, it is possible that any of the Company’s products could be duplicatedby other companies in the

 

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samegeneral market. There can be no assurances that the Company would be able tocompete with similar products produced by a competitor.

 

**PATENTS AND PROPRIETARY RIGHTS**

 

The Company relies on a combination of patent,copyright, trademark and trade secret laws to establish its proprietary rightsin its products. The Company owns several issued and pending United States andinternational patents for various inventions used in machine-vision, automatedinspection and illumination systems. The Company believes that the patents itowns may have been useful in protecting the Company’s proprietary products andmay be useful in protecting potential future products. The Company alsobelieves its ability to efficiently develop and sell high performance,cost-effective vision systems on a timely basis, whether patented or not, iscrucial to the Company’s future success. The Company requires each of itsemployees to enter into standard agreements pursuant to which the employeeagrees to keep confidential all proprietary information of the Company and toassign to the Company all rights in any proprietary information or technologymade or contributed by the employee during his or her employment or madethereafter as a result of any inventions conceived or work done during suchemployment. Despite these precautions, it may be possible for a third party tocopy or otherwise obtain and use the Company’s products or technology withoutauthorization or to develop similar technology independently. In addition,effective patent, copyright, trademark and trade secret protection may beunavailable or limited in certain foreign countries.

 

The Company has obtained United States federalregistration for a number of its trademarks including its “PPT”, “PPT VISION”, “IMPACT”,“Inspection Builder”, “Passport”, and “Scout” trademarks. The Company has filedfor federal registration of additional trademarks and intends to continue to doso in the future. Although no assurance can be given as to the strength orscope of the Company’s trademarks, the Company believes that its trademarkshave been and will be useful in developing and protecting market recognitionfor its products.

 

**EMPLOYEES**

 

As of January 1, 2006, the Company had 38 full-timeemployees, including 8 employees in research and development, 14 in sales,marketing and application engineering, 11 in manufacturing and 5 in finance andadministration. Although the Company has been successful in attracting andretaining qualified technical personnel to date, there can be no assurance thatthis success will continue. None of the Company’s employees are covered bycollective bargaining agreements or are members of a union. The Company hasnever experienced a work stoppage and believes that its relations with itsemployees are excellent.

 

**IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS**

 

Various forward-looking statements have been made inthis Annual Report on Form 10-KSB. Forward-looking statements may also bemade in the Company’s other reports filed under the Securities Exchange Act of1934, in its press releases and in other documents. In addition, from time totime the Company, through its management, may make oral forward-lookingstatements.

 

Forward-looking statements are subject to risks anduncertainties, including those identified below, that could cause actualresults to differ materially from such statements. The words “anticipate,” “believe,”“expect,” “intend,” “optimistic,” “will” or similar expressions are intended toidentify forward-looking statements. Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the dateon which they are made. The Company undertakes no obligation to update publiclyor revise any forward-looking statements.

 

Important factors that could cause actual results todiffer materially from the Company’s forward-looking statements, as well asaffect the Company’s ability to achieve its financial and other goals, include,but are not limited to, the following:

 

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**RISK FACTORS**

 

**Wehave incurred losses in each of the last three years, have received a goingconcern opinion and may require additional capital.**    The Company has incurred net lossesand negative cash flows from operating activities in each of the past three yearsand has an accumulated deficit of $33.8 million at October 31, 2005.  In 2005, our net loss was $2.4million.   In 2004, our net loss was$1.9 million.  In 2003, our net loss was$4.1 million.  In addition, the Companyexpects to incur losses and negative cash flows for at least the next severalfiscal quarters.  The Company believesthat the amount of the losses will be smaller than in recent fiscal years.  In connection with the audit of our financialstatements for the year ended October 31, 2005, our independentaccountants have issued an opinion that included a going concern paragraph thatstates that we have sustained losses and negative cash flows from operatingactivity in recent years and may need additional capital to support our futureoperations.   The Company also believesit has other sources of financing to fund future operations.

 

During fiscal year 2004, we sold our 3D business for$1.0 million.  All of this cash had beenreceived by the end of the first quarter of fiscal 2005.  The sale of this business unit has reducedour ongoing operating expenses.  As of October 31,2005, we had a cash balance of approximately $778,000, working capital of $2.0million and no long-term debt.  TheCompany believes it has sufficient cash and other sources of financingavailable to it to fund its operations, working capital and capital resourceneeds through the second quarter of fiscal 2006. There can be no assurance,however, that additional capital will be available on acceptable terms or atall, and the failure to obtain additional capital as needed may have an adverseeffect on the Company’s ability to continue to take advantage of futureopportunities or respond to competitive pressures or unanticipatedrequirements, which could adversely affect its business, financial position,results of operations and cash flows.

 

**We have encountered significantlyincreased competition from lower-priced competitive products.**Several of our competitors haveintroduced lower-priced 2D vision inspection systems that present a significantchallenge to us. Although we have introduced our new lower-priced, IMPACThigh-performance 2D inspection system, which currently accounts forsubstantially all of our sales, we cannot guarantee that this system willsuccessfully compete in this market if competitors introduce lower pricedproducts.

 

**Our market is characterized byrapidly changing technology and new product development.**Our future success depends upon ourability to keep pace with the evolving market for machine vision inspectionsystems. We need to continue enhancing our current products, developing andintroducing new products, responding to changes in customer requirements andachieving market acceptance. Our failure to anticipate or respond adequately totechnological developments and customer requirements, or any significant delaysin product development or introduction, could have a material adverse effect onour business, results of operations, financial condition and liquidity. Even ifwe do enhance our current products, develop new products, and remain responsiveto our customers, we cannot ensure that we will achieve market acceptance.

 

**We are dependent upon a limitednumber of principal customers.**In each of the past two fiscal years, we have had oneor more customers that have accounted for ten percent or more of our netrevenues. During fiscal 2005, one customer accounted for over 10% of our netrevenues. This customer,Simac Masic BV PDC, accounted for 12.3% of net revenues. During fiscal 2004,two customers each accounted for over 10% of our net revenues. The largest ofthese customers, Tokyo Weld, Co, Ltd. accounted for 22.9% of net revenues, while, Simac Masic BVPDC accounted for 10.2% of net revenues.

 

In late fiscal 2004, we were informed by Tokyo Weld,Co. Inc. that it would most likely not purchase any additional products from usand we did not receive any orders or ship any product to Tokyo Weld in the fourthquarter of fiscal 2004 or all of fiscal 2005. We were able to effectivelyreplace these sales with sales to other customers in the fourth quarter offiscal 2004, thereby broadening our overall customer base.

 

We do not have in effect long-term agreements with anysignificant customers under which they agree to continue purchasing significantquantities of our products.

 

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The loss of, or significant decrease in purchases by,any of our principal customers and subsequent failure to replace thosecustomers could have a material adverse effect on our results of operations.

 

**Our revenues are dependent in part oncapital spending in the electronics and semiconductor industries.**The electronics and semiconductorindustries combined have historically accounted for over 50% of all machinevision industry sales. Capital spending on new manufacturing capacity by theseindustries has historically been very cyclical. There can be no assurance as to when capital spending in theseindustries will begin a cyclical upturn and how long this upturn may last.While revenues have increased sequentially each of the past three fiscal years,we can not ensure that this trend will continue.

 

**We rely heavily on our proprietarytechnology, much of which is protected as trade secrets.**We rely heavily on our image acquisitionand image processing hardware designs, along with proprietary softwaretechnology. We have been issued patents, or obtained licenses to patents, inthe past on certain technology and have patents pending on new technologies. Wecurrently rely most heavily on protecting our proprietary information as tradesecrets. We cannot ensure that the steps we take will be adequate to preventmisappropriation of our technology by third parties. We also cannot be certainthat the steps taken will be adequate under the laws of some foreign countries,which may not protect our proprietary rights to the same extent as do laws ofthe United States. In addition, the possibility exists that others may “reverseengineer” our products in order to determine their method of operation and thenintroduce competing products. Further, many high technology markets, includingsegments of the machine vision industry, are characterized by the existence ofa large number of patents and frequent litigation for financial gain based onpatents with broad, and often questionable, applications. As the number of ourproducts increases, the markets in which our products are sold expand and thefunctionality of those products grows and overlaps with products offered bycompetitors. We have been sued for patent infringement in the past and may besubject to patent infringement claims in the future. In addition to beingexpensive and time consuming for us, protracted litigation to defend or toprosecute intellectual property could result in some customers deferring orlimiting their purchase of our product until resolution of the litigation.Although we do not believe that any of our products or proprietary rightsinfringe upon the valid rights of third parties, we cannot guarantee thatinfringement claims will not be asserted against us in the future or that anysuch claims will not require us to enter into royalty arrangements or result incostly litigation.

 

**Our revenue fluctuates from year toyear.**We haveexperienced annual and quarterly fluctuations in operating results andanticipate that these fluctuations will continue. These fluctuations have beencaused by various factors, including the order flow of our principal customers,the timing and acceptance of new product introductions and enhancements and thetiming of product shipments. Future operating results may fluctuate as a resultof these and other factors, including our ability to continue to developinnovative products, the announcement or introduction of new products by ourcompetitors, our product and customer mix, and the level of competition andoverall trends in the economy.

 

**We are dependent on a limited numberof outside contractors and suppliers for a substantial portion of ourcomponents and assembly needs.**We currently contract with third party assembly housesfor a substantial portion of our components and assembly needs. Although weinspect these components prior to final assembly, reliance on outsidecontractors reduces our control over quality and delivery schedules. Thefailure by one or more of these subcontractors to deliver quality components ina timely manner could have a material adverse effect on our results ofoperations. In addition, a number of the components integral to the functioningof our products are available from only a single supplier or from a limitednumber of suppliers. Any interruption in or termination of supply of thesecomponents, material changes in the purchase terms, or reductions in theirquality or reliability, could have a material adverse effect on our business orresults of operations.

 

**A significant portion of our revenuearises from international markets.**In the years ended October 31, 2005, and 2004,sales of our products to customers outside of the United States accounted forapproximately 54%, and 59%, respectively, of our net revenues. We anticipatethat international revenue will continue to account for a significant portionof our net revenues. Our operating results are subject to the risks inherent ininternational sales, including various regulatory requirements, political andeconomic changes and disruptions, transportation delays and difficulties instaffing and managing foreign sales operations and distributor relationships.In addition, fluctuations in exchange rates may render our products less pricecompetitive relative to local product offerings. There can be no assurance thatthese factors will

 

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nothave a material adverse effect on our future international sales and,consequently, on our operating results.

 

**The costs to remain competitive mayadversely affect our financial performance.**We compete with other vendors of machine visionsystems, some of which have greater financial and other resources than we do.We cannot be sure that we will be able to compete successfully in the future.In addition, to remain competitive we may be required to incur significantcosts to increase our engineering research, development, marketing and customerservice efforts. Competitive pressures may result in price erosion or otherfactors that adversely affect our financial performance.

 

**We are dependent on key personnel.**Our success depends in large part uponthe continued services of many of our highly-skilled personnel involved inmanagement, research and product development and sales. We must also be able toattract and retain additional highly-qualified employees. The loss of servicesof these key personnel could have a material adverse effect on us. We do nothave key-person life insurance on any of our employees.

 

**We may be unable to utilize our tax netoperating loss carryforwards if we fail to generate sufficient taxable income.**The utilization of net operating losscarryforward is dependent upon our ability to generate sufficient taxableincome during the carryforward period. In fiscal 2005, there was no taxprovision due to the net loss for the period. At October 31, 2005, we hadavailable federal and state net operating loss and tax credit carryforwards forincome tax purposes of approximately $28.9 million, $8.6 million and $1.3 respectively.These carryforwards expire in the years ending October 31, 2006 through October 31,2025.

 

**EXECUTIVE OFFICERS AND OTHER KEY MEMBERS OF MANAGEMENT**

 

Theexecutive officers of the Company are as follows:

 
| **NAME**               | ** ** | **AGE** | ** ** | **POSITION**                                      |
|------------------------|------------|---------|------------|---------------------------------------------------|
| Joseph C.  Christenson |       | 47      |       | President,  Director, and Chief Financial Officer |
| David L. Friske        |       | 61      |       | Vice President,  Manufacturing                    |

 

**Joseph C. Christenson**has been President of the Company since January 1989,a director since December 1987 and Chief Financial Officer since June 2005.Prior to being elected President of the Company, Mr. Christenson served ina series of positions of increasing responsibility since joining the Company in1985. Mr. Christenson has a Masters in Business Administration from theUniversity of Michigan and a Bachelor of Arts degree from St. Olaf College.

 

**David L. Friske**has been Vice President of Manufacturingof the Company since March 1999. From February 1984, Mr. Friskeserved as Director of Manufacturing and Purchasing. Prior to joining theCompany, Mr. Friske was employed by Medtronic, Inc.

 

Mr. Christenson and Mr. Friske serve as fulltime employees of the Company.

 

**Item 2. DESCRIPTION OF PROPERTY**

 

In the secondquarter of fiscal 2005, the Company implemented an amended lease in respect toits headquarters facility in Eden Prairie, Minnesota.  Under the amended lease terms signed on April 29,2005, the Company received a reduction in its base rental rates and itsfacility shrank from approximately 64,000 square feet to approximately 35,000square feet resulting in a savings of approximately $120,000 per quarter.  In exchange for these amended lease terms,the Company paid $140,000 for certain leasehold improvements associated with thereconfigured space and also paid approximately $300,000 in accrued deferredrent.  The Company also agreed to pay a$240,000 lease termination fee, which was accrued, and is being paid for, inthe second quarter of fiscal 2005, in equal monthly installments over a 12month period which started on May 1, 2005 and extend the current leaseterm by two years through May, 2011.  TheCompany also terminated its leased space for its regional sales and supportoffice in Michigan effective December 31, 2005.

 

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**Item 3. LEGAL PROCEEDINGS**

 

None

 

**Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None

 

**PART II**

 

**Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS**

 

**PRICE RANGE OF COMMON STOCK**

 

The Company’s Common Stock trades on the NasdaqCapital Market under the symbol “PPTV”. The following table sets forth the highand low closing sale prices of the Company’s Common Stock as reported by Nasdaqfor the years listed below:

 
| ** **                                  | ** ** | **HIGH** | ** ** | **LOW** | ** ** |
|---------------------------------------------|------------|----------|------------|---------|------------|
| **FISCAL YEAR ENDED OCTOBER 31, 2005** |       |     |       |    |       |
| First Quarter                               |       | $        | 4.40       |    | $          | 2.44 |   |
| Second Quarter                              |       | 3.40     |       | 1.73    |       |
| Third Quarter                               |       | 2.52     |       | 1.21    |       |
| Fourth Quarter                              |       | 1.89     |       | 1.05    |       |
|                                        |       |     |       |    |       |
| **FISCAL YEAR ENDED OCTOBER 31, 2004** |       |     |       |    |       |
| First Quarter                               |       | $        | 7.60       |    | $          | 4.20 |   |
| Second Quarter                              |       | 7.88     |       | 4.88    |       |
| Third Quarter                               |       | 5.84     |       | 4.28    |       |
| Fourth Quarter                              |       | 5.16     |       | 2.40    |       |

 

On January 17, 2006,the Company announced that beginning on January 23, 2006, the Company’scommon stock will trade on the OTC Bulletin Board under the symbol PPTV.ob

 

**HOLDERS**

 

On January 3, 2006, there were approximately 600holders of record of the Company’s Common Stock. This figure does not reflectmore than 1,300 beneficial stockholders whose shares are held in nominee names.

 

**DIVIDEND POLICY**

 

The Company has never declared or paid any cash dividendson its Common Stock. The Company currently intends to retain any earnings foruse in its operations and expansion of its business and therefore does notanticipate paying any cash dividends in the foreseeable future.

 

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**ISSUER PURCHASES**

 

The Company did not repurchase any equity securitiesduring the years ended October 31, 2005 and 2004.

 

**INFORMATIONREGARDING EQUITY COMPENSATION PLANS**

 

The following table sets forth information regardingour equity compensation plans in effect as of October 31, 2005. Each ofour equity compensation plans is an “employee benefit plan” as defined by Rule 405of Regulation C of the Securities Act of 1933.

 

**Securities Authorized for Issuance Under EquityCompensation Plans**

 
| **Plan  category**                                      |   | **Number of shares  of common stock  to be issued upon  exercise of  outstanding  options, warrants  and rights** |   | **Weighted-average  exercise price of  outstanding  options, warrants  and rights** |   | **Number of shares of  common stock  remaining available  for future issuance  under equity  compensation plans** |    |
|---------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------|---------|
| ** **                                              |   | ** **                                                                                                        |   | ** **                                                                          |   | ** **                                                                                                        |    |
| Equity compensation plans approved by stockholders:     |   | 354,768                                                                                                           |   | $                                                                                   | 4.92   |                                                                                                              | 432,216 |   |
| Stock Option Plans                                      |   |                                                                                                              |   |                                                                                |   |                                                                                                              |    |
| Employee Stock Purchase Plan                            |   | 23,540                                                                                                            |   | —                                                                              |   | 76,460                                                                                                            |    |
|                                                    |   |                                                                                                              |   |                                                                                |   |                                                                                                              |    |
| Equity compensation plans not approved by  stockholders |   | —                                                                                                            |   | —                                                                              |   | —                                                                                                            |    |
|                                                    |   |                                                                                                              |   |                                                                                |   |                                                                                                              |    |
| Total                                                   |   | 378,308                                                                                                           |   | $                                                                                   | 4.92   |                                                                                                              | 508,676 |   |

 

TheCompany has four equity compensation plans, all of which have been approved byits shareholders: 1998 Stock Option Plan, 1997 Stock Option Plan, 2000 StockOption Plan and 2005 Employee Stock Purchase Plan.

 

**Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OFOPERATION**

 

During the fourth quarter of fiscal 2004, the Companyimplemented a revised operating strategy which called for a total focus of ourresources on our core 2D machine vision business.  Accordingly, in the fourth quarter of fiscal2004 we initiated and completed the sale of our 3D business unit, and allrelated patents, intellectual property, inventory and equipment.  In accordance with appropriate accountingrules, we have reclassified our previously reported financial results toexclude the results of our 3D business and these results are presented on ahistorical basis as a separate line in our statements of operations and balancesheets entitled “Discontinued Operations.” Our continuing operations represent our 2D business only.  All references to financial information inthis Management’s Discussion and Analysis or Plan of Operations have beenrevised to reflect only our continuing operations and all references to our nowdiscontinued 3D business have been eliminated.

 

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Management’s discussion and analysis of its financialcondition and results of operations are based on the Company’s accompanyingfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America. The preparationof these financial statements requires management to make certain estimates andassumptions that affect the reported amounts of assets and liabilities as ofthe date of the financial statements and the reported revenues and expensesduring the reporting period. Management bases its estimates on historicalexperience and various other assumptions that are believed to be reasonableunder the circumstances, the results of which form the

 

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basisfor making judgments about the carrying values of assets and liabilities.Actual results could differ from these estimates.

 

Management believes the Company’s critical accountingpolicies and areas that require more significant judgments and estimates usedin the preparation of its financial statements to be:

 

•        revenue recognition;

 

•        estimating valuation allowances, specificallythe allowance for doubtful accounts and excess and obsolete inventory; and

 

•        valuation and useful lives of long-livedand intangible assets.

 

The Company typically recognizes revenue on productsales upon shipment to the end user customers if contractual obligations havebeen substantially met and title and risk of loss have passed to the customer,which is generally the case for sales of machine vision systems, spare partsand accessories.  The Company also recognizesrevenue on products sold to distributors upon shipment because contracts withdistributors do not include post-shipment obligations or any right of returnprovisions and pricing is fixed at the time of sale. Revenue related toapplication engineering, product development and customer training services isrecognized when the services are performed.

 

Management estimates the allowance for doubtfulaccounts by analyzing accounts receivable balances by age and consideringspecific factors about each individual customer’s financial condition. When itis deemed probable that all or a portion of a customer’s account isuncollectible, a corresponding amount is added to the allowance for doubtfulaccounts.

 

The Company’s inventory primarily consists of partsand other materials that are used in the manufacture of vision systems.  The Company generally only builds systemsbased on customer orders and as a result maintains only a minor amount offinished goods inventory.  Managementestablishes valuation reserves for estimated excess and obsolete materialsinventory based on the difference between the cost of the inventory and itsestimated market value.  Market value isestimated based on a variety of assumptions about future product demand andmarket conditions.  In view of the rapidpace of technological change in the machine vision industry, the Companygenerally considers inventory that has had no usage for one year to beobsolete. In addition, changes in the Company’s product offerings or those oftheir competitors may also result in excess or obsolete inventory.  Accordingly, these factors will also beconsidered in the determination of the market value of inventory.

 

Actual results could differ from these estimates underdifferent assumptions. If the financial condition of one or more of our customerswere to deteriorate, or if actual product demand or market conditions are lessfavorable than anticipated by management, additional reserves may be required.

 

The Company’s long-lived assets include properties andequipment and intangible assets such as patents.  These assets are evaluated for possibleimpairment whenever changes in facts or circumstances indicate that thecarrying amount of an asset may not be recoverable. Recoverability of assets tobe held and used is measured by a comparison of the carrying amount of an assetto the undiscounted future net cash flows expected to be generated by theassets. If these assets are considered to be impaired, the impairment to berecognized is measured by the amount by which the carrying amount of the assetsexceeds the fair value of the assets. During the fourth quarter of fiscal 2004, the Company decided todiscontinue its 3D business and it sold this business, together with all therelated patents and intellectual property. As a result of this decision, certain of the patents that were directlyrelated to this product were considered impaired and the remaining asset value of$1.7 million was expensed as a cost associated with this sale.

 

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**RESULTS OF OPERATIONS**

 

**Comparison of Year Ended October 31, 2005 to Year Ended October 31,2004**

 

**NetRevenues**decreased 34.9% to $5.6 million in fiscal 2005 from$8.7 million in fiscal 2004. Unit sales of the Company’s machine vision systemsdecreased to 810 in fiscal 2005 from 989 in fiscal 2004. Net revenues decreaseddue to a decline in sales of our older Passport/Scout product lines which havebeen phased out. Themost significant decrease was in sales to a large OEM customer who sellsproduct into the electrical connector market. Sales to this customer represented approximately 23% of our total netrevenues for fiscal 2004.  In late fiscal2004, we were informed by this customer that it would most likely not purchaseany additional products from us and we did not receive any orders or ship anyproduct to them in the fourth quarter of fiscal 2004 or all of fiscal 2005.This customer had purchased our older analog products which we were in theprocess of phasing out. We were able to effectively replace these sales withsales to other customers in the fourth quarter of fiscal 2004 and all of fiscal2005, thereby broadening our overall customer base. Both unit volume and dollarsales of our IMPACT product line increased in fiscal 2005.

 

The Company sold almost 760 IMPACT units in fiscal2005 as compared with 700 IMPACT units in fiscal 2004. The growth in our IMPACTsales indicates strong acceptance of these products in the market and we expectthat sales of our IMPACT units will continue to grow and replace the sales ofour other machine vision systems. Average selling prices in fiscal 2005 were 20%lower on a per unit basis when compared to fiscal 2004, due to the fact that asignificant portion of our sales in fiscal 2005 were related to our IMPACT productline which has a lower average selling price than our other systems. This trendreflects an overall trend in the machine vision industry for more powerful yetlower priced machine vision systems. We expect the trend of lower averageselling price to continue in the next fiscal year.

 

**Gross Profit**declined 40.1% to $2.7 million in fiscal2005 from $4.5 million in fiscal 2004. Gross profit as a percentage of netrevenues for fiscal 2005 decreased to 47.9% compared to 52.1% in fiscal 2004.The decrease in gross profit dollars and as a percentage of net revenuesreflects the overall lower revenue levels achieved by the Company in fiscal2005.  We expect gross profit and grossprofit as a percentage of net revenues to increase as our revenues increase dueto the fact that our IMPACT product line has a larger gross profit margin thanour older product lines had in the past.

 

**Sales and Marketing Expenses**decreased 15.6% to $2.4 million in fiscal2005, compared to $2.8 million in fiscal 2004. This decrease is the result ofcost-control measures implemented during fiscal 2004.  As a percentage of net revenues, fiscal 2005 sellingand marketing expenses increased to 41.8%, compared with 32.3% in fiscal 2004.The percentage increase reflects the decrease in revenues.  We expect the amount of sales and marketingexpenses to remain relatively flat or increase slightly as revenues increase overfiscal year 2006.

 

**General and Administrative Expenses**decreased 10.7% to $1.0 million in fiscal 2005,compared to $1.1 million in fiscal 2004. This decrease is primarily the resultof lower salaries and related costs as the resulted from the restructuring thatwas implemented in the second quarter of fiscal 2004. As a percentage of netrevenues, general and administrative expenses increased to 18.1% for fiscal 2005,compared to 13.2% for fiscal 2004. The percentage increase reflects thedecrease in revenues.  We expect theamount of general and administrative expenses to remain relatively flat overfiscal year 2006.

 

**Research and Development Expenses**decreased 17.7% to $1.3 million in fiscal2005, from $1.6 million in fiscal 2004. The decrease in research anddevelopment spending resulted from the restructuring that was implemented inthe second quarter of fiscal 2004 as well as continuing efforts to controloperating costs while still supporting aggressive new product developmentactivities for the IMPACT product family. Research and development expenses asa percentage of net revenues for fiscal 2005 increased to 23.8%, compared to18.8% for fiscal 2004.  The percentageincrease reflects the decrease in revenues. We expect research and development expenses to remain relatively flatover fiscal year 2006.

 

**Income Taxes:**There was no tax provision or benefit forfiscal 2005 or 2004 due to the net losses in the periods for which no benefitwas recognized..

 

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**Loss from Discontinued Operations** was$55,000 in fiscal 2005 compared to a loss of $805,000 in fiscal 2004 which ismade up of a gain from the results of the discontinued operations for the yearended October 31, 2004 of $246,000 and a loss from the sale of the 3Dbusiness unit of $1,051,000. The loss from the sale of the 3D business unitreflects a difference between the sales price of $1.0 million and the assetvalues of that unit of approximately $2.0 million. We also incurred $38,000 ofcosts associated with the sale of the business.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

As of October 31, 2005, the Company had cash of$778,000 as compared with $2.6 million as of the end of last fiscal year. Dueto its continuing losses, the Company has been using its existing cash and cashequivalents to fund the shortfall in cash generated from its operatingactivities.  During fiscal 2004, theCompany raised cash by selling its 3D business unit for $1.0 million andcontinued to focus on controlling operating expenses in fiscal 2005.

 

Because we have working capital of $2.0 million and nolong-term debt, the Company believes that a variety of financing alternatives areavailable including external borrowing against accounts receivable andinventory, customer or vendor financing, the issuance of additional stock tothe public or to strategic partners, or customer-sponsored research anddevelopment projects. The Company believes it has sufficient cash and othersources of financing available to it to fund its operations, working capitaland capital resource needs through the second quarter of fiscal 2006. There canbe no assurance, however, that additional capital will be available onacceptable terms or at all, and the failure to obtain additional capital asneeded may have an adverse effect on the Company’s ability to continue to takeadvantage of future opportunities or respond to competitive pressures orunanticipated requirements, which could adversely affect its business,financial position, results of operations and cash flows.

 

The Company financed its operations during fiscal 2005through existing cash and cash equivalents. Net cash used in operatingactivities during fiscal 2005 was $1.8 million, a significant increase from$372,000 used in operations in fiscal 2004. Accounts receivable decreased $715,000 primarily due to strongcollections and lower revenue levels. Inventories decreased $487,000 duringfiscal 2005 due to stronger control measures and reduction of older productlines, including a $150,000 charge taken at the end of fiscal 2005 to writedown remaining third generation inventory to the lower of cost or market.Accounts payable and accrued expenses decreased by $867,000 due, in large part,to the completion of the 2004 accruals for the sale of the 3D operations andrestructuring costs.

 

Net cash used in investing activities was $224,000 infiscal 2005.  During fiscal 2005, fixedasset additions totaled $293,000. During fiscal 2004, fixed asset additionstotaled $112,000.  We expect fixed assetadditions in fiscal 2006 to be approximately the same as in fiscal 2005.

 

Net cash provided by financing activities was $5,000for fiscal 2005 and $115,000 for fiscal 2004 from the sale of stock toemployees through our Employee Stock Purchase Plan and through the exercise ofstock options by employees.

 

The Company incurred a net loss of $2,375,000 forfiscal 2005, and has an accumulated deficit of $33.8 million as of October 31,2005. There can be no assurance that the Company will not incur additionallosses, will generate positive cash flow from its operations, or that theCompany will attain or thereafter sustain profitability in any future period.To the extent the Company continues to incur losses or grows in the future, itsoperating and investing activities may use cash and, consequently, may requirethe Company to obtain additional sources of financing in the future.

 

The Company does not have relationships withunconsolidated entities or financial partnerships, such as entities oftenreferred to as structured finance or special purpose entities, which would havebeen established for the purpose of facilitating off-balance-sheet financialarrangements. As such, the Company is not materially exposed to any financing,liquidity, market or credit risk that could arise if we had engaged in sucharrangements.

 

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The following summarizes our contractual obligationsand shows the effect these contractual obligations are expected to have on ourliquidity and cash flows as of October 31, 2005 (amounts exclude requiredpayments for common area maintenance expenses):

 
| ** **       | ** ** | **Total** | ** ** | **1 Year or Less** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **Over 5 years** | ** ** |
|------------------|------------|-----------|------------|--------------------|------------|---------------|------------|---------------|------------|------------------|------------|
| Operating Leases |       | $         | 1,718,000  |               | $          | 304,000       |       | $             | 586,000    |             | $          | 626,000 |   | $ | 202,000 |   |
|                  |            |           |            |                    |            |               |            |               |            |                  |            |  |  |  |  |  |

 

**RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

 

In November 2004, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)No. 151 “Inventory Costs,” (SFAS No. 151) which amends the guidancein ARB No. 43 (ARB 43), Chapter 4 “Inventory Pricing,” to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage).  Paragraph 5 of ARB 43, Chapter 4,previously stated that under some circumstances, items such as idle facilityexpense, excessive spoilage, double freight, and re-handling costs may be soabnormal as to require treatment as current period charges.  SFAS No. 151requires that those items be recognized as current-period charges regardless ofwhether they meet the criterion of “so abnormal.”  In addition, SFAS No. 151requires that allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facilities. SFAS No. 151 shall be effective for inventory costs incurred during fiscalyears beginning after June 15, 2005.  Earlier application ispermitted for inventory costs incurred during fiscal years beginning after thedate SFAS No. 151 was issued.  SFAS No. 151 shall be appliedprospectively.  The Company does not expect the adoption of SFAS No. 151to have a material effect on its financial statements.

 

In December 2004, FASB issued SFAS No. 153 “Exchangesof Nonmonetary Assets” (SFAS No. 153) which amends APB Opinion No. 29,“Accounting for Nonmonetary Transactions.” APB No. 29 is based on theprinciple that exchanges of nonmonetary assets should be measured based on thefair value of the assets exchanged.  The guidance in that Opinion,however, included certain exceptions to that principle.  SFAS No. 153amends APB No. 29 to eliminate the exception for nonmonetary exchanges ofsimilar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance.  Anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. SFAS No. 153 will be effective for nonmonetary asset exchanges occurringin fiscal periods beginning after June 15, 2005.  Earlier applicationis permitted for nonmonetary asset exchanges occurring in fiscal periodsbeginning after the date SFAS No. 153 was issued.  SFAS No. 153shall be applied prospectively.  The Company does not expect the adoptionof SFAS No. 153 to have a material effect on its financialstatements.

 

In December 2004, FASB issued SFAS No. 123(revised 2004), “Share-Based Payment,” (SFAS No. 123R) that focusesprimarily on accounting for transactions in which an entity obtains employeeservices in shared-based payment transactions.  This statement replacesSFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedesAPB Opinion No. 25, “Accounting for Stock issued to Employees.” Beginning November 1, 2006, we will be required to expense the fairvalue of employee stock options and similar awards.  As a public companywe are allowed to select from two alternative transition methods, each havingdifferent reporting implications.  The impact of SFAS No. 123R hasnot been determined at this time.

 

In June 2005, FASB issued SFAS No. 154, “AccountingChanges and Error Corrections”, a replacement of APB Opinion No. 20 andFASB Statement No. 3.  The statement applies to all voluntary changesin accounting principle, and changes the requirements for accounting for andreporting of a change in accounting principle.  SFAS No. 154 requiresretrospective application to prior periods’ consolidated financial statementsof a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 is effective for accounting changes and corrections of errorsmade in fiscal years beginning after December 15, 2005.  Earlierapplication is permitted for accounting changes and corrections of errors madeoccurring in fiscal years beginning after June 1, 2005.  Thestatement does not change the transition provisions of any existing accountingpronouncements, including those that are in a transition phase as of theeffective date of this statement.  The Company does not expect theadoption of SFAS No. 154 to have a material effect on its financialstatements.

 

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In December 2003, FASB issued FASB InterpretationNo. 46R, “Consolidation of the Variable Interest Entities” (FIN 46R). Fin46R states that companies that have exposure to the economic risks andpotential rewards from another entity’s assets and activities have acontrolling financial interest in a variable interest entity and shouldconsolidate the entity, despite the absence of clear control through a votingequity interest. The consolidation requirements apply to all special-purposeentities by the end of the first reporting period ending after December 15,2003. FIN 46R shall be applied to all variable interest entities by the end ofthe first reporting period ending after March 15, 2004, for enterprisesthat are not small business issuers or December 15, 2004 for enterprisesthat are small business issuers. The adoption of FIN 46R did not have amaterial effect on the Company’s financial statements.

 

**EFFECTS OF INFLATION**

 

The Company believes that the effect of inflation hasnot been material during each of the years ended October 31, 2005 and 2004.

 

**QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The Company believes it does not have materialexposure to quantitative and qualitative market risks. The carrying amountsreflected in the balance sheets of cash and cash equivalents, investments,trade receivables and trade payables approximate fair value at October 31,2005 due to the short maturities of these instruments.

 

**INTEREST RATE RISK**

 

The Company’s cash and cash equivalents representinvestments purchased with original maturities of three months or less.  Given the short maturities and investmentgrade quality of the portfolio holdings at October 31, 2005, a 100 basispoint rise in interest rates would not be expected to have a material adverseimpact on the fair value of the Company’s cash and cash equivalents. As aresult, the Company does not currently hedge these interest rate exposures.

 

**FOREIGN CURRENCY EXCHANGE RATE RISK**

 

Historically, the Company’s international sales, whichare primarily in Europe, Canada, South America, Japan and Southeast Asia, havebeen transacted in U.S. Dollars. The Company did have one customer where saleswere denominated in Japanese Yen.  TheCompany does not engage in foreign currency speculation.  During the years ended October 31, 2005and 2004, the Company had no foreign exchange contracts outstanding.

 

**Item 7. FINANCIAL STATEMENTS**

 

The financial statements are listed in Item 13 of thisForm 10-KSB.

 

**Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**Item 8A. CONTROLS AND PROCEDURES**

 

**(a) Evaluation of Disclosure Controls and Procedures.**

 

The Company’s President, Chief Executive Officer andChief Financial Officer Joseph C. Christenson, has reviewed the Company’sdisclosure controls and procedures as of the end of the period covered by thisreport and concluded that the Company’s disclosure controls and procedures areeffective.

 

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**(b) Changes in Internal Control Over FinancialReporting.**

 

There have been no changes in internal control overfinancial reporting that occurred during the fiscal quarter covered by thisreport that have materially affected, or are reasonably likely to materiallyaffect, the registrant’s internal control over financial reporting.

 

**Item 8B.OTHER INFORMATION**

 

None

 

**PART III**

 

**Item 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROLPERSONS; COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT**

 

Information required under this item with respect todirectors is contained in the section ”Election of Directors” in theCompany’s Proxy Statement for the Annual Meeting of Shareholders (the “2006Proxy Statement”), a definitive copy of which will be filed within 120 days of October 31,2005 and is incorporated herein by reference. Information concerning executive officers is set forth in the Section entitled“Executive Officers of the Company” in the 2006 Proxy Statement and isincorporated herein by reference.

 

Information concerning compliance with Section 16(a) iscontained in the section entitled “Compliance with Section 16(a) ofthe Securities Exchange Act of 1934,” and is incorporated herein byreference.  Information concerning theCompany’s Code of Ethics is included in the Section entitled “GovernanceMatters – Code of Ethics,” and is incorporated herein by reference.

 

**Item 10. EXECUTIVE COMPENSATION**

 

Information required under this item is contained inthe section entitled “Executive Compensation and Other Information,” inthe Company’s 2006 Proxy Statement and is incorporated herein by reference.

 

**Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT**

 

Information required under this item with respect toshare ownership is contained in the section entitled “Security Ownershipof Principal Shareholders and Management” in the Company’s 2006 Proxy Statementand is incorporated herein by reference.

 

Information required under this Item with respect tostock ownership under equity compensation plans is contained in the section entitled“Equity Compensation Plan Information” in Item 5 of this form 10-KSB.

 

**Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

None.

 

19

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**Item 13. EXHIBITS**

 

**(a) Documents filed as Part ofthis Report**

 

(1) FINANCIAL STATEMENTS. The following financialstatements of the Company are hereby included in this Form 10-KSB.

 

Report of Independent Registered Public AccountingFirm of Virchow, Krause & Company, LLP

Statements of Operations for the Years ended October 31,2005 and 2004

Balance Sheets as of October 31, 2005 and 2004

Statements of Cash Flows for the Years ended October 31,2005 and 2004

Statements of Shareholders’ Equity for the Years endedOctober 31, 2005 and 2004

Notes to Financial Statements

 

20

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(2) LISTINGOF EXHIBITS

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                  |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                  |       | Restated  Articles of Incorporation of PPT Vision, Inc. (incorporated by reference  to Exhibit 3.1 of Form 10-QSB for the quarter ended April 30,  2005)                                                                                                                                                                                                                                                     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 3.2                  |       | By-Laws  of PPT Vision (incorporated by reference to Exhibit 3.2 of Form 10-QSB  for the quarter ended April 30, 2005)                                                                                                                                                                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 4.1                  |       | Preferred  Stock Purchase Rights Agreement, as amended (incorporated by reference to Exhibit 1  to June 17, 1999 Registration Statement on Form 8-A, as amended by Exhibit 1  to October 19, 1999 Amendment No. 1 to Registration Statement on Form 8-A/A  and as amended by amendment No. 1 to March 11, 2002 Amendment No. 2  to Registration Statement on Form 8-A/A.) |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.1                 |       | Employment  Agreement with Joseph C. Christenson dated as of May 7, 1984 (incorporated  by reference from Exhibit 10.4 to May 15, 1996 Form S-2)                                                                                                                                                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.2*                |       | PPT  VISION, Inc. 1988 Stock Option Plan, as amended (incorporated by  reference to Exhibit 10.6 of 1997 Form 10-K)                                                                                                                                                                                                                                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.3*                |       | PPT  VISION, Inc. 1997 Stock Option Plan (incorporated by reference to Exhibit 10.7  of 1997 Form 10-K)                                                                                                                                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.4*                |       | PPT  VISION, Inc. 2000 Stock Option Plan (incorporated by reference to Exhibit 4.1  to the Company’s Registration Statement on Form S-8 (File No. 333-116481))                                                                                                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.5                 |       | Lease  Agreement dated July 17, 1998 for facilities at Prairie Crossroads  Corporate Center, Eden Prairie, Minnesota (incorporated by reference to Exhibit 10.7  of 1999 Form 10-K)                                                                                                                                                                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.5.1               |       | First  Amendment of Lease dated October 16, 1999 for Facilities at the Prairie  Crossroads Corporate Center, Eden Prairie, Minnesota (incorporated by  reference to Exhibit 10.8 of 1999 Form 10-K)                                                                                                                                                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.5.2               |       | Second  Amendment dated April 29, 2005 of Lease dated October 16, 1999 for  Facilities at the Prairie Crossroads Corporate Center, Eden Prairie, Minnesota  (incorporated by reference to Exhibit 10.1 of Form 10-QSB for the  quarter ended April 30, 2005)                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.6                 |       | Employment  Agreement with David Friske dated as of March 5, 1984                                                                                                                                                                                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.7                 |       | PPT  VISION, Inc. 2005 Employee Stock Purchase Plan (incorporated by  reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-8  (File No. 333-125780))                                                                                                                                                                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 21                   |       | The  Company has no subsidiaries                                                                                                                                                                                                                                                                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 23.1                 |       | Consent  of Virchow, Krause & Company, LLP                                                                                                                                                                                                                                                                                                                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.1                 |       | Certification  of CEO/CFO Pursuant to Section 302 of the Sarbanes-Oxley Act and Rules 13a-14  and 15d-14 of the Exchange Act.                                                                                                                                                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 32.1                 |       | Certification  of CEO/CFO Pursuant to Section 906 of the Sarbanes-Oxley Act and 18  U.S.C. Section 1350.                                                                                                                                                                                                                                                                                                               |

 

----

*Indicates compensatoryplan

 

21

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## **Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

## ** **

Information requiredunder this item is contained in the section entitled “Independent Auditors”is in the Company’s 2006 Proxy Statement and is incorporated herein byreference.

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
|                          | **PPT VISION, INC.** |
|-------------------------------|----------------------|
|                          | ** **           |
|                          |                 |   |
| Date  : January 25, 2006 | **By:**              | **/s/Joseph C. Christenson** |   |
|                          |                 | Joseph  C. Christenson, President |
|                          |                 | (Principal  Executive Officer and Chief Financial Officer) |

 

**Signatures and Power of Attorney**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this Report has been signed by the following persons onbehalf of the Registrant, in the capacities, and on the dates, indicated. Eachperson whose signature appears below constitutes and appoints Joseph C.Christenson and Timothy C. Clayton as his true and lawful attorney-in-fact andagent, each acting alone, with full power of substitution and resubstitution,for him and in his name, place, and stead, in any and all capacities, to sign anyor all amendments to this Annual Report on Form 10-KSB and to file thesame, with the exhibits thereto, and other documents in connection therewith,with the Securities and Exchange Commission.

 
| Date:  January 25, 2006 | **/s/ Joseph C. Christenson**                              |
|------------------------------|------------------------------------------------------------|
|                         | Joseph C. Christenson                                      |
|                         | President, Director                                        |
|                         | (Principal Executive Officer and Chief Financial  Officer) |
|                         |                                                       |
| Date:  January 25, 2006 | **/s/ Robert W. Heller, Director**                         |
|                         | Robert W. Heller, Director                                 |
|                         |                                                       |
| Date:  January 25, 2006 | **/s/ David C. Malmberg, Director**                        |
|                         | David C. Malmberg, Director                                |
|                         |                                                       |
| Date:  January 25, 2006 | **/s/ Peter R. Peterson, Director**                        |
|                         | Peter R. Peterson, Director                                |
|                         |                                                       |
| Date:  January 25, 2006 | **/s/ Benno G. Sand, Director**                            |
|                         | Benno G. Sand, Director                                    |

 

22

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

To the Shareholders, Audit Committee and Board ofDirectors

PPT VISION, Inc.

Eden Prairie, Minnesota

 

We have audited the accompanying balance sheets of PPTVISION, Inc. as of October 31, 2005 and 2004, and the relatedstatements of operations, shareholders’ equity and cash flows for the yearsthen ended.  These financial statementsare the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management as wellas evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position of PPTVISION, Inc. as of October 31, 2005 and 2004 and the results of itsoperations and its cash flows for the years then ended, in conformity with U.S.generally accepted accounting principles.

 

The accompanying financial statements have beenprepared assuming that the Company will continue as a going concern.  As discussed in Note 2 to the financialstatements, the Company has incurred recurring losses and negative cash flowsfrom operating activities in recent years and requires additional workingcapital to support future operations, which raises substantial doubt about itsability to continue as a going concern.  Management’splans in regards to these matters are also discussed in Note 2.  The financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

 

 
|                    | /s/  Virchow, Krause & Company, LLP |   |
|-------------------------|----------------------------------------------|--------|
|                    |                                         |   |
| Minneapolis,  Minnesota |                                         |
| December 12,  2005 |                                         |
|                         |                                              |        |  |

 

23

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**STATEMENTS OF OPERATIONS**

 
| **YEAR ENDED OCTOBER 31,**      | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|
| Net revenues                         |       | $          | 5,648,000  |       | $          | 8,671,000 |   |
| Cost of sales                        |       | 2,943,000  |       | 4,154,000  |       |
| Gross profit                         |       | 2,705,000  |       | 4,517,000  |       |
| Expenses:                            |       |       |       |       |       |
| Sales and marketing                  |       | 2,360,000  |       | 2,797,000  |       |
| Research and development             |       | 1,343,000  |       | 1,631,000  |       |
| General and administrative           |       | 1,022,000  |       | 1,144,000  |       |
| Restructuring Charges                |       | 390,000    |       | —     |       |
| Total expenses                       |       | 5,115,000  |       | 5,572,000  |       |
| Interest and other income (loss)     |       | 90,000     |       | (12,000    | )          |
| Loss from continuing operations      |       | (2,320,000 | )          | (1,067,000 | )          |
| Loss from discontinued operations    |       | (55,000    | )          | (805,000   | )          |
| Net loss                             |       | $          | (2,375,000 | )          | $          | (1,872,000 | ) |
| Basic and diluted loss per share:    |       |       |       |       |       |
| Loss from continuing operations      |       | $          | (0.77      | )          | $          | (0.36 | ) |
| Loss from discontinued operations    |       | $          | (0.02      | )          | $          | (0.27 | ) |
| Net loss                             |       | (0.79      | )          | (0.63      | )          |
| Weighted average shares outstanding: |       |       |       |       |       |
| Basic and diluted                    |       | 2,997,329  |       | 2,969,393  |       |

 

Theaccompanying notes are an integral part of the financial statements.

 

24

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**BALANCE SHEETS**

 
| **OCTOBER 31,**                                                                                                           | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| ASSETS                                                                                                                         |       |        |       |        |       |
| Current assets                                                                                                                 |       |        |       |        |       |
| Cash and cash equivalents                                                                                                      |       | $           | 778,000    |        | $          | 2,617,000 |   |
| Accounts receivable, net                                                                                                       |       | 1,197,000   |       | 1,912,000   |       |
| Inventories                                                                                                                    |       | 490,000     |       | 977,000     |       |
| Other current assets                                                                                                           |       | 160,000     |       | 243,000     |       |
| Assets of discontinued operations                                                                                              |       | —      |       | 200,000     |       |
| Total current assets                                                                                                           |       | 2,625,000   |       | 5,949,000   |       |
| Property and equipment, net                                                                                                    |       | 438,000     |       | 323,000     |       |
| Intangible assets, net                                                                                                         |       | 68,000      |       | 109,000     |       |
| Other assets, net                                                                                                              |       | 22,000      |       | 53,000      |       |
| Total assets                                                                                                                   |       | $           | 3,153,000  |        | $          | 6,434,000 |   |
|                                                                                                                           |       |        |       |        |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                      |       |        |       |        |       |
| Current liabilities                                                                                                            |       |        |       |        |       |
| Accounts payable                                                                                                               |       | $           | 367,000    |        | $          | 944,000 |   |
| Accrued expenses                                                                                                               |       | 223,000     |       | 513,000     |       |
| Deferred revenue                                                                                                               |       | 9,000       |       | 54,000      |       |
| Total current liabilities                                                                                                      |       | 599,000     |       | 1,511,000   |       |
|                                                                                                                           |       |        |       |        |       |
| Commitments and contingencies                                                                                                  |       |        |       |        |       |
| Shareholders’ equity                                                                                                      |       |        |       |        |       |
| Preferred stock $.10 par value; authorized 2,500,000  shares, none issued and outstanding                                      |       |        |       |        |       |
| Common stock $.10 par value; authorized 5,000,000  shares; issued and outstanding 2,998,747 and 2,995,591 shares, respectively |       | 300,000     |       | 300,000     |       |
| Capital in excess of par value                                                                                                 |       | 36,081,000  |       | 36,075,000  |       |
| Accumulated deficit                                                                                                            |       | (33,827,000 | )          | (31,452,000 | )          |
| Total shareholders’ equity                                                                                                |       | 2,554,000   |       | 4,923,000   |       |
| Total liabilities and shareholders’ equity                                                                                |       | $           | 3,153,000  |        | $          | 6,434,000 |   |

 

Theaccompanying notes are an integral part of the financial statements

 

25

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**STATEMENTS OF CASH FLOWS**

 
| **YEAR ENDED OCTOBER 31,**                                                       | ** ** | **2005**   | ** ** | **2004**  | ** ** |
|---------------------------------------------------------------------------------------|------------|------------|------------|-----------|------------|
| Net loss                                                                              |       | $          | (2,375,000 | )         | $          | (1,872,000 | ) |
| Adjustment to reconcile net loss to net cash used in  operating activities:           |       |       |       |      |       |
| Depreciation and amortization                                                         |       | 222,000    |       | 418,000   |       |
| Adjustment to write down inventory to lower of cost  or market                        |       | 255,000    |       | —    |       |
| Stock based compensation                                                              |       | 1,000      |       | —    |       |
| Loss (income) from discontinued operations                                            |       | 55,000     |       | (234,000  | )          |
| Loss on sale of discontinued operations                                               |       | —     |       | 1,051,000 |       |
| Gain on sale of securities                                                            |       | (41,000    | )          | —    |       |
| Change in operating assets and liabilities:                                           |       |       |       |      |       |
| Accounts receivable, net                                                              |       | 715,000    |       | 88,000    |       |
| Inventories                                                                           |       | 232,000    |       | (113,000  | )          |
| Other assets                                                                          |       | 83,000     |       | 76,000    |       |
| Accounts payable                                                                      |       | (577,000   | )          | 245,000   |       |
| Accrued expenses                                                                      |       | (290,000   | )          | 11,000    |       |
| Deferred revenue                                                                      |       | (45,000    | )          | (42,000   | )          |
| Total adjustments                                                                     |       | 610,000    |       | 1,500,000 |       |
| Net cash used in operating activities                                                 |       | (1,765,000 | )          | (372,000  | )          |
| Cash flows from investing activities:                                                 |       |       |       |      |       |
| Purchase of property and equipment                                                    |       | (293,000   | )          | (112,000  | )          |
| Net investment in other long-term assets                                              |       | (2,000     | )          | (4,000    | )          |
| Proceeds from sale of securities                                                      |       | 71,000     |       |      |       |
| Proceeds from sale of discontinued operations, net  of expenses of $38,000            |       | —     |       | 762,000   |       |
| Net cash provided by (used in) investing activities                                   |       | (224,000   | )          | 646,000   |       |
| Cash flows from financing activities:                                                 |       |       |       |      |       |
| Proceeds from issuance of common stock, net of  offering costs                        |       | 5,000      |       | 115,000   |       |
| Net cash provided by financing activities                                             |       | 5,000      |       | 115,000   |       |
| Net cash provided by discontinued operations                                          |       | 145,000    |       | 142,000   |       |
| Net increase (decrease) in cash and cash equivalents                                  |       | (1,839,000 | )          | 531,000   |       |
| Cash and cash equivalents at beginning of year                                        |       | 2,617,000  |       | 2,086,000 |       |
| Cash and cash equivalents at end of year                                              |       | $          | 778,000    |      | $          | 2,617,000 |   |
|                                                                                  |       |       |       |      |       |
| Supplemental disclosure of cash flow information:                                     |       |       |       |      |       |
| Cash paid during the year for:                                                        |       |       |       |      |       |
| Income tax                                                                            |       | $          | —     |      | $          | — |   |
| Interest                                                                              |       | $          | —     |      | $          | — |   |
| Non-cash investing activity:                                                          |       |       |       |      |       |
| Short-term note receivable issued in connection with  sale of discontinued operations |       | $          | —     |      | $          | 200,000 |   |

 

Theaccompanying notes are an integral part of the financial statements.

 

26

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**STATEMENTS OF SHAREHOLDERS’ EQUITY**

 
| ** **                                                        | ** ** | **COMMON  SHARES** | ** ** | **STOCK  AMOUNT** | ** ** | **CAPITAL IN  EXCESS OF  PAR VALUE** | ** ** | **ACCUMULATED  (DEFICIT)** | ** ** | **TOTAL  SHAREHOLDERS’  EQUITY** | ** **  |
|-------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|--------------------------------------|------------|----------------------------|------------|---------------------------------------|-------------|
| October, 31, 2003                                                 |       | 2,950,700          |       | $                 | 295,000    |                                 | $          | 35,965,000                 |       | $                                     | (29,580,000 | ) | $ | 6,680,000 |   |
| Stock issued through the employee stock purchase  plan            |       | 42,668             |       | 4,000             |       | 105,000                              |       |                       |       | 109,000                               |        |
| Stock options exercised                                           |       | 2,223              |       | 1,000             |       | 5,000                                |       |                       |       | 6,000                                 |        |
| Net loss                                                          |       |               |       |              |       |                                 |       | (1,872,000                 | )          | (1,872,000                            | )           |
| October 31, 2004                                             |       | 2,995,591          |       | $                 | 300,000    |                                 | $          | 36,075,000                 |       | $                                     | (31,452,000 | ) | $ | 4,923,000 |   |
| Stock based compensation                                          |       |               |       |              |       | 1,000                                |       |                       |       | 1,000                                 |        |
| Stock issued through the employee stock purchase  plan            |       | 1,942              |       |              |       | 2,000                                |       |                       |       | 2,000                                 |        |
| Stock options exercised                                           |       | 1,000              |       |              |       | 3,000                                |       |                       |       | 3,000                                 |        |
| Additional shares due to rounding related to reverse  stock split |       | 214                |       |              |       |                                 |       |                       |       | —                                |        |
| Net loss                                                          |       |               |       |              |       |                                 |       | (2,375,000                 | )          | (2,375,000                            | )           |
| October 31, 2005                                             |       | 2,998,747          |       | $                 | 300,000    |                                 | $          | 36,081,000                 |       | $                                     | (33,827,000 | ) | $ | 2,554,000 |   |

 

The accompanyingnotes are an integral part of the financial statements.

 

27

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**NOTES TO FINANCIAL STATEMENTS**

**OCTOBER 31, 2005 and 2004**

 

**NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**NATURE OF OPERATIONS**

 

PPT VISION, Inc. (the Company) designs,manufactures, and markets camera-based intelligent systems for automatedinspection in manufacturing applications. The Company’s products, commerciallyknown as machine vision systems, enable manufacturers to realize significanteconomic paybacks by increasing the quality of manufactured parts and improvingthe productivity of manufacturing processes. The Company’s machine visionproduct line is sold on a global basis to end-users, system integrators,distributors and original equipment manufacturers (OEMs) primarily in theelectronic and semiconductor component, automotive, medical device, andpackaged goods industries.

 

**DISCONTINUED OPERATIONS**

 

During the fourth quarter of fiscal 2004, the Companyimplemented a revised operating strategy which called for a total focus of ourresources on our core 2D machine vision business.  Accordingly, in the fourth quarter of fiscal2004 we initiated and completed the sale of our 3D business unit, and allrelated patents, intellectual property, inventory and equipment.  In accordance with appropriate accountingrules, we have reclassified our previously reported financial results toexclude the results of our 3D business and these results are presented on ahistorical basis as a separate line in our income statements and balance sheetsentitled “Discontinued Operations.”  Ourcontinuing operations represent our 2D business only.  All of the financial information in thefinancial statements and notes to the financial statements have been revised toreflect only the results of our continuing operations.  See Note 15 in the Notes to FinancialStatements.

 

**USE OF ESTIMATES**

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

**REVENUE RECOGNITION**

 

The Company typically recognizes revenue on productsales upon shipment to end-user customers if contractual obligations have beensubstantially met and title and risk of loss have passed to the customer, whichis generally the case for sales of machine vision systems, spare parts andaccessories.

 

The Company also recognizes revenue on products soldto distributors upon shipment because contracts with distributors do notinclude post shipment obligations or any right of return provisions and pricingis fixed at the time of sale. Revenue related to application engineering,product development and customer training services is recognized when the servicesare performed. Service revenue is less than 10% of total revenues for each ofthe years ended October 31, 2005 and 2004.

 

**CASH AND CASH EQUIVALENTS**

 

For purposes of reporting cash flows, cash and cashequivalents include cash on hand and investments with original maturities ofthree months or less.  The Companydeposits its cash in high credit quality financial institutions.  The balances, at times, may exceed federallyinsured limits.

 

28

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**ACCOUNTS RECEIVABLE**

 

The Company reviewscustomers’ credit history before extending unsecured credit and establishes anallowance for doubtful accounts based upon factors surrounding the credit riskof specific customers and other information. Invoices are due net 30 days.  Accounts receivable over 60 days areconsidered past due.  The Company doesnot accrue interest on past due accounts receivable. The Company writes offaccounts receivable when they are deemed uncollectible. Accounts receivable areshown net of an allowance for doubtful accounts of $60,000 and $81,000 at October 31,2005 and 2004, respectively.

 

**INVENTORIES**

 

Inventories are stated at the lower of cost or market,with costs determined on a first-in, first-out (“FIFO”) basis.

 

**PROPERTY AND EQUIPMENT**

 

Property and equipment consist of furniture, fixturesand equipment and are stated at cost net of accumulated depreciation.Depreciation is computed for book purposes on a straight-line basis over theestimated useful life of the asset ranging from two to ten years and for taxpurposes over five and ten years using accelerated and straight-linemethods.  When assets are retired ordisposed of, the cost and related accumulated depreciation are removed from theaccounts, and gains or losses are recognized in the same period.  Maintenance and repairs are expensed asincurred; significant improvements are capitalized. Leasehold improvements areamortized using the straight-line method over the shorter of the lease term, orthe estimated useful life of the assets.

 

**INTANGIBLE ASSETS**

 

Intangible assets include patents and trademarks andare amortized using the straight-line method over their respective estimateduseful lives of 5 to 10 years.

 

**IMPAIRMENT OF LONG-LIVED ASSETS**

 

The Company reviews its long-lived assets forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. Recoverability of assets tobe held and used is measured by a comparison of the carrying amount of an assetto undiscounted future net cash flows expected to be generated by the assets.If these assets are considered to be impaired, the impairment to be recognizedis measured by the amount by which the carrying amount of the assets exceedsthe fair value of the assets.  The Companybelieves that there has not been any impairment of long-lived assets as of October 31,2005.

 

**DEFERRED REVENUE**

 

Deferred revenue results from amounts collected fromcustomers in advance of shipment of systems or in advance of performingengineering services.

 

**RESEARCH AND DEVELOPMENT**

 

Expenditures for research and development are expensedas incurred.

 

**INCOME TAXES**

 

TheCompany accounts for income taxes using the asset and liability approach, whichrequires the recognition of deferred tax assets and liabilities for taxconsequences of temporary differences between the financial statement incometax reporting bases of assets and liabilities based on currently enacted ratesand laws. These temporary differences include depreciation, allowance fordoubtful accounts, inventory valuation adjustments, accrued expenses and netoperating losses. Deferred taxes are reduced by a valuation allowance to theextent that realization of the related deferred tax asset is not assured.

 

29

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**ADVERTISING EXPENSE**

 

Advertising expense isexpensed as incurred.  Advertisingexpense was $38,000 and $40,000 for the years ended October 31, 2005 and2004, respectively.

 

**STOCK-BASED COMPENSATION**

 

The Company uses the intrinsic valuemethod prescribed by Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations in accounting foremployee stock options.  Under theintrinsic value method, compensation expense is recorded only to the extentthat the market price of the common stock exceeds the exercise price of thestock option on the date of grant.

 

In December 2002,the Financial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 148, “Accounting for Stock-BasedCompensation - Transition and Disclosure.”  SFAS No. 148 is anamendment to SFAS No. 123 providing alternative methods of transition fora voluntary change to the fair value based method of accounting for stock-basedemployee compensation and also provides required additional disclosures aboutthe method of accounting for stock-based employee compensation.   The Company chose to not adopt the voluntarychange to the fair value based method of accounting for stock-based employeecompensation, pursuant to SFAS No. 148. The Company has adopted the disclosure-only provisions of SFAS No. 148,Accounting for Stock-Based Compensation. Accordingly, no compensation cost has been recognized with respect tostock options related to SFAS No. 148.

 

Duringfiscal 2005, the Company granted 2,500 of seven-year options outstanding topurchase shares of the Company’s common stock to a consultant with an exerciseprice of $1.43 per share.  Pursuant toEmerging Issues Task Force 96-18 (EITF 96-18), “Accounting for EquityInstruments that are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services,” the Company will value and recordan expense related to the options on the earlier of the date a performancecommitment is met or the date the performance is complete.  The Company recorded an expense of $1,000 forthe year ended October 21, 2005 in accordance with EITF 96-18.

 

Hadcompensation cost for stock options been determined based on the fair valuemethodology prescribed by SFAS 123, the Company’s net loss and net loss pershare would have been reduced to the pro forma amounts indicated below:

 
| **FISCAL YEAR ENDED|  OCTOBER 31,** | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Net loss                                 |       | Reported   |       | $        | (2,375,000 | )        | $          | (1,872,000 | ) |
|                                     |       | Pro forma  |       | $        | (2,552,000 | )        | $          | (2,061,000 | ) |
| Basic and  diluted loss per share        |       | Reported   |       | $        | (0.79      | )        | $          | (0.63 | ) |
|                                     |       | Pro forma  |       | $        | (0.85      | )        | $          | (0.69 | ) |

 
| Stock based compensation - as reported |   | $ | 1,000   |   | — |    |
|----------------------------------------|--------|---|---------|--------|--------|---------|
| Stock based compensation - pro forma   |   | $ | 177,000 |   | $      | 189,000 |   |
|                                        |        |   |         |        |        |         |  |

 

The pro forma amounts may not berepresentative of the effects on reported net loss for future years.  The per share, weighted-average fair value ofeach option granted is calculated using the Black-Scholes option-pricing modelwith the following weighted-average assumptions used for grants in thefollowing years:

 
| **FISCAL YEAR ENDED OCTOBER 31,** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Risk free interest rates               |       | 4.0      | %          | 4.0      | %          |
| Expected lives                         |       | 7 Years  |       | 7 Years  |       |
| Expected volatility                    |       | 221      | %          | 156      | %          |
| Expected dividends                     |       | 0        | %          | 0        | %          |

 

30

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**FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The Company’s financial instruments consist of cashand cash equivalents, short-term trade receivables and payables for whichcurrent carrying amounts approximate fair market value.

 

**RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

 

In November 2004, the FASB issued SFAS No. 151“Inventory Costs,” (SFAS No. 151) which amends the guidance in ARB No. 43(ARB 43), Chapter 4 “Inventory Pricing,” to clarify the accounting for abnormalamounts of idle facility expense, freight, handling costs, and wasted material(spoilage).  Paragraph 5 of ARB 43, Chapter 4, previously stated thatunder some circumstances, items such as idle facility expense, excessivespoilage, double freight, and re-handling costs may be so abnormal as torequire treatment as current period charges.  SFAS No. 151 requiresthat those items be recognized as current-period charges regardless of whetherthey meet the criterion of “so abnormal.”  In addition, SFAS No. 151requires that allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facilities. SFAS No. 151 shall be effective for inventory costs incurred during fiscalyears beginning after June 15, 2005.  Earlier application ispermitted for inventory costs incurred during fiscal years beginning after thedate SFAS No. 151 was issued.  SFAS No. 151 shall be appliedprospectively.  The Company does not expect the adoption of SFAS No. 151to have a material effect on its financial statements.

 

In December 2004, FASB issued SFAS No. 153 “Exchangesof Nonmonetary Assets” (SFAS No. 153) which amends APB Opinion No. 29,“Accounting for Nonmonetary Transactions.” APB No. 29 is based on theprinciple that exchanges of nonmonetary assets should be measured based on thefair value of the assets exchanged.  The guidance in that Opinion,however, included certain exceptions to that principle.  SFAS No. 153amends APB No. 29 to eliminate the exception for nonmonetary exchanges ofsimilar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance.  Anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. SFAS No. 153 will be effective for nonmonetary asset exchanges occurringin fiscal periods beginning after June 15, 2005.  Earlier applicationis permitted for nonmonetary asset exchanges occurring in fiscal periodsbeginning after the date SFAS No. 153 was issued.  SFAS No. 153shall be applied prospectively.  The Company does not expect the adoptionof SFAS No. 153 to have a material effect on its financialstatements.

 

In December 2004, FASB issued SFAS No. 123(revised 2004), “Share-Based Payment,” (SFAS No. 123R) that focusesprimarily on accounting for transactions in which an entity obtains employeeservices in shared-based payment transactions.  This statement replacesSFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedesAPB Opinion No. 25, “Accounting for Stock issued to Employees.” Beginning November 1, 2006, we will be required to expense the fairvalue of employee stock options and similar awards.  As a public companywe are allowed to select from two alternative transition methods, each havingdifferent reporting implications.  The impact of SFAS No. 123R hasnot been determined at this time.

 

In June 2005, FASB issued SFAS No. 154, “AccountingChanges and Error Corrections”, a replacement of APB Opinion No. 20 andFASB Statement No. 3.  The statement applies to all voluntary changesin accounting principle, and changes the requirements for accounting for andreporting of a change in accounting principle.  SFAS No. 154 requiresretrospective application to prior periods’ consolidated financial statementsof a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 is effective for accounting changes and corrections of errorsmade in fiscal years beginning after December 15, 2005.  Earlierapplication is permitted for accounting changes and corrections of errors madeoccurring in fiscal years beginning after June 1, 2005.  Thestatement does not change the transition provisions of any existing accountingpronouncements, including those that are in a transition phase as of theeffective date of this statement.  The Company does not expect theadoption of SFAS No. 154 to have a material effect on its financialstatements.

 

In December 2003, FASB issued FASB InterpretationNo. 46R, “Consolidation of the Variable Interest Entities” (FIN 46R). Fin46R states that companies that have exposure to the economic risks andpotential rewards from another entity’s assets and activities have acontrolling financial interest in a variable interest

 

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entityand should consolidate the entity, despite the absence of clear control througha voting equity interest. The consolidation requirements apply to allspecial-purpose entities by the end of the first reporting period ending after December 15,2003. FIN 46R shall be applied to all variable interest entities by the end ofthe first reporting period ending after March 15, 2004, for enterprisesthat are not small business issuers or December 15, 2004 for enterprisesthat are small business issuers. The adoption of FIN 46R did not have amaterial effect on the Company’s financial statements.

 

**NOTE 2: LIQUIDITY AND CAPITAL RESOURCES**

 

The Company has incurred net losses and negative cashflows from operating activities for the years ended October 31, 2005 and2004 and has an accumulated deficit of $33.8 million at October 31, 2005. Duringfiscal year 2004, we sold our 3D business for $1.0 million.  All of this cash had been received by the endof the first quarter of fiscal 2005.  Thesale of this business unit has reduced our ongoing operating expenses.  As of October 31, 2005, we had a cashbalance of approximately $778,000.

 

Because we have working capital of $2.0 million and nolong-term debt, the Company believes that a variety of financing alternativesare available including external borrowing against accounts receivable andinventory, customer or vendor financing, the issuance of additional stock tothe public or to strategic partners, or customer-sponsored research anddevelopment projects. The Company believes it has sufficient cash and othersources of financing available to it to fund its operations, working capitaland capital resource needs through the second quarter of fiscal 2006. There canbe no assurance, however, that additional capital will be available onacceptable terms or at all, and the failure to obtain additional capital asneeded may have an adverse effect on the Company’s ability to continue to takeadvantage of future opportunities or respond to competitive pressures orunanticipated requirements, which could adversely affect its business,financial position, results of operations and cash flows.

 

**NOTE 3:  INVENTORIES**

 

As of October 31, inventories consist of thefollowing:

 
| ** **                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Manufactured and purchased parts |       | $        | 454,000    |     | $          | 828,000 |   |
| Work-in-process                  |       | 34,000   |       | 105,000  |       |
| Finished goods                   |       | 2,000    |       | 44,000   |       |
| Totals                           |       | $        | 490,000    |     | $          | 977,000 |   |

 

In view of the rapid pace of technological change inthe machine vision industry, the Company periodically reviews the carryingvalue of its inventories for excess or obsolete inventories. This analysis ofthe net realizable value of inventories include consideration of a variety offactors including existing inventory quantities, historical usage, expectedfuture demand, the effect of technological advances and the impact of newlyintroduced products.

 

**NOTE 4:  PROPERTY ANDEQUIPMENT**

 

At October 31, furniture, fixtures and equipmentconsisted of the following:

 
| ** **                    | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|
| Equipment                     |       | $          | 3,581,000  |       | $          | 3,666,000 |   |
| Leasehold improvements        |       | 140,000    |       | —     |       |
| Furniture and fixtures        |       | 503,000    |       | 557,000    |       |
|                          |       | 4,224,000  |       | 4,223,000  |       |
| Less accumulated depreciation |       | (3,786,000 | )          | (3,900,000 | )          |
| Totals fixed assets           |       | $          | 438,000    |       | $          | 323,000 |   |

 

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Depreciation expense for continuing operations was $180,000and $371,000 for the years ended October 31, 2005 and 2004,respectively.  During fiscal 2005 and2004, the Company wrote-off fully depreciated properties that were no longer inuse.

 

**NOTE 5:  INTANGIBLEASSETS**

 

Intangible assets at October 31, 2005 and October 31,2004, consisted of the following:

 
| ** **                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Patent and trademark          |       | $        | 610,000    |     | $          | 609,000 |   |
| Less accumulated amortization |       | (542,000 | )          | (500,000 | )          |
| Totals intangible assets      |       | $        | 68,000     |     | $          | 109,000 |   |

 

Patent and trademark costs are amortized over five toten years.  Amortization expense wasapproximately $42,000 and $47,000 in the years ended October 31, 2005 and2004, respectively.  Amortization expensefor fiscal 2006, 2007 and 2008 is expected to be approximately $50,000, $9,000and $9,000, respectively.

 

**NOTE 6:  OTHER ASSETS**

 

Other assets at October 31, 2005 and October 31,2004 were $22,000 and $53,000, respectively. Other assets represent aninvestment of in the common stock of Electro-Sensors, Inc. a related partyshareholder of the Company. The Company’s percentage ownership is less than 1%of Electro-Sensors, Inc. outstanding common stock. There are nocommitments or obligations associated with this investment.  This investment is carried at cost whichapproximates market. During the third quarter of fiscal 2005, the Company sold13,000 shares of Electro-Sensors, Inc. common stock, resulting in grossproceeds of $71,000.  At October 31,2005 the Company owned 9,500 shares of Electro-Sensors, Inc. common stock.

 

**NOTE 7: ACCRUED EXPENSES**

 

Accrued expenses at October 31, include: 

 
| ** **                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Employee stock purchase plan payroll deductions |       | $        | 11,000     |     | $          | 32,000 |   |
| Accrued compensation                            |       | 40,000   |       | 75,000   |       |
| Professional Services                           |       | 52,000   |       | 48,000   |       |
| Restructuring Costs                             |       | 107,000  |       | —   |       |
| Accrued rent                                    |       | —   |       | 317,000  |       |
| Taxes and other                                 |       | 13,000   |       | 41,000   |       |
| Totals                                          |       | $        | 223,000    |     | $          | 513,000 |   |

 

**RestructuringCosts:**

 

Thecomponents of the restructuring charges associated with the lease terminationfee and miscellaneous remaining expenses follow:

 
| ** **           | ** ** | **2005** | ** ** |
|----------------------|------------|----------|------------|
| Restructuring  costs |       | $        | 390,000    |   |
| Payments             |       | (283,000 | )          |
| Ending balance       |       | $        | 107,000    |   |

 

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**NOTE 8: OPERATING LEASES**

 

In thesecond quarter of Fiscal 2005, the Company implemented an amended lease inrespect to its headquarters facility in Eden Prairie, Minnesota.  Under the amended lease terms signed on April 29,2005, the Company received a reduction in its base rental rates and itsfacility shrank from approximately 64,000 square feet to approximately 35,000square feet resulting in a savings of approximately $120,000 per quarter.  In exchange for these amended lease terms,the Company paid $140,000 for certain leasehold improvements associated withthe reconfigured space and also paid approximately $300,000 in accrued deferredrent.  The Company also agreed to pay a$240,000 lease termination fee, which was accrued in the second quarter offiscal 2005, in equal monthly installments over a 12 month period which startedon May 1, 2005 and extend the current lease term by two years through May,2011.  The Company also terminated itsleased space for its regional sales and support office in Michigan effective December 31,2005. Rent expense for all leased property was $507,000 and $714,000 for theyears ended October 31, 2005 and 2004, respectively.

 

Minimum future rental payments due undernon-cancelable operating lease agreements are as follows (amounts exclude requiredpayments for common area maintenance expenses):

 
| 2006                 |   | $       | 304,000   |   |
|----------------------|--------|---------|-----------|--------|
| 2007                 |   | 293,000 |      |
| 2008                 |   | 293,000 |      |
| 2009                 |   | 305,000 |      |
| 2010                 |   | 321,000 |      |
| 2011 and  thereafter |   | 202,000 |      |
| Total                |   | $       | 1,718,000 |   |

 

**NOTE 9: INCOME TAXES**

 

The provision for income taxes (continuing anddiscontinued operations) differs from the statutory U.S. federal tax rate of34% applied to net loss before income taxes for the years ended October 31,as follows:

 
| ** **                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| Expected tax benefit at statutory rate              |       | $        | (800,000   | )        | $          | (630,000 | ) |
| State income tax benefit, net of federal tax effect |       | (40,000  | )          | (100,000 | )          |
| Tax credits and other                               |       | (3,000   | )          | 25,000   |       |
| Expiring loss carryforwards                         |       | 250,000  |       | 320,000  |       |
| Increase in valuation allowance                     |       | 593,000  |       | 385,000  |       |
| Total income tax expense (benefit)                  |       | $        | —     |     | $          | — |   |

 

Based on an increase in the valuation allowance foreach of the years ended October 31, 2005 and 2004, no benefit for incometaxes is applicable for either continuing or discontinued operations.

 

Deferred tax assets are comprised of the following at October 31:

 
| **OCTOBER 31,**                                 | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|------------------------------------------------------|------------|-------------|------------|-------------|------------|
| Depreciation and amortization                        |       | $           | 244,000    |        | $          | 80,000 |   |
| Net operating loss carryforwards                     |       | 10,016,000  |       | 9,629,000   |       |
| Income tax credits                                   |       | 1,263,000   |       | 1,263,000   |       |
| Inventory allowances                                 |       | 147,000     |       | 119,000     |       |
| Other                                                |       | 201,000     |       | 187,000     |       |
| Total deferred tax assets before valuation allowance |       | 11,871,000  |       | 11,278,000  |       |
| Less valuation allowance                             |       | (11,871,000 | )          | (11,278,000 | )          |
| Net deferred tax asset                               |       | $           | —     |        | $          | — |   |

 

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At October 31, 2005, the Company has availablefederal net operating loss, state net operating loss and tax creditcarryforwards for income tax purposes of approximately $28.4 million, $8.9million and $1.3 million, respectively. These carryforwards expire in the yearsending October 31, 2006 through October 31, 2025.  The amount of the federal net operating losscarryforwards that expire in the next five fiscal years are $50,000 $152,000,$0, $16,000 and $0, respectively. Approximately $26,000, $41,000, $39,000, $43,000 and $25,000 of the taxcredit carryforwards expire in each of the next five fiscal years.

 

The utilization of the net operating loss and taxcredit carryforwards is dependent upon the Company’s ability to generatesufficient taxable income during the carryforward period. Because of theuncertainty of future realization, a valuation allowance equal to the deferredtax asset has been recorded.

 

**NOTE 10: SHAREHOLDERS’ EQUITY**

 

**SHAREHOLDER RIGHTS OFFERING**

 

On March 10, 2005, the Company announced that itsBoard of Directors approved a 1-for-4 reverse split of its common stockeffective as of the close of business on March 31, 2005 and the conversionto book-entry share registration also effective as of March 31, 2005.  In connection with the reverse split, theBoard of Directors also approved an amendment to Article 4.1 of theCompany’s Articles of Incorporation to proportionately reduce the number ofshares of common stock authorized from 20,000,000 shares to 5,000,000shares.  All share numbers presented inthis report have been restated to give effect to the 1-for-4 reverse split.

 

**STOCK OPTION PLANS**

 

Under the Company’s 2000 Stock Option Plan, 1988 StockOption Plan and 1997 Stock Option Plan the Company may issue options topurchase up to 550,000 shares of common stock to employees and directors.Options are granted at the fair market value on the date of grant. The grantingof options and their vesting is within the discretion of the Company’s Board ofDirectors.

 

A summary of stock options issued and outstandingunder these plans is as follows:

 
| ** **                       | ** ** | **NUMBER  OF SHARES** | ** ** | **WEIGHTED AVG.  OPTION PRICE** | ** ** |
|----------------------------------|------------|-----------------------|------------|---------------------------------|------------|
| Balance at October 31, 2003 |       | 250,696               |       | $                               | 8.28       |   |
| Granted                          |       | 35,253                |       | $                               | 5.50       |   |
| Cancelled                        |       | (25,604               | )          | $                               | 12.83      |   |
| Exercised                        |       | (2,223                | )          | $                               | 2.94       |   |
| Balance at October 31, 2004 |       | 258,122               |       | $                               | 7.50       |   |
| Granted                          |       | 148,075               |       | $                               | 1.69       |   |
| Cancelled                        |       | (50,429               | )          | $                               | 8.68       |   |
| Exercised                        |       | (1,000                | )          | $                               | 2.60       |   |
| Balance at October 31, 2005 |       | 354,768               |       | $                               | 4.92       |   |
|                             |       |                  |       |                            |       |
| Exercisable Options at:          |       |                  |       |                            |       |
| October 31, 2004            |       | 170,696               |       | $                               | 9.06       |   |
| October 31, 2005            |       | 176,750               |       | $                               | 7.77       |   |

 

In fiscal year 2002, pursuant to an option exchangeprogram approved by the Company’s Board of Directors, the Company allowedemployees to cancel any or all of their current stock options which were issuedpursuant to the 1988 or 1997 plans and which had exercise prices of $20 pershare or greater in exchange for a grant of the same number of stock optionscancelled in six months and one day from the date of cancellation at exerciseprices equal to the fair value of the Company’s common stock on the date ofgrant. Under this program, 52,913 stock options were voluntarily cancelled at aweighted average option

 

35

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priceof $27.52 and 52,913 stock options were subsequently granted at an option priceof $3.60. This option exchange resulted in variable accounting for 6,250 of thestock options granted under the program. Variable accounting will continueuntil all stock options subject to variable accounting are exercised, cancelledor forfeited.  In fiscal year ended October 31,2005, 13,000 stock options remain under variable accounting treatment. Therewas no expense related to this variable accounting treatment in fiscal 2005 orfiscal 2004.

 

The estimated weighted average grant-date fair valueof stock options granted is as follows: 2005 —$1.47, and 2004 – $5.53.

 

The following table summarizes stock optionsoutstanding and exercisable at October 31, 2005.

 
| ** **                | ** ** | **OUTSTANDING** | ** ** | **EXERCISABLE**                                  | ** ** |
|---------------------------|------------|-----------------|------------|--------------------------------------------------|------------|
| **Exercise  Price Range** | ** ** | **Options**     | ** ** | **Weighted  Avg.  Contractual  Life  Remaining** | ** ** | **Weighted  Avg.  Exercise Price** | ** ** | **Options** | ** ** | **Weighted  Avg.  Exercise Price** | ** ** |
| $ 1.11 - $1.70       |       | 143,750         |       | 6.56                                             |       | $ | 1.64 |   | 0 |   | $ | 0 |   |
| $ 2.48 - $3.60       |       | 108,650         |       | 4.11                                             |       | $ | 3.05 |   | 88,465 |   | $ | 3.12 |   |
| $ 4.36 - $6.44       |       | 42,052          |       | 4.15                                             |       | $ | 5.48 |   | 28,677 |   | $ | 5.51 |   |
| $ 7.52 - $9.76       |       | 7,125           |       | 2.60                                             |       | $ | 8.81 |   | 7,042 |   | $ | 8.83 |   |
| $ 11.60 - $15.50     |       | 34,816          |       | 1.19                                             |       | $ | 14.68 |   | 34,191 |   | $ | 14.72 |   |
| $ 18.75 - $24.75     |       | 18,375          |       | 1.24                                             |       | $ | 20.34 |   | 18,375 |   | $ | 20.34 |   |
|                      |       | 354,768         |       | 4.64                                             |       | $ | 4.92 |   | 176,750 |   | $ | 7.77 |   |

 

During October 31, 2005 and 2004 there were nowarrants outstanding.

 

**EMPLOYEE STOCK PURCHASE PLAN**

 

In March 2005, shareholders approved the adoptionof the 2005 Employee Stock Purchase Plan (the “2005 Plan”) to replace the earlier2000 Employee Stock Purchase Plan which, by its terms, expired during 2005. The2005 Plan authorizes the issuance of up to 100,000 shares of common stock.Under the terms of the 2005 Plan, eligible employees may purchase common stockannually at 85% of the lesser of (1) the fair market value on the firstday of the annual offering period or (2) the fair market value on the lastday of each annual offering period.

 

**NOTE 11: EMPLOYEE SAVINGS PLAN**

 

The Company provides a supplementary retirementsavings plan that is structured in accordance with Section 401(k) of theInternal Revenue Code. Employees eligible for the Plan may contribute from oneto fifty percent of their monthly earnings on a pre-tax basis, subject toannual contribution limitations. The Company made matching contributions of onedollar for each dollar contributed by each Plan participant up to a maximum of$500 annually for fiscal years ended October 31, 2005 and 2004.

 

The Company’s contributions under this program wereapproximately $20,000, and $25,000 for the years ended October 31, 2005,and 2004.  In fiscal 2005 and 2004,$9,000 and $5,000, respectively of contributions were funded from accumulatedforfeitures and $11,000 and $20,000, respectively was expensed by the Company.

 

**NOTE 12: SHAREHOLDER RIGHTS PLAN**

 

On June 2, 1999, the Company adopted aShareholder Rights Plan (the “Rights Plan”) designed to deter coercive orunfair takeover tactics and to prevent a person or a group from gaining controlof the Company without offering a fair price to all shareholders. Under the termsof the Rights Plan, a dividend distribution of one Preferred Stock PurchaseRight (“Right”) for each outstanding share of the Company’s common stock wasmade to holders of record on June 22, 1999. These Rights entitle theholder to purchase

 

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oneone-hundredth of a share of the Company’s Series A Junior ParticipatingPreferred Stock (“Preferred Stock”) at an exercise price of $28. The Rightsbecome exercisable (a) 10 days after a public announcement that a personor group has acquired shares representing 20% or more of the outstanding sharesof common stock, or (b) 10 business days following commencement of atender or exchange offer for 20% or more of such outstanding shares of commonstock. The Company can redeem the Rights for $0.001 per Right at any time priorto their becoming exercisable. The Rights expire on June 2, 2009, unlessredeemed earlier by the Company. Under certain circumstances, if a person orgroup acquires 20% or more of the Company’s common stock, the Rights permitshareholders other than the acquirer to purchase common stock having a marketvalue of twice the exercise price of the Rights. In addition, in the event ofcertain business combinations, the Rights permit shareholders to purchase thecommon stock of an acquirer at a 50% discount. Rights held by the acquirer willbecome null and void in both cases.

 

In October 1999, the Company’s Board of Directorsamended the terms of the Rights Plan to enable Mr. P.R. Peterson, a memberof the Board of Directors of the Company, to purchase up to 30% of the commonstock of the Company without being deemed an “Acquiring Person” within themeaning of the Rights Agreement. In March, 2002, the Company amended the termsof the Rights Plan to exclude Mr. Peterson completely from the definitionof Acquiring Person, regardless of his share ownership.

 

**NOTE 13:  NET LOSS PERSHARE**

 

Basic net loss per share is computed using onlyweighted average common shares outstanding. Diluted earnings per share giveseffect to all dilutive potential common shares outstanding during the fiscalreporting periods. Because of our net loss, basic and diluted loss per share isthe same.

 
| ** **                                                    | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|---------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Loss from continuing operations                               |       | $         | (2,320,000 | )         | $          | (1,067,000 | ) |
| Loss from discontinued operations                             |       | (55,000   | )          | (805,000  | )          |
| Net loss                                                      |       | $         | (2,375,000 | )         | $          | (1,872,000 | ) |
| Weighted average shares outstanding – basic and  diluted |       | 2,997,329 |       | 2,969,393 |       |
| Basic and diluted loss per share:                             |       |      |       |      |       |
| Continuing operations                                         |       | $         | (0.77      | )         | $          | (0.36 | ) |
| Discontinued operations                                       |       | $         | (0.02      | )         | $          | (0.27 | ) |
| Net loss per share                                            |       | $         | (0.79      | )         | $          | (0.63 | ) |

 

For the years ended October 31, 2005, and 2004,options to purchase 354,768, and 258,122 shares of the Company’s common stock,respectively. As the Company had a net loss, the inclusion of theaforementioned shares would have been anti-dilutive.

 

**NOTE 14: CUSTOMER AND GEOGRAPHIC INFORMATION**

 

**SIGNIFICANT CUSTOMER INFORMATION**

 

During fiscal 2005 revenue from one customer accountedfor 12% of net revenues. During fiscal 2004 revenue from two customersaccounted for 23% and 10% of net revenues.

 

At October 31, 2005, two customers accounted for19% and 12% of total accounts receivable. At October 31, 2004 twocustomers accounted for 16% and 11% of total accounts receivable.

 

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**CUSTOMER GEOGRAPHIC DATA**

 

United States and export sales by geographic region asa percentage of net revenues at October 31 are as follows:

 
| ** **                | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
| United States             |       | 46       | %          | 41       | %          |
| Europe &  Canada |       | 27       | %          | 20       | %          |
| Asia-Pacific              |       | 24       | %          | 38       | %          |
| South America             |       | 3        | %          | 1        | %          |
|                      |       | 100      | %          | 100      | %          |

 

**NOTE 15:DISCONTUNUED OPERATIONS**

 

In thefourth quarter of fiscal 2004, the Company implemented a strategy to focus allof its resources on its core 2D machine vision business.  In accordance with this plan, in the fourthquarter of fiscal 2004, the Company initiated and completed the sale of its 3Dbusiness unit, and all related patents, intellectual property, inventory andequipment.  The terms of the saleincluded cash payments of $1.0 million and the opportunity to receive royaltieson sales of certain products by the buyer for the next five years.  As of fiscal year end October 31, 2005,no royalties have been received.  As aresult of the sale, in accordance with appropriate accounting principles, theCompany has revised the financial results for all periods presented to includethe 3D business as a discontinued operation. Accordingly, all 3D related revenue and expenses have been removed fromcontinuing operations and presented in a separate line in the statement ofoperations entitled “loss from discontinued operations.”

 

The following arecondensed statements of operations and net assets of the discontinuedoperation:

 

**Statementsof Operations**

 
| ** **                                       | ** ** | **2005** | ** ** | **2004**  | ** ** |
|--------------------------------------------------|------------|----------|------------|-----------|------------|
| Revenues                                         |       | $        | 169,000    |      | $          | 1,939,000 |   |
| Cost of revenues                                 |       | 56,000   |       | 378,000   |       |
| Gross profit                                     |       | 113,000  |       | 1,561,000 |       |
| Total operating expenses                         |       | 168,000  |       | 1,327,000 |       |
| Net income or loss from operation of 3D business |       | $        | (55,000    | )         | $          | 234,000 |   |
|                                             |       |     |       |      |       |
| Sale price                                       |       |     |       | $         | 1,000,000  |   |
| Less costs and expenses:                         |       |     |       |      |       |
| Inventories                                      |       |     |       | $         | 260,000    |   |
| Property and equipment, net                      |       |     |       | 46,000    |       |
| Intangible assets, net                           |       |     |       | 1,707,000 |       |
| Severance costs                                  |       |     |       | 25,000    |       |
| Legal and travel costs                           |       |     |       | 13,000    |       |
| Total costs of sale                              |       |     |       | 2,051,000 |       |
| Net loss on sale                                 |       |     |       | $         | 1,051,000  |   |

 

Theonly asset of the discontinued 3D business as of October 31, 2004 was areceivable from the purchaser of the business in the amount of $200,000.  This amount was received by the Company inthe first quarter of fiscal 2005.

 

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